SOLVENCY AND CAPITAL ADEQUACY IN

TAKAFUL

CONTENT

Introduction

The Need for Solvency

Risk Based Capital

SOLVENCY / CAPITAL ADEQUACY

Solvency or capital adequacy:

system have been typically been developed in

environment dominated by conventional insurance

The need for solvency

Effective mobilization of funds and risk intermediation

Financial institutions tend to be large

To help redress this imbalances by reassuring consumers that financial institutions are safe to entrust their assets

A solvency margin buy times

Specifications of solvency requirements for takaful

Takaful is an inherently risky business- the fund is exposed to contingencies whose outcomes cannot be known at the beginning of the contract.

Solvency position is to ensure that the solvency levels of all PRFs are consistent with their overall risk profiles.

Adequate, unencumbered capital must exist in the shareholders’ fund in order for a facility of this nature to be effective.

Cont…

liabilities

Assets

liabilities

Shareholders’ equity

Regulatory surplus

Regulatory capital

requirementValuation adjustment

The view for shareholder

…..and for the regulator

Capital for Takaful Operations

Solvency Margin - Regulation require that the takaful fund be sufficient to a given degree of certainty to pay claims as they emerged over the future.

A traditional approaches to insurance solvency the required minimum solvency

margin for general insurance is calculated on the basis of ratios of premiums, claim or liabilities

The advantages of being relatively straightforward and reproducible from reported.

The requirement based on premium : 15-20 %

Issues

RBS can have the unwanted effect of rewarding high-risk

behavior by individual insurers.

RBS also cannot capture others forms of risk such as exchange

rate risk, credit risk and exposure to investment

market fluctuations.

Risk Based Capital

Risk-based capital (RBC) represents an amount of capital based on an assessment of risks that a company should hold to protect customers against adverse developments.

In RBC a Risk-Based Capital is determined, which is the amount of capital (assets minus liabilities) an insurance company must have as a basis of support for the degree of risk associated with its company operations and investments.

Risk Based Capital

This standard can be used to identify inadequately capitalized companies, thereby enabling regulatory authorities to intervene before a company becomes insolvent.

The concept of Risk Based Capital (RBC) is simply that the capital needed to support the solvency of a takaful fund should be related to the actual risks faced or covered by the fund.

Challenges implementing RBC

1 •Skill resources for the creation and assessment of capital model are scarce in many jurisdiction and take time to train

2 •Insurance often operates on tight margins

3 •The existing insurance sector may be dominated by a large number of small companies.

Risk Based Capital - Malaysia

The Risk-Based Capital Framework for Insurers (RBC) came into effect on 1 January 2009

The framework aims to better align the regulatory capital requirements with the underlying risk exposure of each individual insurer, improve the transparency of prudential buffers, and allow greater flexibility for insurers to operate at different risk levels that are commensurate with risk management infrastructure and practices

The Total capital Required (TCR) is the higher of the aggregate of capital charges for credit, market, insurance and operational risks faced by an insurer or surrender value capital charges,

CONCEPT OF CAPITAL

Capital may be defined as the money, property, and other assets which collectively represent the material wealth of an individual or a business.

Wealth in this context means the material resources (property, cash, etc.) which are in excess of that needed for immediate consumption.

Capital for Takaful Operations When the takaful fund is weakened and

unable to pay future benefits to participants the takaful fund would deemed to be insolvent.

The inability of the fund to pay claims is contrary to the purpose of the participants in joining the scheme and hence a primary objective of everyone concerned is to ensure fund solvency is maintained at all times.

Capital for Takaful Operations In the event of a fund deficit (i.e. takaful

fund assets being less than liabilities), the takaful operator would be bound by contractual obligation and/or regulatory requirement to cover the deficiency by injecting capital in the form of a temporary benevolent loan (i.e. free of interest or investment return expectation) known as qardhal hasan.

The capital required for solvency is completely different and separate from the capital needed by an operator for management and operational expenses.

Capital for Takaful Operations Hence the two sources of capital for the

takaful fund are: The first, would be the accumulated

capital built up over time from the excess accumulation of contributions and investment profit over claims paid and provisions.

The second, would be from capital injections in the form of qardhal hasan;

Capital Requirement and Biz Growth Capital is needed to finance the growth in new

business in terms of operational expenditure. Rapid expansion of takaful business will cause a drain on resources .

Due to regulations on minimum reserve requirements, business expansions will lead to deficits in the fund (initial reserving requirements imposed on several plans locking up freely available surplus in the takaful fund).

Hence if expansion of such business is too rapid, the operator will need to inject capital as temporary benevolent loans (qardhal hasan) to top up any deficiencies.

Summary The evolution of solvency requirements for

insurance is still continuing Capital may be sourced from participants’

contributions and the takaful operator. The amount of capital needed to absorb

claims fluctuations is related to the risk tolerance of the operator and the nature of the fund operated.