Takaful insurance is the talk of the town these days and even though not a single company has started its Takaful operations yet, however SECP has issued rules containing the detailed infrastructure and discharged its obligation. The taxation of Takaful insurance business is an important area of knowledge because it is one of the special types of activity of insurance sector and current fourth schedule of 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 suggest the improvements required in 4th Schedule of Income Tax Ordinance, 2001 as it is clearly stated in the Takaful rules that it will override Insurance Rules, 2002 and Securities and Exchange Commission of Pakistan Rules 2002 in case of conflict. In furtherance, the deficiencies in existing model of 4th Schedule of Income Tax Ordinance, 2001 and global practice because such inadequacies resulting 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.
INTRODUCTION OF TAKAFUL OPERATIONAL MODEL
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 detailed procedure is 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 means Takaful insurance other than family Takaful.
Family Takaful means Takaful for the benefit of individuals, groups of individuals and their families pertaining to life.
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 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 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 appointed actuary in case of family Takaful apart from Shariah board in accordance with PMD.
However, in case of 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 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 Shariah board and Appointed actuary.
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 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 Family and the General Takaful business on 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 General Takaful operator the income of SHF consist of Takaful operator fee, profit on the investment of the SHF and 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 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 Takaful business shall form part of the expenses of TBSF for family Takaful operators and SHF for General Takaful operators.
TAKAFUL BUSINESS STATUTORY FUND [TBSF]
All contributions received under family Takaful contract needs to be credited to Takaful Business Statutory Fund and needs to be divided into investment, risk related and Takaful operator’s fee.
However, all contribution received under General Takaful contracts needs to be netted of first 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 credit to participants’ Takaful fund.
PARTICIPANTS’ TAKAFUL FUND [PTF]
A participant is an assignee of 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 internal Shariah board of Takaful operator. Any subsequent changes need to be approved from the Shariah board.
Takaful Rules, 2005 requires a separate PTF needs to be created within TBSF. PTF needs to be credited with investment component and Takaful operator’s fee. Such amount is used to pay the benefits. The investment component needs to be credited to one or more 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 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.
The expenses of the PTF shall consist of losses settled – related to participants’ risk and expenses directly related to settlement of claims as defined in the PTF and PMD such as surveyors’ fees but excluding offices 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 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 summarized 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 settlement of claims as defined in the PTF and PMD such as surveyors’ fees but excluding offices 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 the 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 equalization 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 participants of the fund from the same fund apart from all expenses which needs to be incurred for providing Takaful benefits including re-Takaful contributions. However, these need to be specified in PTF rules and PMD. The PTF rules and PMD for each class of business needs to be approved from Shariah Board.
Sharing of Surplus and Deficit
Takaful Rules, 2005 requires that 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 a appointed actuary in case of family Takaful operator and by management of general Takaful operator in case of general Takaful.
he most important point is that Board of Directors, in consultation with 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 summarized as follows: