FAMILY TAKAFUL (Shariah compliant life insurance) Assessment of Business Risk Financial Risk Presenter: Amara Gondal
Contents: SCOPE IFS Rating Takaful Structure Why need a modified rating approach Key risks PACRA s approach Business Risk Financial Risk Snapshot
SCOPE how PACRA assesses the business risk and financial risk of a family takaful undertaking, while assigning Insurer Financial Strength (IFS) rating to the undertaking. This presentation covers modifications, to PACRA s rating approach for conventional life insurers, adopted to rate a Family Takaful undertaking.
IFS Rating of a Family Takaful undertaking IFS rating of a family takaful undertaking assesses the financial strength of the undertaking and its capacity to meet obligations to the participants on a timely basis. The IFS rating is assigned to the undertaking itself, and no liabilities or obligations of the undertaking are specifically rated unless otherwise stated.
FAMILY TAKAFUL MODEL Securities and Exchange Commission of Pakistan has permitted following operational models: WAQALA-WAQF for the management of takaful (insurance) related component; and WAQALA-WAQF or MODARBA or BOTH for the management of investment related component articipants Contribution surplus Participants Takaful Fund (PTF) Operators fee Qard-e-Hasna Takaful Operator (TO) Return* Capital Shareholders Includes Partcipants Investment Fund (PIF) Represents Shareholder s Fund (SHF) *Return on equity (ROE)
Why need a modified rating approach Family takaful undertakings share some similarities with conventional life insurers in attempting to serve certain economic objectives Structural difference, which need to be factored in for the IFS rating of a family takaful undertaking, are Segregation of funds (Partcipants Takaful Fund and Shareholders Fund) with some ring fencing; and Varied degree of exposure of these funds to insurance risk (mortality, morbidity, and longevity), and investment risk (interest rate, credit, an liquidity)
Key Risks faced by the respective funds Risk PTFs SHF Provisioning and Reserving Risk The risks of underestimation of the underwriting liabilities and adverse claims experiences. losses arising from severity and frequency of claims due to changes in anticipated mortality, morbidity and longevity as well as catastrophic events such as epidemic, major accident or terrorist attack. _ Underwriting Management Risks The risks of poor management of accepting risk and claim payouts. losses arising from poor selection, pricing and acceptance of risks and inappropriate product design. _
.Key Risks faced by the respective funds Risks PTFs SHF Operational Risks The risks of loss from inadequate of failed internal processes, people and systems. Shariah non-compliance risk, and failure in TO fiduciary responsibilities Loss of income from tainted income due to Shariah rulings. Losses due to claims fraud. Losses due to legal risk. Administration and acquisition expenses for developing and maintaining the Takaful contracts. This relates to business risk whereby the fund will not have adequate cashflows to meet the operating expenses. Fiduciary risk. Credit Risk The risk for a counterparty failing to meet its obligations according to the agreed terms Takaful contributions receivables; Retakaful recoveries; Profit and capital receivable from invested assets. Wakala Fee (due to contributions receivables); Other debtors, including the risk of non-recovery of a Qard-e-Hasna; Profit and capital receivable from invested assets.
.Key Risks faced by the respective funds Risks PTFs SHF Market Risks The risks of losses arising from movement in market prices i.e. fluctuations in values in tradable, marketable assets (including sukuk) and deviation from actual rate of return from the expected rate of return. The risks relate to current and future volatility of market values of assets, and of foreign exchange rates. The risks relate to current and future volatility of market values of assets, and of foreign exchange rates. Liquidity Risk The risk from inability to meets its obligations or to fund increases in assets as they fall due without incurring unacceptable costs or losses Additional costs through raising additional funds at a premium on the market or through the sale of assets which simultaneously affect the overall appropriate provisioning and reserving methodologies of PTF. Additional costs through raising additional funds at a premium on the market or through the sale of assets which simultaneously affect the overall appropriate capitalization and reserving.
Pacra s Rating approach Business Risk Industry A thorough understanding of family takaful industry, the extent industry dynamics can impact the rating levels that the takaful industry itself can achieve (industry rating) this includes an assessment of Opportunities and threats within the takaful industry Competitive environment in family takaful industry as well as in conventional life insurance sector, market development and customer loyalty Understanding of the regulatory environment (paritcularly Qard-e- Hasna regulations) effectiveness of the regulatory regime, including the quality of supervision, capital requirement and risk assessment. Relative positioning of the family takaful undertaking, being rated, within the takaful industry as well as in overall insurance market (conventional and takaful)
Pacra s Rating approach Business Risk IFS Rating to a family takaful undertaking does not comment on shariah compliance status of the undertaking. However, it only considers other qualitative factors related to Shariah Board and related experience of TO (addressed in the assessment of TO s management quality section) An assessment of Participants Takaful Fund (PTF) Participants Investment Fund (PIF) Shareholders Fund (SHF), and then Combined assessment of the Takaful Operator (TO) along with all the Statutory Funds Performance of any family takaful undertaking (a) Underwriting performance As assessment of products offered group family takaful Vs. Individual Family Takaful
Business Risk Underwriting performance PACRA considers performance of funds (PTF, PIF and SHF) separately as well on overall basis; Ratio analysis An assessment of business model adopted by the TO the agreed fee or split of profits between the Takaful fund and the TO the adequacy of management fee income of TO to absorb expenses in order to ensure the ongoing existence of the whole takaful operation; the fee expense of PTF should be lower than difference between contributions received from participants and the claims (i.e. fund is in surplus).» Note:, as per SECP s Takaful rules, 2005, wakala fee to TO should be allocated irrespective of surplus in PTF. This supports the possibility of higher returns to shareholders in early yaers.
Business Risk Investments performance The appraisal procedure adopted for investments performance assessment is largely similar to conventional life insurers. (Ratio analysis) takaful undertakings are at competitive disadvantage relative to conventional insurers due to shariah related restrictions (limited avenues) and immature Islamic financial sector in Pakistan, which hampers investment related profitability. Structural features of family takaful products may have some distinctive features due to wakala-waqf or modarba or both models for the investment components, as applicable in Pakistan. PACRA would examine profit participation (amongst PIF and TO) terms.
Financial Risk Retakaful Assessment technique for valuing Ratakaful arrangements entered into by a family takaful undertaking is similar as for conventional life insurers. Benefit of retakaful surplus income. Takaful undertakings are exposed to concentration risk due to small number of Retakaful undertakings. Dormant stage of Retakaful industry poses risk of (less experienced) pricing of treaty contracts as compared to conventional alternatives.
Financial Risk Liquidity The asset/liability matching policies for PTF and shareholders fund may be significantly different, according to their respective financial liabilities profiles, Therefore, PACRA would evaluate investment portfolio of the shareholders fund, PTF and PIF separately. An evaluation of liquidity of investments is a key area of PACRA s assessment process for takaful undertakings due to relatively greater concerns than for conventional insurers. This includes limited options available for investments decisions to takaful undertakings due to Shariah conditions and regulatory restrictions, creating concentration issues; e.g. as per SECP s Takaful Rules, 2005, every TO is required to invest 80% of PTF portfolio in Government Islamic instruments.
Financial Risk Solvency possibility of adverse developments in all areas of risk to which the PTF is exposed that the fund can meet claims (represented by technical reserves) The adequacy and sufficiency of creation of technical reserves in PTF is not subject to PARCA s assessment framework, for which PACRA would develop comfort level on the appointed actuary, responsible for determining appropriate level of reserves. The size of the fund is assessed keeping in view the policyholders liabilities. an assessment of TO available resources to meet its own financial and legal obligations includes the possible need to provide capital by way of a Qard-e-Hasna facility to PTF the terms and conditions of drawing down the facility by PTF, and TO s arrangements to earmark its assets as Qad-e- Hasna reserves remains critical part of this part of assessment.
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