Chapter 10

Solvency and Capital Adequacy in Takaful

James Smith1

10.1 INTRODUCTION

Insurance prudential regulation, including that of takaful, is in a state of change. Many jurisdictions, including some in which takaful is strongly represented, are in the process of moving from traditional solvency approaches to more sophisticated methods based on risk rather than ratios.

This chapter starts from the premise that takaful is appropriately considered a part of the insurance sector, and that solvency rules for takaful operations should follow the same principles as for conventional insurers. Identical principles do not necessarily mean identical detailed rules. The treatment should be fair to both takaful and conventional insurers, as in most markets, they will compete. This goal of following the same principles may be becoming easier to attain. In recent decades, a great deal of work has gone into attempting to rectify the perceived deficiencies of traditional solvency systems, and into developing “risk-based capital” (RBC) solvency requirements responding to the individual characteristics of the insurers that are to comply with them. This new conceptual framework for insurance solvency opens the way for solvency requirements for takaful operations to be customized not only for the characteristics of takaful operators as a class but also for the characteristics of individual takaful operators.

Taking a risk-based approach to solvency allows a neutral approach to the debate as to ...

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