Fitch outlines draft Takaful rating methodology

Fitch Ratings has published an exposure draft detailing the agency’s expected approach to rating Takaful firms.

Takaful is a form of financial protection, similar to insurance, designed to be compliant with Islamic principles (Shari’ah). The document, “Exposure Draft - Takaful: Rating Methodology and Review” specifies several areas of analysis that are particularly important to assessing the financial security of a Takaful firm. The document also reviews the current status and prospects for the industry.

“The agency’s Takaful rating methodology is designed to reflect the specifics of these businesses and Fitch welcomes feedback on the proposed approach,” said Andrew Murray, Senior Director in Fitch’s Insurance Department, “Fitch sees strong potential in the Takaful industry, although also some challenges for the coming years.”

Although much of Fitch’s conventional insurance rating criteria is still applicable in the case of a Takaful firm, the agency’s analysis will give greater emphasis to matters such as the applicable legal and regulatory frameworks, risk concentrations, product design, risk management and corporate governance.

For example, Fitch expects that it will generally be important for Takaful firms seeking an Insurer Financial Strength rating to be able to demonstrate that all assets of the firm (including shareholder assets where these exist) will be available to meet underwriting and investment losses. The agency sets out various ways that a Takaful firm may be able to achieve this - for instance by reference to country legislation, firm-specific legal documentation or a binding and legally effective commitment to arrange suitable interest free loans. Fitch is also open to considering other potential mechanisms to ensure that all of a Takaful firm’s assets are available to support participant liabilities.

Fitch considers that the industry has strong potential, although it faces a number of challenges including education of the client base, access to suitable investments, recruitment of qualified staff and the availability of reasonably priced retakaful capacity (i.e. Shari’ah compliant reinsurance capacity). In addition, Fitch expects that further development of the applicable legal and regulatory frameworks will also play a key role in the future growth of the industry.

Takaful is based on the principle of solidarity and mutual guarantee. Compliance with Islamic principles requires factors such as the avoidance of interest-bearing assets or liabilities, not investing in certain industries as well as the avoidance of excessive risk and uncertainty.