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Islamic Banking, Accounting And Finance International Conference–
The 9
thiBAF 2020
Liberalization of Commission Structure: How Minimum Allocation Rate(MAR) Affecting Takaful Operator’s Model
Azrul Azlan Iskandar Mirza, Nor Haziah Hashim, Junaidah Abu Seman
Faculty of Economics and Muamalat, Universiti Sains Islam Malaysia (USIM), Bandar Baru Nilai, 71800 Nilai, Negeri Sembilan Malaysia
Tel: +606 798 8671 E-mail: [email protected] Tel: +606 7651 6324 E-mail: [email protected]
Tel: +606 797 8677 E-mail: [email protected]
Abstract
Effective 1 October 2020, Bank Negara Malaysia (BNM) Life Framework required all Takaful Operator to comply with the new Minimum Allocation Rate (MAR) requirement together with the liberalization of commission structure. Due to the implementation of MAR, few Takaful Operators decided to withdraw their Investment Link plans from the shelves and launches more Family Takaful savings plans. The implementation of the new MAR primarily to establish a sustainable fund for the participant, but the operators look at it as a tight policy that could affect mostly on commission structure for agents. From the distribution side, reducing the commission structure could lead to the withdrawal and reduction of agents. For big players, they can still offer this product by reducing profit margins and an increase in the volume of sales. For small and mid-players, the innovation in Takaful Model is crucial to ensure they can offer a similar product without contradicting the new MAR. This paper will propose an innovation for Takaful Models that could help the Takaful industry remain relevant in the market.
Keywords: Islamic Finance, Takaful, Takaful Model
1. Introduction
Effective 1 October 2020, Bank Negara Malaysia (BNM) Life Framework required all Takaful Operator to comply with the new Minimum Allocation Rate (MAR) requirement together with the liberalization of commission structure. Due to the implementation of MAR, few Takaful Operators decided to withdraw their Investment Link plans from the shelves and launches more Family Takaful savings plans. The implementation of the new MAR primarily to establish a sustainable fund for the participant, but the operators look at it as a tight policy that could affect mostly on commission structure for agents. Insurance companies has already implemented the MAR a year before, particularly starting July 1st, 2019.
2. New Minimum Allocation Rates (MAR) and Its Requirement for ILT
The year 2007 had witnessed the Takaful operators’ commitment to remain competitive and keep on track with the rapid development of the Islamic finance industry by introducing new Takaful products that bridging the current market demand with the appetite of investors. Investment-linked plans (ILPs) are the latest innovations from the Islamic finance industry that offers investors the opportunity to get protection and investment through their family takaful plan. Takaful operators have introduced ILPs that combine both protection and investment tailored to provide the element of structured products.
Based on the performance of the specific underlying assets, these unique products offer the opportunity of capital protection upon maturity and yield enhancement (Kassim & Rahman, 2017; Parveen, Razali
& Salleh, 2019). These ILPs add to the existing long-term Shariah-based investment offered by the Islamic banks to cater the needs of Muslims to invest in non-interest bearing investment instruments.
Typically, a Shariah-compliant investment-linked plan is a single contribution plan with a fixed term of
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maturity. Takaful operators work together with a structure provider, normally a banking institution to integrate the structured product features into the ILPs (Kassim & Rahman, 2017).
Recently released new regulations on ILPs in 2019 by Bank Negara Malaysia (BNM) has received many reactions from the Takaful industry players. Effective from 1 July 2019 onwards, under the Bank Negara policy document on investment-linked businesses, insurance/takaful providers must adhere to three main requirements as following (Tan, 2019):
• Implementation of standards on Minimum Allocation Rates to protect the account values of investment-linked policy/certificate owners;
• Minimum standards on sustainability tests and communication to policy/certificate owners to improve long term persistency of IL policies/certificates and consumer awareness; and
• Strengthened disclosure standards on product illustration to facilitate more informed decision- making by consumers.
Specifically, there are some changes to the ILP policies pursuing the new regulations. One of them is the minimum allocation rate (MAR). MAR refers to the minimum proportion of premiums payable by policy owner/takaful contributions made by takaful participants that are allocated in the unit fund(s) of choice before the deduction of any charges (BNM, 2019). Effective 1 July 2019, the MAR for ILP policies which longer than 20 years will be set at a MAR of at least 60%. The new policy intends to protect the policy’s sustainability in the long run (Tan, 2019). Table 1 shows the new MAR policy.
Table 1 The minimum allocation rate (MAR) effective from 1 July 2019 onwards Contribution Payment Year MAR (% of annual contribution)
1 to 3 60%
4 to 6 80%
7 to 10 95%
11 onwards 100%
Corresponding to the new regulation, from 1 January 2020, all policy owners receive a yearly statement that comprises the expected duration of their insurance/takaful cover based on their current cash values (i.e. how long can the policy run if the customers stopped paying premiums). There are a few implications that insurance companies and takaful operators need to adhere. For policies sold before 1 July 2019, insurance companies/takaful operators should send a pre-lapse notice for ILPs that will lapse within the next 12 months. While, for policies sold after 1 July 2019, insurers/takaful operators must set premiums that are expected to be sustainable until the end of the contract term. For the premiums to be set sustainably, assessments that are current and specific to the individual ILP owner are required by the insurers/takaful operators.
Furthermore, in order to assist the customer in the decision-making process, the regulations also introduce new rules for product illustrations at the point of sale. From the product illustration, the potential ILP customer can obtain information on the possible movements of cash flows as well as the impact of fees and charges on cash values. Under the new rules, insurers/takaful operators are required to base their illustrations on 2% and 5% rates when illustrating hypothetical rates of return to their potential customers. Figure 1 presents the sample ILP product illustration by Bank Negara Malaysia for licenced Takaful operators. Figure 2 illustrates the sample of a product illustration for an ILP policy that must be presented to an ILP customer at the point of sale. Based on Figure 2, starting from 1 July,
“Scenario X” must refer to return rates of 2%, while “Scenario Y” is set at a rate of 5%.
139 Source: Bank Negara Malaysia (2019)
Figure 1 Sample ILP product illustration by a licenced Takaful operator.
Source: Bank Negara Malaysia (2019)
Figure 1 Sample of a product illustration for an ILP policy by a licenced Takaful operator.
This is applicable for all types of funds except for equity funds, for which the rates should be 2% and the 10-year average historical FTSE Bursa Malaysia KLCI returns for the first 20 years and then 5%
following that. The 2% and 5% rates said to be a better way to demonstrate the interactions between cash flows without giving rise to undue expectations (Bank Negara Malaysia, 2019).
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Above all, all these new changes are fall under Bank Negara’s principal aim for ILP which is to protect the interest of the consumers. The raising of the MAR could improve transparency and standards of communication. This promotes better customer service with more informed decisions on their ILP takaful policies (Tan, 2019).
3. Existing Takaful Models
As mentioned in the introduction section, investment-linked takaful (ILT) is a part of a family takaful that combines investment and takaful (protection) cover. The contribution paid will provide coverage that includes death and disability benefits, while the other part of the contribution will be invested in a variety of shariah-compliant investment fund. Participants of ILT plan have the flexibility to choose their own level of protection and investment according to their financial circumstances. They can also switch their current investment funds, such s equities, bonds or other financial instruments to invest in.
participants are also able to redeem part of their investment-linked units at any point of time.
Based on an interview session with the industry player from FWD takaful, there are four existing ILT models, practiced by the company. Diagrams and brief descriptions of the four existing models are explained below:
3.1 Model 1: Non-Investment linked Takaful (ILT) without Participant Investment Fund (PIF) Referring to diagram 1, contribution paid by the participant in a non-ILT without PIF will first be deducted as wakalah fee, which is charged to pay for services rendered, such as fund management fee services and surrender charges. The wakalah fee is credited into Takaful Operator’s Fund, which will be used to pay for management expenses or commissions. After excluding the wakalah fee, the balance of the contribution paid will be allocated in the Participant’s Risk Fund in the form of participative contribution (tabarru’). If there are any surplus after the underwriting and investment activities, it will be divided between participants and the takaful operator based on an agreed ratio portion.
Diagram 1: Non ILT without Participant Investment Fund
Source: Interview session with FWD Takaful
3.2 Model 2: Non-Investment linked Takaful (ILT) with Participant Investment Fund (PIF) Diagram 2 depicts how contribution paid by the participant in a non-ILT with PIF will be allocated.
Just like in diagram 1, the contribution paid by participant will first be deducted as wakalah fee for services such as fund management and other charges. The balance after the deduction of wakalah fee, will then be allocated in the Participant’s Risk Fund for the purpose of tabarru’ that will be shared among the participants, should any of them suffered mishaps. If there is any surplus after the underwriting and investment activities, it will be divided between participants and the takaful operator
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based on an agreed ratio portion. However, the participant’s portion will be credited in the Participant’s Investment Fund (PIF) for investment purposes.
Diagram 2: Non ILT with Participant Investment Fund
Source: Interview session with FWD Takaful
3.3 Model 3: Investment Linked Takaful (ILT) with Participant Investment Fund (PIF) and Unit Deducting Riders
Diagram 3 describes the model for ILT with PIF and Unit Deducting Riders. The contribution paid by the participants are allocated the same way as previous models. A portion of the contribution paid is deducted as wakalah fee upfront and credited into the Takaful Operator’s Fund. The balance of the contribution will be used to provide for takaful coverage in the Participant’s Risk Fund. The basic coverage normally provides death and disability benefits. However, participants can extend the basic cover by adding additional coverage (riders), such as critical illness and personal accident. Another portion of the contribution will be used to purchase units in the Participant’s Investment Fund and be invested in a variety of Shariah-approved investment funds of the participant’s choice.
Participants are given the flexibility to choose their own level of takaful protection and investments, based on their financial circumstances. If there is any surplus, the money will be shared between the participant and the takaful operator based on the pre-agreed ratio. Participant’s share of the surplus will be used to purchase additional investment-linked units.
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Diagram 3: ILT with PIF and Unit Deducting Riders
Source: Interview session with FWD Takaful
3.4 Model 4: Investment Linked Takaful (ILT) with Participant Investment Fund (PIF) and Contribution Paying Riders
Diagram 4 depicts the model for ILT with PIF and Contribution Paying Riders. The modus operandi is the same as in Diagram 3. However, there is an additional benefit of contribution paying riders. These contributor riders will assist to pay for the participant, in the event of death, total and permanently disable (TPD) or critical illness of the participant or covered family member. These riders will not affect the amount of the sum assured.
Diagram 4: ILT with PIF and Contribution Paying Riders
143 Source: Interview session with FWD Takaful 4. Methodology
Qualitative analysis is employed to examine the reactions of Takaful operators towards the new regulations on MAR for the ILPs. A semi-structured interview has been conducted the reach the aim of the study. The interviewees of the interview sessions include nine officers from the licenced Takaful operators in Malaysia.
Secondary analysis is employed to come out with a proposed new model of the ILPs. This study involves critical textual and content analysis of relevant provisions locally and internationally in investment-link products and policies. Library and internet searches are utilized in this study in providing a critical view of the existing literature in the model.
5. Results and Discussion
The reactions of takaful operators towards the new regulations on the ILPs are presented in Table 2 below. Six out of nine takaful operators plan to withdraw all the ILT plan which are not comply with MAR, with five of them either have launched or will replace with new ones. Interestingly, two takaful operators stated that they will comply with the new MAR for their existing ILT plans, with different approaches on the product features and service fee, but the commission rates remain the same.
Table 2 Reactions of Takaful operators towards the new regulations on MAR for the ILPs Takaful
Operator Findings
A They will withdraw all ILT plan by 1 October 2020
B They will withdraw all ILT plan by 1 October 2020 and will replace their products with Ordinary family takaful plans. They keep their hybrid family takaful plan on the shelf.
C They have withdrawn all ILT plan effective 30 July 2020.
D They will withdraw all ILT products by 1 October 2020 and launch new ordinary plans for replacement.
E
They plan to withdraw all existing ILT Plans and replaced with a new ILT plan that comply MAR by 1st September 2020.
The new ILT plan will be simple that provides death/TPD benefits, double indemnity on accidental death/TPD as well as Partial Permanent Disability benefits.
Will only offer 2 riders:
Waiver of contribution on death/TPD/CI and family benefit rider which provides Funeral expenses on death of spouse/kids
F They have launched new ILT products named Mahabbah and Hadiyyah in 2019 which comply MAR.
All their existing ILT plans that do not comply MAR on the shelf will be withdrawn by 1 October and will be replaced with new ILT products.
G They will comply MAR by 1st October for all their existing products with no changes to the commission rates, other fees and features
H They do not have any ILT business on banca channel and currently do not have Agency force.
Currently plan to develop a new Education ILT plan for banca channel (most probably via Bank Islam) I They will comply MAR by 1 October for their existing ILT plans where commission and product features
remain the same. They increase the product monthly service fee.
The reasons behind the majority of the takaful operators choose to withdraw all their existing ILT plans could be explained through the complexity of the changes that need to be made by the takaful operators for each of the individual ILP owners. The assessments to meet the new MAR requirement must be made at the current and specific individual customers of the ILP policy.
Meanwhile, those operators that still offering the investment product will modify the structure and even their existing model to comply the new MAR. If they stick to current models, it could not meet the new structure.
6. Proposed Model
The implementation of the new MAR primarily to establish a sustainable fund for the participant, but the operators look at it as a tight policy that could affect mostly on commission structure for agents.
From the distribution side, reducing the commission structure could lead to the withdrawal and
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reduction of agents. For big players, they can still offer this product by reducing profit margins and an increase in the volume of sales. For small and mid-players, the innovation in Takaful Model is crucial to ensure they can offer a similar product without contradicting the new MAR. The authors recommend the existing model for ILT to be modified to accommodate such changes, and explained as follows
• Participants pays basic OL contributions and Investment rider contribution.
• Basic OL contribution after minus wakalah fees will be allocated into the Participant Savings Account (PSA).
• Investment Rider contribution after minus wakalah fees will be allocated into Participant Investment Account (PIA).
• Any top up contribution after minus wakalah fees will be allocated into the PIA.
• Tabarru’ will be dripped into the Participant Risk Fund (PRF) on monthly basis.
• Upon death/TPD – the Sum Covered plus PSA values and PIA values will be paid.
• Upon Surrender or maturity – the PSA values and PIA values will be paid.
• Fees applicable –
Upfront Wakalah fees – on all contribution payable.
fund management fee - will be charged to the PIA,
Partial withdrawal fee – will be charged on any partial withdrawal from PIA.
• The investment profit of the PSA will be shared between Takaful Operator and PSA in the ratio of x : (1-x).
• Any distributable surplus from the PRF will be shared 50/50 between Takaful Operator and eligible participants. The participant’s portion will be allocated into the PSA.
• If the PRF is in deficit, the Takaful Operator will provide qard. Qard will be payable from the future surplus in the PRF.
The main feature for this model is the separation between PSA and PIA, which previously combined in a fund. New MAR required the minimum allocation in the participant investment account (PIA) to maintain at certain level, and therefore dripping method is quite difficult. Therefore, the MAR will not be been affected at the beginning since it solely a different with investment features. The funds description is as follows
Participant Savings Account (PSA)
• The basic plan contribution will be allocated into the PSA after deduction of applicable Wakalah Fees.
•
Any investment profit in the PSA will be shared between TO and participant in the ratio of x : (1-x). The investment profit for the participant will be allocated into the PSA.145 Participant
Investment Account (PIA)
• The investment rider contribution will be allocated into the PIA.
• Any single top up contribution will be allocated into the PIA.
• Allocation rates for the investment rider contribution and single top up is 95%.
• Customer may withdraw from the PIA – withdrawal fees is applicable.
• Fund management fee will be charged to the PIA.
• PIA values will be payable upon death claim, surrender or maturity date.
•
PIA – customer may choose the available ILT fund Participant RiskFund (PRF) • Tabarru’ will be dripped from PSA on monthly basis to the PRF.
• The Sum at Risk (SAR) will be payable from PRF upon death or TPD.
• The Funeral benefit and Infaq benefit will be payable from PRF.
•
Surplus of PRF will be shared between the TO and participant in the ratio of 50:50.This model could be a hybrid model to enable the practice of similar to investment link in Takaful, with a more flexible side. However, the implementation side is more crucial, since the operators have to prepare on system, accounting entries, and even the margin and commission.
7. Conclusion
Innovation is crucial for financial institutions to ensure its sustainability dan development. It depends on the institution to drive towards innovation. The implementation of MAR leads into the innovation by takaful operators to innovate their product and even the fundamental models. Therefore, it could sustain the takaful industry as a whole.
References
Bank Negara Malaysia. (2019). Investment-linked Business.
Kassim. S., Rahman, P. (2017). Are Shariah-Compliant Structured Products Able to Withstand Global Financial Shocks? A New Perspective on the Performance of ShariahCompliant Structured Investment-Linked Plans in Malaysia. Journal of Economic Cooperation and Development, 38, 1.161-182.
Parveen, T., Razali, S.S. & Salleh, M.C.M. (2019). Preference toward Investment-Linked Takaful Plan: Mediating Role of Attitude. International Tourism and Hospitality Journal 2(2): 1-06. 1-6.
Tan, J. (2019, June 21). What You Need To Know About The New Regulations On Investment-Linked Insurance. Retrived from https://ringgitplus.com/en/blog/insurance/what-you-need-to-know-about-the-new-regulations-on-investment-linked- insurance.html
