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Saturday, 19 July 2014

Takaful: Towards Deepening Insurance Penetration

The universal objective of financial inclusion is to facilitate the establishment and delivery of suitable and affordable financial services for the underserved or disadvantaged segments of all human population regardless of race or religion.
Addressing the constraints for building inclusive financial sectors is, therefore, paramount in helping to improve the lives of people through the creation of sustainable financial services in the society.
Therefore, considering the significant number of the financially excluded segment of the population in the world today, which constitutes more than 2.5 billion working age adults, it is remarkable to indicate that non interest finance can be a very important tool for the promotion of financial inclusion, not only in Nigeria, but the whole world.
One of the major obstacles identified in the universal fight against the prevalence of financial exclusion is the lack of financial literacy among the populace. The observed gap in financial literacy is especially wide among women and of course the less educated segment of the society. Therefore, it is evident that people often lack the ability to save and manage their little earnings for effective personal financial decisions.
For instance, lack of financial education leads many people to erroneously understand insurance as something that can only be done when there is disposable income. This idea forms the basic understanding on risk and the need for mitigating against it among many people.
Perhaps, in order to improve on the issue of financial literacy, the Organisation for Economic Co-operation and Development (OECD) initiated a project in 2003 to develop common financial literacy principles that will serve the needs for global financial education.
Many other countries have also identified their various financial educations needs and have developed strategies towards closing these gaps. The key important areas that require proficiency in personal finance include saving, investment, tax, insurance and retirement among others.
Additionally, the drive towards non interest finance can never be comprehensive without establishing the necessary regulatory framework for non interest mechanism of risk mitigation like the Takaful insurance.
This was the main reason at the completion of its assignment in 1983, the Malaysian Committee on Islamic banking framework, recommended that a special task force be established to study the practicability of islamic insurance (the Takaful).
This was suggested in order to draw up an appropriate legal framework which is feasible for complementing risk management in all non interest banking operations.
It was this process that later heralded the evolution of the pioneering 1984 Malaysian Takaful Act. Prior to that, Takaful as an alternative to conventional insurance was first practiced in Sudan in 1979.
The application of risk management mechanism in Islamic history can be traced to the practice of paying blood money (Diyyah) for manslaughter by members of the Arab clan and that of mutual indemnification among co-workers (Dawaniyya) during the reign (634-644 CE) of Caliph Umar al-Khattab (ra).
These early Arabian risk mitigation practices are today recognised as insurance products. Indisputably, these traditions inculcate and connotes that a Muslim is expected to have an appetite for risk management. Risk and uncertainty are part and parcel of every human endeavour; therefore, it is innate for people to prepare themselves against unforeseen financial or physical loss.
For that reason, one can declare without fear of contradiction that Islam not merely recognises insurance but encourages the practice of insurance as a lawful method for risk management. However, the question that always springs to mind is that if insurance is not prohibited in Islam why then do a majority of Muslims exhibit their overt repugnance over insurance issues?
Many Muslims miscomprehend the role of insurance in Islam and argue that it is forbidden and goes against the belief in the will of Allah whereas the World Fiqhi bodies have collectively issued a favourable ruling for practicing “Takaful” as the Islamic substitute for conventional insurance.
Therefore, allegations on the position of insurance in Islam are all based on sheer misconceptions caused by unawareness or lack of interest on the subject matter because Islam as a way of life sets standards for the conduct of all aspects of human existence.
There are some fundamental elements which made it necessary for Islamic law (Shari’ah) to negate the practice of conventional insurance business. Islamic law explicitly forbids the involvement in any form of any action that is associated with excessive uncertainty (Gharar), gambling (Maisir), and interest (Riba).
Moreover, we can safely infer that the Takaful is not a new phenomenon for some countries in Asia, Middle East, Europe and America because long before the dawn of the 21st century, many countries have realised the need for the development and implementation of inclusive financial products.
In the same vein, the United Kingdom Department for International Development and many international NGOs have since taken the lead in aiding the research and promotional development on financial inclusion in many parts of Asia and Africa.
This has given much impetus for the development of suitable financial products, to those with ethical and faith related reservations towards the practice of conventional finance.
Against this backdrop, the National Insurance Commission NAICOM initiated and and and crafted market development strategies for the industry under the MDRI project. The development of the Takaful Insurance operational framework happens be one of those strategies targeted for accomplishment by the commission as the Nigerian insurance regulatory authority.
Remarkably, the implementation of the Takaful Insurance framework was launched by the NAICOM in November 2013, after the unveiling of the Takaful Insurance Guideline ceremony performed by the then minister of state for finance, Mr Yerima Lawal Ngama, in Lagos.
This landmark achievement clearly indicates that the Nigerian insurance regulator has tremendously given the Takaful Insurance all the attention and supports it required without any prejudice.
The Nigerian insurance industry and all interested stakeholders are expected to take the full advantage of this remarkable initiative towards the expansion of a new business frontier for the betterment of the economy.
Interestingly, the target market for the Takaful in Nigeria is large and recent reports from the few existing window operations indicate the attainment of 70 per cent penetration.
Based on the Financial Services Access survey 2012 conducted by a non-governmental organisation (NGO), Enhancing Financial Innovation and Access (EFInA), there are strong indications that with suitable operational framework like that of the Takaful, proper public education and awareness on the benefits of insurance and how it works, 35.9 million adults who constitute 41.4 per cent of those without insurance in Nigeria could be included in the insurance market.
The experience in other jurisdictions like Asia and Middle-East also depicts the prospects of healthy and viable business conditions.
According to the 2012 World Takaful Report prepared by Ernst & Young, United Kingdom (UK), global Takaful contributions rose from 19 per cent in 2010 which amounts to $8.3 billion to $12 billion in 2013. With this exponential growth trend, the Takaful contribution is, therefore, expected to reach $25 billion by the end of 2015. No doubt, the implementation of the Takaful Insurance will open up another exciting opportunity for the development and growth of the Non-interest Financial Institutions (NIFIs) in Nigeria.
Therefore, one may infer without fear of contradiction that the success of the Takaful operations is certainly going to secure the needed business environment for the operations and the stability of all other non interest financial institutions in the country.
The prospective Takaful insurance operators may have to look beyond these perspectives by coming up with innovative Takaful insurance products that shall suit the specific needs of its potential market in Nigeria.
However, the predictable emerging challenge for the Takaful Insurance business can be observed in the following important areas: consumer awareness, investment restrictions, liquidity management, re-takaful arrangement, market development, capacity building, availability of Advisory Council of Experts (ACE) and the continuous professional development for the ACE.
These challenges must be seen as very imminent and requires urgent strategic plans for the smooth take off by the new Takaful operators.
(Leadership Newspapaer / 18 July 2014)
Alfalah Consulting - Kuala Lumpur:
Islamic Investment Malaysia:

Turkey: Prominence Of Sukuk In Turkey As An Islamic Finance Instrument

Turkey's first regulation for Islamic Finance was realized during the 1980s, during a period of liberalization as part of a plan to attract foreign direct investments. Interest free banking was introduced with the legalization of "special finance houses" which did not possess bank status and therefore did not benefit from banks' privileges.

The Islamic Finance sector kept evolving steadily in the 1980s and 1990s with Arab Gulf investors setting up finance houses and commencing lending activities, accommodating mainly specific religious clientele.

The leap for interest free banking came after the 2001 economic crisis. Banking finance legislation went through a major overhaul after the crisis. A union was formed to provide a certain level of state control and support for special finance houses. 2006 saw the introduction of Banking Law No. 5411, which legitimized participation banking and provided insurance through the Savings Deposit Insurance Fund for participation deposits. Along with these changes, the special finance houses union became the Participation Banks Association of Turkey ("TKBB"), which sets forth the ethical, professional principles for participation banks. All participation banks had to be a member of TKBB. The following years saw a rapid increase in participation banking and the 2008 global crisis highlighted the need for more stable financing. In line with the government's support of Islamic Finance and interest free finance instruments, the World Bank Global Islamic Finance Development Center was launched on the premises of the Istanbul Stock Exchange in late 2013.

Sukuk Financing

Turkey had various previous experiences with interest free financing in the form of profit-loss sharing certificates and real estate certificates mainly used for the financing of large infrastructure and construction projects. The issuance of sukuk was initially regulated with the Capital Markets' Board ("CMB") Communiqué Series III, No. 43 on Lease Certificates and Asset Lease Companies ("Communiqué Series III, No. 43") in 2010. Communiqué Series III, No. 43 regulated lease certificate (sukuk) issuance in a broad manner without specifics and several issuances were realized under it. In 2013, it was abolished by the Communiqué Series III, No. 61 on Lease Certificates ("Communiqué"). In 2012, Law No. 6327 was introduced allowing for the Undersecretary of Treasury to issue sovereign lease certificates. Statistics of the Organization of Islamic Cooperation indicate that Islamic banking in Turkey has not received the same level of interest as compared to other Muslim countries and is far from saturation. As such, the sukuk market is yet to develop. In fact, the first sovereign sukuk issuance was realized in August 2013 with significant over-subscription closing at USD 8 billion which shows huge demand for sukuk.

Legal Framework

As is known, sukuk holders obtain a partial ownership over a specific asset enjoying the profit that such asset generates and the proceeds from the sale, if sold.

The Communiqué introduced five types of lease certificates consisting of certificates based on ownership (ijara sukuk), management (musharakah sukuk), trading (murabaha sukuk), partnership (mudarabah sukuk) and engineering, procurement and construction (EPC) contracts (istisna sukuk) or through the combined use of these different types. Yet lease certificates that may be issued are not limited to these, as the CMB is receptive to novel instruments.

The legislation also regulates the establishment and management of asset leasing corporations ("ALC") and their capacities. ALCs may issue more than one lease certificate at a time and may issue for companies that are not the originating company.

ALCs may be established by banks, intermediary institutions, listed real estate investment trusts, public corporations with an average market value above TRY 1 billion and average market capitalization over TRY 250 million, partnerships where the Treasury holds 51% and more shareholding.

The board of directors of the ALC is liable for failure to collect the proceeds obtained from the rights and assets as well as to make payment to lease certificate holders pro rata their share as per their lease certificate.

The Communiqué regulates the issuance of lease certificates in a broad manner, leaving space for interpretation and practice. As per the Communiqué, real persons or legal entities execute a written agreement, indicating their intention to pool their properties to establish the originating institution. The originating institution transfers assets and rights to the ALC for the issuance of ownership-based lease certificates, or to the companies incorporating the ALC that manage the assets or rights on behalf of the ALC in the issuance of management agreement-based lease certificates. The ALC serves as the special purpose vehicle to which the assets or rights are transferred or leased.

The characteristics of each type of lease certificate are as follows:
  • Ownership based lease certificates are issued to provide financing for the acquisition of the rights and assets by the ALC from the originating institution for the purposes of leasing to the originator or third parties or management on behalf of the ALC.
  • Lease certificates backed by management contracts are issued so as to transfer the proceeds generated by managing the assets or rights owned by the originating institution to the ALC.
  • Lease certificates backed by trading are issued for proceeds generated from the sale of assets and rights on deferred basis in order to finance the acquisition of such asset or right by the ALC.
  • Lease certificates backed by a partnership are issued for providing financing to enable the ALC to be a shareholder of the joint-venture.
  • EPC based lease certificates are issued to finance the realization of the relevant work for which the ALC shall be party to the EPC contract as well.
Assets and rights included in the portfolio of an ALC cannot be disposed of until the redemption of lease certificates, for any purpose other than collateralization to the benefit of lease certificate owners, even in the case of transfer of management or supervision of the ALC to public authorities. Accordingly, its assets cannot be pledged or attached, or be subject to interim injunction in favor of third parties or attached even for the collection of public receivables, or included as part of an estate in the case of bankruptcy. The ALC cannot conduct any activities other than those related to the issuance of lease certificates.

Risk Management

Apart from financial risks, a lease certificate issuance may bear operational risks in respect of the management of the rights and assets that are subject to the lease certificate and regulatory risks depending on the location of the issuance.

The Communiqué explicitly prohibits the attachment, pledge or otherwise collateralization of the assets subject to sukuk in favor of third parties in a manner that may be detrimental to the rights of the certificate holders. Although this provision does mitigate a major legal risk that may occur on the part of the investors, it is not clear which party will bear the consequences. Operational risks are covered in terms of collection and distribution of proceeds.

Another issue that bears importance is compliance with Sharia rules. Sharia rules are not applicable in Turkey and the Communiqué naturally does not impose any obligations in this respect. However, compliance with Sharia rules may be important especially for foreign investors. As known, there is no uniformity or written set of rules regarding the interpretation of Sharia rules. Different issuers may adhere to different interpretations, some of them get consulting from experts in the area, whereas others follow the interpretations of the Islamic Financial Services Board and Accounting and Auditing Organizations for Islamic Financial Institutions. These issues may be significant in the issuance of lease certificates based on businesses which include elements both compliant and non-compliant with Sharia rules. There are currently four participation banks in Turkey all of which are member of TKBB, the association for participation banking which acts as a superior authority setting out guidelines. According to the website of the TKBB, goods and services that are allowed according to Sharia may be subject to Islamic Financing even if the provider also engages in prohibited activities. However, there is no clarity as to how this rule may be applied in case of lease certificate issuances.

Depreciation of the assets may also pose a risk. The Communiqué sets forth that the value of the issued lease certificates shall not exceed 90% of the total value of the relevant asset or rights for ownership based lease certificates.

Tax Incentives

ALCs and investors in sukuk market enjoy numerous tax exemptions.
Proceeds from transfer of assets and rights to ALCs and the holders of the lease certificates are tax-exempt. The same rule applies to VAT as Value Added Tax Law No. 3065 exempts the delivery of lease certificates issued by ALCs, the transfer of assets to the ALC and their subsequent lease and transfer back to the originating entity. Documents and certificates executed for the purposes of lease, transfer and pledge transactions regarding relevant assets or rights for the purposes of lease certificates also enjoy stamp tax-exemption. The transfer, lease and pledge transactions are exempt from duties. Withholding tax percentages vary from 10% of the lease proceeds obtained from lease certificates with a term of up to 3 years, to 3% for those with a term of 3 to 5 years. Government issued lease certificates (sovereign sukuk) as well as privately issued lease certificates with a term of over 5 yearsarenot subject to withholding tax. For proceeds obtained from lease certificate trading and coupon payments; non-resident and resident stock corporations' are free of withholding tax whereas non-stock corporations, other institutional investors and real persons are subject to a withholding of 10% on income. The income obtained from lease certificates issued abroad is also exempt from tax.

On the other hand, earnings from the acquisition and disposition of lease certificates issued domestically in Turkish Lira through promise to sell or buy back and earnings from the sale before term of lease certificates are subject to banking and insurance transaction tax in the amount of 1% for issuers.


Islamic Finance and interest free finance instruments are increasing their popularity globally as part of an effort to attract Gulf investors. And Turkey's legislation and practice on the matter is rapidly evolving with its foreign investor friendly and Islam espousing political and economic environment. Thus, the favorable tax regime for issuers, investors and the finance institutions offers broad opportunities in Sukuk market of Turkey.

(Mondaq / 17 July 2014)
Alfalah Consulting - Kuala Lumpur:
Islamic Investment Malaysia:

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