takaful accounting in malaysia full paper

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A REVIEW OF TAKAFUL ACCOUNTING REGULATIONS AND PRACTICES

IN MALAYSIA

Shahul Hameed bin Mohamed Ibrahim International Islamic University Malaysia

Hairul Suhaimi Nahar

International Islamic University Malaysia

ABSTRACT This research undertakes an empirical investigation of the accounting practices of Takaful Companies in Malaysia for the period 2003-2005. We start by reviewing the need for and the development of the Takaful industry in Malaysia followed by a review of the differences in the concepts, operations, accounting and reporting between conventional insurance and Takaful. Our thesis is that the concepts and operations of Takaful call for a different set of accounting and reporting practices; which we believe to be a subset of what we term as Islamic accounting. We then compare the accounting practices suggested by the Malaysian Financial Reporting Standards for Insurance (FRS 17 & 18) and AAOIFI accounting standards for Islamic Insurance as well as the Bank Negara Malaysia (Central Bank) Guidelines on Insurance and Takaful (GPI3&15 and GPT6 respectively) which includes accounting disclosures. We then extract a list of accounting requirements from AAOIFI accounting standards for Islamic Insurance and GPT6 and score these using the annual reports of the four Takaful operators in Malaysia. The results show that, while AAOIFI accounting standards for Islamic Insurance are not completely followed, the introduction of GPT6 had indirectly encouraged Malaysian Takaful operators to abide by AAOIFI standards (which are not compulsory in Malaysia). Further, we also report and comment on the response we obtained from the telephone interviews of the Takaful operators we conducted to seek clarification for some of the findings from the analysis of the annual reports.

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1. INTRODUCTION The Islamic banking, Islamic financing, Islamic Insurance and Islamic capital market are essentially creatures of the Islamic economics. They emerged as a result of Al-Tajdid Al-Islami (Islamic revivalism) i.e. the “cleansing of Islamic practices of all un-Godly elements” in an effort to return Islam to its original pure form (Mawdudi, 1999). The efforts have been concentrating on various spheres such as in the aspect of politics (the establishment of Islamic states e.g. Sudan and Iran), knowledge (the Islamization of knowledge and the setting up of Islamic Universities), legal aspects (the adoption of Shari’ah law i.e. Hudud and Qisas), as well as economics (the introduction and promotion of Islamic economics, Islamic banking and Islamic Insurance). In economic aspect particularly, given its extensive Islamic revivalism efforts, it is unsurprising to note its rapid development practically and considerable growth of research in the same area academically.

Equivalent to the case of Islamic banking which forms part of the Islamic economics system, the Islamic insurance system (Takaful) is essentially creature of the same economic system – the Islamic economics, formulated and established as a result of the Islamic revivalism efforts in many Muslim and non Muslim countries. It operates based on fundamentally different set of parameters, heavily guided by the rules of Shari’ah (Islamic law). In Malaysia, the National Fatwa Council had resolved in 1972 that conventional insurance is a fasid practice, therefore is haram (forbidden). The above decree was premised on the fact that there exist elements of gharar (uncertainty), maisir (gambling) and riba (usury) which are totally in contradictory to the spirit of Shari’ah. As such, in contrast to conventional insurance, the operational set up of Takaful is formulated to be free from these three elements. In addition, Takaful system also employs several Islamic elements such as Ta’awun (mutual help), Tabarru’at (willingly relinquish individual rights over the contributions paid, for collective benefits) and Mudharabah (profit sharing relationship) or Wakalah (principal-agent relationship).

The above concepts of gharar, maisir and riba as well as the existence of

elements of Ta’awun, Tabarru’at, Mudharabah and Wakalah in Takaful have been moderately covered by prior academic studies. Such literatures on Takaful are reasonably extensive. However, these studies have shown lack of focus on the specific area of accounting and reporting for Takaful. Most of the literatures are rather theoretical in nature which focuses on Takaful concepts and its operational aspects, leaving ample space for research theoretically and empirically in the specific area of accounting and reporting for Takaful. In Malaysia particularly, there are currently no specific Takaful accounting and reporting standards. Instead, Takaful operators are required to abide by circulars and guidelines issued by the central bank (Bank Negara Malaysia – BNM). Nonetheless, operators are also presented with Shari’ah based accounting and reporting standards on Islamic insurance which were produced by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). These standards however have never been enforced by the Malaysian regulatory body on Takaful operators. Nevertheless, Malaysian operators could only consider adopting it on a voluntary basis.


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This paper seeks to first; explore the nature of Takaful and its differences with conventional insurance from the conceptual, operational, accounting as well as reporting perspectives. Secondly; it will explore the nature of the currently available and applicable Takaful accounting and reporting regulations in Malaysia, providing special attention to the currently-in-use BNM type of accounting and reporting regulation on Takaful as well as the accounting and reporting regulation on Islamic Insurance provided by AAOIFI. Thirdly; the paper will assess the extent of compliance by Malaysian Takaful operators to Takaful guideline (BNM type of accounting and reporting regulation on Takaful) and the extent of acceptance to AAOIFI Islamic insurance standards and subsequently obtaining reason(s) for operators’ full (or partial) compliance/acceptance.

In this study, the choosing of Malaysia as the country of reference is supported by

the fact that it provides an interesting cultural setting for the study of related issues on Islamic institution of Takaful in which, its establishment forms part of the economic Islamization process by its leaders. Being an Islamic state as claimed by many of its leaders, Malaysia was the 6th country in the world to introduce Islamic insurance system, right after Sudan, Saudi Arabia, Switzerland, Belgium and Bahamas (see Maysami & Kwon, 1999). Thus, it would be interesting to see its development particularly from the accounting and reporting perspectives after more than 20 years of Takaful existence.

The rest of this paper is organized as follows:

Section 2 will proceed to discuss the differences between Takaful and insurance from the conceptual and operational perspectives. This will then be followed by a brief discussion on the background and development of Takaful in Malaysia. The 3rd section discusses, in the context of Takaful, the conceptual insights of its accounting and reporting. The position of accounting and reporting in Islam is highlighted and the role of BNM in regulating Takaful industry is presented. The role of AAOIFI as the international standard setter for Islamic financial institutions will also be noted. Section 4 outlines research methods employed in this research. Section 5 presents findings on the comparative analysis between insurance standards, Takaful guideline and AAOIFI standards. Section 6 discusses findings from the analysis of the conformance scoring based on annual reports of 4 Takaful operators. Section 7 concludes the paper which includes some suggestions for changes to the regulatory body concerned. 2.0 TAKAFUL AND INSURANCE: CONCEPTS AND OPERATIONAL

DIFFERENCES Literatures on Takaful are growing considerably. Most of these literatures cover almost the same areas albeit, with slight variation in terms of focus. The topics of Takaful concepts and its operational mechanism are the most frequently discussed topics in such growing literatures of Takaful (For example in Ali, 1989; Mohd Fadzli 1996a&b; Azman, 1997; Maysami & Kwon, 1999; Billah, 2003; Yon Bahiah, 2004; Hairul Annuar, 2005). Literally, conventional insurance refers to financial protection system which involves the execution of contracts (insurance contracts) between an insurer and insured in which insurer agree to underwrite the subject risk of such contracts (Webb et al., 1992).


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Arrow (1980) as quoted in Siddiqi (2000) provides a conceptual definition of insurance as an exchange of money now for money payable contingent on the occurrence of certain events (or risks). Risk in insurance primarily refers to losses arising from specified or defined perils. According to Arrow (1980), in providing financial protection to insured, insurer will sell insurance coverage. Before selling it, insurer will make advance projection on the maximum probable losses of any particular risk. Premiums are then allocated to risk in line with coverage limit. Subsequently, premium payment is set to be in accordance to such risks projection. Implicitly, these insurance operations involve a process of transferring losses in advance based upon past experiences (Omar & Dawood, 2000). By selling insurance coverage, insurance companies are basically assuming the subject risk as stated in the insurance contract. This is reflected in the extent to which premiums paid are then treated as insurers’ income which signifies the shift of rights of such premiums to insurer from insured. As a legal owner to insurance funds, insurer has full control over such funds and there is no obligation on their part to distribute back any underwriting and investments surpluses generated to policyholders except for in the case of claims payment and in life insurance policy which had reached maturity and that insured survived at the maturity date. This constitutes a one way economic relationship between insure and insured if no risks occurred since only insurer will get the economic benefit, had the risk did not occur.

On the other hand, Islamic insurance (commonly referred to as Takaful) is

conceptually defined as an Islamic financial protection system which involves a joint-guarantee scheme in providing possible indemnity or contingency against pure risk1 resulting from an unexpected occurrence of loss or damage to one’s life or property (Billah, 2003). It operates based on concepts of Ta’awun (mutual help or co-operation), solidarity, trusteeship, brotherhood and Tabarru’at (willingly relinquish individual rights over the contributions paid, for collective benefits2) (Mohd Fadzli 1996a&b; Azman, 1997; Maysami & Kwon, 1999; Billah, 2003; Yon Bahiah, 2004). Takaful operator (Islamic Insurance company) collects contributions (premiums as in insurance) from participant(s) (policyholders) and subsequently agree to manage those contributions (i.e. Takaful fund) based on certain set of guidelines. The management of Takaful fund by operator could be based on either Mudharabah (profit sharing) or Wakalah (agency) model. The former regards participants collectively as "Sahibul-Maal" (capital providers) while Takaful operator as Mudharib (entrepreneur) and Takaful contributions as Ra’sul Maal (capital to the Mudharabah contract). The latter regards Takaful operator as an agent and Takaful participants collectively as principal. Unlike the sharing of profits in Mudharabah model, the reward for agent in the Wakalah model is the fee payment.

1 According to Omar & Dawood (2000), risk or uncertainty can be divided into Pure Risk and Speculative Risk. The former involves the possibility of Loss or No Loss. For example, damage to property due to fire. Such Risks are the subject of insurance risk protection and Takaful. On the other hand, Speculative Risk involves the possibility of Loss, No Loss or Gain. For example, venturing into new business or gambling on horse race. Speculative Risks that include potential Gain or Profit cannot be insured. 2 Even though the literal meaning of Tabarru’at is sadaqah or donation, however in Islamic insurance or Takaful, it carries a different operational meaning that is the willingness to relinquish individual rights over the contributions paid for mutual collective benefits of participants in the Takaful scheme.


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The striking conceptual difference between Takaful and conventional insurance is that risks in Takaful are not exchanged by way of contribution payments to operators (Omar & Dawood, 2000). In essence, operators are not selling and participants are not buying any risk coverage. Thus, operators are not assuming or underwriting any risks from participants. Rather, risks are distributed among Takaful participants whom agree to jointly assume the risk (Mohd Fadzli 1996a&b; Maysami & Kwon, 1999; Billah, 2003). It is in this sense that operators are considered as merely intermediary or fund managers, managing Takaful funds on behalf of participants. As fund managers, contributions paid by participants are regarded as ‘fund’ or ‘liability’ to operators and rights over it remains attached to participants. Several Islamic concepts in Takaful system (but not in conventional insurance) further differentiate Takaful from insurance conceptually. Ta’awun, Tabarru’at, Mudharabah and Wakalah are the Islamic concepts which are justified by Shari’ah and employed by Takaful system. Mudharabah and Wakalah for instance depict economic contractual relationship between operators and participants. Mudharabah concept works based on the sharing of profits between the two parties while Wakalah concept operates based on the payment of fees.

Ta’awun and Tabarru’at are concepts which illustrate the Islamic social relationship among participants in Takaful system. Participants mutually agree to help and guarantee each other through the relinquishing of individual rights over the contributions paid for the mutual benefits of participants in the scheme collectively i.e. Tabarru’at (Mohd Fadzli 1996a&b; Maysami & Kwon, 1999; Omar & Dawood, 2000; Billah, 2003). It embraces the elements of shared responsibility, joint indemnity and mutual protection. It is this aspect in Takaful system that makes uncertainty element allowable under Takaful contract (Billah, 2003). This is truly in line with the objective of achieving social and economic well being of the ummah (Islamic society). Moreover, God is said to have stated in Qur’an thus; "Assist one another in doing of good and righteousness. Assist not one another in sin and transgression, but keep duty to Allah" (Qur’an 5:2).

Operational wise, conventional insurance works on the basis of “risk assumption” by insurer or the “trade of risk” (Omar & Dawood, 2000). Through the selling and buying of insurance contracts and in the absence of Ta’awun, Tabarru’at and Mudharabah or Wakalah, the whole system of insurance is said to have operated involving 3 basic elements which are totally contradictory to Islamic rules of Shari’ah (Mohd Fadzli 1996a&b; Maysami & Kwon, 1999; Omar & Dawood, 2000; Billah, 2003). The elements are “gharar” “maisir” and “riba”. According to Azman (1997), Gharar could exist in insurance in 4 forms: Gharar in the outcome, Gharar in the existence, Gharar in the results of the exchange and finally Gharar in the contract period3. Maisir or gambling originates from gharar (uncertainty), and exist in insurance since profits or losses to insurer would very much depend on chances which closely associated with claims level. Claims are in turn, could not be controlled by insurer. Also, maisir in insurance operation resembles to a certain extent “risk-taking” whereby insured could either receive huge amount of money (claims payment) without an equivalent amount of input (premium paid) (Omar & Dawood, 2000).

3Please refer to Azman (1997) for further discussions on these four types of Gharar.


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Insured could also be paying premium without getting any amount in return (if no risk occurred). Insurer on the other hand could either loose if there are too many claimants or could make huge profits when premiums collected exceeds claims (Omar & Dawood, 2000). Therefore, the uncertainty in insurance system leads to gambling as discussed above. Besides Gharar and Maisir, Riba could also exist in insurance and it could be in various forms. If we go by the classification of riba by Imam As-Shafiie, then riba in insurance relates to riba Al-Buyu’ which exist in trade (sales contract). The types of riba are riba Al-Fadl’ (uneven exchange value – small premium in return for bigger coverage value) and riba Al-Nasiah (deferred payment – claims payments are deferred to period when there is occurrence of risks) (Mohd Fadzli 1996a).

In another aspect, riba could also be found in the investment operations of any

insurance companies since the sources of income to insurance (and Takaful companies) are mainly from 2 channels – underwriting and investment. As mentioned earlier, the underwriting scheme of conventional insurance involves the elements of gharar and maisir. In investment, conventional insurance has no spiritual and moral sanctions in their investment guidelines. In generating funds to maximize company’s profits whilst meeting claims obligation, insurance companies normally placed insurance fund in interest-bearing (riba based) investment instruments such as conventional bonds and loans as well as non-Islamic deposits, which are not permissible in Islam (Mohd Fadzli 1996a&b; Maysami & Kwon, 1999; Omar & Dawood, 2000). Returns on investments are also not shared with policyholders particularly in non-investment-linked insurance policy since insurance contract only involve the assumption of risk by insurer without the obligations to share the profits with insured.

Unlike conventional insurance, the operational mechanism of Takaful is based on the principle of joint guarantee which employs the concepts of Ta’awun and Tabarru’at. It indemnifies participants facing material hardship through the payment of claims benefits using Takaful fund which are pooled by participants in the Takaful scheme. In Takaful, participants themselves as opposed to insurer, agree to jointly guarantee among each other. In other words, it is the participants who jointly underwrite the subject risks and not the operator. At the end of the contract period, surplus from Takaful fund (if any) will be distributed back to participants. Depending on the model adopted, if it is Mudharabah model, only participants’ portion (as specified in the Mudharabah contract) of the surplus will be distributed. If it is the Wakalah model, the surplus after deducting the agency fees will be distributed back to participants. The use of such Islamic concepts in addition to the concept of mutual assistance through the sharing of losses among participants are principally, having the overall objective of eliminating (or minimizing) uncertainty in Takaful contract (Mohd Fadzli 1996a&b; Omar & Dawood, 2000). According to Siddiqui (2000), the rule of “large number” also plays its role i.e. what is uncertain with regards to an individual will ceased to be uncertain with regards to a very large number of individuals. As gharar is eliminated (or minimized), maisir (gambling) which is the consequence of gharar, will also be avoided.


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Takaful: Malaysia’s Progress of Development Essentially, religious revival had successfully pushed for the introduction of Takaful in Malaysia. The demand for Takaful system in the early period of its inception was inspired mainly by the prevailing needs of Malaysian Muslims public for Shari’ah compliant alternative to conventional insurance, besides complementing the operation of the first Islamic bank4 that was established at that time (Mohd Fadzli, 1996a; Bank Negara Malaysia, 2004a). In the spirit of Islamic revivalism, there was a great pressure for an alternative product of insurance from Malaysian Muslims during 1980’s, who wanted to practice Islam fully in their daily life. They were looking for a system of protection which forms part of the suitable financial system that supports the establishment of credible and sustainable Islamic based economic system (Mohd Fadzli, 1996a). Almost simultaneously, the Malaysian National Fatwa Committee issued a decree which ruled that life insurance in its present form is a void contract due to the presence of 3 main elements (riba, gharar and maisir) that are contradictory to the spirit of Shari’ah. Realizing the importance of supporting the economic growth of the ummah coupled with the promising potential of Takaful industry, a Special Task Force was established by Malaysian Government in 1982 to study the viability of the setting up of an Islamic insurance company. Following the recommendations of the Task Force, Takaful Act was enacted in 1984 which modelled after the existing Insurance Act for conventional insurance but has been modified to conform to Shari’ah principles.

Indeed, Takaful is one of the promising and developing areas in the applied socio-

economic environment (Billah, 2003). Looking at the vast potential of Takaful, and in line with its vision of trying to be the Islamic financial hub in the region, Malaysia had taken a big leap in introducing and developing Takaful system systematically. Learning from the experience of other pioneers in Islamic insurance industry abroad, the first Takaful Company was set up in 1984 – Syarikat Takaful Malaysia Sendirian Berhad (now Berhad). 9 years later, another Takaful company was established – Takaful Nasional Sendirian Berhad (1993), followed by Mayban Takaful Berhad (2001) and the latest one is Takaful Ikhlas Sendirian Berhad (2003). A few other operators had also been granted license by the central bank (BNM), the regulatory authority responsible for overseeing and monitoring the financial service sector in Malaysia and will start operating in near future. BNM has adopted “gradual” approach in developing Takaful industry in Malaysia. Such approach can be specifically divided into 3 phases (Bank Negara Malaysia, 2004a):

Phase I (1984-1992) – The primary focus during this period was the establishment of basic infrastructure for the industry. It started with the enactment of specific regulatory law i.e. Takaful Act 1984. This is to govern the conduct of Takaful business and it requires the registration of Takaful operators and the establishment of Shari’ah Committees to ensure that the business operations of any Takaful operators are in compliance with Shari’ah principles at all times.

4 Bank Islam Malaysia Berhad (BIMB)


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Phase II (1993-2000) – This period marked the introduction of competition within the Takaful industry. Simultaneously, the period had also shown greater cooperation among Takaful operators in the region including the formation of ASEAN Takaful Group in 1995 and the establishment of ASEAN ReTakaful International (L) Ltd. in 1997. This has facilitated ReTakaful (reinsurance) arrangements among Takaful operators in Malaysia and in the region, namely Brunei, Indonesia and Singapore. Phase III (2001-2010) – The phase had begun with the introduction of Financial Sector Master plan (FSMP) in 2001 which, among its objectives is to enhance the capacity of Takaful operators and to strengthen the legal, Shari’ah and regulatory framework. The section of FSMP which relates to Islamic banking and Takaful is a roadmap towards realizing the aspiration of Malaysia becoming an international centre for Islamic finance. 3.0 ACCOUNTING AND REPORTING FOR TAKAFUL: ITS CONCEPTUAL

INSIGHTS 3.1 Islam, Accounting & Reporting and The Islamic Accounting

Literally defined as “peace” and “submission”, Islam requires its followers to submit to God in everything and principally recognize the position of ALLAH as God – the only God in Islam. Such act of bearing witness on the existence and oneness of God is termed as Tawheed (unity of God). In Islam, God created humans for a purpose – that is to serve God (Qur’an, 51:56). Upon creating humans, God also recognizes the position of humans on earth as His vicegerent (Qur’an, 2:30). As God’s vicegerent, humans are granted with worldly resources (e.g. material resources, etc.) for them to live their life according to Shari’ah Islami’ah. According to the 5th Islamic article of faith (to believe in the existence of the Day of Judgment), there will be another life after death i.e. the hereafter. Humans will be resurrected and subsequently judged and rewarded (or punished) accordingly. Hence, humans are made accountable for the use of any resources granted to them as well as for their worldly conducts (good or otherwise). Thus, the position of humans as vicegerent of God and the concept of dual life provide profound impact on human behaviour in the sense that it would induce humans to act in accordance with the rules of Islam by observing their accountability towards both, fellow humans and God.

As a matter of fact, Islam is more than just merely a religion as it is been commonly understood. Rather, it is a social order with a complete code of life (Al Buraey, 1990). Due to the nature of Islam as a complete guidance on life, worldly activities including (but not limited to) accounting and reporting must also find its position and relevance in Islam and its functions should transcend beyond that of worldly purposes. From a secular perspective, the position of accounting could be seen conceptually as a mechanism in discharging and portraying the state of accountability of enterprise due to the separation of ownership and control. Reporting on the other hand relates to accounting disclosure through a proper presentation format to relevant users if it is viewed specifically from the perspective of accounting discipline. Both however find its position as tools in discharging and portraying the state of accountability of an enterprise.


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In another dimension, accounting and reporting also functions as a means in providing useful information so that accounting users are equipped with necessary information in making any subsequent related decisions. In this regard, the position and functions of accounting and reporting in a secular dimension are generally limited to only for worldly aims and purposes. However, the position of accounting and reporting in Islam is argued to be extremely important and unambiguous and it has wider functions. This is reflected in the number of recurrence of the word “hisab” or “account” mentions by God in His glorious book i.e. the Holy Qur’an. According to Ros Aniza (2003), such word appears more than 80 times in various verses of the Holy Qur’an. “Hisab” is the root word of “Al-Muhasabah” in Arabic which refers to “accounting”. “Account” in Islam relates to “man’s obligations as God’s vicegerent to “account” to God on all matters pertaining to their endeavours for which every man is accountable” (Ros Aniza, 2003 p.25). This is given the fact that humans are trustee (or steward) to God and therefore, humans agree to assume the responsibility of being vicegerents on earth in covenant with God (Abdul Rahim, 2003).

According to Abdul Rahim (2003), accounting and reporting in Islam is expected to be influenced by both the way the economic system is organized and the philosophy underpinning its system. Since in Islam, the economy is organized in a way that it aims at achieving the Shari’ah objectives i.e. falah – comprehensive welfare in both, this world and hereafter (Abdul Rahim (2003), hayyatan tayyibah (good life) and Al-Adl – social justice (Haniffa & Hudaib, 2002), it warrants all economic activities to be religiously and morally directed towards the achieving of those objectives. As a result, the process of accounting and reporting upon economic activities in Islam demands for ethical and religious values to be regarded as a norm and economic relationship as moral relationship with spiritual attachment (Abdul Rahim, 2003). These were driven by the fact that Islam does not recognize the separation between sacred and secular (Al Attas, 1993), necessitating for worldly activities including accounting and reporting to be shaped and guided by sacred (religious) aims and to be regarded as an act of worship (ibadah). These will ensure accounting and reporting in Islam to operate in line with the spirit of Shari’ah, paving path for the attainment of falah, hayyatan tayyibah and Al-Adl.

One unique characteristic of the concept of accounting and reporting in Islam

could also be seen in the existence of two angles (Raqib and A’tid) monitoring and taking account of all human deeds thoroughly at all times. In hereafter, those accounts will be presented (reported) before God and humans will be judged accordingly. Similarly, in business transactions, each transaction should be accurately and properly recorded and accounted for. At the end of accounting period, a set of accounting documents will be drawn and both, directors and management of the company (as shareholders’ trustee) will be judged accordingly by shareholders who will then act (either to reward or otherwise) on management and directors, based on results stated in those accounting documents. Thus, “account” in Islam resembles “accounting” in the sense that every Muslims are responsible to do their duties as prescribed in the Qur’an since such responsibilities will be questioned, judged and rewarded (or punished) in the hereafter. This is effectively the accountability concept. In Islam, “accountability” is embedded in the concept of humans as God’s vicegerent on earth.


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Hence, besides having its secular functions discussed earlier, accounting and reporting in Islam should also play its role as a service activity which provide information that aims at assisting humans in discharging accountability towards both, fellow humans and God i.e. by providing information to users so that they (users) could follow God’s commandments (Shahul, 2000). Ultimately, as an auxiliary function of economic activities, accounting and reporting will also therefore, serve as a tool for Muslims to achieve the very objectives of Islamic economics, which are also the objectives of Shari’ah (Haniffa & Hudaib, 2002).

Accounting therefore, is not a new phenomenon in Islam and to Islamic society

(Zaid, 1997). So do the concept of reporting. Both accounting and reporting find its position and functions well attached and embedded in the concept of “vicegerent” and “Islam as a way of life”. The introduction and promotion of a new aspect in the field of accounting termed as the “Islamic Accounting” is seen as a direct manifestation of Islam as a way of life. As summarized and defined by Shahul & Yaya (2005), Islamic accounting is “the process which provides appropriate information (not necessarily limited to financial data) to stakeholders of an entity which will enable them to ensure that the entity is continuously operating within the bounds of Shari’ah and subsequently ensuring the entity’s ability to achieve the Islamic socioeconomic objectives” i.e. Shari’ah objectives. In addition, accounting and reporting in Islam are also tools, which enable Muslims to evaluate their own accountabilities, to both fellow humans and God (Shahul, 2000; Abdul Rahim, 2003). Hence, accounting and reporting in the context of Islamic accounting carries holistic and wider functions from the secular view point, and having a position well attached to sacred aims of achieving the Shari’ah objectives. 3.2 Accounting and reporting in Islamic Institutions of Takaful – Its conceptual

insights Accounting has close relationship with the social and economic values of the society (Khan, 1994 p.1). It is in this sense that historically, the activities of accounting and reporting are conducted in a manner appropriate to the social, economic and cultural needs of a society in which the activities are undertaken. For example, Takaful companies are essentially Islamic business organizations, operating in conformance with the Shari’ah. Since accounting and reporting are the auxiliary functions of its business operations, both of the underlying concepts and functions of accounting and reporting are arguably, should also be in line with the spirit by which its business operations are based upon i.e. Shari’ah. Thus, accounting and reporting in Takaful companies should also comply with Shari’ah. This necessitates for both accounting and reporting in Takaful to serve relatively different functions from that of its conventional counterparts i.e. insurance companies, which are not based on Shari’ah. In the academic stream, the area of accounting and reporting for Takaful receives little attention in the literature as opposed to accounting and reporting for Islamic Banks (e.g. Karim, 1990; Ali, 1994; Khan, 1994; Adnan & Gaffikin, 1997). This is hardly surprising given the fact that Islamic banks were the first Islamic institutions that emerged as a result of Islamic revivalism. Following its rapid development, their accounting and reporting issues were given specific and focused attention by both practitioners as well as academicians.


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In principle, accounting and reporting for Takaful should be able to reflect the striking difference between Takaful and insurance which lies in the existence of a pre-specified relationship between operator and participants. Hence, accounting and reporting for Takaful should be able to accommodate properly, such type of relationship i.e. either Mudharabah or Wakalah. In either type, the accounting principles, method and techniques as well as the reporting content and format should serve the spirit of justice which is the central theme of both types, which is also one of the objectives of Shari’ah. This would then ensure fair calculation and allocation of surplus (or fees in Wakalah type) between operator and participants. In this regard, accounting and reporting for Takaful should be able to guarantee the separation of funds established between participants and operator. Different funds available in the business should be properly separated and the management and usage of such funds should also be properly observed since certain usage or direct expenses on one fund could not be simply absorbed by the other. This is primarily because, the assumption of risks in Takaful system is undertaken by participants collectively and not the operator. This affects the ownership concept over the contributions pooled in the scheme whereby the right over such contributions remains in the hands of participants collectively. Accounting and reporting for Takaful should therefore be able to properly address these requirements.

In addition, reporting in Takaful requires for a more comprehensive disclosure

compared to insurance reporting. The focus of reporting should be on both, the Shari’ah adherence and the financial strength (of both the operator and the Takaful funds established). In essence, participants in Takaful scheme should rightfully be entitled to several rights, including receiving regular flow of information on underwriting strategies, investment objectives and policies relating to Takaful funds, operational guidelines that govern the relationship between operator and participants, and the basis of allocation of profits (if Mudharabah model) between the two parties and the basis of fees payment (if Wakalah model). More importantly, adequate disclosure of information in which participants will be better able to assess the potential risks and rewards attached to their contributions paid, as well as on the extent on adherence to Shari’ah over the management of such contributions and subsequently making appropriate decisions to protect their own interest, if the situation warrants. In this regard, it is argued that the accounting and reporting for Takaful is consistent with the attributes of Islamic accounting. The processes of accounting and reporting in Takaful companies should provide appropriate information (financial or otherwise, economic and Shari’ah related) to its stakeholders. The processes should also enable operators to ensure that they will continuously operating within the bounds of Shari’ah. 3.3 Malaysian Takaful Accounting & Reporting Regulations In Malaysia, the enactment of Financial Reporting Act (1997) has given birth to Financial Reporting Foundation (FRF) and Malaysian Accounting Standards Board (MASB). This new financial reporting framework requires the role of standard setting to be undertaken by a statutory body (MASB) independent of the accounting profession. Most of standards issued by MASB are consistent with the international standards (International Financial


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Reporting Standards – IFRS)5. To date, after more than 7 years of its establishment, MASB had produced a total of 97 technical pronouncements, comprising among others 33 Standards, 1 Interpretation Bulletin, 2 Technical Releases, 1 Discussion Paper and 52 Exposure Drafts6. Interestingly, MASB had also introduced a parallel set of Islamic accounting standards for Islamic financial institutions, the FRSi. However, as of to date, the accounting and reporting for Takaful has not been covered by FRSi and is still being developed. As an alternative, the Malaysian Government through its specific Takaful Act (1984) delegated the function of formulating the accounting techniques, format and contents of accounting disclosure of Takaful companies to the Central Bank (BNM).

3.4 The Role of the Central Bank (BNM) Unlike other industries operating in the Malaysian economy, Malaysian financial services industry (Islamic or otherwise) is subject to additional layer of supervision, regulation and control, which is by the Central Bank i.e. Bank Negara Malaysia (BNM). Areas under supervision, regulation and control by BNM include operational, accounting as well as reporting. This is predominantly due to the nature of the industry itself which is of paramount importance to the Malaysian economy, directly influencing the overall Malaysian economic growth and financial stability. In this regard, the Takaful sector, being part of Malaysia’s comprehensive Islamic financial services industry is of no exception. This is by virtue of specific Malaysian Law – the Takaful Act 1984. In its Part IV (Miscellaneous and General) the Act states that “The Central Bank (BNM) shall be responsible for administering, enforcing, carrying out and giving effect to the provisions of this Act and the Governor of the Central Bank shall be the Director General of Takaful”.

Having such power and responsibilities, BNM regulates and supervises the operational, accounting as well as reporting aspects of Takaful through its 2 divisions within the BNM; the Regulation and Supervision Divisions. The former aims at providing sound and effective framework for the operation, accounting as well as reporting of Takaful. The latter on the other hand plays both the enforcement and supervisory functions, primarily to ensure those rules and regulations as stipulated in the formulated framework are well adhered to. In accounting and reporting aspects, having the aims of enhancing the accounting practices as well as the disclosure and transparency regime of the Takaful industry, BNM has, in addition to specific provisions regarding accounting and reporting in the Act, requires Takaful operators to strictly adhere to circulars and guidelines issued by BNM from time to time. In the year 2004 for example, BNM had issued 18 circulars and 4 guidelines covering the areas of operations, accounting, reporting as well as Shari’ah governance for Takaful operators. One of which is the Guidelines on Takaful Reporting (Takaful Guideline No. 6 i.e. GPT6) which aims at enhancing disclosure and transparency in operators’ financial statements. GPT6 supercedes various circulars on accounting and reporting previously issued to Takaful operators.

5 As at 13 September 2004, MASB had issued 33 accounting standards, 26 of which were adopted from 31 IASs in use today. 6 http://www.masb.org.my/masbmr_pr_detail.asp?prid=29122004-171339


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In the absence of specific and established Takaful accounting and reporting standards in Malaysia, Takaful operators are only left with BNM circulars and guidelines. Nonetheless, operators are also presented with Shari’ah based, non-legal backed accounting and reporting standards produced by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). These standards however, have never been enforced on operators for their adoption by BNM but it did indirectly allowed operators to adopt AAOIFI standards on a voluntary basis. 3.5 AAOIFI Standards on Islamic Insurance The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is an Islamic international autonomous non-profit making corporate body that prepares accounting, auditing, governance, ethics and Shari'ah standards for Islamic financial institutions (Pomerantz, 1997). It was established in accordance with the “Agreement of Association” which was signed by several Islamic financial institutions on 26 February, 1990 in Algiers. As of to date, there are 18 accounting standards produced by AAOIFI in which three 3 standards are directly relevant to Islamic insurance. Such standards are Financial Accounting Standard (FAS) No. 12 (General Presentation and Disclosure in the Financial Statements of Islamic Insurance Companies), FAS 13 (Disclosure of Bases for Determining and Allocating Surplus or Deficit in Islamic Insurance Companies), and FAS 15 (Provision and Reserves in Islamic Insurance Companies). The earliest standard issued was FAS 12, in the year 2000. 4.0 RESEARCH METHODOLOGY

In general, a mixture of various research methods will be used in this study. To

achieve the 1st research objective, literatures on concepts and operational aspects of Takaful and insurance respectively will be reviewed. The understanding on the conceptual and operational aspects of both insurance and Takaful would then be extended to accounting and reporting in order to build a linkage between those concepts and operational aspects and that of accounting and reporting. This will also be assisted by the comparative study between insurance standards and Takaful guideline. For the 2nd research objective, it involves the process of reviewing the Takaful Act, relevant MASB standards on insurance, relevant BNM guidelines and circulars on accounting and reporting for Takaful, the survey on BNM corporate reports and website as well as the reviewing of relevant AAOIFI standards on Islamic insurance. In addition, the relevant guideline on accounting and reporting for Takaful and the relevant AAOIFI standards on Islamic insurance will also be critically examined and subsequently compared. These are expected to provide reasonable coverage on the nature of accounting and reporting regulations currently available for adoption by Takaful operators in Malaysia. Finally, in building the empirical evidence on the extent of compliance to BNM guideline and the extent of acceptance to AAOIFI standards on Islamic insurance, and subsequently seeking reason(s) for such extent of compliance and acceptance, two steps are required. First, a scoring of conformance to BNM guideline and AAOIFI standards on Islamic insurance based on three consecutive years (2003-2005) of Takaful operators’ annual reports will be conducted.


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Secondly, telephone interviews with accounting staffs of Takaful operators will also be conducted. This is to obtain consensus over the reasons for full (or partial) compliance or acceptance of the standards and guideline in question. On the scoring of conformance, both BNM guideline and AAOIFI standards will be transformed into scoring lists. Such lists comprise of items which are relevant to the specific nature of Takaful operations. The items are classified into several categories which reflect the specific operational mechanism of the Takaful system. A score of ‘0’ will be given to company which do not comply and ‘1’ for company which complies. Then, the percentage is used to gauge the extent of compliance and acceptance to standards and guideline concerned. 5.0 COMPARATIVE ANALYSIS BETWEEN FRS 17&18, GPT6 & AAOIFI FAS

12,13&15 The unique and reasonably complex nature of insurance as well as Takaful business have prompted the responsible authorities in Malaysia (MASB and BNM) to establish specific accounting and reporting standards and guidelines to cater for their specific accounting and reporting needs and requirements. These standards and guidelines are FRS 17 (General Insurance business) and FRS 18 (Life Insurance business) issued by MASB for conventional insurance which are further supplemented by various BNM insurance guidelines (e.g. GPI3 – Insurance Accounting, GPI15 – Insurance Reporting) while for Takaful, operators are only having BNM Takaful guideline (e.g. GPT6 – Takaful Reporting) for their guidance. In addition, Malaysian Takaful operators are also required to follow the relevant MASB standards (e.g. FRS standards on Investment) and BNM insurance guidelines (e.g. GPI25 – Corporate Governance). At the international level, AAOIFI had produced 3 specific standards for Islamic insurance i.e. FAS 12, 13&15 (all of which relates to accounting disclosures).

Comparisons between the requirements attribute in Malaysian FRS insurance standards and BNM’s GPT6 provides justification on the accounting and reporting differences between insurance and Takaful. Apparently, the accounting and reporting for Takaful are dissimilar from insurance. The dissimilarities originate from the unique operational aspect of Takaful which requires the establishment of a pre-specified relationship between operator and participants. This brings about the differences in the task of “risk assumption” and the “contributions ownership” which influences and affects both the accounting and reporting aspects of the Takaful system. Essentially, Takaful system requires the establishment of a pre-specified relationship between operator and participants as opposed to direct seller and buyer relationship in insurance system. This primarily because risks in Islam could not be exchangeable and constitute as subject in the Islamic commercial contract since it will lead to the existence of gharar (uncertainty). As such, to avoid having sales contract as in insurance, Takaful does not have any sales contract, rather a combination of Ta’awun and Tabarru’at contracts among participants and Mudharabah or Wakalah contract between operator and participants. The operator-participants relationship of either Mudharabah or Wakalah in Takaful necessitates for risks to be assumed by participants collectively and not operator.


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This is given the fact that Takaful system works on the basis of mutual scheme (or fund) which participated by a group of people having the same objective of mutually assisting each other. The function of operator in the system is limited to being an intermediary only, and this has resulted in contributions paid by participants to be regarded as revenue to Takaful scheme (NOT to operator!!!) which is collectively owned by participants. As such, the contribution ownership remains attached to participants. Effectively, contributions become liability to Takaful operator since operator is merely intermediary whose function is to manage the fund. The nature of pre-specified relationship also warrants for underwriting surplus and investment returns to be shared between operator and participants. In this regard, only operator’s portion of the underwriting and investments surpluses (Mudharib share or Wakalah fee) are transferred to operator’s income statement, the balance goes to Takaful fund account which resides in the liability side of operator’s balance sheet. This reflects the two way economic relationship between the two parties.

The defined relationship also puts sanctions over the permissibility of charging

expenses incurred by operator to Takaful fund. This is because Takaful fund belongs to participants and operator is only entitled to its portion of rewards for efforts rendered in terms of Mudharib share or Wakalah fee. It is in this sense that the proper management of separate fund accounting in Takaful system is really imperative. Claims and ReTakaful are now direct expenses to Takaful scheme i.e. expenses to participants, and should not be borne by operator. ReTakaful is effectively the shift of risk assumption function from one Takaful scheme to the other and not from one operator to the other. In terms of reporting, the pre specified relationship which is governed by the Islamic religious principles demands the reporting framework of any Takaful entities to be based on the need to portray both the financial strength (of the operator and the Takaful fund managed by the operator) as well as the extent to which such fund has been properly managed in accordance with the rules of Shari’ah i.e. Shari’ah adherence. These are broader than the reporting framework of insurance which only focuses on the reporting of matters that portray the financial strength of insurer and the insurance funds established only.

In contrast, since the insurer-insured relationship in insurance is based on a direct

seller and buyer relationship, premiums paid by policyholders (insured) are considered as revenue to insurer and not to the insurance fund. This signifies the shift of ownership over such premiums from insured to insurer, who is now the legal owner of such premiums. As a result, it makes the responsibility of assuming the risks to lie on the shoulders of insurer. Hence, claims and reinsurance are now becoming direct expenses to insurer since they legally owned the insurance fund. In terms of surplus allocation, insurer is not obliged to share with policyholders both the underwriting surplus and investment returns. This is with the exception of investment linked policies (in life insurance) in which the agreed portion of investment surplus is shared with policyholders. Also, there is no sanction on the permissibility of charging management expenses to insurance funds since the fund is legally and effectively belongs to insurer.


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The above differences in terms of accounting and reporting are reflected in both the Malaysian insurance standards and BNM Takaful guideline respectively, which forms part of the accounting and reporting regulations for insurance and Takaful in Malaysia. With respect to Takaful accounting and reporting regulations in Malaysia, it is observed that the accounting and reporting regulations currently available and applicable to Malaysian operators are of 2 types. The first is the accounting and reporting regulation provided by BNM and secondly the accounting and reporting regulation issued by AAOIFI. The latter becomes applicable since the former is considered by BNM as the minimum guideline only and that operators are allowed to adopt any other relevant standards provided that it does not contradict the prevailing requirements stipulated in its circulars and guidelines, provisions of the Takaful Act 1984 and more importantly the Shari’ah requirements. The accounting and reporting regulation provided by BNM is by virtue of the enactment of Takaful Act, 1984 which confers BNM the role of formulating the accounting and reporting framework as well as undertaking the supervision and enforcement functions through the issuance of circulars and guidelines for operators’ adoption. The nature of the accounting and reporting regulation provided by BNM are argued to be based on a hybrid framework whereby in addition to Takaful circulars and guidelines, operators are also required to adhere to insurance guidelines (GPI). This is particularly true in the case of certain reporting aspects (e.g. corporate governance reporting). In addition, the only Takaful accounting and reporting guideline i.e. GPT6 is noted to have resembled much of the conventional insurance guideline i.e. GPI15.

Comparing BNM’s Takaful accounting and reporting regulation with that of

conventional insurance accounting and reporting regulations (provided by both MASB and BNM), it is argued that in terms of scope, is less comprehensive since insurance has its own specific accounting and reporting standards produced by MASB and such standards are further supplemented by BNM circulars and guidelines. Such comprehensive regulation on insurance accounting and reporting was notably the result of the reasonably important and well established insurance industry which has been in Malaysia for more than 60 years. However, it is rather unfortunate to note that Takaful industry which is equally important to the Malaysian economy is still lacking in terms of accounting and reporting regulation. It is only after 20 years of Takaful existence in Malaysia that operators are having its owned, standardized guideline on accounting and reporting through the introduction of GPT6 in July 2004. Even so, it was predominantly developed in a conventional manner whereby many of its underlying concepts in the reporting format do not clearly represent the unique characteristic of Takaful operation which essentially operates based on different set of parameters. This is supported by the fact that GPT6 had to a certain extent, replicated the requirements in GPI15. As such, it does not clearly represent the pre-specified relationship of either Mudharabah or Wakalah which is considered as the unique and the main striking difference between insurance and Takaful. In this regard, it is argued that the insuring public particularly the non Muslims (or even the Muslims) would not be able to fully differentiate the underlying concepts between insurance and Takaful system and subsequently unable to appreciate the comparative advantage of opting for Takaful system as opposed to the conventional insurance system.


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The damage to Takaful system will be more severe if we consider from the moral hazards perspective. Operator’s position as an intermediary effectively demands for accounting and reporting in Takaful to function as tools in minimizing information asymmetry in the relationship between operator and participants. This is essentially to avoid the creation of moral hazards activities such as the misuse of participants’ funds. If the reporting requirements in Takaful for instance, resembled much of the insurance reporting attributes, which do not cater for the pre-specified relationship and the subsequent specific disclosures that the relationship warrants (e.g. the method of surplus sharing and the treatment of management expenses), then it is argued that the information asymmetric would exist and subsequently, governance in Takaful companies will be seriously at stake.

When compared with the 2nd type of regulation (i.e. AAOIFI), the analysis suggest

that AAOIFI type of regulation on accounting and reporting is less detailed in terms of accounting treatment over certain areas of the Islamic insurance operations (e.g. ReTakaful), but more holistic, focused and specific in some other relatively important reporting areas which are vital to the unique nature of the Islamic insurance operations. In terms of scope, AOOIFI standards cover almost all of areas covered under GPT6 albeit in a different structure and focus. The areas which AAOIFI standards are smaller in scope relative to GPT6 are on the specific accounting treatment on reinsurance, management expenses and acquisition costs, which AAOIFI does not specifically provides for. This is perhaps such areas are rather technical and variations of practices are still acceptable so long as it is within the boundary of Shari’ah. Moreover, by not providing specific requirements over such technical accounting aspects would make AAOIFI standards more universal and flexible, thus increasing its acceptability level. However, in terms of holisticity, focus and specificity, AAOIFI standards are argued to be more holistic, focused and specific albeit less detailed compared to GPT6. This is demonstrated in the introduction of AAOIFI FAS 13 and 15 in which it covers comprehensively the specific and important areas of surplus or deficit in Islamic insurance companies and provisions and reserves respectively. These reflect their prioritized focus on areas which are important to the specific nature of the Islamic insurance operations.

In FAS 12 for instance, the “Statement of policyholders’ surplus (deficit)” and

“Statement of sources and uses of funds in the Zakah and charity fund” are classified as “Main Statements” in its component of financial statements, but GPT6 relegated them to “Notes to the Accounts” section, referred to as the “Takaful Fund Accounts” and “Zakah” respectively. “Statement of policyholders’ surplus (deficit)” is basically the Islamic insurance fund account which contains items reflecting its movement. This is considered important to policyholders since they are the owner of the funds and perhaps this is the reason why AAOIFI requires the statement to be the main statement. This as discussed earlier, primarily reflects AAOIFI prioritized focus and emphasis on areas which deemed to be important to the specific nature of the Islamic insurance operations. In FAS 13, the requirements are far more comprehensive and relatively more transparent than GPT6. It prescribes clearly the disclosure requirements on the nature of relationship between policyholders and operator and its subsequent implications on the operational aspects of Islamic insurance.


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Such requirements are premised on the underlying objective of determining and protecting rights and obligations of both parties i.e. policyholders and operator. Having no equivalent section in GPT6, this area is however only been addressed minimally by GPT6. For example, its reporting format indirectly requires disclosure of the reward amount entitled by operator out of the surplus, but the nature of relationship between policyholders and operator is still left unaddressed. As a matter of fact, GPT6 does not even require operators to specify in operator’s financial statement, their model of operation i.e. either Mudharabah or Wakalah. Such information need to be inferred from the allocation of surplus amount provided in the financial statements. This would render the financial statements of Takaful companies to be less useful since Islamic insurance system operates based on the concept of funds which requires the relationship between participants and operator who manage those funds to be clearly specified. In essence, this is not in line with the suggested conceptual insights on Takaful accounting and reporting as discussed in the earlier section. In addition, FAS 15 demonstrates the well structured nature and the relative focus of AAOIFI standards compared to GPT6 by way of clearly separating the provisions and reserves items. It also introduces 2 additional reserves which are not clearly referred to by either Malaysian FRS standards or GPT6. This is essentially to provide extra precautionary measure in cushioning the impact of uncertainty over the occurrence of risks in Islamic insurance system.

6.0 RESULTS & DISCUSSIONS ON CONFORMANCE SCORING AND TELEPHONE INTERVIEWS

Tables below tabulate trend of conformance/acceptance of 4 Malaysian Takaful operators to both GPT6 and AAOIFI standards on Islamic Insurance over 3 years period (2003 to 2005). Since GPT6 was introduced in July 2004 and that the latest annual report date (financial year end) among the 4 operators was June, thus it makes 2003 and 2004 as the “pre GPT6 period” and 2005 as its “post period”7. The results indicate that, prior to the introduction of GPT6, constant trend of conformance was observed and it was at a reasonably high percentage of 91%. This could be explained by the fact that ever since their inception, operators have been following BNM accounting and reporting circulars for Takaful which were developed based on GPI15 and that GPT6 is basically the replication of GPI15 (as argued in the earlier section) in many reporting aspects with only slight modification to suit Takaful principles. As such, it explains the reasonably high level of conformance to GPT6 even before its introduction. The percentage however represents the average for all the first 3 operators’ conformance (4th operator only issued their 1st annual report in 2004). Detailed analysis shows that the percentage was dragged down by the relatively low conformance level during the pre period by the 1st operator in which it only managed to get slightly above 80% score.

7 It should be noted that the segregation of period analyzed into pre and post is for the purpose of examining the nature of GPT 6 which is argued in the earlier section to have replicated GPI 15.


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Table 6.1 – Analysis on Conformance/Acceptance Trend – Malaysian Takaful Guideline & AAOIFI Standards (For all Operators)

Malaysian Guideline AOIFI Standards Pre Period

Post Period

2003 2004 2005 2003 2004 2005

Total Number of Items Complied With 91 120 134 76 103 106

Total Number of Applicable Items 98 130 136 109 144 143

Average Number of Items Complied With 30 30 33.5 25 25.8 26.5

Average Number of Applicable Items 33 33 34 36 36 35.8

Average Percentage of Conformance 91% 91% 98.5% 70% 72% 74%

Table 6.2 – Analysis on Conformance/Acceptance Trend – Malaysian Takaful Guideline

& AAOIFI Standards (By Operator) Malaysian Guideline

AAOIFI Standards Pre Period

Post Period

2003 2004 2005 2003 2004 2005

Operator 1 82% 82% 100% 65% 65% 73%

Operator 2 97% 97% 97% 68% 68% 70%

Operator 3 100% 100% 100% 76% 76% 76%

Operator 4 N/A 90% 97% N/A 77% 77%

Average Percentage of Conformance 91% 91% 98.5% 70% 72% 74%

The nature of BNM’s regulatory framework on Takaful and its circular could best

be used to explain such low level of conformance that is; prior to the introduction of GPT6, operators were required to follow BNM circulars on Takaful accounting and reporting. Such circulars only provide minimum guideline on the accounting and reporting aspects. Further disclosures if deemed necessary are allowed within its regulatory framework. Owing to the flexible nature of BNM circulars and its regulatory framework on the aspects of accounting and reporting for Takaful, it makes the first operator’s accounting and reporting practices as reflected in its annual reports for 2003 and 2004 to be rather different from the requirements set out in GPT6 (and also different from the practices of other operators). This has resulted in the overall low level of conformance recorded during that period. During the post GPT6 period, improvement on the overall conformance level was observed. The substantial increase in conformance was due to the impact of operators’ 1st time adoption of GPT6 which came into effect the year earlier. Detailed analysis shows that the improvement was directly attributed by immediate response to GPT6 by all 4 operators. Unlike the 1st and 3rd operators, the 2nd and 4th operator did not fully comply with requirements set out in GPT6. That explains why only 98.5% of the overall conformance was achieved during the post period.

The improved conformance level during the post period provides an indication on

the effectiveness of the supervisory functions of BNM over the accounting and reporting practices of Malaysian Takaful operators, through its department of Insurance supervision which undertakes the supervisory role over both the insurance and Takaful industries. It is


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also obvious that GPT6 had to a great extent, minimized the divergence in terms of accounting and reporting practices among Malaysian Takaful operators i.e. harmonized the practices. This is illustrated by the fact that, during the pre period, the 1st operator only managed to score 82% conformance level, the lowest among the 4 operators. The 3rd operator on the other hand complied with 100% of GPT6, the highest among the 4. This had resulted in a percentage divergence of almost 22% during the pre period. However, during the post period, the percentage of divergence had shrunk to only 3% with the highest conformance level being 100% and the lowest was 97%.

On AAOIFI standards, the results indicate that the average number of items complied with had increased, albeit marginally from year to year. This is on the back of decreasing average number of applicable items, subsequently translating into an overall increasing conformance trend over the 3 years period. The relatively low average of conformance level could be explained by the fact that AAOIFI standards are not mandatory to be adopted in Malaysia; rather it can only be adopted on a voluntary basis. Even so, due to operators’ attitude towards minimum guidelines – they just follow the minimum prescribed rules. Thus, any additional, non-compulsory standards (such as AAOIFI) are considered as less relevant, hence not followed. Further analysis reveals that, consistent with the overall low conformance level to AAOIFI standards, there was a relatively low conformance level shown by all operators towards AAOIFI standards with all operators managed to only score less than 80% through out the 3 years period. During 2003 and 2004, the highest percentage ever achieved by operators was 77% (4th operator) and the lowest was 65% (1st operator) with a percentage margin difference of 18%. However in 2005, the percentage margin difference reduced to 10% with the lowest percentage of conformance achieved by one of the operators was 70% and the highest being 77%. This indicates that, the introduction of GPT6 had, to a certain extent, minimized the differences in terms of accounting and reporting practices (with reference to AAOIFI standards) among Malaysian Takaful operators whilst it had also indirectly, to a certain extent, brought Malaysian operators closer towards adopting AAOIFI standards on Islamic Insurance.

Detailed analysis on GPT6 reveals that non conformance could be found in several disclosure areas. Among others, they includes the reporting on unearned contributions reserve (UCR), net outstanding claims and claims incurred, disclosure on investment for each fund available, Zakah disclosure and the disclosure on the confirmation statement that Shari’ah rulings and precepts should prevails at all times over the other applicable approved accounting standards and guidelines. Telephone interviews were then arranged with operators to get explanation on their non-conformance. Upon inquiring the operators concerned regarding UCR and claims, they explained that since the various classes of risks arranged under the general Takaful business have already been considered as one unit Takaful scheme, and that participants collectively, willingly relinquished their individual rights over the contributions paid (i.e. tabarru’at), hence separate UCR and claims disclosure for each class of risks are deemed as unnecessary. However, it is argued that given the nature of UCR and claims which are an expenses to the Takaful fund, and that participants should have the rights to know what constitutes the elements which reduces the surplus attributable to them, then it is


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imperative for operators to clearly disclose the components of UCR and claims by providing breakdown details for each class of risks arranged under the general Takaful scheme. This would enhance transparency in their disclosure practices which will subsequently further assist participants to make better appropriate judgments and decisions, if necessary.

On the non-conformance to disclosure requirement regarding investment, the operator concerned argued that their emphasis of investment reporting on shareholders’ fund only was due to the fact that the annual report is only for the reporting on the business operations of the entity i.e. operator. Takaful fund is considered as a different entity and the role of the company is only to manage the fund. As such, the disclosure of information on investment income (in the respective Takaful funds’ revenue account) is deemed to be sufficient. Thus, the information on the value of each investment for respective funds and its movement are considered as unnecessary. In this regard we argued that comprehensive reporting on cost value and the movement of each investment types for each Takaful fund managed by an operator is reasonably important and necessary. The reason is that, as the ultimate owner of the Takaful fund from which the investment monies were sourced, participants should rightfully be entitled to comprehensive information regarding the investment which should cover the information on its cost value, related expenses incurred as well as its income or losses generated, separately for each funds available. In this respect, GPT6 has rightfully considered such information as part of its disclosure requirements. Information on investment income, its related expenses, surplus and losses will only explain part of the story regarding investment i.e. the viability and profitability of the investment portfolio. The cost value and its movement are also necessary in providing the complete picture on the position of the investment on a certain date (annual report date). As such, both aspects (profitability and position) of the investment should be made known to participants.

The telephone interviews also reveals that operators are unaware that they did not

abide by GPT6 requirement which requires operators to confirm that “Shari’ah rulings and precepts had prevailed at all times over the other applicable approved accounting standards and guidelines” during the reporting period. They claimed that their non-conformance did not trigger any non-compliance issue during BNM on-site audit and hence operators considered what they had disclosed as sufficient. This could be explained by the fact that BNM on-site auditing exercise on Takaful companies was undertaken by Insurance supervision staffs and they might not have the necessary Shari’ah background to consider the importance of providing confirmation statement as required by GPT6. As discussed earlier, besides operations, accounting and reporting in Takaful companies must also be subject to Shari’ah and that Shari’ah must have the upper hand in all aspects. If operators did not confirm that Shari’ah rulings and precepts had prevailed at all times over the other applicable approved accounting standards and guidelines, users might have the impression that the Shari’ah adherence of the operators is questionable. This is extremely important since adherence to Shari’ah constitutes the main striking difference between insurance and Takaful.


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7.0 CONCLUSIONS & RECOMMENDATIONS

Current study is designed to elucidate the differences between insurance and Takaful from 4 defined perspectives – concepts, operations, accounting and reporting. The paper also explored the nature of the currently available and applicable Takaful accounting and reporting regulations in Malaysia with the focus on BNM and AAOIFI types of regulations. In addition, it also builds empirical evidence on the extent of compliance and acceptance of Malaysian operators towards each type of regulations.

The study observes that concepts, operations, accounting and reporting between

insurance and Takaful are dissimilar. The dissimilarities originate from the concept of insurer-insured or operator-participants relationship in which Takaful system requires the establishment of a pre specified relationship between operator and participants as opposed to direct seller and buyer relationship in insurance system. This brings about the differences in the task of “risk assumption” and the “premiums/contributions ownership” which influences and affects both the accounting and reporting aspects of both the insurance and Takaful system. Essentially, Takaful accounting reflects the striking difference in terms of the operational mechanisms in Takaful which is based on the pre-specified relationship between operator and participants. Takaful reporting on the other hand covers wider focus than that of insurance which includes additional aspect of Shari’ah adherence. This is consistent with the central theme of Islamic accounting which includes processes that ensure operators’ survival within the boundary of Shari’ah. Hence, Takaful accounting and reporting by its nature is arguably the subset of Islamic accounting.

The findings of this study on the nature of the currently available and applicable

Takaful accounting and reporting regulations in Malaysia have important implications on policy development in Malaysia, particularly on Takaful standard which is still being developed. Noting the unavailability of established and specific accounting and reporting standards for Takaful in Malaysia coupled with the nature of BNM type of regulation which was analyzed to be predominantly developed in a conventional manner – despite the relative importance of Takaful industry to the economy of the ummah, it becomes extremely imperative for the pace of development of the Takaful standard being developed to be accelerated. In developing the Takaful standard, it is argued that both types of regulations (i.e. BNM’s GPT6 and AAOIFI standards) could serve as a foundation for MASB in developing such standards. A mixture of sound requirements from both types of regulations would be able to provide a holistic and comprehensive Takaful standard without which, operators will be left with non codified accounting and reporting requirements which are not at a level equivalent to the international best practice. As a result, comparison on both the financial performance and Shari’ah adherence based on operators’ annual reports across local and international level would be difficult. This is expected to jeopardize the Malaysian Takaful industry as a whole in times of financial market liberalization which will take place sooner.


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Alternatively, the regulatory authority (BNM & MASB) should consider adopting (with modification, if necessary) the readily available AAOIFI Islamic insurance standards which were analyzed to be more holistic, focused and more reflective of the underlying nature of Takaful. This would save a lot of the precious time needed for MASB to come out with a whole new body of Takaful standard. In addition, for immediate corrective measure, it is also suggested that the Malaysian regulatory body (both MASB & BNM) should at the very least, consider enforcing AAOIFI standards as a complementary to GPT6 and be part of its existing hybrid framework. This is practical and reasonable given the fact that many requirements in both types of regulations share similar attributes and it does not contradict each other. Moreover, AAOIFI standards are considered as the international benchmark for Shari’ah based accounting and reporting standards for Islamic institutions such as Takaful companies. The additional accounting and reporting requirements in AAOIFI over GPT6 if adopted would be able to cover several areas which GPT6 seems not to addressed, particularly on the reporting of the pre-defined contractual relationship between operator and participants. This would subsequently bring the accounting and reporting practices of Malaysian operators closer to international best practice.

The results of telephone interviews also highlighted several weaknesses in BNM’s

supervisory processes. The “NO non-compliance” status given to operators despite the fact that operators did not provide the confirmation statement on the superiority of Shari’ah requirements over and above other applicable approved accounting standards and guidelines during BNM on-site audit indicates lack of coordination between its regulation and supervision division. In this case, the Insurance supervision staffs did not consider the importance of providing confirmation statement as required by GPT6 which was developed by the Islamic Banking & Takaful department (belongs to Regulation division of BNM). As such, it is suggested that Insurance supervision staffs of BNM should at least understand the whole operational aspects of Takaful business and its relationship with the Shari’ah and more importantly the importance of each requirements set out in any current and future guidelines formulated by the Islamic Banking and Takaful department of BNM (Regulation Division). For this reason, better coordination between the two departments is extremely imperative.

In addition, findings on conformance towards AAOIFI standards suggest that AAOIFI Islamic insurance standards (which were analyzed and found out to be better in certain aspect compared to GPT6) are less accepted by Malaysian Takaful operators. This is primarily because BNM neither directed nor recommended for such standards to be adopted by operators, even in the event of operators are operating without comprehensive and codified rules on accounting and reporting, at least until July 2004 (the date which GPT6 was introduced). The decision not to recommend AAOIFI standards is however seems to be logical (albeit intriguing) since GPT6 was introduced only 4 years after the introduction of the 1st AAOIFI standard on Islamic insurance i.e. FAS 12. BNM might not want to affect the consistency of accounting and reporting practices of operators by having to adopt different set of standards and guideline within a short period of time.


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The other explanation would be, equivalent to the case of Islamic accounting standards (FRSi), the Malaysian government tends to produce their own standard, rather than adopting the readily available Islamic accounting standards produced by the International Islamic regulatory body such as AAOIFI. This perhaps the manifestation of its “Malaysia Boleh – Malaysia can do attitude” campaign which provides that Malaysia as a developing country is able to do everything by its own, including its own accounting and reporting guideline for Takaful companies without relying on others – even if it takes the conventional insurance guideline to be the model of Takaful guideline. More importantly, the non acceptance to AAOIFI standards also signals considerable lack of coordination between AAOIFI and the Central Banks of Islamic countries, particularly the BNM in this case. Tracing back one of the basic functions of AAOIFI, among others is to promote the formulated standards to other Islamic countries through various promotional mechanisms including strategic coordination with the central banks of Islamic countries. In this regards, it is suggested that AAOIFI should consider optimizing its efforts through various plausible means in promoting its Shari’ah based standards which are considered to be the international benchmark of the accounting and reporting standards for Islamic financial institutions such as Takaful. This should include the marketing of its standards directly towards core users i.e. Islamic banks and Takaful companies. Else, the holistic standards will only be adopted by a smaller group of entities operating in the Middle East regions only. References AAOIFI (2002) Financial Accounting Standard No. 12: General Presentation and

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