Takaful - Unfriendly Regulations and Governance Challenges

Concise Overview

Takaful needs innovation in order to grow and remain competitive. However, innovation can be restricted by regulations that were originally designed for conventional insurance and may not properly accommodate the special structure of Takaful. At the same time, management teams that focus heavily on shareholder profit may sometimes compromise product design, affordability, or service to participants. One possible alternative is to provide Takaful through mutual organisations, cooperatives, or affinity groups, although these structures require strong governance because Takaful is complex to manage.

Regulations Can Restrict Takaful Innovation

Takaful operators need to develop new products, distribution methods, and operating structures to meet changing customer needs. However, some regulations may unintentionally make innovation difficult.

These regulations may not be deliberately hostile to Takaful. Instead, they may have been designed mainly around the structure of conventional insurance and may therefore not fully recognise Takaful concepts such as:

• Participants’ Risk Funds
• Tabarru’
• Mutual risk sharing
• Separation of participants’ and shareholders’ funds
• Surplus distribution
• Qard arrangements
• Shari’ah governance

For example, a regulator may impose the same capital, organisational, or licensing requirements on a small community-based Takaful scheme as on a large commercial insurer. This may make it too expensive for smaller or innovative Takaful models to enter the market.

Simple Idea

Regulation designed for conventional insurance → May not fit Takaful structure → Innovation becomes more difficult

Profit-Focused Management Can Also Limit Innovation

Another challenge may come from the management of commercial Takaful companies. Since shareholders provide capital, management is normally expected to generate an acceptable return for them.

This objective is understandable because a Takaful operator must remain financially sustainable. However, if management focuses too strongly on shareholder profits, it may prioritise products and customers that generate the highest financial returns.

For example, a Takaful operator may have the choice between developing:

Product A

• High-income customers
• Large contributions
• High profit margins

and

Product B

• Low-income participants
• Small contributions
• Higher distribution costs
• Lower profit margins

A strongly profit-oriented management team may choose Product A even if Product B would provide greater social benefit.

This may create compromises in:

• Product affordability
• Coverage
• Customer service
• Claims service
• Access for low-income groups
• Innovation aimed at underserved communities

Simple Idea

Too much focus on shareholder return → Participant needs may receive less priority

Possibility of Mutual Takaful

Some regulators may be willing to support the establishment of mutual Takaful organisations.

In a mutual structure, the organisation is essentially operated for the benefit of its members rather than outside shareholders. Participants collectively have a stronger interest in the organisation and its financial results.

This may allow the Takaful arrangement to place greater emphasis on:

• Mutual protection
• Participant welfare
• Affordable coverage
• Long-term sustainability

rather than maximising shareholder returns.

Takaful Through Cooperatives

Another possible model is to embed Takaful within a cooperative.

A cooperative is an organisation owned or operated for the benefit of its members. It may provide several services, such as:

• Savings
• Financing
• Agricultural support
• Purchasing services
• Healthcare assistance
• Takaful protection

Takaful becomes only one service offered to members.

Example

Suppose a farming cooperative has 20,000 members.

The cooperative already provides:

• Agricultural supplies
• Financing
• Training
• Marketing support

It could also establish a Takaful arrangement for:

• Crop losses
• Livestock losses
• Death or disability
• Farm equipment

Because the cooperative already has an established membership, it may be able to distribute Takaful more cheaply than a separate commercial operator.

Takaful Through Affinity Groups

An affinity group is a group of people connected by a common relationship or interest.

Examples include:

• Employees of the same company
• Members of a professional association
• Members of a mosque or community
• Farmers’ associations
• Trade unions or occupational groups
• University alumni
• Members of a cooperative

A Takaful arrangement could be offered specifically to members of that group.

Example

A professional association has 50,000 members.

Instead of every member individually searching for Family Takaful, the association could arrange a group Takaful plan for its members.

This can reduce:

• Marketing costs
• Customer acquisition costs
• Distribution expenses

because the group already has direct access to its members.

Why These Models May Be Attractive

Mutuals, cooperatives, and affinity groups may help Takaful because they already have:

• Existing members
• Trust relationships
• Distribution channels
• Shared interests
• Knowledge of member needs

This can reduce some of the high distribution costs faced by conventional commercial Takaful operators.

Simple Formula

Existing Membership + Existing Trust + Shared Needs = Lower Takaful Distribution Cost

Governance Becomes a Major Challenge

Although these models may be attractive, they create significant governance challenges.

A cooperative may offer many different services besides Takaful. The organisation must therefore ensure that Takaful funds and activities are properly managed and not mixed improperly with other activities.

For example, a cooperative may operate:

• A grocery business
• Financing services
• Agricultural services
• Takaful

The Participants’ Risk Fund should not simply be treated as general cooperative money that can be used to finance unrelated activities.

The organisation therefore needs clear rules regarding:

• Separation of Takaful funds
• Claims management
• Investment of participants’ money
• Shari’ah compliance
• Risk management
• Actuarial valuation
• Accounting
• Solvency
• Internal controls
• Management responsibilities

Why Takaful Governance Is Complex

Takaful is not simply about collecting money and paying claims.

The organisation must manage:

Contributions → Risk pooling → Underwriting → Investments → Reserves → Claims → Surplus or deficit → Shari’ah compliance

Each stage requires specialist knowledge.

For example, if a cooperative starts Takaful without proper actuarial expertise, it may charge contributions that are too low.

Suppose:

Annual contributions collected = RM5 million

but expected claims and expenses eventually reach:

RM8 million

The Takaful fund would suffer a deficit.

Therefore, good intentions alone are not enough. The scheme must also have professional risk management and governance.

Main Challenge

The industry therefore faces a balance between three objectives:

Innovation

Financial Sustainability

Participant Protection

Too much regulation may prevent innovation, while too much commercial pressure may reduce the social purpose of Takaful.

Easy Way to Remember

Unfriendly regulations

= Rules may not properly fit the Takaful structure.

Profit-focused management

= May prioritise shareholder returns over participant needs.

Mutuals / cooperatives / affinity groups

= Possible alternative ways to provide Takaful.

Main challenge

= Strong governance is needed because Takaful is financially and operationally complex.

Simple Formula

Supportive Regulation + Innovation + Strong Governance + Participant Focus = Sustainable Takaful Development