WEALTH PLANNING AND MANAGEMENTMWS 4143Topic 6: INSURANCE AND TAKAFUL SCHEMES

LEARNING OUTCOMESAt the end of the topic, students should be able to,Describe the various types of insurance and takaful schemesElaborate on the difference between basic policies and ridersCompare the differences between conventional insurance and takafulElaborate on scholars opinions on various types of insuranceElaborate on the different insurance and takaful plans and their relevance in financial planningHighlight the significant differences on the laws governing insurance and takaful

CONTENTSIntroductionRole of Insurance and Takaful in Wealth PlanningFactors affecting the need for Insurance and TakafulMechanisms of Insurance and TakafulTypes of Insurance and TakafulProducts Related to Insurance and TakafulLaws and Governing Bodies of Insurance and TakafulRevision Questions

INTRODUCTIONOne of the important areas of wealth planning is the distribution of the estates. Insurance and takaful are instruments that create instant estates and hence they are very important in the distribution of such estatesWe should not forget to protect our ability to earn or generate wealth. This can be done through insurance and takafulWe may save money for the future but such savings need preservation

ROLE OF INSURANCE AND TAKAFUL IN WEALTH PLANNINGInsurance and takaful creates instant estates with a small premium or contribution. It provides financial security against premature death and disability in the context of wealth preservation and wealth distribution.Death or accidents can happen any time. Insurance and takaful can to some extent guarantee our loved ones will have something to depend on when we are gone or become incapacitated. Insurance and Takaful, helps to settle debt , as well as fund for education

E&Y World Takaful Report (2010)

FACTORS AFFECTING THE NEED FOR INSURANCE AND TAKAFUL

NATURE OF INSURANCEA pays a PREMIUM to BB promises in a POLICY contract to pay A if a specified INSURED EVENT occursA is the INSUREDB is the INSURER or the UNDERWRITERC may intermediate as a BROKERD may RE-INSURE B against the INSURED EVENT

HOW RISK IS TRADEDInsure a RM1,000 PC against theft for a premium of RM100 a zero-sum game

INSUREDINSURERNo accident- 100+ 100Accident+ 900- 900

PROBABILITY WEIGHTED CASH-FLOWSIf risk of accident is 1%

INSUREDINSURERNo accident-100 x 99%= - 99+ 100 x 99%= + 99Accident+ 900 x 1%= + 9- 900 x 1%= - 9

PROBABILITY WEIGHTED CASH-FLOWSInsurer has expected revenue of RM90. Community pays RM90 for peace of mind

INSUREDINSURERNo accident- 99+ 99Accident+ 9- 9Expected revenue- 90+ 90

EXPECTED PROFIT FOR INSURER

INSUREDINSURERNo accident- 99+ 99Accident+ 9- 9Expected revenue- 90+ 90Overheads- 10Expected profit+ 80

MUTUAL AGENCY CASH-FLOWSInsurer repays surplus to community.Community pays RM10 for peace of mind

INSUREDINSURERExpected revenue- 90+ 90Overheads- 10Repaid to community+ 80- 80

PREMIUMPROFITPREMIUM+PROFITCOSTSSURPLUSTO COMPANYConventional Insurance100%100%

10040010001001000+100700400TO COMPANYConventional Insurance

MECHANISMS OF INSURANCEAND TAKAFULThe contract mechanismInsurance contract is one of indemnity. It indemnifies the client from having to bear the costs of some mishap just because the client has paid a premium to the insurance company.On the other hand takaful contract is not just between the company and the participant but it is a group of participants who have come together to donate (tabarru) a portion of the contribution to the takaful fund which will be used to compensate any of the unfortunate participants who face a mishap or hazard.

MECHANISMS OF INSURANCEAND TAKAFULAccording to the working committee for the establishment of Islamic Insurance in Malaysia the important aspects of takaful operation are as follows:The company does not assume the risk but it is the various participants who mutually cover each otherThe co. acts as trustee on behalf of participants to manage the operation of the takaful business. As such the co. does not have any right to the takaful benefits

MECHANISMS OF INSURANCEAND TAKAFULAll contributions on the basis of donation or tabarru (premiums) paid by the participants will be accumulated in the Takaful FundAll payment of the takaful benefits (i.e. claims) will be paid by the Takaful Fund. At the same time money credited to the said fund can be invested in areas approved by the Shariah.Should there be a profit/surplus from the operation the co. will share it with the participants as capital providers (rabbul mal) according to the principles of mudharabah.According to the principles of mudharabah the party which acts as the entrepreneur (mudharib) is entitled to a share of the profit/surplus according to a pre-agreed ratio from the investment of the shareholders fund.

TAKAFUL MODELSBasically there are two types of products: family takaful (life insurance) and general takaful (general insurance): eg Takaful Malaysia and eTIQa.General takaful business mainly deals with specific contingencies such as fire, accident and theft. General takaful usually is renewable annually, e.g. motor vehicles.General takaful historically operated with the mudharabah model but most now use the wakalah model, or wakalah-waqf model (S.Africa or Pakistan).Family takaful does not insure the life of the person (unlike life insurance) but provides a lump sum payment to the family of the deceased.Family takaful can adopt the mudharabah model but most operators employ the wakalah model.

PURE MUDHARABAH MODELCONTRIBUTIONPROFITCONTRIBUTIONPLUSPROFITCOSTSURPLUSCOMPANYX%(1-X)%100%PARTICIPANT

10001001000+ 70

700370COMPANYPARTICIPANTPure Mudharabah70% = 70100-70%=30370

CONTRI-BUTIONRISKACCOUNTRISKACCOUNTINVESTMENTACCOUNTINVESTMENTACCOUNTEXPENSESSURPLUSTAKAFULOPERATORPARTICIPANTPARTICIPANTPROFITX%(100-X)%100%Pure Mudharabah For Family Takaful

1000100100+ 7900900+638027TAKAFULOPERATORPARTICIPANTPARTICIPANT100703027Pure Mudharabah For Family Takaful

MODIFIED MUDHARABAHCONTRIBUTIONCONTRIBUTIONPLUSPROFITPROFITCOSTSURPLUSTO COMPANY(100-X)%TO PARTICIPANT100%X%

10020010001001000+100700400TO COMPANYTO PARTICIPANTModified Mudharabah200

MECHANISMS OF INSURANCEAND TAKAFULThe relationship between the company and the participants can also be based on wakalah (agency) contract.The wakalah contract is more popular now. The co. takes the fee of managing the business upfront and will not share the underwriting surplus.

WAKALAH MODELUnder this model risk sharing is done on a co-operative basis amongst the participants while Takaful operator acts as a wakil or Agent and is entitled to charge a fee for managing the operations and a performance incentive for better performance but is not entitled to any share in underwriting profits which exclusively belongs to the participants. However, if the underwriting results show a loss the same is made good through Qard al-Hasan raised from shareholders fund. However, surplus distribution among the participants will give rise to the problem of inheritance in the event of demise of a participant.

CONTRIBUTIONPROFITCONTRIBUTION+PROFITCOSTSSURPLUSTO PARTICIPANTPure Wakalah100%100%FEE

90090900+90700290TO PARTICIPANTPure Wakalah90290100

MODIFIED WAKALAH MODELe.g.*

WAKALAH WAQF MODELUnder this model a Waqf is created by the shareholders who make the initial donation of a reasonable amount. The contribution made to the Wakalah Waqf fund cannot be utilized for operational expenses but is intended to provide relief to the participants against defined losses as per Waqf rules and the participants membership document (PMD).The Wakalah Waqf Fund is held invested in Shariah compliant instruments. Underwriting profit or loss belongs to the fund and if needed can be utilized to pay losses. This fund will not be used for any other purpose than to pay claims.

WAKALAH-WAQF MODEL

TAKAFUL, INSURANCE SUMMARYAssuming 10% return on similar premiums of RM 1,000Similar costs, RM 700PSR of 70:30 in favour of insuredWakil fee of RM 100, with performance fee PSR of 70:30 in favour of insuredModified mudharabah & modified wakalah (via performance fee) sees surplus shared

Insurance & Takaful

10%50%50%

modelpremiumprofitcostsinsurerinsured

conventional1,0001007004000.0

pure mudharabah1,00010070050350

modified mudharabah1,000100700200200

pure wakalah90090700100290

modified wakalah90090700145245

family mudharabah1,0001000.0500.0

investment a/c900450.00.0945

operating a/c10058025

970

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THE RISK MANAGEMENT MECHANISMRisk control mechanismWhen client is known to have a serious illness such as diabetes. Steps need to be taken to minimise claims by suggesting participant to take medical insurance or takafulRisk retention mechanismInsurance or takaful co. takes up all claims and has no recourse to claim from any third party

THE RISK MANAGEMENT MECHANISMRisk transfer mechanismThe insurance or takaful company would transfer part of risk to reinsurance or retakaful co. The contract is between the client and the takaful operator and the client has now recourse to the reinsurer or retakaful operator if they do not honour the contractRisk sharing mechanismThey share the risk with another insurance or takaful company under a co-insurance or co-takaful arrangement.

TYPES OF INSURANCE AND FAMILY TAKAFUL PRODUCTSThere are four major types of life insurance: term; whole life; endowment and investment-linkedTerm insurance pays only when death occurs during coverage and no payment at the end of the term. The term is for 1; 5; 10; 15 or 20 or even 30 yrs. This is the cheapest and can be renewed at a higher premium. Instead of specifying the number of years the policy is stated in terms of age such as up to age 65 or 80 etc. and normally there is no renewal guarantee.The disadvantage is when there is no renewal guarantee especially for those who are ill. In most cases there is renewal guarantee or flexibility of changing to other policies such as for permanent coverage so that the person is covered throughout his life.

TYPES OF INSURANCEAND FAMILY TAKAFUL PRODUCTS

Whole life insurance covers the insureds entire life or very long terms such as up to age 88 or 100. Unlike term insurance, whole life insurance includes an element of savings or cash values.Cash values represent the excess premiums that have accumulated for their policies to date, and are refunded if the policy is terminated before the insureds death.The more premium dollars paid early in the the life of the contract, the greater the cash value on policy termination.

TYPES OF INSURANCEAND FAMILY TAKAFUL PRODUCTSWhole life cash values are determined by the method selected for paying premiums;A straight life contract is one where premiums are payable as long as the insured lives.In a limited-pay life policy premiums are paid for a specified period of time such as 20 years or until age 65. No further payment is required but the insured is covered until deathInstead of paying in instalments the premium can be paid in one lump sum and is called single-premium life.

TYPES OF INSURANCEAND FAMILY TAKAFUL PRODUCTS

Endowment is another type of permanent insurance similar to whole life. The only difference is that it provides death benefits for a specified period of time. It has cash values and the policy holder is paid the contracts face value at the end of the protection period.

TYPES OF INSURANCEAND FAMILY TAKAFUL PRODUCTSInvestment-life insurance contract divides the premium into two parts: the investment account and the risk account. The risk account takes care of the insurance benefits but the investment account belongs to the policy holder. Investment-linked life insurance is more risky to the policy owners whom participates in the investment risk, albeit with possibility of higher returns.In the event of death the insured will get the face amount plus whatever is in the investment account at the time. Should the insured wish to surrender, he will get the amount in his investment account.

FAMILY TAKAFUL PRODUCTSFamily takaful products are similar to investment-linked insurance. The difference is in the contract either wakalah or mudharabah. It has two separate accounts: the Participants Accounts (PA) and Participants Special Account (PSA) which is based on tabarru. If participant dies before maturity date he or she will receive whatever he or she has contributed up to the date of death plus his portion in the PSA including the profits from investment.

How Rates Are Charged?Mortality TableSuch as M8388 for MalaysiaInvestment ReturnLong Term DurationExpensesManagementMarketing & AgencyTaxProfit

PremiumsInvestmentAccountcostssurplusProfitProfitOperator50% to OperatorMudharabah contract betweenParticipants & Operator50% to Operator100% to participantsInvestmentAccount +ProfitTakafulAccount +ProfitTakafulAccount

Illustration of a Family Takaful PlanParticipants age: 36 yearsYearly premium: RM 1,000Term: 20 yearsInvestment account: 20 yearsParticipants account: 10%Profit rate: 5% (investment return to policy-holder)

Family Takaful - IndividualOriginally takaful products provided decreasing death cover and increasing surrender benefits.More recently, many takaful products are similar to conventional investment-linked life insurance

PRODUCTS RELATED TOINSURANCE AND TAKAFULMortgage Reducing Term Assurance (MRTA) or Mortgage TakafulFireMarineEtc.

TM

CHANNEL OF DISTRIBUTIONAGENCY & AGENTSBASED ON COMMISSIONSTOTAL AGENTS ABOUT 88,895 (FAMILY 55,898; GENERAL 32,997)

DIRECT MARKETINGPRACTICES BY COMPANIES

CHANNEL OF DISTRIBUTIONBANCATAKAFULPREFERREDCHANNEL

CHANNEL OF DISTRIBUTIONBANCATAKAFULCHALLENGESPOTENTIAL CONFLICTS OF INTEREST BETWEEN THE SHARIAH-COMPLIANT TECHNICIANS WITHIN THE BANK INTERMS OF PRODUCT DESIGN AND DEVELOPMENT WITH RETAIL NETWORK

NO STAND ALONE WORKFORCE

SHELF SPACE MANAGEMENTJOSTLE BETWEEN TAKAFUL PRODUCTS WITH CONVENTIONAL INSURANCE AND BANKING PRODUCTS. WHICH GETS THE PRIORITY?TO STAND OUT FROM CREDIT CARDS, PERSONAL FINANCE AND OTHER RETAIL BANKING PRODUCTS

CHANNEL OF DISTRIBUTIONBANCATAKAFULOVERCOMING CHALLENGESLEVEL PLAYING FIELD WITH SIMILAR SALES INCENTIVESDEDICATED INVESTMENT TEAM FOR THE SALE OF PRODCUTS WITH LONGER SHELF LIVES e.g. MUTUAL FUNDS, INVESTMENT LINK TAKAFULWHITE LABELING GIVE OWN NAME TO THE PRODUCTS BY INTEGRATING WITH THEIR OWN MUTUAL FUNDS TO THE MIXREDUCE INVESTMENT IN RESEARCH AND DEVELOPMENTCONSTANT TRAINING OF THEIR STAFF GENERALIST PLAYERS ON ALL ASPECT OF TAKAFUL KNOWLEDGE THROUGH DEDICATED ON-LINE TRAINING

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LAWS AND GOVERNING BODIES OF INSURANCE AND TAKAFULThe Insurance Act 1996The Takaful Act 1984Regulated by BNMDifferences between the twoThe requirement of Shariah Advisory Council under Takaful ActProvision of Insurable interest in the Insurance Act to abolish gambling elements. Takaful Act is silent on this.Takaful Act does not require any letters of administration to make payment to claimants.

REVIEW QUESTIONSDescribe the roles of insurance and takaful in wealth planningExplain the differences between the underlying principles of insurance and takaful contractsBriefly compare the differences in the takaful modelsExplain the main differences in the life insurance contracts

THANK YOU

Takaful is derived from the Arabic root word kafala which means to guaranteeThe Takaful Act 1984 of Malaysia defines takaful as a scheme based on mutual assistanceTakaful operators are owned by investors - e.g. Syarikat Takaful Malaysia being listed on Bursa Malaysia; and Etiqa is the Insurance & Takaful arm of Maybank Group.Co-operative insurance shares surpluses with policy-holders and members in proportion to their purchases. A mutual insurance company has no shareholders but instead is owned entirely by its policyholder, which share in the risks and the returns of the scheme. The main difference between a mutual and a cooperative is that a mutual must be owned by its customers (policyholders), whereas a cooperative may be owned by other members that are not necessarily its customers.Proprietary insurance: early insurance provided by individual underwriters; as coverage & claims expanded, individuals underwriters combined into associations, e.g. Lloyds of London.Lloyds is an association of individuals and not an insurance institution - 1,400 individuals write insurance on an individual basis.Each underwriter member is personally liable for the amount of insurance for which he is pledged. This liability is individual and not joint; that is, each underwriting member is separately liable for his share of the loss. There is no group liability. Lloyds of London might be classified as a market place like the New York Stock Exchange.Income replacement: income lost had the client been aliveFuneral expenses: if the client was living and working abroad, travel & repatriation expensesReadjustment: wife unable to work in the short term if the client, a single working husband diesDebt-repayment: loans outstanding on house, car, as well as personal loans, overdrafts, credit cardsCollege: future inflation adjusted expenses relating to fees, accommodation, living expenses including travelGovernment: social security benefits can take the form of public pension funds, such as EPF & CPFExisting insurance: employers often provide life insurance, but clients often take out additional family takaful intended for retirementThe conventional contract is based on sale & purchase:Al-gharar: uncertainty exists has historical knowledge about the possibility of an insured event but cannot know whether it will happenAl-maysir: the insured is prepared to risk the loss of the premium if the risk does not materialise, hence the element of chanceRiba: many of the returns the operators invest the insureds funds involve ribaPremiums divided between the investment account (90%) & the risk or operating account (10%)Note front-end feeFrom a 1,000 contribution, a 100 fee is deducted, and the 900 balance is investedRisk retention: e.g. if a client dies or becomes permanently disabled then the insurer is liable for all claimsRisk sharing: when insurance is shared all claims are dealt with via the lead insurer, whom will charge a fee from the other operators for this serviceActuaries assess insurance risk: A mortality table shows, for each age, what the probability is that a person of that age will die before his or her next birthday ("probability of death").Hence, insurers estimate (1) the probability of surviving any particular year of age; and (2) the remaining life expectancy for people at different ages.

Pure mudharabah family takafulMRTA extends cover to the outstanding principal, so that should a person dies before paying off the mortgage, the insurer will settle the debt and the house will release the house. Under Islamic loan either the selling or the buying price can be used.Some banks also require fire takaful: damage to fire, lightening, flood etccoverage concerning flooding can differ between policiesHouseowner & Householder Takaful: covers damage to belongingsMarine takaful: covers loss or damage to cargoPersonal Accident takafulBancatakaful is defined as the delivery and distribution of a suitable range of tailored bankable protection and long term savings and pension products designed to meet the lifecycle needs of the customer base of a bank or other financial institution.

Bancatakaful involves a retail solution to tapping a banks customer base. Banacatakful models include;Distribution Arrangements: easy to set up, although questionable commitment from BankFull Integration within Financial Group: better commitment requiring greater effort to set up and maintainJoint Venture: Hybrid of the above, with increased commitment as Bank shares in profitability of Takaful operator.

'Bankassurance', is the conventional counterpart, which describes the partnership or relationship between a bank and an insurance company whereby the insurance company uses the bank sales channel in order to sell insurance products.It allows the insurance company to maintain smaller direct sales teams as their products are sold through the bank to bank customers by bank staff.Bank staff and tellers, rather than an insurance salesperson, become the point of sale/point of contact for the customer. Bank staff are advised and supported by the insurance company through product information, marketing campaigns and sales training.Both the bank and insurance company share the commission. Insurance policies are processed and administered by the insurance company.MENA = Middle East and North AfricaWithout insurable interest, any person can insure another persons life and as a consequence may profit from it.