Two models of Takaful

Norton Rose examines the regulatory approach to Takaful in Bahrain

By Susan Dingwall, partner, Norton Rose

Takaful and Re-Takaful fall within the regulatory parameter of the Central Bank of Bahrain (CBB), formerly the Bahrain Monetary Agency. The CBB has publicly proclaimed that its regulation of this market sector is intended to follow the guidelines laid down by the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI). The Insurance Rulebook constitutes the CBB’s regulatory regime in this area and is designed not to favour one form of insurance over another – allowing both conventional insurance and Takaful to operate in a competitive environment.

Two models of Takaful are usually adopted by commercial Takaful operators; the Wakala and Mudarabah models. However, Takaful operators that operate in the Middle East market have widely begun to adopt a model that mixes both the Wakala and Mudarabah models. In this mixed model, the Takaful operator has two funds – one for the shareholders of the Takaful operator and the other for the participants (the policyholders). The Al-Wakala contract is used for underwriting activities while the Al-Mudarabah contract is adopted for investment activities.

The CBB has prescribed the adoption of the mixed model, pursuant to which the Wakala model is adopted for underwriting activities and the Mudarabah model for the investment activities of the Takaful fund. By prescribing the use of the mixed model, the CBB is seeking to ensure that a common understanding of Takaful is developed, both in the market and in the minds of consumers.

The CBB will refrain from taking a view as to whether the activities carried out by the Takaful operator comply with the principles of Shariah. Instead, each licensed Takaful firm is required to have a Shariah Supervisory Board, to whom that task is devolved.

It is also important to note that the CBB requires insurance firms to operate either on a conventional basis or on Takaful principles. They cannot combine features of both.

Conduct of business

The CBB has adopted international standards of regulation and its principles of business apply to all applicants for authorisation (including Takaful and Re-Takaful firms). Takaful firms must provide participants and shareholders with clear information about the performance of their business. As a minimum, this information is required to comply with relevant AAOIFI standards.

Capital adequacy

The capital framework laid out by the CBB for Takaful operators maintains that all Takaful funds are subject to available capital and solvency requirements equivalent to their conventional counterparts. Each Takaful fund must maintain and calculate its solvency requirements as if each were a separate licensed insurance firm.

Takaful firms must maintain separate books of account in respect of each type of business and for each fund. The Wakala fee charged for a Takaful contract must be directly proportional to the costs associated with establishing and maintaining that contract. Takaful firms must establish a policy for the distribution of surplus, but may only distribute a surplus if the firm meets its required solvency margin requirements both prior to and after the distribution. All Bahraini insurance licensees require CBB pre-approval for the distribution of dividends to shareholders.

In instances where the Takaful fund’s available capital fails to meet the required solvency requirements, the shareholder fund must provide a loan to the Takaful fund in order for the deficient fund to meet its solvency requirements. Such a loan from the shareholder fund to the Takaful fund must be pre-approved by the CBB as well as ensuring that the loan represents capital meeting the permanency and quality requirements outlined in the capital adequacy rules of the CBB.

Any loan from the shareholder fund will present an additional risk to the shareholders of the Takaful operator. Due to this additional risk, the minimum the Takaful operator must include is a specific note in its financial arrangements explaining the arrangements and their implications to shareholders.

Management, systems and controls

The CBB requires adequate human resources and provides that those persons who occupy “controlled functions” must be “honest and straightforward in their dealings with customers”. Such controlled persons must act with due skill, care and diligence. Although the CBB refrains from commenting on whether any insurance product complies with the principles of Shariah, the CBB has provided that membership of a Takaful operator’s Shariah Supervisory Board is a controlled function. As a “controlled function” the CBB must approve the members of the Shariah Supervisory Board.

The CBB also requires the Takaful operator to take reasonable care to ensure its affairs are managed effectively and responsibly, with appropriate management, systems and controls. The CBB expects Bahraini insurance licensees and Bahrain to be the principal place of business and for Bahrain to be the center of its governance and management.