Takaful insurance is the scream of the day and not a single company has started operations yet. However, the Securities and Exchange Commission of Pakistan has issued rules containing the detailed infrastructure and obligations.
However, the taxation of Takaful insurance business is an important area of knowledge because it is one of the special activities of the insurance sector and the current fourth schedule of the Income Tax Ordinance, 2001 does not encompass this new model of taxation.
This article is an endeavour to understand the Structure of Takaful Insurance in Pakistan and to suggest the improvements required in the 4th Schedule of the Income Tax Ordinance, 2001, as it is clearly stated in the Takaful rules that it will override the Insurance Rules, 2002 and the Securities and Exchange Commission of Pakistan Rules 2002 in case of conflict.
In furtherance, the deficiencies in the existing model of the 4th Schedule of the Income Tax Ordinance, 2001 and the global practice because of such inadequacies result in un-appropriate taxation model, owing to the lack of home work by the Securities and Exchange Commission of Pakistan and consequently in not collecting the tax due.
The principal operational model of Takaful insurance infrastructure for insurance risk management and the investment component is based on the Islamic concept of Wakala or modaraba model. Initially, the composite Takaful is not allowed to existing insurance companies for five years, however, existing companies are required to transform into a Takaful business in order to undertake the activity.
It is worthwhile here to note that there is a detailed procedure specified for such conversion in Takaful Rules, 2005. Under the Takaful Rules, 2005, a Takaful operator is allowed to do the business of Takaful insurance, while the window takaful operator is allowed to do the business of family Takaful.
GENERAL TAKAFUL: General Takaful means Takaful insurance other than family Takaful.
FAMILY TAKAFUL: Family Takaful means takaful for the benefit of individuals, groups of individuals and their families pertaining to life.
PARTICIPANTS' INVESTMENT: Participants' investment account [PIA] is the investment account of participants under a Family Takaful Plan, while participants' investment fund [PIF] means a separate fund comprising of the underlying assets representing the units of the PIA under a Family Takaful plan.
A PIF is divided into PIAs and under the Takaful Rules, 2005, a separate account is maintained for each PIA. As mentioned earlier, the investment component needs to be credited to one or more PIF in a proportion clearly defined in a participants' membership document [PMD]. A PMD is a document which deals with the detailed matter relating to the benefits and obligations of the participants.
Investment of funds needs to be made in accordance with the Islamic concept of the modaraba, Wakala or a combination thereof at the option of takaful operator in case of general takaful and at the option of an appointed actuary in the case of family takaful apart from the Shariah board in accordance with the PMD.
However, in case of a Family Takaful plan, each year a portion of contributions needs to be invested to build up surrender values for the participants and maintained in the form of units for each participant in a PIA. As stated earlier, the underlying assets against these units shall be maintained in a separate fund called the PIF.
The investment of participants' contributions within the PTF as well as in the PIF shall be managed under a Wakala, modaraba or a combination of both against a set fee structure and the profit sharing ratio. These must be set in consultation with the Shariah board and Appointed actuary.
FUNDS: A Takaful operator is required to maintain and minister two funds - Participants Takaful Fund [PTF] and Shareholders' fund [SHF]. However, in case of Family Takaful plans, a PIF related to the PIA shall also needs to be maintained but the PTF, PIF and PIA needs to be linked to the Takaful Business Statutory Fund [TBSF].
SHARE HOLDERS' FUND [SHF]: The shareholders' fund shall consist of the paid up capital and undistributed profits to the shareholders. Such funds need to be maintained for the Family and the General takaful business on a similar basis. However, the shareholders must undertake to discharge all the contractual liabilities of the PTF unconditionally, but their liability in this regard shall not exceed the SHF.
In the case of the General Takaful operator, the income of SHF consists of the takaful operator fee, profit on the investment of the SHF and the proportion of the investment profits generated by the investment of the PTF or the fees for investment as per the PTF rules and the PMD.
On the other hand, the expenses of the SHF shall consist of all the expenses related to the Takaful operator, including the marketing, administrative, investment and operational, but does not include those mentioned in the PTF rules and the PMD, commissions, over-riders paid to the business intermediaries, benefit payments and related expenses such as surveyor's fees.
All the administrative and marketing expenses of the takaful operator shall be borne by the shareholders in consideration of receiving a stipulated proportion of the gross contribution to the PTF by way of takaful operator fee. It is worthwhile here to note that all expenses of the takaful business shall form part of the expenses of the TBSF for family takaful operators and SHF for General Takaful operators.
TAKAFUL BUSINESS STATUTORY FUND [TBSF]: All contributions received under the Family Takaful contract needs to be credited to the Takaful Business Statutory Fund and needs to be divided into investment, risk related and Takaful operator's fee.
However, all contributions received under the General Takaful contracts need to be netted against government levies. Such contribution needs to be credited in the participants' account. A General Takaful Operator may create a single PTF or separate PTF for different classes of business. Risk related component and Takaful operators' fee is credited to the participants' takaful fund.
PARTICIPANTS TAKAFUL FUND [PTF]: A participant is an assignee of the takaful policy or the legal heirs of a deceased participant in case of entitlement against participant takaful fund according to the benefit of the policy. Participant takaful fund [PTF] is a separate risk pool which is required to be created under Takaful Rules, 2005 and to which the participants' risk related contributions are pooled and from which risk related benefits are paid out.
The management of PTF and its related risk lies on the Takaful Operator. At the initial stage of setting up a PTF, the takaful operator and the shareholder may make a initial donation or qard-e-hasna to the PTF, however, it is discretionary. The objective of the PTF is to provide relief to participants against defined losses as per the PTF rules and the participants' membership document [PMD]. It is the responsibility of the takaful operator to define the PTF rules, however, such rules needs to be in accordance with generally accepted principles and norms of insurance business.
These rules need to be suitably modified with the guidance from the internal Shariah board of the takaful operator. Any subsequent changes need to be approved from the Shariah board. Takaful Rules, 2005 requires that a separate PTF needs to be created within the TBSF. The PTF needs to be credited with the investment component and the takaful operator's fee. Such an amount is used to pay the benefits.
The investment component needs to be credited to one or more of the participants' investment fund [PIF]. The income of the PTF shall consist of contributions received from participants, including takaful operator's fee, claims and commission received from re-Takaful operators and re-insurers, investment profits generated by the investment of funds, other reserves attributable to the participants in the PTF, salvage and recoveries, Qard-e-Hasna in the case of deficit not including initial Qard-e-Hasna, any donation made by the shareholders.
The expenses of the PTF shall consist of losses settled - related to the participants' risk and expenses directly related to the settlement of claims as defined in the PTF and the PMD, such as surveyors' fees but excluding office expenses, retakaful and reinsurance costs, takaful operator's fee not determined with reference to the surplus in the PTF, a share of investment's profit being the mudarib's share or a percentage of profit as Wakala fees for the investment management or any other combination approved by the appointed actuary in the case of family takaful and Shariah board, surplus distributed to participants' and return of Qard-e-hasna to the shareholder fund. This can be summarised as follows.
INCOME
-- Contributions received from participants including takaful operator's fee
-- Claims and commission received from re-Takaful operators and re-insurers Investment profits generated by the investment of funds
-- Other reserves attributable to participants in the PTF
-- Salvage and recoveries
-- Qard-e-Hasna in case of deficit not including initial Qard-e-Hasna;
-- Any donation made by the shareholders.
EXPENSES
-- Losses settled - related to participants' risk and expenses directly related to the settlement of claims as defined in the PTF and PMD, such as surveyors' fees but excluding office expenses
-- Retakaful and reinsurance costs
-- Takaful operator's fee not determined with reference to the surplus in the PTF
-- Share of investment's profit being mudarib's share
-- Percentage of profit as Wakala fees for investment management
-- Any other combination approved by the appointed actuary in the case of family takaful and Shariah board
-- Surplus distributed to participants' and;
-- Return of Qard-e-hasna to the shareholder fund [discussed below].
Takaful operator is required to set up technical reserves, which may include unearned contributions reserves, incurred but not reported reserve, deficiency reserve, contingency reserve and reserve for Qard-e-Hasna to be returned in future and surplus equalisation reserve.
These reserves are discretionary and the takaful operator may set up all of such reserves, any of them or a combination of them. As stated under the head expenses, the takaful operator is required to pay the losses of the participants of the fund from the same fund apart from all the expenses which need to be incurred for providing takaful benefits, including retakaful contributions.
However, these need to be specified in the PTF rules and PMD. The PTF rules and the PMD for each class of business needs to be approved from the Shariah Board.
SHARING OF SURPLUS AND DEFICIT Takaful Rules, 2005 requires that the surplus or deficit needs to be ascertained at the end of each financial year. However, it may be done more frequently depending upon the system in operation. Surplus or deficit needs to be done by an appointed actuary in case of a family takaful operator and by management of the general takaful operator in case of the general takaful.
The most important point is that the Board of Directors, in consultation with the Shariah Board, must initially set out the detailed mechanism for the distribution of such surplus, including the frequency which must be on the basis of technical evaluation.
This mechanism shall form part of the PTF and needs to be mentioned in the PMD. The surplus or deficit, done at each valuation date, needs to be made up of technical results and investment returns related to the PTF and may be summarised as follows.
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Contribution from participants XXX
Claims received from re-Takaful or re-insurance XXX
Less: Claims paid for the risk covered under PTF XXX
Less: Takaful operator's fees charged XXX
Less: Commission paid to intermediaries XXX
Less: Changes in technical reserves XXX
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Surplus or deficit XXX
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Takaful operator may hold a portion of the surplus as contingency reserve which may be over and above the technical provisions stated above. The rest of the surplus shall be distributed to participants in proportion to the contributions to the PTF net of any risk-related claims, which they may have received during the inter-valuation period, if any.
In case of the General Takaful business, the distribution of surplus shall be made after each valuation. Each valuation must consider the contracts completing their risk period during such valuation period for surplus distribution based on the results of the previous valuation. In case of Family Takaful business, the surplus distribution needs to be done after each actuarial valuation.
The surplus may be distributed without actuarial valuation only to those participants who actually left the risk pool by way of termination of membership owing to the payment of benefits as per the PMD or otherwise. The Takaful operator has the choice to compute the distributable surplus on the basis of each class of business or the combined result.
The Takaful operator may distribute the surplus either in cash or adjust against future contributions in case of General Takaful. In case of Family Takaful, the takaful operator may credit the surplus to the PIA. In case a member does not wish to continue as a participant in the PTD it shall be necessary to pay surplus to such member based on his entitlement.
In furtherance, if a participant wishes to donate its surplus for social or charitable purposes, he or she may do so through a takaful operator. However, in the case of deficit in the PTF, the takaful operator shall undertake to give Qard-e-Hasna to the PTF which may be recovered from future surpluses without any interest on the actual amount.
The Qard-e-Hasna can also be taken from the Share holders' fund [SHF defined below] in case the PTF including reserves are insufficient to meet their current payments less receipts and needs to be interest free. It is worthwhile here to note that all receipts of the takaful operator properly attributable to the business to which the PTF relates, including the income of the PTF, needs to be paid into the PTF.
The assets, comprising of the PTF, can only be used to meet such part of the PTF's liabilities and expenses which are properly attributable to the PTF. In case of Family Takaful business, no part of PTF shall be allocated by way of takaful benefits to participants except with the prior approval of the appointed actuary.
Any surplus of assets over liabilities needs to be allocated as per statutory valuation of the PTF and such allocation needs to be treated as the reduction. It is worthwhile here to note that the assets of the PTF need to be kept separate from all other assets of the takaful operator.
The assets must not include assets comprised in a deposit under Takaful Rules, 2005 nor any amounts on account of goodwill, benefit of development expenditure or similar item which are not realisable.
(To be concluded)
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