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.
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.
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.
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.
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.
-- 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.
-- 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.
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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