Takaful Investment Portfolios

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3 Takaful Investment Portfolios

4 Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers professional and personal knowledge and understanding. The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors. Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation and financial instrument analysis, as well as much more. For a list of available titles, visit our Web site at

5 Takaful Investment Portfolios A Study of the Composition of Takaful Funds in the GCC and Malaysia ABDULRAHMAN KHALIL TOLEFAT MEHMET ASUTAY

6 Cover image: Ranjan Chari/iStockphoto Cover design: Leiva-Sposato Copyright 2013 by John Wiley & Sons Singapore Pte. Ltd. Published by John Wiley & Sons Singapore Pte. Ltd. 1 Fusionopolis Walk, #07-01, Solaris South Tower, Singapore All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as expressly permitted by law, without either the prior written permission of the Publisher, or authorization through payment of the appropriate photocopy fee to the Copyright Clearance Center. Requests for permission should be addressed to the Publisher, John Wiley & Sons Singapore Pte. Ltd., 1 Fusionopolis Walk, #07-01, Solaris South Tower, Singapore , tel: , fax: , enquiry@wiley.com. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor the author shall be liable for any damages arising herefrom. Other Wiley Editorial Offices John Wiley & Sons, 111 River Street, Hoboken, NJ 07030, USA John Wiley & Sons, The Atrium, Southern Gate, Chichester, West Sussex, P019 8SQ, United Kingdom John Wiley & Sons (Canada) Ltd., 5353 Dundas Street West, Suite 400, Toronto, Ontario, M9B 6HB, Canada John Wiley & Sons Australia Ltd., 42 McDougall Street, Milton, Queensland 4064, Australia Wiley-VCH, Boschstrasse 12, D Weinheim, Germany ISBN (Cloth) ISBN (epdf) ISBN (Mobi) ISBN (epub) Typeset in 10/12 pt. SabonLTStd by MPS Limited, Chennai, India Printed in Singapore by Ho Printing Pte. Ltd., Singapore

7 Contents Preface Acknowledgments List of Abbreviations ix xiii xv CHAPTER 1 Introduction 1 Rationale for Researching Investment Portfolio Composition of Takaful Companies 1 Aims and Objectives 4 Scope and Delimitation 5 Research Methodology 6 Overview of the Book 6 CHAPTER 2 Insurance and Islamic Law: An Introduction to Takaful 9 The Concept of Insurance in Islamic Sources 9 Views of Contemporary Jurists on the Insurance Contract 13 Arguments Regarding the Validity or Invalidity of Commercial Insurance 15 Conclusion 27 Notes 28 CHAPTER 3 Takaful Models and Implementations, Trends, and Developments 31 Takaful Undertaking Principles 31 Islamic Insurance Operational Models 32 Differences Between Takaful and Other Forms of Insurance 44 Trends and Developments in the Takaful Industry 45 Conclusion 52 Notes 53 v

8 vi CONTENTS CHAPTER 4 Research Methodology 55 Methodological Shortcomings of the Literature 56 Research Strategy 56 Research Questions, Objectives, and Hypotheses 57 Research Design 58 Sampling Strategy 59 Research Methods 61 Quantitative Data Analysis 68 Qualitative Data Analysis 70 Conclusion 70 Notes 71 CHAPTER 5 Exploring Investment Behaviours and Investment Portfolios of Takaful Operating Companies in the GCC and Malaysia 73 Total Investment Portfolio of Takaful Operating Companies for All Funds 74 Investments in Shareholders Fund 75 General Fund 86 Family Funds 94 Conclusion 97 CHAPTER 6 Locating the Differences Between Actual and Desired Investment Portfolios 99 Shareholders Fund 101 General Fund 106 Family Funds 111 Conclusion 114 CHAPTER 7 Contextualising the Findings 117 Overall Portfolio Compositions 117 Investment Accounts 125 Investment in Sukuks 129

9 Contents vii Investment in Equities 134 Return on Investment (ROI) 138 Mutual Funds/Unit Trusts 140 Real Estate Investments 141 Conclusion 142 Notes 143 CHAPTER 8 Conclusion and Recommendations 145 Main Findings of the Study 145 Recommendations of the Study 149 Research Limitations 153 Recommendations for Future Research 153 Conclusion 154 Note 155 Appendix A 157 Appendix B 163 Appendix C 215 Bibliography 217 About the Authors 223 Index 225

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11 Preface I slamic finance emerged as an alternative financing method in the postcolonial period with the objective of developing an Islamic moral economy system in accordance with the norms, values, and principles of Islam. This constructivist strategy produced its first institution in the form of an Islamic social bank (Mith Ghamr Bank) in the early 1960s in Egypt. However, the development trajectory of Islamic finance is marked with the establishment of the first Islamic commercial bank in 1975, which defined the model to be followed in the future of Islamic banking and finance (IBF). Since then, IBF has made important inroads in mainstream banking and the global financial centres. Once considered a voodoo economy by BBC, it is now an everyday news subject. With over 500 IBF institutions, the asset base of the industry has passed the trillion-dollar threshold to US$1.2 as reported by The Banker (2011). While IBF has compromised on its value proposition due to the observed convergence between IBF and conventional finance, it has managed to get the attention of bankers, financiers, and business people all over the world. The product development and diversity provide a great opportunity for IBF to sustain its growth, as evidenced with the modest yet positive performance it has shown during the global financial crisis. An important aspect of Islamic finance is the insurance, for which takaful as an Islamic alternative has been functioning in civil society on the peripheries of the Muslim world for a long time. However, the institutionalisation of takaful operating companies is also a new phenomenon limited to only about three decades. The scepticism regarding insurance in the Muslim world can be considered an important factor in the slower growth and late development of Islamic insurance or takaful in the Muslim world. However, in particular in the GCC region and Malaysia, the takaful industry has shown a robust growth in the recent years, and its development has been possible with the facilitatory regulations and standards issued by these countries. The developments in IBF also contributed to its expansion, growth, and development. Ernst & Young s World Takaful Industry Report 2012 states that the takaful industry will reach the US$12 billion threshold by the end of Such impressive growth is expected to continue with a positive attitude being developed ix

12 x PREFACE in the Muslim world to overcome the observed skepticism toward insurance in general and takaful in particular. The efficiency and effectiveness of the takaful industry is directly related to the way the companies manage the funds collected. The diverse Shari ah complaint products available paved the way for the efficient investment of these funds, which will further contribute to the development of the takaful industry. It is observed that there is a gap between the ideal or the expected asset allocation of takaful operating companies and their actual investment or asset portfolios. As Asaria (2012) suggests, the ideal asset allocation should be: cash, 10 15%; debt securities, 60 70%; equity, 10 20%; and alternative assets, 5 10%. However, the experience and observations demonstrate that the asset allocation of takaful companies is approximately: cash, 40 45%; debt securities, 10 15%; equity, 25 30%; and alternative assets, 10 20% (Asaria, 2012). Thus, there is a gap between the desired and actual asset or investment portfolios of takaful operating companies, which was more visible in the last decade. This observed gap provided the motivation for this study on the emergent years of the takaful industry in the middle of the past decade. The research presented in this study aims to explore, examine, and analyse the investment behavior and hence the asset composition of the takaful operating companies in the GCC and Malaysia with the objective of identifying the observed gap between the desired and actual asset allocation or portfolios of the takaful companies from 2002 to While the research was completed in 2009, the availability of the data and also the low willingness of takaful operating companies and their managers for disclosure necessitated focusing on the period for which better data was available, and hence the scope of the research is limited to It should be noted that this was the expansionary period for IBF industry as well, which has had implications for the development of the takaful industry. The findings, implications, and recommendations of this research should, therefore, be understood and contextualised within this period, namely Despite being historical, this will help to reveal the behaviour of the takaful companies in the emergent period. Therefore, it is suggested in the conclusion chapter that this research can be repeated with a larger sample within a more matured takaful industry to search for the change that has taken place in the asset allocation or the investment behaviours of the takaful companies. The subject matter, method of analysis, and findings presented in this study should be considered an important and early contribution to the nascent literature on takaful and on the performance and operations of the takaful operating companies. It is hoped that the subject matter can be taken up by other researchers to examine more recent years so that the

13 Preface xi development trajectories in the asset allocation and investment behaviours of takaful companies can be located. This book is not on takaful itself, and therefore does not aim to discuss takaful as a financial instrument and institution. It is a book developed out of research based on the exploration and analysis of the investment behaviour and portfolio composition of takaful companies. Hence, it should be considered an empirical research based book. We hope that the material and the findings presented in this book can shed some light on our understanding of the portfolio composition and investment behaviours of takaful companies, which are also related to the development of and product diversity in the IBF industry. Dr. Abdul Rahman Tolefat Founder and Chairman, Itqan Asset Management, Bahrain Dr. Mehmet Asutay Reader, Middle Eastern and Islamic Political Economy and Finance; Director, Durham Islamic Finance Doctoral Training Centre, Durham University, UK

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15 Acknowledgments E ach research project is a result of hard work and effort not only by people who conduct the research but also by a number of other individuals that provide physical but also spiritual support. We are grateful to all of those who in one way or another directly or indirectly supported this research through their own particular ways. We are thankful to all of the participants who provided valuable primary data in relation to the portfolios of takaful operating companies in the initial formation years of the industry, as the published data were scattered and not satisfactory to conduct this research. Their contribution is highly appreciated and acknowledged in this study. We would like to put on record our gratitude for our development editor Gemma Rosey at John Wiley & Sons Singapore Pte. Ltd. for her patience with us in the completion of this work, and for her continuous help and support. We are grateful to our families in particular for their support in every way, as this project was completed at the expense of the time that was supposed to be spent with them. Abdulrahman acknowledges the sacrifices made by his wife Manar while contributing to his professional achievements and in the completion of this project. His children, Saud and Aisha, always remained his source of inspiration despite using time for the completion of this project rather than enjoying it with them. Mehmet is grateful to his wife, Nihal, as due to this and many other projects she has sacrificed a great deal, yet she believed that I was doing the right thing. xiii

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17 List of Abbreviations AAOIFI BNM CBB CEO CV GCC HSSC IAIS IFSB MY OIC pbuh PF PRF SPSS SSB US$ Accounting and Auditing Organization for Islamic Financial Institutions Bank Negara Malaysia Central Bank of Bahrain Chief Executive Officer Coefficient of Variation Gulf Cooperation Council Higher Shari ah Supervisory Council International Association for Insurance Supervisors Islamic Financial Services Board Malaysia Organisation of Islamic Cooperation Peace Be Upon Him Participants Fund Participants Risk Fund Statistical Package for Social Science Shari ah Supervisory Board US Dollars xv

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19 CHAPTER 1 Introduction RATIONALE FOR RESEARCHING INVESTMENT PORTFOLIO COMPOSITION OF TAKAFUL COMPANIES Islamic finance has been one of the fastest-growing industries over the past decade, with an average annual double-digit growth rate. The total Shari ah -compliant assets worldwide were estimated at US$700 billion in 2007 compared with US$150 billion in the mid-1990s (Grewal, 2008), and are expected to reach US$1.2 trillion in 2012 ( The Banker, 2011). The Islamic banking sector dominated the Islamic finance industry, with assets representing 78.6 percent of total worldwide Shari ah-compliant assets in the mid-2000s (Grewal, 2008). Moreover, the Gulf Cooperation Council (GCC) countries account for two-thirds of global Islamic assets ( The Banker, 2009), where Islamic banking and finance is expected to become the major banking alternative by Some believe that the industry would be able to serve percent of the total 2.5 billion Muslims worldwide in the next eight to ten years (Grewal, 2008). According to Moody s Report (2008), the growth of the Islamic finance industry has been driven by the increase in oil prices, which signals that there will be no slowdown in the growth of this industry in the future. Furthermore, all other parts of the Islamic finance industry are also expected to register substantial growth, such as the Islamic bonds ( sukuk ) market, Islamic funds, and Islamic insurance ( takaful ), despite the impact of the global financial crisis. The research presented in this book is concerned with the Islamic insurance industry, which has registered rapid growth over the years. During the period covered by this study, , there were 133 takaful operating companies in the world, of which 59 were located in the GCC market, which is the largest market for the takaful industry and represented 1

20 2 TAKAFUL INVESTMENT PORTFOLIOS 50% of the takaful global market as of the end of 2006 (Ernst & Young, 2008), demonstrating substantial growth in recent years. The global takaful industry has maintained a growth rate of 20% per annum; the contributions underwritten rose to more than US$4.3 billion by the end of 2010 compared with US$2 billion in 2006 (Ernst & Young, 2008), and are expected to increase to US$12 billion by the end of 2012 (Ernst & Young, 2012). The tipping point for the takaful industry remains the GCC region despite the fact that Malaysia has demonstrated important achievements in a proactive manner for the development of takaful industry. The growth of Shari ahcompliant products sold by Islamic banks, reduction in government welfare benefits, and economic and demographic growth in the Muslim countries will be among the factors that will see the growth of this industry soar in the GCC region (Ernst & Young, 2008). The growth and development in Malaysia can be explained by the political will and business appetite for Shari ah- compliant business. There have also been important developments in terms of Islamic finance as well as takaful in other countries that benefit from a plural financial system. Although the takaful industry has been growing and gaining substantial interest, there are still several challenges facing this industry, such as asset management problems, limited re- takaful capacities, and lack of expertise. This research focuses on the asset management of takaful operating companies in the GCC and Malaysia by exploring their investment compositions and the gaps in the asset classes required by the companies in these regions. This research is conducted in absence of adequate literature and statistics pertaining to the industry, particularly in the area of asset management. Hence, this research is essential, and therefore the data gathered and presented in this study could be considered a first step toward exploring the investment behaviour of takaful operating companies. The rationale for the interest in the Islamic insurance industry in general was motivated by many factors. First, the Islamic insurance industry has been registering substantial growth during the last five years and gaining a lot of interest from international players, including the leading international insurers and reinsurers such as American Insurance Group, Allianz SE, Hannover Re, Swiss Re, and the Lloyd s market. Second, the Islamic insurance industry is a complementary part of the Islamic banking industry, whose assets are expected to grow significantly in the near future. Finally, the booming of economies in Islamic countries and particularly those within the GCC will cause this industry to flourish. The amount of infrastructure projects to be conducted in the region and mega-projects handled by Islamic banks will lead to the growth of general takaful business. However, reduction in government support, economic and demographic growth, and increase in cost of education could lead to the growth of family takaful business.

21 Introduction 3 Despite the importance of the Islamic insurance industry, there has been very limited research and literature related to this industry. In particular, not much is known about the structure of takaful operating companies. For example, the current model being adopted by takaful operating companies has not yet been explored in detail and documented. Some researchers believe that the Islamic insurance industry has been neglected in the literature because of the specialised nature of insurance as a subject (Mervyn, 2005). Moreover, there is a lack of standardisation and statistics pertaining to this industry. All of the above mentioned problems would make understating of the operation of this industry very difficult for international players, regulators, and customers, whose fears might affect the growth of this industry. The interest behind choosing asset management of Islamic insurance companies was due to several reasons. First, the Islamic insurance industry will not be able to grow and support the development of the Islamic banking industry without proper investment channels that are suitable to cover their insurance liabilities. Second, the asset management of takaful could be a first step toward attracting Islamic banks to give further attention to this industry. The highlighting of the gaps in asset classes that takaful operating companies require may attract some Islamic banks to play a role in developing the required asset classes, especially with the potential for growth of the assets of this industry. Until now, there has been no study conducted on the investment behaviour addressing each of the funds individually. Likewise, detailed statistics about investment portfolio composition for each fund are not available. Therefore, this study was conducted with the aim to explore the asset classes comprising investment portfolio of the shareholders fund, general funds, and family funds of takaful operating companies. Moreover, this study compared the current and desired levels of the investment portfolio composition for each of the abovementioned funds. The hybrid structure of takaful, which is in contrast to that of conventional insurance undertakings, requires special attention once an investment strategy is under investigation. In particular, the investment strategy for each of the funds under the takaful structure should be individually studied. These funds comprise the shareholders funds of the takaful operator on the one hand, and the funds of takaful participants (policyholders) on the other hand. Moreover, the latter include underwriting or risk funds and, in the case of life (or family) takaful, the participants investment funds. The underwriting or risk funds include mortality risk funds in family takaful and, in the case of general (non-life) takaful, the relevant underwriting funds (e.g., that for motor insurance), referred to below as general funds. The reason for the need for individual study lies in the different nature of

22 4 TAKAFUL INVESTMENT PORTFOLIOS the liabilities under each fund, which calls for a different investment strategy or composition. The research presented in this book aims to explore the portfolio composition and hence investment behaviours of takaful operating companies beyond the observed trends and developments. Thus, in terms of subject matter, analysis, and findings, this new research line is expected to contribute to the literature. AIMS AND OBJECTIVES The research presented in this book aims to explore the investment behaviour of the takaful operating companies in the GCC and Malaysia by focusing on investment composition of shareholders, general, and family funds individually. Also, the study aims to identify the gaps in the asset classes that the takaful operating companies in both of these regions require to cover their liabilities under each of the abovementioned funds. Given the research problems and questions, the following objectives and hypotheses have been identified: 1. To explore the asset classes comprising investment portfolio composition of shareholders funds, general funds, and family funds of takaful undertakings in the GCC and Malaysia. 2. To compare the actual and desired levels of the investment portfolio composition of shareholders funds, general funds, and family funds between GCC and Malaysia. This second objective was formulated into three testable hypotheses: 1. There is no significant difference between the actual and desired levels of composition of shareholders fund investment portfolio in the GCC and Malaysia. 2. There is no significant difference between the actual and desired levels of composition of general fund investment portfolio in the GCC and Malaysia. Due to the negligible business of family takaful in the GCC, the third hypothesis is confined to Malaysian takaful undertakings: 3. There is no significant difference between the actual and desired levels of composition of family fund investment portfolios in Malaysia.

23 Introduction 5 As regards the research questions, the existing research in the field of Islamic insurance, particularly the investment side, has been facing several difficulties regarding the research methodology that will require further investigation. For example, a conclusion was made from a previous study that the takaful investment undertakings in the GCC countries are heavily invested in equities; however, this conclusion might be wrong as some of the takaful operating companies invested their shareholders funds in equities rather than participants funds (Fisher, 2005; Jaffer, 2008). Therefore, the study research problem breaks down into the following questions: 1. What was the investment portfolio composition of takaful undertakings during the years 2002 to 2005? 2. Did the investment portfolio composition of Shareholders funds, general funds, and family funds in takaful undertakings differ in the GCC and in Malaysia during the years 2002 to 2005? 3. Did the takaful undertakings desire to change the current composition of their investment portfolios as of the end of 2005? SCOPE AND DELIMITATION In terms of scope and delimitation, this study was confined to two geographical groups, namely the GCC countries and Malaysia, for several reasons. First, the majority of takaful undertakings in the world are concentrated in the GCC countries and Malaysia. It should be noted that although Saudi Arabia is the biggest insurance market in the GCC, the coverage of this country was excluded at the time the study was conducted for several reasons. One of these included (at the time the study was conducted) the absence of regulation of insurance as a consequence of which all operating companies in Saudi Arabia were either unregulated or registered as offshore companies in Bahrain or as divisions operating under existing licensed banks. Oman was also excluded due to the nonexistence of takaful operating companies in that country. Furthermore, although there were many takaful operating companies in Sudan, this market was excluded due to the difficulties faced in gathering the required information. Second, the Islamic finance industry, which includes banking, insurance, and capital markets, has been established in these regions, which continuously represents the hub of this industry. At the time this study was conducted, the number of takaful operating companies in the market was small, so the author tried to cover the total population. Complete coverage was not achieved, but the author covered 90% of the GCC market and 95% of the Malaysian market.

24 6 TAKAFUL INVESTMENT PORTFOLIOS It should also be noted that the research covered by this study focuses on the period, and therefore the findings should be contextualised within this initial period of the emergent takaful industry. Since then, the takaful industry and also the Islamic finance industry have demonstrated unprecedented growth and development. The development of Islamic finance and product diversification have increased the investment opportunities for takaful operating companies as well in recent years. RESEARCH METHODOLOGY In order to achieve the designated objectives and hypotheses, a multistrategy research approach, known as triangulation, has been employed in this study. Under this approach, the data was gathered using a quantitative research strategy reinforced by a qualitative research strategy. As this is an exploratory study, the use of such a multi strategy research approach is very crucial for several reasons, which are discussed in detail in Chapter 4. The data has been collected through an ed prestructured questionnaire followed by a mix of structured and unstructured interviews. The purpose of the interviews was to verify the data collected and to inquire about any certain trend or data that needed to be justified. Given the detailed data required and in order to achieve the cooperation of the takaful operating companies, the regulatory authorities for the insurance sector in these countries except Qatar were approached to gain their approval and to ask the takaful operating companies under their supervision to cooperate to fill out the required questionnaire. The data collected were analysed by utilising various statistical methods through Statistical Package for Social Science (SPSS) software. Moreover, two nonparametric statistical techniques were used, namely the Mann- Whitney U Test and the Wilcoxon Signed-Rank Test. Descriptive statistics were also applied in the analysis of the data. OVERVIEW OF THE BOOK The study comprises eight chapters. This first chapter is an introductory one that highlights the research problem, the motivation for, and the significance of the study, and the research objectives, hypotheses, and research design. The literature review is presented in Chapters 2 and 3. The review of legal aspects of insurance contracts under Islamic law is covered in Chapter 2, and Chapter 3 covers the Islamic insurance practices, with special comparisons between Islamic and conventional insurance.

25 Introduction 7 The empirical work commences in Chapter 4 by first presenting the research methodology applied in the study. The chapter covers all aspects of the chosen research methodology, including the research designs and methods, with special highlights of the limitations of the study and the sample chosen. Chapters 5 and 6 present the empirical findings. The results for the first objective of the study are presented in Chapter 5, and the findings related to the second objective are presented in Chapter 6. The analysis and discussion of results for both objectives of the study are presented in Chapter 7 by linking the findings of both objectives. Chapter 8 summarises the thesis and draws the study conclusion. Moreover, it offers recommendations for regulatory authorities, takaful operating companies, and Islamic banks based on the findings of the study.

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