Accounting, Auditing and Governance for Takaful Operations

By Sheila Nu Nu Htay, Mohamed Arif, Younes Soualhi and 2 more

A comprehensive guide to current issues and practices in governance for Takaful and re-Takaful operations

As the global demand for Islamic insurance products increases, a thorough understanding of Takaful principles is vital for accountants, auditors, and leaders of companies offering these products. This book covers the basic accounting principles and practices of Takaful operations, including the segregation of assets, liabilities, income, and expenditures between the Takaful operator and participants; the setting aside of cash reserves for meeting outstanding claims and future claims; and the management of revenue and expenditure. Featuring extensive case studies from real-world situations, this book is the perfect primer for accounting students and practitioners unfamiliar with Islamic finance and Takaful operations.

• Written by experts from the International Islamic University Malaysia, the leading organisation in research in Islamic finance
• Covers all the major accounting principles and practices
• Based on real-world experience and packed with illustrative case studies

For practicing accountants and business leaders, this book offers a thorough education in Takaful operations while also serving as an excellent guide for undergraduate students and researchers.

• Language: English
• Publisher: Wiley
• Release date: Sep 24, 2012
• ISBN: 9781118503966

Book preview

Contents

Foreword

Preface

Acknowledgments

Chapter 1: Introduction to Takaful and Retakaful

Learning Outcomes

Introduction

History of Insurance and Takaful

Differences between Takaful and Conventional Insurance

Shariah, Legal, and Regulatory Framework of Takaful

The International Association of Insurance Supervisors (IAIS) and Islamic Financial Services Board (IFSB)

Different Types of Takaful Models

An Overview of Retakaful

Conclusion

Chapter Questions

Notes

References

Chapter 2: Takaful Companies and Their Accounting Environment

Learning Outcomes

Introduction

The Concept of Accounting in Business and Its Historical Development

Malaysian Accounting Environment

International Accounting Standard Setting Bodies

Malaysian Insurance Institute

Conclusion

Chapter Questions

References

Chapter 3: Prevailing Accounting Standards and Accounting Entries for Takaful Operators

Learning Outcomes

Introduction

Guidelines on Financial Reporting for Takaful Operators

AAOIFI FAS 12: General Presentation and Disclosure in the Financial Statements of Takaful Companies

AAOIFI FAS 13: Disclosure of Bases for Determining and Allocating Surplus or Deficit in Takaful Companies

AAOIFI FAS 15: Provisions and Reserves in Takaful Companies

AAOIFI FAS 17: Investments

AAOIFI FAS 18: Islamic Financial Services Offered by Conventional Financial Institutions

AAOIFI FAS 19: Contributions in Takaful Companies

Accounting Entries

Conclusion

Chapter Questions

References

Chapter 4: Financial Statement Analysis

Learning Outcomes

Introduction

Financial Ratios for General Takaful Funds

Financial Ratios for Family Takaful Funds

Financial Ratios for Shareholders’ Funds

Conclusion

Chapter Questions

References

Chapter 5: Zakat Computation and Distribution for Takaful and Retakaful Companies

Learning Outcomes

Introduction

Zakat and the Islamic Worldview

Zakat Computation Methods (AAOIFI)

Suggested Disclosure Information

Conclusion

Chapter Questions

Notes

References

Chapter 6: Auditing and Governance for Takaful Operators

Learning Outcomes

Introduction

An Overview of the Auditing Standards

Suggested Guide for Shariah Audit

Practical Implementation

Governance for Islamic Finance

Conclusion

Chapter Questions

References

Appendix 1: Sample Audit Proposal

Appendix 2: Audit Plan Timeline

Appendix 3: Audit Program

Appendix 4: Report on Shariah Compliance Audit for Takaful X Sdn. Bhd. as of 31 March 2011

Contents

1. Executive Summary

2. Aims and Objectives

3. Background/Introduction

4. Shariah Audit Methodology

5. Shariah Audit Findings and Result

About the Authors

Index

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Foreword

The establishment of an Islamic bank in Malaysia, in the early 1980s, generated significant interest in the populace for an institution that would fulfil a prevailing need for an alternative to conventional insurance in order to complement and supplement the insurance needs of Islamic banking. This interest, coupled with a fatwa declaring conventional insurance as a void contract due to its Shariah-noncompliant elements, issued by the Malaysian National Fatwa Council in 1972, prompted the government to establish a working team of Islamic scholars, legal experts, and insurance practitioners, called the Special Task Force to Study the Incorporation of an Islamic Insurance Company in Malaysia. I was afforded the privilege of serving as a member of the Task Force. Arising out of the recommendations of the Task Force, a Takaful Act was enacted in 1984 and the first takaful operator was incorporated in November 1984.

Since its inception the Malaysian takaful industry has seen monumental growth, from a single entity with relatively limited products, to one that is well integrated into the mainstream financial system. Over the years the industry has registered double-digit growth constantly, and has proven to be extremely resilient despite the intense competition from a well-established, well-financed conventional insurance sector, as well as economic upheavals. The efforts of the takaful operators as well as Bank Negara have to be commended. It was these resolute efforts that made the achievements of the Malaysian takaful industry possible.

As a person who built its foundation and had been working in the Malaysian takaful industry for more than two decades and seen its development first hand, I cannot help but feel extremely proud—proud not only of the phenomenal growth the industry has already achieved but mostly of the fact that takaful keeps on growing by leaps and bounds, pointing to an extremely bright future. However, in our pride we should not ignore the challenges facing the industry. One such challenge is talent development. To maintain such rapid growth the industry demands adequate supplies of knowledgeable and competent human talent. The operators are constantly on the lookout for human talent that would take the industry to the next level.

Malaysia has medium- and long-term plans to develop this requisite human talent. A key component of these plans is academic programs offered by various educational institutions. For these programs to be successful, proper materials, including books, are needed. Lack of books and writings on takaful was a key challenge that we faced during the initial development of takaful. Today this is not so. There are a number of books available on takaful. However, there is still a noticeable lack of books on specialised areas of takaful—accounting and auditing are two such areas. As such, this book is not just another book on takaful. It does fill a gap. It is written in a language that is straightforward and easy for an average man to understand, and at the same time avoids oversimplification that might put off professionals. This book provides a one-source alternative for knowledge of every aspect of takaful operations—from the basic principles to accounting entries. I take this opportunity to thank the authors for their efforts in writing this book, which I am sure will form a must-read for anyone interested in takaful. May Allah make this effort a success and bless their future endeavours.

Dato’ Mohd Fadzli Yusof

Preface

What started as a search by Muslim scholars and political economists for an alternative to the economic and financial system forced upon the Muslim world after their colonisation has today developed into a thriving industry that has witnessed rapid evolution and expansion within the past decade. This is visible not only in the Islamic world but in the Western world as well, signifying its robustness and vigor in the face of the financial crises that rocked the major economies of the world. It is no longer a product offered to a niche market but a genuine financial alternative with presence in more than 60 countries of the world with assets worth billions of dollars.

What started as a collection of mostly banking institutions has evolved into a comprehensive system consisting of a robust takaful (Islamic insurance) sector as well as other nonbanking financial institutions. While the success of Islamic finance is typically signified by the number and strength of Islamic banking institutions, the role of takaful should not be underestimated. The success and development achieved by the takaful sector is especially impressive when it is placed in the context of insurance penetration rates in Muslim countries, which typically tend to be very low.

In contemporary times, Islamic finance is considered one of the fastest-growing areas of international finance. The span of Islamic finance and takaful is growing remarkably fast not only in the Gulf region but also in non-Muslim countries. Expansion in the takaful business has been robust in recent times.

The demand for takaful and different takaful products is quite strong and consequential. Islam is the fastest growing religion and constitutes the second largest religion in the world. Present era Muslims are looking for religion-based solutions to the problems they face.

The achievements of the takaful sector and the potential for future growth, underlined by increasing affluence and positive demographic changes, paint a very positive picture of the future for the industry. To reach its potential, the sector has to be anchored on stable institutional foundations—none more important than human capital. Institutions such as the IIUM Institute of Islamic Banking and Finance (IIiBF) have already put in place robust programs to develop talents that would take the Islamic finance industry to the next level. This book is aimed at providing proper material that can be used as a part of academic curriculums of such a program.

A comprehensive curriculum needs to address each and every aspect of the program and needs to be supplemented by easy-to-get references, including textbooks. While there currently are a multitude of books on Islamic finance in general and takaful specifically, there seems to be a lack of texts on the accounting and auditing aspects related to takaful. This book is aimed at filling this gap. It is hoped that this book can help guide the educational journey of students interested in takaful as well as act as a useful reference guide to accounting and auditing practitioners in the takaful sector and the Islamic financial industry at large.

About the Contents

Chapter 1 is presented as an introduction to takaful (Islamic insurance). Through the discussions in this chapter, the reader should be able to grasp a basic understanding of the history and development of conventional insurance as well as takaful. This discussion also encompasses the differences between these two concepts. Furthermore, this chapter also explains the Shariah, legal and regulatory framework behind takaful operations, as well as the basic takaful models being practised around the world.

Chapter 2 focuses on accounting and its relationship with takaful operators. This chapter starts out with a brief explanation of what accounting is and how it was developed. After that, the discussion is aimed at providing a brief look at the operating environment of takaful operators—specifically the accounting and governance aspects. This includes the accounting and governance standards and guidelines as well as the organisations that set them. The discussion in this chapter is mostly focused on the standard-setting organisations and institutions.

Chapter 3 provides a detailed look at the financial reporting requirements of a takaful operator. The emphasis of this chapter is mostly on the requirements of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) standards for takaful operators. Furthermore, this chapter also provides typical journal entries that a takaful operator has to pass in order to record its transactions, including retakaful.

Chapter 4 discusses financial statement analysis. The discussion is from the perspective of a takaful operator; hence, it is different from a typical financial statement analysis. The ratios discussed in this chapter include underwriting, profitability, as well as liquidity ratios. The ratios are grouped according to the source of funds—general takaful fund, family takaful fund, and shareholders’ fund. Readers should be able to calculate the ratios as well as describe the results and make sense of the financial statements of a takaful operator after reading this chapter.

Chapter 5 focuses on zakat—computation and distribution—for takaful operators. The discussion starts with an introduction to zakat and its relationship to the Islamic worldview. After that, the discussion moves on to zakat computation for takaful operators. The discussion here is based on the methods suggested by the AAOIFI. After discussing computation, the chapter ends with a look at the disclosure requirements as suggested by the AAOIFI.

Chapter 6 provides a detailed look at the auditing and governance standards that a takaful operator has to follow. The standards discussed include those set by the AAOIFI, the Islamic Financial Services Board (IFSB), Bank Negara Malaysia (BNM), and Bursa Malaysia.

Background and Readership

This book is intended as an introduction to accounting, auditing, and governance issues related to takaful operations for students, practitioners, and the general public who may be interested in the inner workings of the takaful industry. With this readership in mind, the book has been written in such a way that a reader would have no difficulty understanding the content. Special care was given to ensure that less technical jargon was used and that the language was kept as simple as possible. Similarly, with the potential dryness of the subjects being discussed in mind, every attempt has been made to keep the discussion interesting through the use of easy-to-understand examples and figures.

Although the book is seen as an introduction to accounting, auditing, and governance issues related to takaful operations, we have assumed that readers will be acquainted with the very basic concepts of Islamic finance. As an integral part of the burgeoning Islamic finance landscape, proper understanding of takaful requires an understanding of Islamic finance. Despite the importance of Islamic finance as a theoretical foundation for the issues being discussed in this book, it is not within the scope of this book to discuss those principles.

Relationship with Other Books

While a large number of books have been written on Islamic finance and to a slightly less degree on takaful, books concentrated on accounting and auditing for takaful operators are extremely limited. Although takaful is unique as a product and industry, students and practitioners currently do not have any references on accounting and auditing techniques, principles, and procedures applied and used by takaful operators. The only alternative they have is to rely on books written on accounting for insurance companies. However, the unique nature of takaful makes this an unsatisfactory compromise. While students and practitioners do have limited books on accounting for Islamic financial institutions available for reference, the institutions focused on in these books are mostly banks and other similar institutions. Therefore, this book is targeted at filling this gap.

While the writers view the material related to accounting and auditing presented in this book as mostly unique, the reader can refer to a number of other books to gain knowledge of basic Islamic finance concepts to act as a foundation and, at the same time, to enhance their understanding of basic takaful principles and operations discussed in this book.

Acknowledgments

In the Name of Allah, The most Gracious, The most Merciful.

All praises and thanks to the Almighty Allah (SWT) and peace and blessings are upon our beloved Prophet Muhammad (SAWS), his family, and his companions. Whose patience and steadfastness in hard times stand as a model for humanity.

First and foremost, we would like to thank and praise Allah for blessing us with the ability and perseverance to complete this book. For without His blessing and mercy, this book would not have seen the light of day.

The mission of organising this book has been deeply facilitated by the sincere assistance and encouragement of many persons, who have contributed directly or indirectly towards this effort. It is our obligation to acknowledge these contributions and thank them.

Sincere and special thanks are due to Wan Zamri Wan Ismail, consultant (takaful), first international consultant (FIC). His assistance, encouragements, and cooperative behaviour were instrumental in the completion of this book.

Furthermore, our deepest thanks to Mr. Mustapha Hammat (Distinguished Fellow, Institute of Islamic Banking & Finance, IIUM) and Dato Professor Dr. Mohd Azmi Omar (Director, Islamic Research and Training Institute) for their kind support, assistance, and invaluable guidance.

In addition, we would also like to extend our infinite gratitude and thanks to all the IIiBF staff.

Last but not least, our thanks and appreciation to all those who contributed towards the completion of this book.

May Allah bless and repay their kindness and bestow his blessings on all of you.

CHAPTER 1

Introduction to Takaful and Retakaful

Learning Outcomes

After reading this chapter, you will have:

1 A basic understanding of the history and development of insurance (conventional insurance) and takaful as well as an awareness of the differences between these two concepts.

2 An understanding of Shariah, the legal and regulatory framework behind takaful, including Shariah principles, legal requirements, and regulatory agencies.

3 Knowledge of the basic takaful models being practised around the world.

Introduction

Although this book is mainly aimed at explaining the accounting treatment for takaful operators, it is important for readers to acquire a basic understanding of the history and principles behind takaful operations in order to fully appreciate the setup of takaful operators. For this reason, Chapter 1 provides a brief history of insurance and takaful as well as a brief look at the principles behind takaful.

History of Insurance and Takaful

History of Insurance (Conventional Insurance)

Conceptually, insurance is a form of risk management primarily used to hedge against the risk of a contingent loss. Insurance is defined as the equitable transfer of the risk of a loss from one entity to another in exchange for a premium and can be thought of as a guaranteed and known small loss to prevent a large, possibly devastating, loss. An insurer is a company selling the insurance; an insured or policyholder is the person or entity buying the insurance. The insurance rate is a factor used to determine the amount to be charged for a certain amount of insurance coverage, called the premium.

Historically, the Chinese and Babylonian traders practised the early methods of transferring or distributing risk as long ago as the third and second millennia b.c., respectively. A thousand years later, the inhabitants of Rhodes invented the concept of the general average. Merchants whose goods were being shipped together would pay a proportionally divided premium which would be used to reimburse any merchant whose goods were jettisoned during storm or sinkage.¹ The Greeks and Romans introduced the origins of health and life insurance around 600 a.d. when they organised guilds called benevolent societies, which cared for the families and paid funeral expenses of members upon death. Before insurance was established in the late seventeenth century, friendly societies existed in England, in which people donated money to a general sum that could be used for emergencies. The devastating effects of the Great Fire of London in 1666 (which destroyed more than 13,000 houses) converted the development of insurance from a matter of convenience into one of urgency.²

And modern insurance can be traced back to its beginnings in the 1600s, when British merchants and ship owners began to meet at a coffeehouse near Lombard Street in London, called Lloyd’s, where they made an agreement to mutually share