Islamic insurance debates over fund deficits

The Islamic insurance industry, or takaful, is debating who should chip in extra cash when its funds see deficits, showing the conflict of interests between policy holders and shareholders caused by its hybrid structure.

Islamic insurance is similar to mutual insurance but with a clear segregation of the assets owned by policy holders and those owned by the insurer.

Policy holders contribute to a common pool of fund claims and benefit if the pool is left in surplus, while in conventional insurance the insurer takes on the risk in return for premiums.

The Islamic Financial Services Board (IFSB), whose members include 50 financial regulators, in December started a consultation process on new rules that would see shareholders' cash being used to avoid solvency deficits, triggering the debate in the industry.

A solvency deficit occurs when a fund is in deficit if all claims needed to be paid out at that moment.

"This position has to be reconsidered again by regulators in order to help the industry grow smoothly," said Abdul Rahman Tolefat, chief executive of Allianz Takaful.

Tolefat said one option was for shareholders to simply issue a letter of guarantee to policy holders in case a solvency deficit turns into an actual cash deficit.

While there are no statistics on how many takaful funds are in deficit, it is a young industry that is still building up the scale and assets needed to avoid the deficits typically seen during the first three years of operations.

Tolefat said the industry needed clarity on these issues as these determined how much capital was needed by new investors to enter the industry.

The regulators' approach may also contradict Islamic law.

"Under sharia, the policy holders should contribute if there's a deficit," said Muddassir Siddiqui, an Islamic finance scholar and partner at law firm Denton Wilde Sapte.

The underlying conflict is who can claim the income earned from the additional funds pumped in in case of solvency deficits.

"Sharia says this goes to shareholders as there is no actual deficit; the regulator says this money should go to policy holders funds ... to strengthen the position of the takaful fund," said Tolefat.

The takaful industry is a hybrid structure between commercial insurance and mutual insurance, also leading to conflicts of interest between shareholders and fund holders for which the industry has not yet found a framework.

Islamic finance is an emerging industry that is governed by a patchwork of regulators, its own standard-setting bodies and scholars interpreting Islamic law, making it difficult to predict how the debate will play out and when the rules proposed by the IFSB could be adapted by national regulators.

"We have the shareholders that are looking for profits as well as the policy holders whose funds are managed on a mutual basis, so this carries some conflict of interests ... unique to the takaful structure", Tolefat said.

Dawood Taylor, an Islamic insurance executive at Prudential, told a conference held in Manama last week the corporate governance framework of the industry needed to be improved.

"The operator has control over the surplus, but if you appoint an actuary who reports to the board of directors, then you're limiting that conflict of interest (between policy holders and the takaful operator)", he said.