Takaful & IFRS on insurance contracts MASB Islamic Finance Master Class 21 November 2013
2 COMPETITION LAW CAUTION The participants in this event and the MASB shall not enter into any discussion, activity or conduct that may infringe, on the part of the participants or the MASB, the provisions of the Malaysian Competition Law 2010. By way of example, participants shall not discuss, communicate or exchange, any commercially sensitive information. DISCLAIMER The views and opinions expressed during the MASB event do not represent the official views of the MASB or necessarily represent the organisations that the participants belong to. Official positions of the MASB on accounting matters are determined only after extensive deliberations and due process. The materials presented during this event are intended to convey the general information only and they should not be taken as the official MASB view. Neither the MASB nor any member of the MASB Secretariat accepts responsibility or legal liability arising from or connected to the accuracy, completeness or reliability of the materials and information contained in this event. Participants are hereby advised that entity specific matters concerning the application of the MFRSs and the appropriate treatment should be addressed by the preparers with their respective auditors and/or their independent accounting advisors.
Agenda How takaful works Comparison with insurance Common takaful structures How to account for takaful IFRS 4 & IASB EDs AAOIFI FAS on Islamic insurance Other matters Presentation of financial statements Qard MIA Guidance on Special Matter No. 2 3
How takaful works Comparison with insurance. Common takaful structures. 4
What s wrong with insurance? Many contemporary Shariah scholars disapprove of insurance. Sale of an insurance policy is a defective sale. Some view insurance as sale of protection by insurer to a policy holder who pays premium as consideration. Protection is not a valid subject of sale under Shariah. Insurance may contain prohibited elements. Riba (interest) profit on investment may be from haram sources Gharar (uncertainty) policyholder s counter-value (i.e. protection) is of an uncertain nature and amount Maisir (speculation / chance) policyholder contributes small amount and hope to gain a larger sum policyholder loses if damages do not occur & insurer loses if damages occur 5
Why is takaful an acceptable alternative? Takaful is a modern innovation, based on accepted medieval risk-sharing practices. There is co-operation among participants. Participants contribute (donate) to a fund and mutually indemnify coparticipants by agreeing to compensate a participant if a pre-specified event adversely affects the participant. Takaful operator (TO) and participants are in a permissible contract. A licensed TO establishes participants funds and manages them for participants based on classical contracts. TO receives a fee and/or a share of profit from the fund s surplus, depending on the contract type. In case of a deficit in participants risk fund, regulators require TO to provide interest-free loan (qard), which will be repaid from future surpluses. Contributions on both family (life) and general takaful are divided into: Participants account (investment fund) Participants special account / tabarru account (risk fund) 6
How insurance/takaful works Premium Risk fund Participants special account (Tabarru ) Underwriting surplus Life/non-life and insurance company s portions of underwriting surplus and investment returns depend on contract and/or insurance regulations Contribution Investment fund Participants account Investment returns Family/general and TO s portions of underwriting surplus and investment returns depend on Shariah, structure, contract, takaful regulations Policyholder pays to insurer / TO Insurer / TO puts into separate funds Funds generate returns Policyholder & insurer / TO share returns 7
What s the difference? Concept Governing law Risk transfer Deficit in risk fund Life (family) fund Non-life (general) fund Insurance Takaful Accounting considerations Policyholder pays premium in return for protection by insurance company. Insurance regulations. Policyholder transfers risk to insurance company. Insurance company makes good a deficit, with expected recovery from future surplus. Life funds may or may not be legally separate from insurance company, depending on type and/or jurisdiction. Insurance company not contractually bound to allocate investment return between itself and general fund. Participant contributes to mutually indemnify coparticipants. Takaful regulations; shariah law. Participant transfers risk to a pool of participants. TO requires to extend interest-free loan, with contractual repayment from future surplus. Family fund assets are conceptually separate from TO, but not necessarily legally separate. TO must abide by contractual profit-share on investment return between itself and general fund. Pay same amount, expect same returns/compensation. Economic similarity? Does this lead to an economic difference? Pool of participants = insurer? Is expected recovery = contractual repayment? Has significant insurance risk passed to TO? Does TO control fund? Are separate financial statements prepared for the general fund? 8
Common takaful structures Mudarabah Wadi ah Yad Dhamanah Common contracts between TO and participants Wakalah Wakalah waqf Wakalah Mudarabah hybrid 9
Mudarabah (profit-sharing) model Participants = capital provider (rab ul mal) Takaful operator = entrepreneur (mudarib) Pure mudarabah TO shares in investment profit Underwriting surplus remains in risk fund Modified mudarabah TO may share in underwriting surplus 10
Wakalah (agency) model TO manages participants funds as an agent. TO receives a fee either a fixedfee or a percentage of turnover. 11
Wakalah-mudarabah (hybrid) model Wakalah model for underwriting Mudarabah model for investment 12
Wakalah waqf model Part of capital of shareholders fund is used to create waqf fund. Investment returns on waqf fund can be used to cover deficits in participants fund. Widely used in Pakistan and Africa. 13
Wadiah yad dhamanah model Wadiah yad dhamanah = Safekeeping with guarantee TO may charge participants funds a safekeeping fee. TO can utilise participants funds, as long as it honours its guarantee. TO may (or may not) share investment profits with participants through hibah. Underwriting surplus remains in risk fund. Questions: Is this similar to deposit-taking, or a loan to TO? Are those within a TO s license? 14
Retakaful Spreads takaful risk among various takaful operators. Retakaful operator receives wakalah fees and/or profit share (depending on the structure used). Reduce probability of bearing a large deficit in the participants funds that may trigger a large qard facility. 15
Malaysian body creates new Islamic reinsurance model BY LIAU Y-SING KUALA LUMPUR Thu Mar 18, 2010 7:04pm IST (Reuters) - Islamic finance researchers backed by the Malaysian central bank have developed a new wadiah retakaful model which could boost protection for sharia insurers. The structure aims to address some of the sharia objections to the popular wakala, mudaraba and hybrid models currently used by Islamic reinsurers who play a key role in the $14 billion takaful industry. Based on the contracts of wakala and wadiah yad dhamanah, the concept devised by the International Sharia Research Academy for Islamic Finance (ISRA) states that takaful players own the surplus from contributions paid into a fund. "The wadiah fund is owned by the takaful companies so there is no issue of ownership and with that you can resolve quite a number of other issues," ISRA Executive Director Mohamad Akram Laldin told Reuters by telephone. Under the pure wakala and mudaraba models now used, there are differences in opinions as to who is entitled to the surplus in the funds, with some companies sharing it with participants while others returning it to the participants only. Under the new model, takaful companies would contribute to a fund managed by an Islamic reinsurer. The reinsurer is paid an agent's fee and invests the fund or uses it for other purposes. The retakaful firm gets the profits earned from investments. Reserves and claims are deducted from the fund and the surplus is returned to the takaful companies. The system is similar to operating a current account with an Islamic bank which guarantees the principal, ISRA said. "It's sensible to say that these assets are owned by the participants in the fund rather than the retakaful operator," said Peter Hodgins, a Dubai-based takaful lawyer with Clyde & Co. "If you didn't have the ownership point, what happens in insolvency then starts to just look like a conventional reinsurance model ie. all of those assets in the fund are owned by the retakaful operator." The Kuala Lumpur-based ISRA said the new model would help takaful companies reach a wider market. "The return of the full surplus to participants complies with (industry body) AAOIFI guidelines," ISRA said in a report to brief industry players. "It will consequently result in a greater number of (takaful companies) that can do business with the retakaful operator." Akram said the wadiah model was not expected to affect the profitability of retakaful companies and would "motivate them to really find a good avenue (of investments). He said the concept would be refined taking into account industry feedback. Despite the entry of new players, the retakaful industry remains small and the limited capacity has been cited as a key factor holding back the global takaful industry. The world's largest retakaful company is ACR ReTakaful Holdings Ltd, owned by ACR Capital Holdings, the Dubai Group and Malaysian sovereign wealth fund Khazanah Nasional Bhd, with a paid-up capital of $300 million, according to its website. Other companies that have retakaful business include Swiss Re, Munich Re and Best Re. 16
How to account for takaful IFRS 4 & IASB EDs. AAOIFI FAS on Islamic insurance. 17
IASB s project on insurance contracts IFRS 4 (2004) Phase I: Interim standard to introduce limited improvements and disclosures. Temporary exemption from para 10-12, IAS 8. ED/2010/8 Phase II: Comprehensive recognition and measurement Building-block approach ED/2013/7 Revised exposure draft Improvements based on feedback to ED/2010/8 18
IFRS 4 Insurance contracts Definition of insurance contract Scope A contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder. In takaful, requirement to extend interest-free loan may expose TO to significant insurance risk as repayment is dependent on underwriting surplus. Applies to an insurance contract and a financial instrument with a discretionary participation feature. Exception to IAS 39 - Need not separate nor FV policyholder s option to surrender contract for a fixed amount. Unbundling of deposit components 19
IFRS 4 Insurance contracts Temporary exemption from para. 10-12, IAS 8 Para 10-12, IAS 8 use of judgement in developing and applying an accounting policy in absence of an IFRS Meaning? In practice, can continue to use existing insurance accounting policies. Changes in accounting policies If and only if change makes FS more relevant to economic decision-making needs of users. Liability adequacy test Assess whether recognised insurance liabilities are adequate, using current estimates of future cash flows under its insurance contract Impairment of reinsurance asset to P/L 20
IFRS 4 Insurance contracts Discretionary participation features (DPF) in insurance contracts Issuer may, but need not, separate guaranteed element from discretionary participation feature Guaranteed element liability DPF either liability or component of equity; shall not classify that feature as an intermediate category that is neither liability nor equity. If do not separate, whole contract is recognised as liability. May recognise all premiums as revenue Changes in liability recognised in P/L; changes in equity recognised as an allocation of P/L. DPF in financial instruments Above applies. Disclosures Explanation of recognised amounts Nature and extent of risks arising from insurance contracts 21
Example current accounting policies Takaful contract liabilities 22
Example current accounting policies Takaful contract liabilities 23
Example current accounting policies Revenue 24
IASB ED/2010/8 Insurance contracts Main proposal: Building blocks measurement model Initial measurement of insurance contract at the sum of: Present value of fulfilment cash flows A current estimate of future cash flows, i.e. outflows (claims and benefits) and inflows (premiums) A discount rate that adjusts those cash flows for the time value of money An explicit risk adjustment, i.e. estimate of effects of uncertainty about amount and timing of those future cash flows A residual margin Eliminates any gain at inception of the contract. Arises when fulfilment cash flows is less than zero (i.e. when expected present value of the future cash outflows plus risk adjustment is less than expected present value of future cash inflows) If present value of fulfilment cash flows is greater than zero (i.e. expected present value of future cash outflows plus risk adjustment exceeds expected present value of future cash inflows), the insurer shall immediately recognise that amount in profit or loss as an expense. 25
IASB ED/2010/8 Insurance contracts Subsequent measurement of insurance contract is sum of: PV of the fulfilment cash flows at that date, and the remaining amount of the residual margin. Residual margin is recognised in P/L over coverage period in systematic way Note: There is no provision to recognise any changes as adjustment to residual margin, i.e. residual margin is locked Statement of comprehensive income (SOCI) A summarised-margin approach Shall not present in SOCI Premiums, which are treated in the same way as deposit receipts. Claims expenses, claims handling expenses, incremental acquisition costs and other expenses included in the measurement of the insurance contract, which instead are treated in the same way as repayment of deposits. An entity shall present all income and expense from insurance contract in P/L Note: There is no provision to recognise any changes in OCI. 26
2010 ED: Insurance contract liability Initial measurement Scenario 1 PV FCF < 0 Scenario 2 PV FCF > 0 EPV outflows 690 990 Risk adjustment 30 30 EPV inflows (900) (900) PV fulfilment cash flow (180) < 0 120 > 0, recognise P/L expense Residual margin 180 0 Insurance contract liability 0 120 Residual margin is locked and recognised in P/L over coverage period. Subsequent measurement Changes recognised in P/L 27
IASB ED/2013/7 Insurance contracts Limited revision and re-exposure. Main changes: Unlock contractual service margin (CSM), previously called residual margin. Recognise changes in discount rate in OCI. New measurement for contracts that with cash flows that vary with returns on underlying items, i.e. participating New definition of revenue in the statement of comprehensive income Transitional provisions 28
2013 ED: Unlocking CSM Why unlock CSM? To faithfully represent that prospective profit may be higher or lower due to more accurate estimates of future cash flows. 2013 ED proposes the remaining amount of CSM at the end of the reporting period is: Carrying amount at starting period + interest accreted - amount recognised for services provided + favourable difference between current and previous estimate of cash flows - unfavourable change in cash flows See paragraphs 30-31, B68, BC25-BC41 and IE9-IE11 29
2013 ED: Changes in discount rate to OCI Why put changes due to discount rate in OCI? In 2010 ED, all changes in discount rate flow to P/L. Insurer s performance may be distorted by short-term fluctuations in market interest rates. 2013 ED proposes an entity should recognise In P/L interest expense on insurance contract liabilities determined using discount rates that applied at the date that the contract was initially recognised. In OCI the difference between the carrying amount of the insurance contract measured using the discount rates that applied at the reporting date; and that applied at the date the contract was initially recognised. See paragraphs 60-68, BC117-BC159 30
2013 ED: The mirroring approach What is the mirroring approach, and why is it needed? Some insurance contracts have cash flows that vary with returns on underlying items, i.e. there is no economic mismatch. But if the insurance liability and the underlying items are measured on different bases, there may be an accounting mismatch. In these cases, insurance liability measurement should mirror measurement of the underlying items. 2013 ED mirroring approach applies if the contract Requires entity to hold underlying items, such as specific assets, an underlying pool of insurance contracts, or assets and liabilities of an insurer as a whole; Specifies a link between payments to policyholder and the returns on those underlying items. At initial recognition and subsequently, Measure fulfilment cash flows that are expected to vary directly with returns on underlying items by reference to the carrying amount of the underlying items. If not, measure in accordance with building block approach. 31
2013 ED: The mirroring approach In SOCI, recognise changes in fulfilment cash flows as follows: Type of linkage Expected to vary directly with returns on the underlying items Expected to vary indirectly with returns on the underlying items Not expected to vary with returns on the underlying items In SOCI In P/L or OCI, on same basis as recognition in value of underlying asset In P/L In P/L and OCI in accordance with building blocks approach See paragraphs 33-34, 66, B83-B87, BC42-BC71 and IE23- IE25 32
2013 ED: New presentation for revenue and expenses 2010 ED proposed that SOCI show summarised margins Prohibited presentation of premiums, claims expenses, claims handling expenses, incremental acquisition costs and other expenses Feedback showed that stakeholders wanted information on volume and gross performance 2013 ED introduces new presentation of insurance contract revenue and expenses See paragraphs 56-59, B88-B91, BC73-BC116 and IE12-IE18 Change in risk adjustment for future coverage Changes in contractual service margin Expected claims and benefits for the period Insurance revenue Source: IASB 33
2013 ED: New presentation for revenue and expenses Source: IASB 34
2013 ED: Statement of comprehensive income Statement of comprehensive income Insurance contract revenue Incurred claims and expenses Operating result Investment income Interest expense on insurance liability Investment result Profit or loss Effect of discount rate changes on insurance liability Total comprehensive income X (X) X X (X) X X (X) X New presentation of revenue and expenses Interest on insurance liabilities using discount rates that applied at initial recognition Change in interest expense due to changes in discount rate 35
2013 ED: Transitional provisions 2010 ED required prospective application Feedback was negative, as unearned profit would not be carried forward. 2013 ED requires Retrospective application, when practicable Modified retrospective application, if not practicable See paragraphs C1-C13, BC160-BC191 36
In a nutshell IFRS 4 (2004) 2010 ED 2013ED Measurement of insurance contract liability Temporary exemption. Various accounting policies existed in practice. Proposed building blocks approach comprising: - Fulfilment cash flows - Residual margin Main change: Unlock contractual service margin (previously called residual margin) Presentation of revenue and expenses Contracts with link to returns on underlying items Change in EPV cash flow due to change in discount rate Temporary exemption. Various accounting policies existed in practice. Allowed shadow accounting Proposed summarisedmargin presentation. General requirement to measure insurance contract liability on the basis of all expected cash flows Main change: New revenue presentation Main change: Mirroring approach N/A Recognise in P/L Main change: Recognise in OCI Transition N/A Prospective Main change: Retrospective, if practicable Modified retrospective, if not 37
Other notable changes IFRS 4 (2004) 2010 ED 2013ED Noninsurance component Unbundling may be required, permitted or prohibited depending on criteria met. If not closely related to the insurance coverage, shall apply another IFRS to that component. Separation of embedded derivatives, distinct investment components, performance obligations and other remaining components. Exception for separation of policyholder s option to surrender contract. IAS39 applies to embedded derivative, unless it is itself an insurance contract See above. Simplified approach (premiumallocation) N/A Short-duration contracts 1 yr: Measure pre-claims liability by allocating premium over coverage period. Measure claims liability using building block approach for insured events that have occurred. May use premium-allocation approach if: - Reasonable approximation to building blocks approach; or - Coverage is 1 yr DPF Financial instruments with DPF are within scope. New condition that the investment contract must participate with insurance contracts in the same pool of assets, company, fund or other entity. Modified requirements for investment contract with a discretionary participation feature. 38
AAOIFI FAS on Islamic insurance FAS No. 12 General Presentation and Disclosure in the Financial Statements of Islamic Insurance Companies Prescribes disclosures FAS No. 13 Disclosure of Bases for Determining and Allocating Surplus or Deficit in Islamic Insurance Companies Prescribes disclosures FAS No. 15 Provisions and Reserves in Islamic Insurance Companies Prescribes definitions of various reserves Prescribes computation of certain technical reserves FAS No. 19 Contributions in Islamic Insurance Companies Applies to contributions on the basis of donation to general insurance; and donation to insurance on persons Earned contributions recognised in Statement of Policyholders Revenue and Expenses Unearned contributions recognised in liability 39
Why don t we use AAOIFI FAS? Lacks robust measurement principles. Uses concept of contribution in revenue recognition. Computation of technical reserves is an actuarial matter; not financial reporting. BUT, entities may apply AAOIFI FAS disclosure requirements, if not in conflict with IFRS/MFRS. 40
Other takaful matters Presentation of financial statements. Qard. MIA Guidance. 41
Presentation of takaful financial statements Does a TO control the participants funds it manages? This would determine the type of FS: Separate financial statements Combined (aggregated) financial statements Consolidated financial statements IFRS requires either Separate or Consolidated; no Combined FS. Malaysia Before 2013, combined FS (TO + Family + General) plus separate FS for Family and separate FS for General 2013 onward, consolidated FS (TO + Family + General ± inter-entity adjustments) plus separate columns for TO, Family, General Globally, divergent presentations 42
Qard In separate FS of TO, how should a Qard receivable be measured? Is it a financial instrument? If so, is it AC, FVOCI or FVTPL? Is it an expense? Isn t covering deficits a normal cost of running insurance/takaful business? Is it investment in subsidiary? (??!) See MIA Guidance on Special Matter No. 2 43
MIA Guidance on Special Matter No. 2 Presentation of financial statements for takaful companies Paragraph 6.2 of the Bank Negara Malaysia s Guidelines on Financial Reporting for Takaful Operators ( BNM Guidelines ) requires TOs to present the assets and liabilities of the TFs separately from the assets and liabilities of TOs. However, MFRS requires consolidated financial statements of a TC to be prepared and presented when the TO could demonstrate its control over the respective TFs. To ensure compliance with both MFRS and the BNM Guidelines, the financial statements for TCs shall be presented, where: a) Financial positions of the TO, each of the TFs and the TC (on a consolidated basis) are presented in columnar format on the face of the statement of financial position of the TC; b) Financial performance of the TO, each of the TFs and the TC (on a consolidated basis) are presented in columnar format on the face of the statement of comprehensive income of the TC; and c) Retained earnings/accumulated losses of the TO, each of the TFs and the TC (on a consolidated basis) are presented in columnar format on the face of the statement of changes in equity of the TC; and d) Relevant notes for the above. In preparing and presenting the financial statements in this manner, the following should be addressed: a) Every line items of income and expenses as well as assets and liabilities of the TO, each of the TFs and the TC should comply with the recognition and measurement principles of MFRS; b) Deficit of TFs should be reported as a loss in the financial statements of TFs and TC as losses are recognised in the income statement when there is a decrease in future economic benefits related to a decrease in asset or an increase in a liability in accordance with the Conceptual Framework for Financial Reporting ; and c) Intragroup transactions and balances (i.e. transactions and balances between TO and each of the TFs and transactions and balances between the TFs) should be eliminated in full upon consolidation. 44
MIA Guidance on Special Matter No. 2 Classification and measurement of Qard in the statement of financial position of TO From the TO s perspective, Qard is in substance, an investment by the TO in TFs. The Qard, although is refundable by the TF when it has surplus assets, carries more features of an equity instrument rather than a debt instrument because: Its recoverability is dependent on the performance of the underlying assets and liabilities of the TF; It is only provided in specific circumstances i.e. when the TF has a shortfall of assets to cover its obligations; It does not have a fixed repayment period; It acts as a temporary capital to determine that the TF will be able to continue as a going concern and provides returns to the operator via profit sharing or management fee arrangements; As it can only be refunded via surplus assets of the TF, it is subordinated below other liabilities of the TF. Since a TF is controlled by the TO, pursuant to MFRS 127 Separate Financial Statements and as required under BNM Guidelines, such investment should be carried at cost less any accumulated impairment losses. 45
2012 Statement of financial position 46
2012 Statement of financial position (cont.) 47
Thank you. Any questions? 48