Issues and Challenges of Takaful Industry in Malaysia’s Dual Banking System PDF

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“Issues and Challenges of Takaful Industry in Malaysia’s Dual Banking System” Name: Dr. Hani Kallil [email protected] 2014 Hani Kallil Mangat Abstract The presence of Takaful Industry in Malaysia is a distinctive development. It is a fact that the Takaful Industry survives in a dual legal fram...

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“Issues and Challenges of Takaful Industry in Malaysia’s Dual Banking System”

Name: Dr. Hani Kallil [email protected]

2014

Hani Kallil Mangat

Abstract The presence of Takaful Industry in Malaysia is a distinctive development. It is a fact that the Takaful Industry survives in a dual legal framework where the legal frameworks for both Takaful and Insurance interlock each other. This paper examines the issues and challenges which are faced by Takaful Industry in a dual banking and insurance system like Malaysia. This paper takes the Malaysia as an example of the case. This paper covers a brief definition of Takaful and history of Takaful in Malaysia. A comparison between Takaful and conventional insurance has been included in this paper. Based on the study it is clear that the Takaful industry in Malaysia has been benefited from the dual system.

Hani Kallil Mangat

Introduction Takaful is derived from its Arabic root word “kafala” which literally means “to guarantee”. In terms of usage and implication, the term “kafala” certainly denotes the agreement by one party to indemnify another for any liability that has been pre-agreed upon. Since Islamic banking is developed to an system that carries the principle of shariah, and also shariah prohibits the payment or acceptance of interest fees for lending and accepting of money respectively, and also Islam prohibited any kind of investment in business that involve interest (Riba), or goods and service that considered contrary to its principles forbidden. Takaful is an Islamic substitute to conventional insurance based on the theory of trusteeship, brotherhood and cooperation encouraged by the beliefs of Islam. Majority of Muslims across the world is practicing Takaful as their own way of sharing financial losses to assist each other. At recently, every person is likely to meet any kind of disasters that causes loss of wealth, life and many other things that have importance to the human life, in order to rover the losses, human being should have Takaful. Notwithstanding belief of all Muslims in Allah and Qadha-o-Qadr, Islam provides that one must find ways and means to avoid such catastrophe and disaster wherever possible, and to lighten his or his family's burden should such event occur. One possible resort in this contest is insurance cover as available in the conventional system. Takaful is the Islamic principle that Islamic shari’ah accept and it is the counterpart of conventional insurance, it deal with both life (“family”) and general forms. Takaful system embodies the elements of shared responsibility; joint indemnity, common interest and solidarity, as well as Takaful will consist of a two-tier structure that is a hybrid of a mutual and a commercial form of company. This in itself poses significant issues for regulation and supervision. In addition, all the functions of a Takaful undertaking should conform fully to Islamic law (Shari’ah), and this has implications in other areas of regulation and supervision. The concept of takaful The concept of Takaful is very wide and clear. The concept of Takaful is to protect the human being especially, when they are harm. It is nature, when one person is harm or in danger, the rest of people will help that person who suffering the loss. Besides, it seems that every person take

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care about others. Such a feeling of responsibility is being reinforced by the Islamic teachings as found in the following injunctions: Allah SWT precisely explains in the Qur’an the human being should help each other when they are in danger or need help. And there are a lot of verse in Qur’an that encourages human being to help each other, these verse are, Surah Al ‐ Maidah (5): 3 ,Surah Al‐Maidah (5): 3 Essentially Takaful is a cooperative insurance where members are those who face the same risk or danger of incurring losses and who willingly contribute a certain sum of money which will be used to compensate those members of the group who incur such losses. As in the case of ancient Arab tribal custom, every member of the tribe faces the same danger of being inflicted harm by another tribe which is at war with them. Takaful is not only concern to protect individual or one’s own life, it is based on to protect and help in whole society especially, those who are suffering from financial problems. It is one of the means of providing a material safeguard for offspring and is thus in line with the saying of the holy prophet SAW. He (SAW) spoke to this effect: "it is better for you to leave your off-spring wealthy than to leave them poor, asking others for help". The Holy Prophet (SAW) also encouraged the providing of security for the widows and poor persons as he highlighted in one of his traditions: "The one who looks after and works for a widow and for a poor person (dependent), is like a warrior fighting for The Cause of Allah (SWT), or like a person who fasts during the day and prays throughout the night. According to world takaful report, it is understood that there are approximate 200 Takaful operators’ worldwide, mostly providing general Takaful business. It is estimated that the combined total premium managed by world Takaful industry is around USD 13 billion in 2014. In addition to that, according the Bank Negara Malaysia, the assets of Takaful industry has been increased by 20% from 2012 to reach RM16 billion as at end of 2013. Now the Takaful assets account for 10% of the total assets in the insurance and Takaful industry. It is admitted that this amount is very small and insignificant compared to the total Muslim population of Islamic countries. Although it is a fact that the Takaful industry in Malaysia co-exists with its conventional counterpart in a dual frameworks that interlocks each other leading in to some issues and challenges, it is so far looks beneficial the country’s economy. These issues and challenges may turn out to be opportunities waiting to be explored. Hani Kallil Mangat

The prime objective of this paper is to analyze those issues and challenges and see whether these issues and challenges are beneficial or not to the Takaful industry in Malaysia. History of Takaful in Malaysia The development of takaful industry in Malaysia in the early 1980s was motivated by the fundamental needs of the Muslim public for a Shariah-compliant substitute to conventional insurance, as well as to complement the operation of the Islamic banks that was established in 1983. It was to a large extent, trigged by the verdict issued by the Malaysian National Fatwa Committee which ruled that life insurance in its present form is a void contract due to the presence of the elements of Gharar (uncertainty) Riba(interes) and Maisir (gambling). A Special Task Force was established by the Government in 1982 to study the validity of the setting up of an Islamic insurance company in the country. Following the recommendations of the Task Force, the Takaful Act was enacted in 1984 and the first operator was incorporated in Malaysia in November 1984. In Malaysia there are currently more than 10 Takaful and 6 Retakaful operators, with foreign and local ownership, and these operators offer a wide range of product from General to life and family coverage. Recently, the issuance of few new family takaful licenses to joint ventures between global and regional players and strong domestic entities has further strengthened Malaysia’s position as a global hub for Islamic finance. Comparison between Takaful and Insurance The core difference between Takaful and conventional insurance is in the way the risk is treated. In a conventional insurance system, the insured transfers the risk of loss or damage to an insurance company. The makes the profit if its premium and investment income exceed its incurred losses and underwriting expenses. In a takaful system, participants make payments to a common fund that is managed by a takaful operator under one of three models: 1. Profit sharing (Mudharabah) 2. As an agent for some management fee ( Wakalah) 3. Hybrid form of Agency with a foundation (Wakalah with waqf)

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The takaful operator does not assume the risk of loss or damage on the part of the participants. Rather, the risk is shared among the takaful participants whose contributions provide the means to cover any losses or damages incurred by themselves or others. In order to understand the issues and challenges that takaful industry faces, it is necessary to examine differences between takaful and conventional insurance. The major differences between takaful and insurance are summarized below: Principles

Takaful

Insurance

Contract

A combination of Tabarru An exchange contract (sale contract agency

(donation) or

profit

and and purchase) between insurer sharing and insured.

contract. Payments

make Policyholders pay “premium”

Participants

“contributions” to the scheme to other insurer. and mutually guarantee each other under the scheme. Risks

All

participants

mutually Risk is transferred from the

agree to share the risks among policy holders to the insurer. them. Funds

The takaful fund belongs to The insurance fund belongs to the

participants.

Takaful the insurer.

operator only acts as the manager and custodian of the fund. Liability

Takaful operator acts as the Insurer is liable to pay the manager of the scheme and insurance pays the takaful benefits from contracted the

funds.

In

case

of (insurance

benefits

as

from its

assets

funds

and

deficiency, takaful operator shareholders fund) will provide benevolent loan. The operator will not share the

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deficits of the funds. Investments

Funds are invested in Sharia Insurer may invest in any compliant approved

instruments instruments by

Shariah considering

Supervisory Board (SSB) Bonus from Investments

without the

Sharia

Compliance of the instrument.

The profit to be shared among It is at the sole discretion of the participants and operator. the insurer whether to pay or The agreed profit sharing ratio no to pay the bonus depending should be applied consistently on the investment returns. regardless of the performance of takaful investment.

Benefits

Paid from the defined funds Paid from the funds legally jointly setup and borne by the owned by the company. participants.

Issue and challenges of Takaful industry in Malaysia’s Dual Banking Environment This is section analyzes the issues and challenges that arise from the existence of Takaful in a dual economic system with respect to the conflicts among the two different legal frameworks i.e. conventional and Islamic. Malaysia has often cited as one of the success stories in Islamic finance and this is mainly due to the presence of regulator support and legislative frame work specifically to cater for Islamic financial transactions and place Islamic finance in equal footing with its conventional counterpart. The Malaysia takaful industry is governed by the Takaful Act, which provides the legislative framework for the licensing and regulation of takaful businesses to ensure the businesses are in accordance with the Sharia Principles. On the other hand, insurance companies in Malaysia are governed by the Insurance Act 1996. Malaysia’s legal framework is designed to cater for Islamic finance matters as the policy of the present government is to promote and encourage Islamic Finance. There is a dedicated judge at Hani Kallil Mangat

the High court level for Islamic finance matters. On top of that, the Kuala Lumpur Regional Centre for Arbitration was established and has specific capabilities to deal with Islamic contract disputes. This legal framework enables the enforceability of Islamic finance contracts while providing strong governance and legal redress for Islamic financial institutions. The Central Bank of Malaysia has established a centralized Shariah Advisory Council to advise on issues related to Shariah compliance matters pertaining to the Islamic Banking and Takaful Industry. The approach was taken, by recognizing the importance of Shariah compliance in the Islamic Financial System. The SAC is responsible for analyzing issues on Islamic banking and takaful matter, to ensure the aspects of the operations of Islamic financial institutions are in accordiance with Shariah Principles. According to the Central Bank’s report 2010 on The Financial Stability and Payment System, the regulatory framework for the Islamic financial system was strengthened with the development of a more robust solvency framework, enhanced regulatory framework for the management of takaful funds and Shariah governance standards for Islamic banks and takaful operators. The existing legislations will be reviewed from time to time to further strengthen the bank’s regulatory and supervisory framework. This will be complemented by enhancements to the governance framework and solvency standards as well as ensuring the smooth implementation of the new financial reporting framework. In the area of Islamic finance, the regulatory framework will be further strengthened to reflect the unique attributes of Islamic financial contracts. Another incentive by Central Bank is the establishment of Bursa Suq Al-Sila in Kuala Lumpur in August 2009 as an international commodity murabahah platform. It was a key initiative to strengthen the Islamic liquidity management infrastructure. It is the world’s first, end-to-end Shariah-compliant multi-currency commodity trading platform specifically dedicated to facilitating commodity-based Islamic financing and investment transactions in the Islamic money market. This will ultimately enhance the liquidity and risk management capacity of participants in the international Islamic financial market. Although takaful and re- Takaful operators have yet to utlize Bursa Suq Al- it is hoped that the platform will be used in the future to enhance liquidity management, particularly in the event that operators need to raise during shortage.

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Regulation for the takaful market is evolving and the creation of more consistent standards is set to increasingly more up the agenda. Islamic financial services board has approved the issuance of draft proposals for regulators to adopt, enabling the supervision of Takaful to be consistent with that of the conventional insurers. The Central Bank also has introduced a Guidline for Takaful operational Network recently in 2011. The Guidelines serves as guidance for takaful operators in conducting their operations, to ensure business activities and innovations are within their risk management capacity and do not compromise prudence, as it outlines parameters within which takaful operations take place. The Guidelines emphasize on the need for takaful operators to put in place comprehensive internal procedures and safeguards to ensure long term sustainability of the business and those interests of the stakeholders are safeguarded. The objectives of the Guidelines are as follows: 1. To enhance operational efficiency of takaful business 2. To build healthy takaful funds which are sustainable 3. To safeguard the interests of the participants and 4. To promote uniformity in takaful business practices. Legislative framework is therefore essential for the authority to exercise its supervisory function both in terms of business operation as well as Shariah compliance. In most of the Muslim countries there exists a dual financial system side by side. What is therefore statutory required of the conventional financial system such as good governance, compliance of regulations and other provisions should also be applicable to the Islamic financial system. Other Challenges and issues that faced by Takaful industries in a Dual Banking System: There are few challenges and issues that mainly faced Takaful industry especially when they are operating within a dual banking and insurance regime. Some of the challenges are as follows:Development of human resource: Since Takaful industry has tremendously growing and developing day after day, but there is still obstacle and challenge that put behind the development of Takaful which is really less human resource development. In order to address this challenge and to achieve further improvements, we cannot ignore the fact that we need talented people.

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So far there are less people who have mainly understood the concept of Takaful. There is shortage of human skill that regarding or have no enough knowledge, experience about Takaful. Progress is being made in some regions currently, for example, in Malaysia the Islamic banking and finance institutions Malaysia offers a compressive training programmers which is more regarding Islamic banking and Takaful industry, also training programs that enhance financial industry experts. But it is not widely solved because of small number of people have knowledge about Takaful. However, it’s more appropriate to have great people or scholars who have knowledge and understand the concept of Takaful in Islamic way of method. Scholars, in particular, have to play a greater role for improving the concept of Takaful or Shariah concept that regarding Takaful. Scholars may have to operate differently in order to facilitate the innovation process, without compromising Islamic principles. They have to be involved in the new product development process and also the way to implement and practice it. In addition they do have come out new strategy to develop the new product that issued. Other responsibility that Scholars have to do is to supervise and work with other people in order to insure that the new product is implement as it was intended and also work is been done as it is. Furthermore, scholars have to understand customers’ needs, safeguard their interests and represent them to the management of the organizations. Finally, scholars have to develop Shariah compliance systems that can deal with the standard developed by AAOIFI and other Islamic banking institutions. In order to solve this challenge, it is good to teach people Takaful concept and also its good to reeducate the talent people have forced to operate as conventional insurers, because they are best people who can understand Takaful concept easily. Lack of awareness: The Islamic financial institutions play a significant role in developing and implementing Takaful concept through the entire world. But currently, it seems like that Islamic financial institutions are not putting too much effort in developing Takaful. Actually, it is big challenge and it is one of the reasons that Takaful is not widely known and also it is the reason why it less developed.

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Apart from Scholars or talent people, it is crucial for marketers to enhance the development of the industry and maintain the innovation and development of new products. Financial markets are increasing in sophistication; so that they should aware a lot of consequences that could possibly face while they are marking the new product, because, currently, the world is changing and there is competition. Financial markets must understand the needs and wants of customer in order to match the desire of the customers, because we are of, as customer you need a product that meet your needs and wants as well as your desire Despite all these efforts of Islamic financial markets, many consumers are still unaware the concept of Takaful. Some of them they even do not know that there is Takaful. Many consumers are still stick to conventional insurance, and they adopt more than Takaful which is Islamic insurance. In order to decrease this challenge, it is mainly important to address educational ...