A REVIEW OF TAKAFUL ACCOUNTING REGULATIONS AND PRACTICES IN MALAYSIA
Shahul Hameed bin Mohamed Ibrahim
International Islamic University Malaysia
Hairul Suhaimi Nahar
International Islamic University Malaysia
Ros Aniza Mohd. Shariff
International Islamic University Malaysia
ABSTRACT
This research undertakes an empirical investigation of the accounting practices of Takaful Companies in Malaysia for the period 2003-2005. We start by reviewing the need for and the development of the Takaful industry in Malaysia followed by a review of the differences in the concepts, operations, accounting and reporting between conventional insurance and Takaful. Our thesis is that the concepts and operations of Takaful call for a different set of accounting and reporting practices; which we believe to be a subset of what we term as Islamic accounting. We then compare the accounting practices suggested by the Malaysian Financial Reporting Standards for Insurance (FRS 17 & 18) and AAOIFI accounting standards for Islamic Insurance as well as the Bank Negara Malaysia (Central Bank) Guidelines on Insurance and Takaful (GPI3&15 and GPT6 respectively) which includes accounting disclosures. We then extract a list of accounting requirements from AAOIFI accounting standards for Islamic Insurance and GPT6 and score these using the annual reports of the four Takaful operators in Malaysia. The results show that, while AAOIFI accounting standards for Islamic Insurance are not completely followed, the introduction of GPT6 had indirectly encouraged Malaysian Takaful operators to abide by AAOIFI standards (which are not compulsory in Malaysia). Further, we also report and comment on the response we obtained from the telephone interviews of the Takaful operators we conducted to seek clarification for some of the findings from the analysis of the annual reports.
1. INTRODUCTION
The Islamic banking, Islamic financing, Islamic Insurance and Islamic capital market are essentially creatures of the Islamic economics. They emerged as a result of Al-Tajdid Al-Islami (Islamic revivalism) i.e. the “cleansing of Islamic practices of all un-Godly elements” in an effort to return Islam to its original pure form (Mawdudi, 1999). The efforts have been concentrating on various spheres such as in the aspect of politics (the establishment of Islamic states e.g. Sudan and Iran), knowledge (the Islamization of knowledge and the setting up of Islamic Universities), legal aspects (the adoption of Shari’ah law i.e. Hudud and Qisas), as well as economics (the introduction and promotion of Islamic economics, Islamic banking and Islamic Insurance). In economic aspect particularly, given its extensive Islamic revivalism efforts, it is unsurprising to note its rapid development practically and considerable growth of research in the same area academically.
Equivalent to the case of Islamic banking which forms part of the Islamic economics system, the Islamic insurance system (Takaful) is essentially creature of the same economic system – the Islamic economics, formulated and established as a result of the Islamic revivalism efforts in many Muslim and non Muslim countries. It operates based on fundamentally different set of parameters, heavily guided by the rules of Shari’ah (Islamic law). In Malaysia, the National Fatwa Council had resolved in 1972 that conventional insurance is a fasid practice, therefore is haram (forbidden). The above decree was premised on the fact that there exist elements of gharar (uncertainty), maisir (gambling) and riba (usury) which are totally in contradictory to the spirit of Shari’ah. As such, in contrast to conventional insurance, the operational set up of Takaful is formulated to be free from these three elements. In addition, Takaful system also employs several Islamic elements such as Ta’awun (mutual help), Tabarru’at (willingly relinquish individual rights over the contributions paid, for collective benefits) and Mudharabah (profit sharing relationship) or Wakalah (principal-agent relationship).
The above concepts of gharar, maisir and riba as well as the existence of elements of Ta’awun, Tabarru’at, Mudharabah and Wakalah in Takaful have been moderately covered by prior academic studies. Such literatures on Takaful are reasonably extensive. However, these studies have shown lack of focus on the specific area of accounting and reporting for Takaful. Most of the literatures are rather theoretical in nature which focuses on Takaful concepts and its operational aspects, leaving ample space for research theoretically and empirically in the specific area of accounting and reporting for Takaful. In Malaysia particularly, there are currently no specific Takaful accounting and reporting standards. Instead, Takaful operators are required to abide by circulars and guidelines issued by the central bank (Bank Negara Malaysia – BNM). Nonetheless, operators are also presented with Shari’ah based accounting and reporting standards on Islamic insurance which were produced by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). These standards however have never been enforced by the Malaysian regulatory body on Takaful operators. Nevertheless, Malaysian operators could only consider adopting it on a voluntary basis.
This paper seeks to first; explore the nature of Takaful and its differences with conventional insurance from the conceptual, operational, accounting as well as reporting perspectives. Secondly; it will explore the nature of the currently available and applicable Takaful accounting and reporting regulations in Malaysia, providing special attention to the currently-in-use BNM type of accounting and reporting regulation on Takaful as well as the accounting and reporting regulation on Islamic Insurance provided by AAOIFI. Thirdly; the paper will assess the extent of compliance by Malaysian Takaful operators to Takaful guideline (BNM type of accounting and reporting regulation on Takaful) and the extent of acceptance to AAOIFI Islamic insurance standards and subsequently obtaining reason(s) for operators’ full (or partial) compliance/acceptance.
In this study, the choosing of Malaysia as the country of reference is supported by the fact that it provides an interesting cultural setting for the study of related issues on Islamic institution of Takaful in which, its establishment forms part of the economic Islamization process by its leaders. Being an Islamic state as claimed by many of its leaders, Malaysia was the 6th country in the world to introduce Islamic insurance system, right after Sudan, Saudi Arabia, Switzerland, Belgium and Bahamas (see Maysami & Kwon, 1999). Thus, it would be interesting to see its development particularly from the accounting and reporting perspectives after more than 20 years of Takaful existence.
The rest of this paper is organized as follows:
Section 2 will proceed to discuss the differences between Takaful and insurance from the conceptual and operational perspectives. This will then be followed by a brief discussion on the background and development of Takaful in Malaysia. The 3rd section discusses, in the context of Takaful, the conceptual insights of its accounting and reporting. The position of accounting and reporting in Islam is highlighted and the role of BNM in regulating Takaful industry is presented. The role of AAOIFI as the international standard setter for Islamic financial institutions will also be noted. Section 4 outlines research methods employed in this research. Section 5 presents findings on the comparative analysis between insurance standards, Takaful guideline and AAOIFI standards. Section 6 discusses findings from the analysis of the conformance scoring based on annual reports of 4 Takaful operators. Section 7 concludes the paper which includes some suggestions for changes to the regulatory body concerned.
2.0 TAKAFUL AND INSURANCE: CONCEPTS AND OPERATIONAL DIFFERENCES
Literatures on Takaful are growing considerably. Most of these literatures cover almost the same areas albeit, with slight variation in terms of focus. The topics of Takaful concepts and its operational mechanism are the most frequently discussed topics in such growing literatures of Takaful (For example in Ali, 1989; Mohd Fadzli 1996a&b; Azman, 1997; Maysami & Kwon, 1999; Billah, 2003; Yon Bahiah, 2004; Hairul Annuar, 2005). Literally, conventional insurance refers to financial protection system which involves the execution of contracts (insurance contracts) between an insurer and insured in which insurer agree to underwrite the subject risk of such contracts (Webb et al., 1992).
Arrow (1980) as quoted in Siddiqi (2000) provides a conceptual definition of insurance as an exchange of money now for money payable contingent on the occurrence of certain events (or risks). Risk in insurance primarily refers to losses arising from specified or defined perils. According to Arrow (1980), in providing financial protection to insured, insurer will sell insurance coverage. Before selling it, insurer will make advance projection on the maximum probable losses of any particular risk. Premiums are then allocated to risk in line with coverage limit. Subsequently, premium payment is set to be in accordance to such risks projection. Implicitly, these insurance operations involve a process of transferring losses in advance based upon past experiences (Omar & Dawood, 2000). By selling insurance coverage, insurance companies are basically assuming the subject risk as stated in the insurance contract. This is reflected in the extent to which premiums paid are then treated as insurers’ income which signifies the shift of rights of such premiums to insurer from insured. As a legal owner to insurance funds, insurer has full control over such funds and there is no obligation on their part to distribute back any underwriting and investments surpluses generated to policyholders except for in the case of claims payment and in life insurance policy which had reached maturity and that insured survived at the maturity date. This constitutes a one way economic relationship between insure and insured if no risks occurred since only insurer will get the economic benefit, had the risk did not occur.
On the other hand, Islamic insurance (commonly referred to as Takaful) is conceptually defined as an Islamic financial protection system which involves a joint-guarantee scheme in providing possible indemnity or contingency against pure risk[1] resulting from an unexpected occurrence of loss or damage to one’s life or property (Billah, 2003). It operates based on concepts of Ta’awun (mutual help or co-operation), solidarity, trusteeship, brotherhood and Tabarru’at (willingly relinquish individual rights over the contributions paid, for collective benefits[2]) (Mohd Fadzli 1996a&b; Azman, 1997; Maysami & Kwon, 1999; Billah, 2003; Yon Bahiah, 2004). Takaful operator (Islamic Insurance company) collects contributions (premiums as in insurance) from participant(s) (policyholders) and subsequently agree to manage those contributions (i.e. Takaful fund) based on certain set of guidelines. The management of Takaful fund by operator could be based on either Mudharabah (profit sharing) or Wakalah (agency) model. The former regards participants collectively as "Sahibul-Maal" (capital providers) while Takaful operator as Mudharib (entrepreneur) and Takaful contributions as Ra’sul Maal (capital to the Mudharabah contract). The latter regards Takaful operator as an agent and Takaful participants collectively as principal. Unlike the sharing of profits in Mudharabah model, the reward for agent in the Wakalah model is the fee payment.
The striking conceptual difference between Takaful and conventional insurance is that risks in Takaful are not exchanged by way of contribution payments to operators (Omar & Dawood, 2000). In essence, operators are not selling and participants are not buying any risk coverage. Thus, operators are not assuming or underwriting any risks from participants. Rather, risks are distributed among Takaful participants whom agree to jointly assume the risk (Mohd Fadzli 1996a&b; Maysami & Kwon, 1999; Billah, 2003). It is in this sense that operators are considered as merely intermediary or fund managers, managing Takaful funds on behalf of participants. As fund managers, contributions paid by participants are regarded as ‘fund’ or ‘liability’ to operators and rights over it remains attached to participants. Several Islamic concepts in Takaful system (but not in conventional insurance) further differentiate Takaful from insurance conceptually. Ta’awun, Tabarru’at, Mudharabah and Wakalah are the Islamic concepts which are justified by Shari’ah and employed by Takaful system. Mudharabah and Wakalah for instance depict economic contractual relationship between operators and participants. Mudharabah concept works based on the sharing of profits between the two parties while Wakalah concept operates based on the payment of fees.
Ta’awun and Tabarru’at are concepts which illustrate the Islamic social relationship among participants in Takaful system. Participants mutually agree to help and guarantee each other through the relinquishing of individual rights over the contributions paid for the mutual benefits of participants in the scheme collectively i.e. Tabarru’at (Mohd Fadzli 1996a&b; Maysami & Kwon, 1999; Omar & Dawood, 2000; Billah, 2003). It embraces the elements of shared responsibility, joint indemnity and mutual protection. It is this aspect in Takaful system that makes uncertainty element allowable under Takaful contract (Billah, 2003). This is truly in line with the objective of achieving social and economic well being of the ummah (Islamic society). Moreover, God is said to have stated in Qur’an thus; "Assist one another in doing of good and righteousness. Assist not one another in sin and transgression, but keep duty to Allah" (Qur’an 5:2).
Operational wise, conventional insurance works on the basis of “risk assumption” by insurer or the “trade of risk” (Omar & Dawood, 2000). Through the selling and buying of insurance contracts and in the absence of Ta’awun, Tabarru’at and Mudharabah or Wakalah, the whole system of insurance is said to have operated involving 3 basic elements which are totally contradictory to Islamic rules of Shari’ah (Mohd Fadzli 1996a&b; Maysami & Kwon, 1999; Omar & Dawood, 2000; Billah, 2003). The elements are “gharar” “maisir” and “riba”. According to Azman (1997), Gharar could exist in insurance in 4 forms: Gharar in the outcome, Gharar in the existence, Gharar in the results of the exchange and finally Gharar in the contract period[3]. Maisir or gambling originates from gharar (uncertainty), and exist in insurance since profits or losses to insurer would very much depend on chances which closely associated with claims level. Claims are in turn, could not be controlled by insurer. Also, maisir in insurance operation resembles to a certain extent “risk-taking” whereby insured could either receive huge amount of money (claims payment) without an equivalent amount of input (premium paid) (Omar & Dawood, 2000).
Insured could also be paying premium without getting any amount in return (if no risk occurred). Insurer on the other hand could either loose if there are too many claimants or could make huge profits when premiums collected exceeds claims (Omar & Dawood, 2000). Therefore, the uncertainty in insurance system leads to gambling as discussed above. Besides Gharar and Maisir, Riba could also exist in insurance and it could be in various forms. If we go by the classification of riba by Imam As-Shafiie, then riba in insurance relates to riba Al-Buyu’ which exist in trade (sales contract). The types of riba are riba Al-Fadl’ (uneven exchange value – small premium in return for bigger coverage value) and riba Al-Nasiah (deferred payment – claims payments are deferred to period when there is occurrence of risks) (Mohd Fadzli 1996a).