Regulatory and Supervisory measures to Mitigate the Impact of COVID-19: Recommendations Relating to the Takāful/Retakāful Industry
Date posted: 6 August 2021
The COVID-19 pandemic and the measures taken to prevent its spread have had a significant impact on the global economy and financial markets. Several IFSB member jurisdictions have already pursued a range of regulatory and supervisory measures1 to alleviate the impact of COVID-19 on financial stability in their jurisdictions.
The pandemic has accentuated the fundamental value of the establishment of takāful2 as significantly defined by one of the core principles3 known as Ta’awun, which emphasizes the importance of takāful to assist one another mutually for the losses arising from specified risks by providing financial protection and promoting financial soundness and stability of the Islamic financial system. The IFSB supports various efforts undertaken by the IFSB members in responding to the pandemic through policy responses including government assistance, pooling fund from takāful operators (TOs) to cover the impact of COVID-19, extending the grace period for takāful contributions, easing and accelerating payment of claims and promoting adoption of technology to communicate with takāful participants. IFSB members’ use of relief measures for takāful participants featured more prominently compared to regulatory flexibilities. This is coherent with the essence of the concept of takāful, i.e. mutual assistance among takāful participants.
Based on the policy responses adopted by IFSB member countries, the IFSB acknowledges that the regulatory supervisory authorities (RSAs) are in a delicate position on striking the right balance in competing priorities between providing assistance to TOs and offering relief to takāful participants. The IFSB recommends that RSAs remain vigilant in performing the act of balancing with a focus on ensuring the takāful business sector remains financially and operationally resilient. Taking cognizance of the wide spectrum in terms of level of maturity of the TO couple with limited knowledge on takāful products among the takāful participants, RSAs are expected to play a key role in this unprecedented situation.
The main objective of this public statement is to foster regulatory responses across jurisdictions to mitigate the negative effects of the COVID-19 crisis and to ensure continued clear guidance for the takāful industry during this challenging environment.
(A) SUSTAINING CAPITAL ADEQUACY
TOs may be impacted on both sides of the balance sheet. Market volatility may have effects on investment assets and mismatches on duration with liabilities for any or all of the shareholder fund (SHF), participant risk fund (PRF) and participant investment fund (PIF). IFSB-11, Standard on Solvency Requirements for Takāful (Islamic Insurance) Undertakings, requires TOs to hold sufficient eligible PRF on an on-going basis to cover their Minimum Solvency Requirement. The objective of solvency requirements at PRF level is to provide a high degree of confidence that the PRF can withstand adverse conditions over the expected terms of its assets and liabilities. Furthermore, IFSB-11 includes solvency control levels at the respective takāful and shareholders’ funds that trigger proper interventions by a TO and the supervisory authority when the available solvency is less than the solvency control level. This allows for flexibility in cases of extreme situations, including measures to extend the recovery period of the affected TO. IFSB-14, Standard on Risk Management for Takāful (Islamic Insurance) Undertakings, also emphasises the performance of stress testing by TOs as part of a prudent risk management mechanism particularly in monitoring solvency. Both IFSB-11 and IFSB-14 are relevant in this pandemic situation.
(i) Capital Adequacy
The RSA may require TOs to:
- closely monitor the capital position of the takāful undertakings (TU) and each of their constituent funds, report to the RSA when intervention trigger points are reached or approached thus enabling the RSA to propose guidance, take necessary actions and make timely supervisory decisions.
- perform forward-looking assessments on the TU’s capital position, predicting the level of capital adequacy over a reasonable timescale. Where continuing capital weakness is apparent, the TO should report its plan to the supervisor for remediation or exit.
- reassess the risk funds that are expected to face potential deficit due to retained surplus not being able to support the fund against expected claims. SHF shall take into account the potential need for Qard to support related risk funds (where the regulatory framework in a jurisdiction permits the use of a Qard facility for providing additional capital to PRFs).
- take action, where necessary, to conserve capital with mitigation actions as allowed by the regulation in a jurisdiction. Some of the examples include cancelling or postponing transactions such as dividend pay-outs to shareholders, share buybacks or similar transactions, bonus payments and surplus distributions to takāful participants.
- be vigilant when a firm breaches the prescribed target capital requirements (PTC) for the shareholders. The supervisor may consider exercising its power (if it has the power) to extend the prescribed deadline for restoration of PCR due to the extraordinary circumstances, imposing such conditions as it considers necessary.
- continuously monitor for breaches of prescribed capital requirements (PCR) for individual PRFs. No action would be taken as long as a TO would be able to demonstrate to their supervisors that SHF is able to provide appropriate Qard amount in an event of deficit.
- ensure the adequacy of a Qard facility. A TO should carry out regular actuarial appraisals of the solvency of the relevant PRF, so as to determine the amount of any shortfall with respect to the solvency requirement which would need to be covered by the Qard facility, as prescribed in paragraph 36 of IFSB-11.
Market volatility is likely to change the balance of TUs’ investment portfolios, in terms of the balance of liquid and illiquid and the balance of different types of investment, and also in terms of the suitability for asset-liability matching. In performing a rebalancing exercise during a time of crisis and to avoid any unwanted procyclical impacts, RSAs may require TOs to:
- obtain focused information and data from TOs regarding their solvency and liquidity position and the extent of asset-liability mismatches (if any), and the action taken by the TO, in order to enable supervisory decisions to be taken in appropriate time. Requirements for focused information and data can be directed to those TOs whose operations by their size and nature appear to the RSA to be particularly vulnerable to solvency or liquidity strain, but the RSA should expect all TOs to perform similar updates regularly, and report them to their Boards of Directors (BODs).
- consider the need for guidance to TOs to assist them in mitigating procyclicality impact. This might include relaxation of regulatory submission deadlines as prescribed by the regulations or guidelines relating to asset liability management, as well as guidance on the extent to which TOs may regard volatility as short-term and attributable to COVID- 19 (as opposed to real losses that would have occurred anyway).
(B) PROTECTING INTERESTS OF TAKAFUL PARTICIPANTS
IFSB-25, Disclosures to Promote Transparency and Market Discipline for Takāful/Retakāful Undertakings (December 2020) emphasises the protection of the interests of takāful participants, alongside other stakeholders. It promotes providing reliable and timely information in order to assist them making informed decisions. The outbreak of the pandemic occurred during the final phase of issuing IFSB-25. Hence, the issuance of this standard was timely given the standard provided guidance on factors to be considered during crisis management, taking measures learnt from IFSB members and international best practices which enable RSAs to apply during this pandemic.
(i) CONDUCT OF BUSINESS
Disruption caused by an event such as the COVID-19 pandemic may pose challenges for TOs to undertake proper investigations of claims or of contract proposals. The takāful participants behaviour may also change, for example by extension of working from home, that could trigger other exclusions in contracts (e.g. business use of residential premises) leaving participants without coverage, as a result of circumstances over which they have no control and which were not contemplated when the exclusions in question were written. It is also possible that contracts in force become potentially onerous, to the extent that TOs seek to terminate the contracts or to refuse renewal, or withdraw them from the market.
Whilst some defensive actions by TOs are likely to be within the contract terms, there is a risk that the unusual circumstances are used as an excuse for actions that are not in accordance with contract terms and detrimental to customers, for example denial of claims, attempts to write exclusions into in-force contracts retrospectively, or attempts to write exclusions into contracts prospectively where the contract makes no provision for such action.
The RSA may:
- be alert to the risk of unfair treatment of the takāful participants, and actions that represent unreasonable conducts, that may require prompt enforcement action.
- require TOs to inform or provide reminders to the market of its expectations of honest, transparent, fair and professional treatment of the takāful participants.
- require TOs to publish guidance for their takāful participants, suggestion and answers to frequently asked questions in a manner that is clear, fair and not misleading in the form of web or social media pages or similar.
- encourage the market to agree on a common and sensible approach to matters such as household policies with business use exclusions, in the context of enforced working from home.
- play a role in helping TUs in ensuring fair treatment to the takāful participants e.g. provide clarity where uncertainty persists over contract coverage.
(ii) DISCLOSURE AND TRANSPARENCY
During a COVID-19 pandemic, takāful participants and other counterparties of TUs often depend upon data and information published by TOs to understand their rights under their contracts in extraordinary situations and to make such decisions as they need to. Where government has intervened, takāful participants again treat the TO as a primary source of data and information on how that intervention affects them. Therefore, it is integral for the information to be clear, transparent, up-dated and accurate to ensure that takāful participants make informed decision in their best interest while minimising asymmetry of information.
The RSA may apply supervisory measures towards TOs with a view to ensuring that the takāful participants are treated fairly and appropriately, by requiring the TO to:
- provide clear, transparent and timely information to takāful participants on contractual rights, scope of their cover, the exemptions that apply and the impacts, if any, of COVID-19 on their takāful policies.
- highlight to participants the risk of phishing and other scams, as well as the dangers of acting on the basis of news that may be fake, and recommend to them that they seek advice before taking actions.
- communicate clearly with takāful participants about the terms of the economic relief provided, whether voluntarily or under a government or industry initiative.
- disclose the performance of participants’ investment funds in a more frequent basis, at times of high volatility in investment markets.
- communicate clearly with the takāful participants and inform them about the major operational disruptions which make it difficult to process claims in a timely fashion.
(C) ENSURE BUSINESS CONTINUITY
Meeting TU’s obligations, for both takaful funds and SHF, is a crucial responsibility for TO at all times. Achieving this requires the firm to be operated within a robust framework to ensure business continuity. IFSB-8: Guiding Principles on Governance for Takâful (Islamic Insurance) Undertakings sets out various principles, including prudential guidance pertaining solvency and investment. Also, IFSB-10 Guiding Principles on Sharî`ah Governance Systems for Institutions offering Islamic Financial Services Sharī’ah shows the importance of having operating procedures and lines of reporting between governance organs, in order to ensure the activities are in line with Sharī’ah rules and principles.
Enterprise risk management is one of the main components discussed in IFSB-14 that should be dealt differently due to segregation of funds. As the stability of the industry and the protection of the participants are the core objectives for RSAs, IFSB-20 Key Elements in the Supervisory Review Process of Takāful/Retakâful Undertakings provides dynamic supervisory tools for RSAs and encourages adoption of risk-based approach in supervising market players.
(i) SHARÎ`AH GOVERNANCE
During this uncertain time, it is even more critical to perform more vigilant oversight function on Sharī’ah governance to ensure that any business activities and affairs relating to regulatory measures comply with Sharî`ah rules and principles and particularly in supporting the Sharī’ah Board to perform robust deliberations to achieve timely decisions for effective dissemination. Effective communication between relevant organs of Sharī’ah governance is key to ensure adequate and timely information and assessment are provided to the Sharī’ah Board.
Areas for RSA may emphasise the TO to embrace (i) ability for Sharî`ah functions to keep abreast with the latest information and development in the takāful business operation, and provide relevant support (ii) adequacy of information being communicated to various stakeholders to make informed decisions during times of uncertainty; (iii) effectiveness of Sharî`ah organs to perform their functions including effective deliberation by the Sharî`ah board in spite of potential limitations of accessibility and infrastructure for meetings; and (iv) agility of the Sharî`ah functions to respond to changes such as intervention from government; volatility of market in light of Sharî`ah rules and principles.
RSAs may require TOs to ensure that those responsible for Sharî`ah governance are provided with the ability to perform their oversight functions in the event of inability to meet as normally and regularly, and that arrangements to enable them to do so and to ensure that management is able to escalate matters for Sharî`ah scrutiny in the event of business disruption are regularly tested (as with other business contingency planning).
In the event of business interruption, key functions in performing Sharî`ah governance oversight should be continued, if necessary by adaptation (for example, the adoption of technology for remote consultation). Where changes are necessary to the takāful operation, the Sharî`ah board should be consulted to assess the impact of those changes on compliance with Sharî`ah principles and the fairness of treatment to the participants involved.
(ii) CORPORATE GOVERNANCE
The impact of the COVID-19 on an organisation has placed greater emphasis on the agility of governance organs’ ability to respond to a crisis situation. Underpinning the three guiding4 principles of IFSB-8, among areas that the RSA may wish for the BOD to perform are to: (i) set a clear tone from the top on the expectations set by the BOD in response to COVID-19 including actions, decisions and communications and the influence of the pandemic on the TO’s risk appetite and direction; (ii) identify, evaluate and regularly update crisis-related compliance processes i.e. regulatory or internal policies specific to the TU; (iii) designate a committee to specifically oversee pandemic-related matters as this will allow a centralised function to provide timely and adequate information for stakeholders; (iv) effectively engage with the management through transparent and frequent discussions, dedicated areas for deliberation on managing crisis situations and recording of details on COVID-19 related discussions; (v) strengthen evaluation of the TO’s business continuity particularly on the effectiveness of outsourced functions either within the group or to third-party service providers given the high reliance of takāful operations on either conventional insurance or third-party services and; (vi) manage the working time and rotation of staff to ensure work continuity; (vii) perform a high-level and comprehensive assessment of the impact on the effectiveness of the governance functions, and report to the RSA on the results of that assessment and the steps taken to mitigate the impacts, anticipate the stress condition and enable effective governance; (viii) actively monitor the short-term, medium-term and long-term impacts of the exceptional situation on the financial position of the TU, with management information focusing on key impacts and actions to mitigate. Frequency of relevant management information may be increased. The BOD may establish a special committee or task force for this purpose; and (ix) evaluate whether it is necessary, in order to protect the financial resilience of the TU, to postpone or cancel any withdrawal of assets (for example dividends, share buybacks and bonuses).
(iii) ENTERPRISE RISK MANAGEMENT
Significant changes to the economic and non-economic environment may greatly influence the way TOs operate their business. For example, TOs may be unable to operate from their premises and must enable remote working, or may be unable to carry out pre-contractual or post-claim verification in a normal manner. The new way of working changes the risk profile of the firm, and its existing enterprise risk management (ERM) framework may require some modification to address new risks that may have transpired from the new circumstances.
The RSA may require TOs to:
- review the TU’s risk appetite in respect of key risks and revise the appetite to reflect the current business and economic conditions.
- review the ERM framework in light of revised risk appetites, revised perceptions of risk and changes in the availability or practicability of risk mitigation actions.
(iv) OPERATIONS OF A TAKĀFUL OPERATOR
Under the COVID-19 or a similar critical situation, operational risks may be increased due to logistical challenges that affect internal control processes. Therefore, there is a need for TOs to adapt to such changes in order to maintain its operational ability to perform adequate underwriting, execute timely claims, respond to policyholders’ requests, perform a resilient investment strategy as well as instil best practices and protocol on the critical assets to counteract cyberthreats.
Supervisory measures on which the RSA could focus during COVID-19 or a similar situation include the following:
- The ability of TOs to execute their business continuity plan and to report to the RSA the experience gained during the COVID-19 pandemic and exposures that emerge as business-critical (e.g. secure internet service with encryption).
- The efficiency of the TOs in, and the outcomes of, executing the business continuity plans with a focus on critical operations and functions, to manage their operational risk exposures.
- The adequacy of the TOs’ report to the RSA on their assessment of the effectiveness of their IT security and any actions being taken to remediate perceived risk areas.
- The robustness of the TO’s parameters, methodologies and quality of data in performing stress testing and effectiveness of mitigation actions by the TO to minimise the risk as well as action plans to restore the operations to a regulatory acceptable condition.
(v) SUPERVISORY REVIEW AND REPORTING5
A fast developing and unprecedented situation such as the COVID-19 pandemic may quickly render reported information to be outdated, as it may not adequately reflect the risk profile and condition of the TO, for the purposes of both current and prospective supervisory assessments. In addition to difficulties in data collection and compilation due to reporting lags within parts of the TO, the quality of data may also be impacted by unavoidable simplifications or compromises to processes arising from challenges posed by movement restrictions.
The RSA may:
- adopt operational relief measures – e.g. extending deadlines to submit supervisory returns, reducing or remitting fees, and extending deadlines for penalty payments - in order to allow TOs to focus their resources on managing the crisis.
- require focused information and data from TOs on the impacts of the circumstances on their financial and solvency positions and operational abilities, as well as other matters relevant to crisis management (e.g. RSAs requiring TOs to notify participants about claims that are connected to the crisis that may be disputed).
- reduce or postpone on-site inspection visits, thematic reviews and non-critical investigations. These initiatives will help TOs to focus on other critical functions, as well as allow the RSA’s own personnel to concentrate on immediate threats.
- give examples of key areas on which supervisors could focus on or prioritise during this time. This may include capital adequacy, business continuity, Anti-Money Laundering and Countering Financing of Terrorism (AML/CFT), and cyber security.
- emphasise on continued supervisory engagements with TOs, especially where typical modes of supervisory monitoring may not be available (e.g. on-site visits). It may also be useful to provide examples of approaches that supervisors can take in lieu of on- site monitoring (e.g. intensify engagements with control functions of TOs).
- monitor the retakāful operators’ financial rating arising from COVID-19 and perform review on the treaty contracts to address the claims arising from COVID-19.
- use the experience of COVID-19 pandemic to assess TO’s approach to perform stress and scenario testing. A key supervisory objective in such testing is to simulate potential losses on takāful firms’ balance sheets, including risk-adjusted capital levels, investment portfolios, reserve adequacy, retakāful/reinsurance exposure and other risk factors. This will help RSAs analyse the soundness and stability of the firms.
Disruption caused by an event such as the COVID-19 pandemic may affect the ability of intermediaries to carry out their functions effectively. Among the challenges faced by intermediaries such as agents, takāful brokers, financial advisers, third-party administrator, and loss adjuster, are:
- Financial difficulties due to decreased revenue from intermediary activities.
- Inadequate technological facilities and infrastructure to work remotely from office during periods of restricted movement.
- Having limited access to physical files.
- Inability or limited ability to perform routine tasks requiring meeting the customer physically such as performing Know Your Customer or evaluating the cost of repairing a damaged vehicle and performing site visits.
The RSA may:
- require TOs to ensure that intermediaries representing the TOs are supplied with adequate resources, data and information to carry out their functions.
- encourage TOs to communicate with intermediaries to facilitate renewal of expiring policies and assessment of claims.
- consider providing regulatory flexibilities and other special treatments to accommodate the challenges faced by the intermediaries.
- encourage intermediaries to remain abreast of market developments, so that updated advice can be provided to their customers.
- encourage intermediaries to collaborate with TOs to ensure fair treatment of customers where disruption to operations is preventing proper assessment and fulfilment of customers’ valid entitlements. Collaboration between trade bodies and market players at a market level, to provide mechanisms for overcoming logistical difficulties in servicing customers, may also be encouraged in extraordinary circumstances.
1 Taking cognizance of the dual regulatory systems in the majority of IFSB members (conventional and Islamic), RSAs may also make reference to the Global Insurance Market Report (GIMAR) Covid-19 Edition, issued by the International Association of Insurance Supervisors (IAIS) in December 2020. It discussed the impact of Covid-19 on the global (re)insurance sector in 2020 from a supervisory perspective.
2 Including retakāful except where stated otherwise
3 IFSB 8 – Guiding Principles of Governance for takāful (Islamic Insurance) Undertakings.
4 Principle I: Reinforcement of relevant good governance practices as prescribed in other relevant internationally recognised governance standards for insurance companies, while addressing the specificities of takāful undertakings; Principle II: A balanced approach that considers the interests of all stakeholders and calls for their fair treatment; and Principle III: An impetus for a more comprehensive prudential framework for takāful undertakings.
5 Taking cognizance of the dual regulatory systems in the majority of IFSB members (conventional and Islamic), RSAs may also make reference to the Redefining Insurance Supervision For The New Normal, Co-authored by the IAIS Secretariat and Financial Stability Institute (FSI) of the Bank for International Settlements (BIS), issued in April 2021. The report explores the experiences and challenges of insurance supervisors as they were forced to adapt to prolonged remote working conditions during the Covid-19 pandemic.
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