On 18 November 2015, the IAIS and the IFSB published the final version of their paper on issues in the regulation and supervision of microtakaful. The paper focuses on three objectives:
• Identifying current practices and models for the provision of microtakaful products, and the challenges in offering them to target markets;
• Reviewing the current regulatory and supervisory framework for the microtakaful sector, and suggesting initiatives to strengthen this; and
• Providing guidance to regulatory and supervisory authorities on establishing an environment (and adapting current approaches) for the development and growth of the microtakaful sector.
Microtakaful has developed considerably over the last decade, particularly in Indonesia, Pakistan, India and Bangladesh. Takaful operators are increasingly interested in developing an effective microtakaful sector, not least for social objectives but also for the opportunity to develop customer loyalty as low-income populations become more affluent over time.
Challenges of microtakaful and comparison to takaful
While there are differences between microtakaful and takaful, they do not differ conceptually. Rather, microtakaful is a sub-set of takaful. The paper examines the differences between the markets for microtakaful and takaful, including:
• Types of providers: as takaful exists in a highly regulated environment, takaful providers must be licenced, meet minimum capital requirements, and have in place robust Shariah compliance and governance frameworks. Microtakaful, however, can be provided by a variety of operators, from sophisticated takaful providers and microfinance institutions to unregistered, unregulated informal entities.
• Types of participants: In comparison to takaful participants, microtakaful participants (who overlap significantly with users of microfinance) are likely to be underprivileged, and will have less exposure to financial products in general. On a related note, consumer education is considerably lower amongst microtakaful participants, who are therefore more vulnerable to mis-selling of microtakaful products. Participants therefore will need to be educated and protected, and supplied with appropriate educational information about the benefits of the products concerned.
• Product features and distribution channels: Takaful products may be relatively complex, and therefore require more sophisticated distribution channels so that features can be explained by providers and clarification sought by participants. Microtakaful products are more likely to be simpler and easier to understand, both in order to appeal to the target market and to remain affordable. Distribution channels for microtakaful also need to be low-cost and innovative.
No specific regulation of microtakaful
The IFSB and the IAIS undertook a survey on microtakaful in the third quarter of 2014. The findings confirmed that there is no specific regulation of microtakaful in place. The results also showed that, while microtakaful is not as widespread as takaful, it is a developing market with some institutions taking steps to provide coverage to low-income populations through low-contribution, simple products.
The regulatory and supervisory framework for microtakaful
External stakeholders
The paper sets out the various stakeholders who play key roles in the microtakaful sector, including:
• Governments – given that many low-income populations do not enjoy social security systems, such as Indonesia (where only 17% of the working population is covered by social insurance), they often rely on informal, mutual support arrangements. State agencies may able to promote awareness and understanding of the benefits of microtakaful, contribute to schemes, and help microtakaful providers deliver their products to their members.
• Regulatory and supervisory authorities are important in the microtakaful sector to protect more vulnerable populations, ensure that the products are tailored to the needs of participants, and provide proportionate supervisory requirements. They will also need to monitor the financial condition of providers in order to ensure that risks taken by them will not affect the takaful industry in the long-term. The paper remarks that tensions may arise where microtakaful initiatives are government-funded programmes and are regulated by government regulators.
The paper observes that, where microtakaful providers are unlicenced, they may not have access to the retakaful market. Microtakaful entities that are not regulated by the financial regulatory authorities but by other regulators may also pose a challenge, as they may not be subject to the stringent product development process required by financial regulators. The paper encourages regulators to consider re-examining the relevant regulations before allowing non-takaful entities to offer microtakaful products.
Internal stakeholders
Internal stakeholders include:
• Shareholders, who will need to be convinced that the microtakaful products offered will not jeopardise the profitability of the microtakaful provider. This can be achieved through stress testing of the microtakaful products, including carrying out profitability tests. However, shareholders will need to be in this market for the right reasons, take a long-term approach and be willing to sacrifice some of their expected financial returns for the sake of meeting social objectives.
• Shariah boards, which will carry out their usual supervisory roles, including approving specific microtakaful products. The paper emphasises that consistency in Shariah governance is vital to confidence in, and the growth of, the microtakaful sector. If a microtakaful provider does not have its own Shariah board, then it should outsource this function to a Shariah advisory firm.
• Board of directors – members of the board should be “fit and proper” and they should establish a sound and robust Shariah governance framework. The board should also be diverse – at least one of its members should be a member of the Shariah board. Consideration might also be given to having a representative of the participants on the board of directors.
• Participants – given that microtakaful participants are likely to be less-informed consumers, providers must ensure that they make efforts to simplify documents and complaints procedures, and take steps to make sure that participants understand the surplus-sharing mechanisms of the provider.
Guidance to regulatory and supervisory authorities
The paper highlights that the Insurance Core Principles as set out by the IAIS set out a proportionality principle, allowing for simpler and less burdensome ways of meeting regulatory requirements for low-risk activities whilst ensuring that appropriate enhanced regulatory supervision exists for more complex risks.
The paper emphasises that microtakaful providers must ensure that they make an appropriate judgment about, and ensure that participants understand the principles and practicalities in relation to, separation of funds and surplus sharing.
There is a general recognition that the very nature of the microtakaful market segment calls for the need to have a different regulatory approach in order to assist market participation by low-income sections of the population, who, under ordinary circumstances, would be excluded from the financial system. While, in an ideal world, microtakaful providers would meet all the IFSB-11: Standard on Solvency Requirements for Takaful (Islamic Insurance) undertakings, regulators need to bear in mind the size and complexity of the risks being underwritten by microtakaful providers.
Again, turning to risk management, while it would be ideal for microtakaful providers to put in place a risk management framework that met all the requirements of IFSB-14: Standard on Risk Management for Takaful (Islamic Insurance) undertakings, a proportionate approach needs to be adopted so that the risk management framework is appropriate to microtakaful providers.
Even then, it may not be easily implemented by microtakaful providers. Unregulated providers may not possess the expertise to assess the risks that relate to their business and put in place an appropriate control framework. The paper warns that various intermediaries involved in the distribution chain and the types of potential moral hazards involved in providing cover to microtakaful participants may not be captured in the risk management framework. As such, regulators must ensure that mechanisms are developed to capture the risks that unregulated intermediaries in the chain of business involved in microtakaful may bring into the financial system.
Regulators may also consider less strict underwriting requirements for microtakaful providers, given that their target markets may experience higher risk occupations and irregular income streams. For microtakaful initiatives to work, regulators should encourage a more flexible underwriting environment, and consider limiting the amount and coverage that may be provided by microtakaful providers. The Insurance Core Principles on capital adequacy and risk management allow for special consideration for insurance markets for the under-served, although exemption is not allowed. Instead of requiring microtakaful providers to provide elaborate regulatory reports, regulators may consider simplified reports that still allow them to gauge the financial strength of the provider.
As to licencing requirements, microtakaful providers should ideally be required to have a licence prior to being allowed to offer products. However, the paper recognises that this is not necessarily straightforward, given that some providers may not be regulated by the takaful sector. All providers should however meet minimum requirements of a robust business plan, evidence of sufficient financial resources, and where necessary, evidence of retakaful.
Recognise the requirements of microtakaful
Finding an appropriate balance in the regulation and supervision of microtakaful providers and their products is key to the growth of the market. The IAIS principle of proportionality has worked well in the development of microtakaful’s conventional counterpart, microinsurance. There is therefore good guidance to follow, but always recognising the specific requirements of microtakaful, including the foundation requirement for Shariah compliance.
Ms Susan Dingwall is a Partner and Mr Rahul Mansigani is an Associate with Norton Rose Fulbright LLP.