Takaful - Investment Management

The particular Takaful model adopted by an operator can influence how its funds are invested. Different models may determine how investment profits are allocated and how the operator manages participants’ funds. However, the common objective is to invest available funds in a Shari’ah-compliant manner so that they can grow while remaining sufficiently safe and liquid.

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Takaful operators generally manage several types of funds. These may include the participants’ individual or investment fund, the Participants’ Risk Fund, and the operator’s own shareholders’ fund. Instead of leaving all these funds as idle cash, the operator invests appropriate amounts to generate returns and strengthen the financial position of the Takaful arrangement.

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A major challenge is the limited availability of suitable halal investment opportunities. This problem can be especially serious in countries where the Islamic financial system is still at an early stage of development. Such markets may have only a small number of Islamic banks, Sukuk, Shari’ah-compliant shares, and other Islamic financial instruments available for investment.

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For example, Takaful operators need Islamic bank accounts or Islamic money-market instruments where they can place short-term funds while earning competitive Shari’ah-compliant returns. This is particularly important because part of the Participants’ Risk Fund must remain liquid so that claims can be paid when they arise. If there are very few Islamic banking facilities available, the operator may find it difficult to achieve both liquidity and attractive returns.

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Investment in shares or equities creates another challenge. A Takaful operator cannot simply invest in any listed company. The company must satisfy the relevant Shari’ah screening requirements, including restrictions relating to prohibited business activities and excessive involvement in interest-based financing.

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This can become difficult in markets where companies depend heavily on conventional bank loans and interest-based financial instruments. Even if the company’s main business activity is permissible, excessive conventional debt or non-compliant financial income may cause its shares to fail the applicable Shari’ah screening criteria. Therefore, the number of suitable stocks available to the Takaful operator may be limited.

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Sukuk provide another important investment avenue for Takaful operators because they can offer Shari’ah-compliant income and may be suitable for matching longer-term obligations. However, not every Sukuk has the same level of liquidity. Some Sukuk may be difficult to sell quickly in the secondary market.

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Liquidity can be particularly important for certain debt-based Sukuk or similar instruments. Some Shari’ah scholars and standards, including relevant AAOIFI principles, place restrictions on the trading of instruments that predominantly represent debts or receivables. Consequently, a Takaful operator may not always be able to freely buy and sell such instruments at market prices.

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This creates an important investment-management problem. The operator may find an investment that is Shari’ah compliant and provides a good return, but if it cannot easily convert that investment into cash, it may not be suitable for a fund that needs to pay claims at short notice.

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Example

Suppose a General Takaful operator has RM100 million available in its Participants’ Risk Fund. It cannot invest the entire RM100 million in long-term or illiquid Sukuk because claims may arise unexpectedly.

It may therefore allocate the money between:

• Islamic bank deposits for short-term liquidity
• Highly liquid Shari’ah-compliant instruments
• Sukuk for more stable returns
• Shari’ah-compliant equities for potential growth

The operator must balance return, safety and liquidity.

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Takaful operators must also consider regulatory requirements when making investment decisions. Shari’ah compliance alone is not sufficient. The operator must also comply with the investment rules imposed by the regulator in the jurisdiction where it operates.

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One important consideration is the solvency ratio. Regulators require Takaful operators to maintain sufficient financial resources to meet their obligations to participants and claimants. Certain investments may carry greater risk or may receive less favourable treatment when calculating regulatory capital. Therefore, an operator cannot simply select an investment because it provides the highest return.

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For example, investing heavily in volatile shares might produce higher potential returns, but it could also increase the possibility of investment losses and weaken the operator’s solvency position. The operator must therefore construct a portfolio that supports both investment growth and financial stability.

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Investment management in Takaful therefore requires the operator to balance several objectives at the same time:

Shari’ah Compliance + Return + Safety + Liquidity + Solvency + Regulatory Compliance

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The overall challenge is that Takaful operators must grow participants’ and shareholders’ funds without compromising Shari’ah principles or their ability to meet claims. This becomes more difficult in markets where Islamic investment instruments are limited or where Shari’ah-compliant securities have insufficient liquidity.

Simple Idea

Takaful funds should not remain idle → Funds are invested → Investments must be halal → They must also provide suitable returns, remain sufficiently liquid, and satisfy regulatory and solvency requirements.