Shariah Risk Exposure in Takaful Company Investments in Malaysia

Shariah Risk Exposure in Takaful Company Investments in Malaysia

Mohd Faiz Mohamed Yusof^*1, Mohd Hapiz Mahaiyadin², Muhammad Syahrul Deen Ahmad Rosli³, Nurhanani Romli⁴, Muhamad Hasif Yahaya⁵

^1,2,3,5Academy of Contemporary Islamic Studies, Universiti Teknologi MARA, Shah Alam, Malaysia

⁴Department of Economics, Faculty of Management and Economics, Sultan Idris Education University, Tanjong Malim, Perak, Malaysia.

*Corresponding Author

DOI: https://dx.doi.org/10.47772/IJRISS.2024.814MG0055

Received: 23 December 2024; Accepted: 30 December 2024; Published: 25 January 2025

ABSTRACT

Takaful Company is one of the Islamic financial institutions licensed as Sharia-compliant financial institutions by Bank Negara Malaysia (BNM). The main areas of risk management in takaful are sharia compliance, investment management, and human resources. Shariah compliance is a continuous process, and the takaful company needs to be responsible for ensuring that the entire operation is Shariah compliant. Sharia non-compliance will result in serious losses not only to customers but also to stakeholders, the takaful company, and the industry as a whole. Therefore, this study will examine the exposure to sharia risk in takaful company investments. Next, this study will analyse what approaches are practiced to manage shariah risk in takaful company investments. This study applied the qualitative method by interviewing 11 informants who are responsible for managing the takaful companies sharia compliance activities. Next, all collected data will be analysed through content analysis and thematic analysis using the qualitative data analysis program Nvivo. The results of the study show that there are shariah risk factors for takaful company investments, including changes in the status of sharia-compliant securities and not disposing of non-shariah-compliant securities, as well as the lack of expertise and experience of investment fund managers related to shariah compliance investment activities. In summary, the takaful company will manage shariah-risk investment according to the guidelines and regulatory framework of the Malaysian Securities Commission and screen all investment securities through a shariah review process.

Keywords: Takaful Companies, Shariah Risks, Investment

INTRODUCTION

The National Council for Islamic Religious Affairs of Malaysia convened the 16th Fatwa Committee Conference on February 15–16, 1979, to deliberate on insurance issues. The conference decided that life insurance as it is currently practiced by most insurance companies is haram and a fraudulent transaction because it doesn’t follow Shariah and involves gharar, gambling, and exorbitant interest rates. The 80th Muzakarah Committee of the National Council for Islamic Religious Affairs of Malaysia was held from 1 to 3 February 2008 and deliberated on an analysis of general insurance law. The Muzakarah concluded that Islamic law prohibits general insurance. The 89th National Council for Islamic Religious Affairs of Malaysia Fatwa Committee Meeting discussed the Law of Promoting Conventional Insurance Products. The meeting took place from December 14-16, 2009. From a Shariah point of view, it has been decided that Muslims cannot support traditional insurance products that are based on usury and have parts of gambling and prohibited behaviour. The National Council for Islamic Religious Affairs of Malaysia’s Fatwa Committee Meeting decided that all Muslims must support and take part in the new takaful products that meet the needs of modern Muslims. Takaful products designed for controlling family risks, property, and various liabilities are certified according to Sharia principles. Consequently, every Muslim bears the obligation to pursue what is halal, encompassing food, beverages, and matters pertaining to muamalat. Anas bin Malik said that Rasulullah SAW (peace and blessings of Allah be upon him) stated, “The pursuit of what is halal is obligatory for every Muslim” (al-Tabrani, 1985).

Operations of Takaful companies in Malaysia encompass two categories of Takaful business types: general Takaful and family Takaful. Several takaful companies engage in both general takaful and family takaful, which are subsequently allocated to distinct takaful business entities based on the takaful company’s operational type. There are 11 takaful companies licensed to offer family takaful products, yet only four takaful companies offer general takaful products. All takaful companies are required to comply with sharia compliance mandates as stated in Part IV of the Islamic Financial Services Act 2013 (IFSA 2013), which indicates the sharia standards for the Islamic financial sector as a whole. The takaful industry is an important part of the Islamic financial industry. Therefore, the takaful industry has to comply with the sharia stipulations outlined in Part IV of the IFSA 2013. Part IV of IFSA 2013, addressing sharia standards, is segmented into three sections: Section 1 addresses sharia compliance, Section 2 relates to sharia governance, and Section 3 focusses on sharia compliance audits.

Shariah Risk

DeLorenzo (2007) defines shariah risk as the likelihood that a financial product or service is currently non-compliant or will become non-compliant with sharia in the future. Bayram, Shahwan & Ergun (2023) described sharia risk as the potential for non-compliance with sharia principles caused by the internal systems of Islamic financial institutions and the employees who perform Islamic financial operations and transactions. Sharia risk, according to Ibn Dawiyan (2004), is defined as the uncertainty surrounding a matter that could cause disagreements and raise the possibility of sharia non-compliance. Ali & Hassan (2019) defined sharia risk as the likelihood of an Islamic financial transaction being contested for non-compliance with sharia law. Ginena (2014) introduced the idea of Sharia risk as a type of operational risk. He said that it is the chance of losing money because Islamic financial institutions don’t follow Sharia rules when they run their business, as judged by the Sharia Committee (SC) or other groups that are in charge of making sure Sharia rules are followed. Nevertheless, Ginena (2014) has overlooked the dimension of non-financial damages in relation to Sharia risk. Muhammad (2011) argues that sharia risk comprises non-financial damages, specifically losses incurred when the Muslim community fails to adhere to sharia law, as commanded by Allah S.W.T. Disobedience to the commands of Allah S.W.T. results in the absence of His pleasure and blessings. This will significantly affect the financial standing of the takaful operator itself.

Billah (2019) explains the term shariah non-compliance risk or sharia non-compliance risk. There is a part of operational risk called “Sharia risk” that needs to be identified in order to figure out how to reduce the chances of Sharia non-compliance happening. The takaful industry generally faces exposure to incidences of sharia risk. Investment-linked family takaful plan products necessitate the selection of an investment portfolio from a takaful operator. The takaful company has either intentionally or unintentionally selected a non-Shariah-compliant portfolio for the investment of participants’ funds. This condition results in occurrences of sharia risk within the operations of the takaful company. The incidence of this sharia risk incidence results in income that is not acknowledged by sharia within the profitability of Islamic financial firms (Frenz & Soulhi, 2010). Dusuki, Ali, & Hussain (2012) argue that takaful firms must segregate profits not compliant with sharia and subsequently allocate them to charity organisations as stipulated by the SC of the respective takaful companies. This indicates that the entire income of the takaful company would diminish, resulting in losses. This is a preliminary illustration that elucidates the influence of sharia risk on takaful companies.

The term “Sharia risk” refers to the possible loss of money or other things due to disagreements or actual or possible violations of Sharia in the actions and dealings of Islamic financial institutions. Simultaneously, there are two aspects to delineating sharia risk exposure. An event that is likely to happen or has already happened and clearly does not follow Sharia as explained in the Sharia manual or a decision made by the appropriate authority. Secondly, sharia risk exposure includes factors that precipitate sharia risk occurrences, including human resources, systems, operations, or external issues.

Legal Aspects of Islamic Finance in Malaysia

Malaysia features a distinctive legal system comprising two frameworks: English law, referred to as common law, and Sharia law. English law is predominantly implemented in civil courts in Malaysia, with the exception of specific subjects pertaining to Sharia law. In Malaysia, Sharia law governs marriage and inheritance exclusively for the Muslim community. However, the components of Islamic finance exhibit distinctions as they are classified as finance under the Malaysian constitution (Hasan, 2012; Ahmad et al., 2023). All conflicts pertaining to Islamic finance will be adjudicated in civil courts.

In collaboration with the regulator, specifically BNM, and the legislature, the Malaysian Financial Sector Master Plan 2001-2010 outlined a framework for the establishment of a Sharia commercial court within the legal framework of Malaysia. The Sharia commercial court was instituted to resolve legal matters pertaining to Islamic finance. In response to the rapid development of the Islamic finance sector in Malaysia, the Department of Justice has promptly established a specialised branch within the Civil Court to adjudicate disputes pertaining to Islamic banking and finance. The creation of this specialised commercial court is founded on Practice Direction No. 1/2003 promulgated by the former Chief Justice, Dato’ Haidar Mohd Nor. Since 2003, issues pertaining to Islamic finance have been filed in the High Court Commercial Division 4. The Muamalat Court commenced operations in February 2009 at the Kuala Lumpur High Court (Hasan, 2012; Ahmad et al., 2023).

Abdullah and Aziz (2010) stated that takaful companies in Malaysia require extensive and integrated legal measures to enhance and strengthen the legal framework of the takaful industry in Malaysia. Legal lacunae subject the takaful sector to litigation. For instance, certain takaful companies decline to adopt practices such as naming in conditional hibah in the absence of explicit legislative provisions governing the practice. All disputes pertaining to Islamic money, including Takaful agreements, are resolved under civil law. Consequently, legal provisions are the primary strategy required to mitigate sharia risk exposure, particularly concerning the jurisdiction of sharia governance and regulations pertaining to adherence to sharia decisions.

Sharia Compliance of Islamic Financial Institutions

The legal requirements of IFSA 2013 employ the term “institution,” denoting an authorised individual or operator of a specified payment system, which incorporates takaful companies according to Section 27 IFSA 2013. According to Section 7(2) of the IFSA 2013, the jurisdiction of BNM’s SAC persists and is enforceable under the authority of BNM as stipulated under the Bank Negara Malaysia Act 2009. Furthermore, IFSA 2013 is perceived as an initiative to enhance and fortify the compliance for takaful companies with the sharia resolutions established by BNM’s SSC. Moreover, Section 28(2) of the IFSA 2013 explicitly states that conformity to resolutions and decisions issued by the SAC BNM is deemed syariah-compliant. This firmly signifies that the Shariah resolutions on Islamic finance issued by the SAC BNM become a standard for the Shariah compliance of Islamic financial institutions, including takaful businesses. Furthermore, Section 28(4) of the IFSA 2013 authorises the SC via BNM to evaluate the strategic plans of Islamic financial institutions in addressing Shariah non-compliance in their business operations and activities. BNM’s initiatives to develop space and opportunities for Islamic financial institutions, particularly takaful companies, demonstrate its support for managing Shariah compliance by promoting the establishment of robust and autonomous internal Shariah departments in takaful companies. The internal Shariah department of takaful firms must adhere to the resolutions and decisions of the SAC BNM while conducting research on Shariah concerns and challenges that emerge within their organisations.

The incorporation of Shariah compliance in the IFSA 2013 represents a novel component in legislation pertaining to Islamic finance. Consequently, there are diverse perspectives regarding the anticipated implications for sharia compliance post-IFSA 2013. Hassan and Salleh (2017) elucidated that IFSA 2013 has both advantageous and disadvantageous consequences for sharia compliance elements. According to Section 29(1) of IFSA 2013, sharia compliance in IFSA 2013 exclusively acknowledges sharia rulings and resolutions from the SAC BNM, which are deemed sharia compatible within the Islamic financial sector in Malaysia. Therefore, Hassan and Salleh (2017) argue that this provision has restricted the freedom and space for ijtihad by the Shariah Committee at the takaful company level itself. The stipulation that only the decisions of the SAC BNM are deemed compliant will establish uniformity and standards in the Shariah-compliant practices of the Islamic finance sector, thereby enhancing public comprehension and trust in the Islamic finance industry, including the takaful industry. Furthermore, takaful companies must have a robust internal sharia governance system to identify and manage any risk situations, given their autonomy in handling sharia risks internally. Inadequate management of sharia risks will undoubtedly result in detrimental consequences for the Islamic financial institution, accompanied by numerous sanctions and measures as stipulated by IFSA 2013.

Management of Shariah Non-Compliant Funds

The takaful company must segregate Shariah-compliant investment funds from other funds. In their annual statements, most takaful companies clarify that they allocate the non-compliant funds for charitable plans. For instance, according to the report of Takaful Company A, it states: “During the financial year under review, the company monitored non-halal income and allocated it to charity upon receiving approval from the Shariah Advisory Bodies…”. The company designated all earnings derived from sources or means prohibited by Shariah for charitable disposal. The segregation of non-compliant Shariah funds acquired by the takaful company from charitable funds is a result of incidences of Shariah risk within the takaful company related to non-compliant income. Ginena (2014) states that the audit team has to supervise the disposal of non-compliant Shariah charitable funds due to a significant increase of up to millions of ringgit in the charitable fund. The takaful company receives the gains from the prohibition of using charitable funds for investment. Conventional financial institutions, particularly those that reinvest and subsequently offer profits to takaful operators, must not receive the welfare funds. This evidently leads to potential exposure to Shariah risks in Islamic financial institutions due to inadequate management of non-Shariah-compliant funds (Ginena, 2014).

Shariah Risks Exposure Framework in Islamic Finance 

The potential for sharia risks in the Islamic finance industry has a critical theoretical and practical framework and requires in-depth explanation. However, this study only explains the potential for sharia risks in general without providing detailed examples in the Islamic finance industry. The potential for sharia risk exposure in the Islamic finance industry is divided into two categories: internal potential and external potential. There are sharia risks that can happen when financial institutions don’t follow certain sharia rules when it comes to their employees, systems, and processes. Firstly, there are risks associated with the staff of the Islamic financial institution itself, such as the potential for fatwas, information errors, procedural violations, and other related issues. Sharia risks arise from the failure of Islamic banks to comply with Shariah principles and decisions. This is defined by the IFI’s Shariah committee or an authorised body, and it can lead to losses by affecting the IFI’s reputation in financial or non-financial terms (Asni, 2022). In Islamic financial institutions, fatwa risks can also happen if the Shariah Committee doesn’t keep an eye on the overall Sharia-compliant structure of operations. This failure will cause the Sharia Committee to issue fatwas that are incorrect, unclear, or too difficult to practice in the actual Islamic financial market (DeLorenzo 2007). In addition, information errors can cause sharia risks. This mistake in information happens if the sharia compliance manual is not used with the right system to make screening transactions easier in Islamic financial contracts. Violation of procedural guidelines in the approval of products, transactions, and legal documents will also cause operational risks. If the approval involves sharia compliance. This will cause sharia risk incidents. It is necessary for both civil legal officers and the Sharia Committee to be involved in the approval of products, transactions, and legal documents in real life. This is to make sure that each approval is based on both sharia compliance and civil legal approval (Ginena, 2014). Also, the takaful industry will have sharia risk incidents because there aren’t enough staff with a background in sharia, and there isn’t any training on how to follow sharia. Sharia department staff will not be able to do audits, current studies, or reassessments on issues, products, transactions, and other operations in Islamic financial institutions because they do not know enough about sharia. Potential risk exposure is also due to the internal processes of the financial institution itself. Internal processes have a number of issues. For example, Islamic financial institutions’ policies, procedures, and areas of operational responsibility change and vary a lot. This means that staff and other important parties don’t have clear guidelines to follow, which could lead to sharia risk incidents. Next, the fact that Islamic financial institutions haven’t set up a sharia governance system will make it harder to make sure that Sharia law is followed. Sharia governance issues that aren’t handled well at the institutional level could leave it open to sharia risk (Hasan, 2012; Ahmad et al., 2023). Information technology systems in Islamic financial institutions also contribute to potential sharia risk exposure. This is because most information technology systems in financial institutions are based on conventional financial institutions. So, the system isn’t good at checking for things that aren’t in line with sharia, which leaves Islamic financial institutions open to sharia risk incidents.

External potential is external matters from the Islamic financial institution itself that cause exposure to sharia risk. Fatwa risk from outside is part of the external potential of sharia risk exposure. DeLorenzo (2007) explained that there are three reasons for rejecting fatwas from outside. First, differences in decisions due to differences in schools or minority school adoption. Second, lack of transparency and detailed disclosure of fatwa decisions to investors and the internal Sharia Committee. Third, rejection of fatwas from customers because customers believe that fatwa decisions are insufficient in complying with religious requirements. Potential sharia risk from outside sources can also be caused by conflicts in the sharia auditing process. Sharia auditing from outside parties could be biased if the internal Sharia compliance department of Islamic financial institutions is involved. This could imply a failure to achieve the objectives of sharia auditing. Failures during the sharia auditing process also increase the potential for sharia risk incidents to occur. Next, sharia risk could be caused by the person or group that is supposed to make sure that sharia is followed not having enough knowledge and experience (Marzuki et al., 2024). Possible exposure to sharia risk may also be because regulators haven’t come up with any rules or guidelines, especially for main sharia issues that need to be followed. The possible sharia risk that has been mentioned is a general sharia risk that can happen in any Islamic financial industry, like takaful, Islamic banking, or Islamic capital markets.

RESEARCH METHODOLOGY

This study applies a qualitative methodology, as articulated by Tracy (2024), which emphasises the in-depth interview technique for collecting opinions on the research questions and objectives. Dunwoodie, Macaulay & Newman (2023) elucidated that the in-depth interview method is conducted in an open and unrestrained manner, as opposed to a structured and formal approach, to elicit clear information from the informant’s viewpoint without preconceived expectations from the researcher. This study comprised interviews with experts directly engaged in Shariah compliance, operations, and procedures within the takaful industry. This study will employ informant labels to identify the study participants, thereby safeguarding the data and the reputations of the companies involved. The subsequent list comprises study informants:

 Table 1: List of Informants

Following the interview, the data is analysed in accordance with a specified theme. The qualitative analysis approach implements the methodology suggested by Tracy (2024). This qualitative analysis procedure need not be conducted sequentially; it may, at times, need simultaneous and iterative implementation. During the preliminary phase of the research, the researcher will encounter uncertainty in the analysis of qualitative data. This issue necessitates proactive exploration by the researcher. Upon the comprehensive investigation and analysis of all qualitative data by the researcher, the goals and objectives of the study become more specified. The analysis of qualitative data involves three stages: coding, memoing, and thick descriptions. Yusof & Romli (2013) explained that memoing involves documenting and evaluating preliminary findings during field data collection. The data is subsequently categorised to establish the themes of the study findings through deductive and inductive analysis. The qualitative method necessitates that the researcher elucidate the data analysis process and thoroughly analyse the study results.

Figure 1: Overview of the Qualitative Data Analysis Process (Yusof & Romli, 2013)

Figure 1 presents a comprehensive description of the qualitative data analysis method. Three data analysis procedures are employed: open coding, axial coding, thematic coding, and memo notes. Coding is the method of organising and structuring data following the collection from interviews. Coding seeks to categorise, structure, and systematise the collected raw data. Subsequently, coding is employed to connect data and assessments to data. Following category coding, the category codes will be integrated according to themes and concepts derived from the coded interview data. This thematic coding aims to create themes to develop a novel model, theory, or relationship derived from the qualitative study analysis (Hennink, Hutter, & Bailey, 2020)

FINDINGS AND DISCUSSION

Sharia Risk in Takaful Company Investments

The investment of a Takaful company is subject to Sharia risk. The study informants frequently remarked on the Sharia risk exposure in investments initiated by takaful companies. Informant 1 remarked that the sharia risk exposure in takaful company investments is frequent, as the selection of investment portfolios must adhere to the sharia-compliant guidelines established by the Securities Commission Malaysia (SC). The sharia-compliant status of investment assets is continually evolving. Securities Commission Malaysia will release the most updated sharia-compliant list biannually, specifically in May and November each year. The semiannual update of the sharia-compliant securities list by the SC results in the takaful company’s investment portfolio first being sharia-compliant, but then transitioning to non-sharia-compliant status upon the release of the latest list by the SC.

Figure 2: Findings on Shariah Risk in Takaful Company Investments

Figure 2 of the data analysis indicates that all nine informants agree that the change in the status of sharia-compliant securities issued by the SC in May and November annually results in exposure to sharia risk incidents. This is an explanation provided by several informants regarding the changes in the sharia-compliant status of securities in May and November.

Informant 1 explained that there is a difference of view among takaful companies regarding the classification of delisted securities as sharia risk incidents. Informant 1 argues that the change in the status of delisted securities does not constitute a Sharia risk event. Sharia risk exposure pertains to the change of investment status to non-sharia-compliant due to an updated list of sharia-compliant securities, which does not require reporting to the takaful company’s Sharia Committee or Bank Negara Malaysia (BNM), as this situation is not considered a sharia risk incident but rather a routine function of the takaful company’s Sharia Division. The acronym B.A.U., signifying business as usual, refers to the routine duties and obligations of the Sharia Officer within the takaful company. Business as usual refers to the condition in which all operations of a takaful company are conducted normally. In the presence of inadequacies or weaknesses, the standard operational procedure persists, and ongoing enhancement will be pursued. The presence of a non-shariah-compliant portfolio is not deemed a shariah risk event and does not constitute a possible shariah risk that requires reporting to BNM. Informant 1 stated that the actual shariah risk occurrence has not yet transpired. The Shariah officer of the takaful company is tasked with executing procedures in accordance with the standards established by the SC concerning investment portfolios that transition from Shariah-compliant to non-Shariah-compliant.

The SC has established criteria for securities that transition from shariah-compliant to non-shariah-compliant status. Takaful businesses are permitted to retain delisted securities until their market price equals the investment cost price. Delisted securities refer to “Shariah-compliant securities” that subsequently transition to “Shariah-non-compliant” status. However, after the market price of the non-Shariah-compliant assets has attained the investment cost. The takaful corporation must divest the non-Shariah-compliant securities through sale within one month. All gains, in the form of dividends, must be allocated to the Treasury or charitable organisations. This indicates that the takaful company is permitted to cover solely the investment expenses. Subsequently, the earnings accrued post-announcement from securities transitioning to non-shariah-compliant status must be segregated and remitted to the Treasury or charitable organisations, as determined by the takaful company’s Shariah Committee (Yusof et al., 2019). Informant 1 stated that the earnings not complying with Sharia law were allocated for charitable purposes, including the restoration of drainage systems for public benefit.

Informant 2 also addressed investment matters that entail exposure to Sharia issues. Informant 2 focused on the sharia risk exposure associated with takaful firm investments that may arise from changes to the list of sharia-compliant securities published by the SC biannually. Informant 2 stated that the sharia-compliant status of securities is revised biannually. The takaful company has been charged with selling securities that transition to non-sharia-compliant status in accordance with the directives established by the SC Sharia Advisory Council. Informant 2 also highlighted that the investment matter requires greater scrutiny, particularly for sharia compliance, in light of changes to the list of sharia-compliant securities.

Furthermore, informant 5 argues that the investment dimension within takaful enterprises is susceptible to sharia risks. He additionally remarked on the matter of the list of sharia-compliant securities, which is perpetually evolving and revised biannually. Informant 5 explained the shariah compliance of takaful company investments according to SC standards, permitting takaful companies to retain delisted funds until they attain the investment cost price (i.e., Commission Malaysia, 2022). Nonetheless, takaful corporations permit the management of securities that have transitioned to non-Shariah compliance for a duration of two years, allowing time for the securities’ prices to recover to the initial investment cost. If the securities that have transitioned to non-Shariah compliance fail to attain the investment cost within a two-year period. The takaful corporation will continue offering for sale and divest the securities that have transitioned to non-Shariah compliance.

Informant 5 claims that this approach is not included in the SC guidelines. The SC rules permit the retention of any securities that have transitioned to non-Shariah compliance for an indefinite duration until their market price aligns with the investment cost. The practical option to divest securities that have transitioned to non-Shariah compliance, although not having attained the investment cost, is determined internally at the takaful company E. This demonstrates the dedication of the takaful company E to manage sharia risk exposure in its assets through internal practices. Furthermore, informant 5 stated that non-shariah-compliant securities, resulting from delisting following the most recent list of shariah-compliant securities published by the SC, were not reported to BNM, except for delisted securities that generated profit and required segregation and management in accordance with the non-shariah-compliant income methodology (Securities Commission Malaysia, 2022).

Additionally, informant 6 remarked on the shariah concerns regarding the investments of takaful company F. Informant 6 noted that a shariah risk incident transpired in investments due to the external party managing the takaful company’s investment funds failing to divest from non-shariah-compliant securities, despite their appreciation beyond the investment cost price (Securities Commission Malaysia, 2022). Informant 6 possessed a perspective distinct from that of the other informants. Informant 6 believed that stocks delisted for being non-Shariah-compliant were classified as potential Shariah non-compliance risks. Informant 6 clarified that the jurisdiction to ascertain whether the matter constitutes a possible or actual occurrence of sharia risk resides with the SC. While the SC of the takaful company resolves the matter, the Shariah Division is able to define the exposure to sharia risk as a prospective risk.

Informant 4 claims that the investment dimension of takaful companies is particularly vulnerable to sharia risk. This results from the management of investment funds performed by the takaful company, which entails numerous staff and substantial financial resources. There are certain deficiencies, particularly with the expertise and understanding of investment fund managers regarding sharia compliance. Takaful firm investment funds are concurrently subject to changes in sharia compliance standards established by the SC Shariah Advisory Council.

Shariah Risk Management Approach in Takaful Company Investment

Figure 3: Findings of the Shariah Risk Management Approach in Takaful Company Investments

The sharia risk management approach in takaful company investments, illustrated in figure 2, indicates a scenario where funds are removed from the list of sharia-compliant securities. All takaful companies employ varying approaches in addressing this challenge. The majority of informants classify securities that have been delisted from sharia-compliant status as ordinary transactions or “business as usual,” without considering them as potential or incidental sharia risks, provided that the management of these securities continues to adhere to the SC guidelines (Securities Commission Malaysia, 2022). Meanwhile, there are two informants who categorise securities that have been delisted from the sharia-compliant list as potential sharia risks. Two informants indicate that assets delisted as sharia-compliant are classified as incidental sharia risks (in fact, non-shariah compliant). This research indicates disparities in the procedures of takaful companies regarding the classification of the security status of securities that have been delisted from the sharia-compliant list. The classification of delisted securities remains at the discretion of the takaful company’s SC, and there are no explicit standards for assessing the status of assets that transition to non-shariah compliant as determined by the SC. The management of sharia risk exposure in takaful company investments entails multiple stakeholders. The investment fund managers are tasked with ensuring that the investment securities of the takaful firm adhere to Shariah compliance. Consequently, when a new list of securities is produced in May and November annually, managers must remain vigilant and prepared for any alterations in the status of takaful company investment securities.

Furthermore, certain takaful organisations engage external investment managers; for instance, informant 5 remarked, “We outsource to a third-party fund manager.” They possess their own Sharia advisor. The shariah advisor produces a monthly report regarding the company’s investments. Informant 5 stated that the investment funds are allocated to an international investment portfolio. The investment manager will adhere to the Shariah compliance standards established by the nation’s Shariah supervisory authority. Informant 6 stated that sharia compliance in the investments of the takaful company, especially concerning foreign investment funds, is managed by an external investment manager designated by the takaful company, specifically Investment A, which engages a sharia advisory service body pertinent to Islamic finance to supervise the sharia compliance of the investment funds under their management.

Informant 7 stated that particular takaful companies engage Islamic banks to manage their investment capital. Consequently, the appointed bank is accountable for ensuring that the investment funds adhere to the regulations established by the SC. Informant 8 indicated that the takaful company that is employed by appoints an external fund manager. This indicates that takaful corporations engage external fund managers to ensure competitive performance and attractive returns while simultaneously adhering to all sharia compliance standards established by the SC.

The study shows that any exposure to sharia risk in Takaful company investments is recognised by the primary party, specifically the investment manager of the Takaful company, regardless of whether they are within or external to the organisation. Nonetheless, this provides a strategy to mitigate sharia risk in takaful firm investments. The investment manager must periodically report the performance and Sharia compliance status of the takaful company’s investments for monitoring by the company’s management and SC. Furthermore, the sharia assessment process is conducted about the investments of takaful companies. Informant 6 reported that the sharia review done by the takaful company revealed the presence of delisted securities still retained by the company, despite surpassing the investment cost and exceeding the one-month time permitted by the SC.

The Sharia review findings, which indicated that the delisted securities remained in the possession of the takaful company, were deliberated at the Shariah Committee level of the takaful company for a decision to be issued. The takaful company retained the delisted securities; however, it was evidently non-compliant with Sharia as per the Securities Commission Malaysia standards (2022). Thus the takaful company’s Shariah Committee held the authority to determine and affirm that the delisted securities constituted a sharia risk incident. Income from securities that were delisted from the sharia-compliant list was classified as unrecognised income. The unrecognised income was segregated and then distributed to charitable charities approved by the takaful company’s Shariah Committee. The act of segregating unrecognised income and allocating it to charity organisations serves to mitigate the occurrence of sharia risk within the takaful company, as mandated by the legal stipulations in sections 28(3) and (4) of the IFSA 2013. The aforementioned explanation indicates that the takaful company’s investments are subject to sharia risk. In a similar vein, the takaful corporation consistently oversees and evaluates the sharia-compliant status of investment assets, particularly upon the issuance of a new list of sharia-compliant securities by the Securities Commission Malaysia (2022).

The takaful company’s Sharia Committee has the responsibility of ensuring Sharia conformity within the takaful operator, including offering advice services to the takaful company’s Board of Directors regarding Sharia compliance in takaful operations. The Committee will issue a sharia manual derived from the sharia resolutions established during the meetings and discussions of the takaful operator’s Sharia Committee to be implemented in takaful operator operations and activities. The takaful operator’s Shariah Committee is responsible for validating and certifying documents related to takaful operator operations, including application forms, nomination forms, legal contracts, marketing brochures, product manuals, investment matters, and takaful company funds. Additionally, the takaful operator’s Shariah Committee must provide insights and advice services to specific entities, including auditors and legal authorities, when these bodies require perspectives associated with Shariah compliance. The takaful operator’s Shariah Committee also contributes at the internal level by providing written opinions to BNM about applications for new takaful products from the takaful operator. (Bank Negara Malaysia, 2011). The Shariah Committee, the Shariah Secretariat Division of the takaful company, and the accountable management of the takaful company will address and oversee the Shariah challenges encountered by takaful companies, including Shariah risks in investments.

CONCLUSION

In conclusion, all takaful companies experience sharia risk regarding investments. The company must allocate participants’ investment funds, particularly for investment-linked family Takaful products and other Takaful fund investments. All takaful companies have the risk of investment securities being removed from the current list of sharia-compliant securities, including general takaful companies that possess investments, whether through shareholder investment funds or other operational investment funds. Consequently, sharia risk exposure arising from the most updated list of SC sharia-compliant funds is a prevalent issue for all takaful companies in Malaysia. BNM, the regulator, does not specify the criteria for determining risk categories, allowing the Sharia Committee and management to engage in internal deliberations and develop solutions for solving sharia risk concerns in takaful firm investments. Takaful companies make decisions regarding incidences of sharia risk, potential risks, or standard transactions in their operations. The variety of sharia risk management approaches provides an opportunity for takaful companies to succeed in managing sharia-compliant investments. Takaful companies must adhere to the SC’s list of Shariah-compliant securities; however, takaful companies can manage investment funds based on the Shariah Committee’s deliberations and the oversight of designated employees responsible for ensuring Shariah compliance in the investment of Takaful company funds. Section 28(4) of the IFSA 2013 allows the SAC, via BNM, authority to assess the strategic plans of Islamic financial institutions in addressing Shariah non-compliance in their operations and activities. BNM’s initiatives to create possibilities and space for Islamic financial institutions, particularly takaful companies, demonstrate its support for managing Shariah compliance by promoting the establishment of robust and autonomous internal Shariah departments inside takaful companies. The internal Shariah department of takaful companies must adhere to the resolutions and decisions of the BNM Shariah Advisory Council while also engaging in research and discussions regarding Shariah issues and challenges that emerge within their respective financial institutions.

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