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KEY ELEMENTS OF THE PROPOSED RULES

TRR 1 - General

TRR 1 introduces a number of key terms and concepts including Takaful Business. It requires Insurers to classify Takaful Contracts they write by reference to the categories of insurance identified in Schedules 1 and 2.

A feature of the leading international insurance regimes is a restriction on Takaful Operators combining different kinds of Takaful business. Such requirements are directed at limiting ‘internal-contagion’ risk. This is the risk that losses or liabilities from one activity might deplete or divert financial resources held to meet liabilities from another activity. TRR, therefore, prohibits TakafulOperators from carryingon both Family Takaful Businessand General Takaful Business and requires Takaful Operators to limit non- insurance activities to those that are directly connected with, or carried on for the purposes of, takaful business; guidance explains which activities will normally be considered to be directly connected.

TRR 1 also contains guidance as to the more limited extent to which the TRR regime will apply to branches of entities established outside the AIFC. The term AIFC-Incorporated Takaful Operator is used to refer to a Takafuloperator that is incorporated as a legal entity under the laws of the AIFC and thus excludes branches of legal entities incorporated outside the AIFC. TRR 1.5 sets out the core obligations of Takaful Operators by reference to the various chapters of TRR. A number of these obligations are limited to AIFC- Incorporated Takaful Operators.

TRR 2 – Governance Framework

A Takaful Operator must ensure the adoption and effective implementation of sound risk management practices, robust Shari’ah governance and high standards of business conduct. The board of directors and senior management of a Takaful Operator are responsible for ensuring such effective governance framework as it is critical for achieving the objectives of the TRR rules.

TRR 3 - Risk Management Strategy

TRR 3 requires a Takaful Operator to establish and maintain a risk management strategy. This should be clearly defined and well documented, and take into account the Takaful Operator’s overall business strategy and its business activities. This strategy contains a number of important components including a Risk Management Policy setting out how all relevant and material categories of financial and non-financial risk are monitored, measured and managed, both in the Takaful Operator’s business strategy and its day-to-day operations. Schedule 3 sets out in detail what the AFSA would expect to find covered in a Takaful Operator’s Risk Management Policy. A Takaful Operator is also required to prepare a Risk Tolerance Statement which sets out its overall quantitative and qualitative risk tolerance levels.


TRR 4 - Own Risk and Solvency Assessment (ORSA)

A feature of the leading international regimes is a requirement that Takaful Operator perform an own risk and solvency assessment (ORSA) regularly to assess the adequacy of its risk management and current, and likely future, solvency position.

TRR 4 contains a requirement that every AIFC-Incorporated Takaful Operator (i.e. an Takaful Operator which is not a branch) must conduct an ORSA annually (or with greater frequency if preferred by the AFSA), and that such ORSA must be appropriate to the nature,scale and complexity of the insurer’s business. TRR then sets out a detailed explanation of what an ORSA is, its contents, and the matters to which an insurer must have regard in conducting an ORSA. An AIFC-Incorporated Takaful Operator is required to prepare a report after it conducts its ORSA, which is to be reviewedand approved by the Takaful Operator’s Governing Body.

TRR 5 - Capital adequacy requirements

The amount of capital available to a Takaful Operator is fundamental to its financial strength. It provides a buffer against losses that have not been anticipated and, in the event of problems, enables the insurer to continue operating while those problems are addressed or resolved. In this way, the maintenance of adequate capital resources can engender confidence on the part of policyholders, creditors and the market more generally in the financial soundness and stability of the insurer. TRR 5 accordingly requires an AIFC- Incorporated Takaful Operator to calculate its qualifying capital resources (referred to as its Eligible Capital) on an ongoing basis and to monitor the extent to which its Eligible Capital exceeds two benchmarks referred to as the Minimum Capital Requirement (MCR) and the Prescribed CapitalRequirement (PCR).

Schedule 4 sets out detailed rules for the calculation of Eligible Capital and identifies two types of capital (Tier 1 and Tier 2 Capital) that an AIFC- Incorporated TakafulOperator is permittedto recognise and which it is obliged to hold in specified ratios. Schedule 5 sets out the calculation for the MCR relating to Family Takaful Business and General Takaful Business. Schedule

6 identifies a more detailed methodology for calculating the PCR which involves a highly sensitiveanalysis of the different types of risk engendered by the Takaful Operator’s Takaful Business.

TRR 5.3 provides that an AIFC-Incorporated Takaful Operator may be permitted by the AFSA under certain circumstances to use its own internal models to calculate either the whole or a component of the PCR. However, it should be noted that the AFSA does not initially anticipate accepting applications for permission to use internal models.

TRR 5.4 sets out the “solvency control levels” which place various obligations upon an Takaful Operator should it become aware that its Eligible Capital has fallen below or close to either level. Guidance sets outs an indicative range of actions that AFSA may take on breach of either the MCR or the PCR.

Further provisions limit the circumstances in which an AIFC- Takaful Operator is permitted to reduce its Eligible Capitaland require an AIFC-Incorporated

Takaful Operator to notify the AFSA of all dividends and other distributions to shareholders.

TRR 6 - Investment

TRR 6.1 requires Takaful Operator i.e. all Takaful Operators including branches) to ensure that where they invest in assets they invest in assets that are secure, liquid, appropriately located and suitably diversified. Takaful Operators are required to invest in a mannerappropriate to their liabilities and only to invest in assets where they are able to assess and manage the risks involved. TRR 6.2 restricts Takaful Operator from investing in certain high risk assets and TRR 6.3 requiresTakaful Operator to maintain writtenrisk policies and procedures.

TRR 7 - Segregation of Family Takaful assets and liabilities

TRR 7 requires Takaful Operator carrying on Family Takaful Business to segregate the takaful liabilities and matching assets of the various categories of Family Takaful and to establish a fund to which Family Takaful Contracts are attributed. The effect of this is that such assets may only be used to meet obligations to the policyholders with respect to which the fund has been established. Limitations are placed by TRR 7.4 upon the use of assets in a Family Takaful Fund.

TRR 8 - Valuation

TRR 8 sets out rules regarding matching of Takaful Operator’s assets to liabilities, on the basis of a consistent and transparent economic valuation of those assets and liabilities. An economic valuation of assets and liabilities reflects the risk-adjusted presentvalues of their cash flows. The basic principle of measurement that a Takaful Operator must adopt as the basis of its accounting is specified as the IFRS.

TRR 8.1 requires a Takaful Operator to hold supporting assets of a value at least equal to the amount of its liabilities. TRR 8.2 sets out basic principles for the recognition and valuation of such assets and liabilities. TRR 8.3 identifies particular assets relating to General Takaful Business which require special treatment, namely premium liability, future claims payments and expected recoveries. TRR 8.4 takes a similarapproach for certainFamily Takaful assets and liabilities namely policy benefits due before the Solvency Reference Date (i.e. the date of measurement) and the net value of future policy benefits.

TRR 9 - Actuarial reporting

TRR 9 elaborates on the requirements for Insurers which are obliged to retain an Approved Actuary, requiring in particular that an Approved Actuary carry out annually an actuarial investigation to enable him to prepare a report about the insurer’s financial condition (a “financial condition report”) which is to be submitted to the AFSA annually at the time of the insurer’s annual regulatory return. The AFSA will also have a power to direct that financial condition reports more frequently than annually, and also to direct an insurer that the Approved Actuary is to carry out an investigation into any matter which the AFSA specifies.

TRR 7.2 requires Takaful Operators not required to appoint an Approved Actuary to consider annually whether to commission an independent actuary to report on its business, and to commission such a report at least once every 3 years.

TRR 10 – Takaful Operators that are members of Groups

A TakafulOperator is exposedto risks throughthe relationships that it has with other companies in its group.Group membership can be a source of strength, but it can also be a source of weakness. TRR 10 contains additional requirements for Takaful Operators that are members of a group to ensure that: (i) the Takaful is capitalised adequately to protect itself against the risks arising from its membership of the group, and is otherwise protected against those risks; (ii) it can be properly supervised by the AFSA; (iii) it provides the AFSA with information about the structure and financial position of the group; and (iv) it assessesthe effect of, and notifiesthe AFSA of, certain transactions within the group.

The effect of these provisions is broadly as follows. The structure of a Takaful Operator’s group is to be transparent with clear governance, controls and reporting lines, and such that it does not hinder the Takaful Operator’s stability and solvency. The AFSA has the power to direct that a Takaful Operator hold additional capital to cover risks arising because of the Takaful Operator’s group membership. Takaful Operators are to ensure that any material transaction with another member of its group is entered into on an ‘arms- length’ basis and on fair and reasonable commercial terms. Certain transactions – such as inter-group loans, guarantees or investments – are not to be entered into unless the Takaful Operator’s Governing Body is satisfied that it does not adversely affect the interests of policyholders.

TRR 11 - Transfer of Takaful business

TRR 11 then sets out various requirements which will apply to application for an order of the AIFC Court effecting an Takaful Business Transfer. These include that a report (“the Scheme Report”) be prepared by an independent actuary. This report is to be put beforethe AIFC Court and, amongother things, must contain: a rationale for the proposed relevant scheme; the categories of business to be transferred; and a confirmation that there will be no materially adverse consequences from the proposed transfer to the policyholders of either the transferor or transferee. Notification of the proposed transfer must also be given to all affected Policyholders.

TRR 12 – Takaful Operators in run-off

TRR 15 applies to all AIFC-Incorporated Takaful Operators along with Branches in respect of their AIFC Takaful Businessand contains requirements that apply where such insurer has gone into “run-off”. This means that an Takaful Operator has ceased to effect Takaful Contracts in respect of the whole or a category of its Takaful Business.

Takaful operator that go into run-off will be required to notify the AFSA and provide a run-off plan complying with TRR 12.3, including an explanation of how, or the extent to which, all liabilities to policyholders will be met in full as they fall due. A Takaful operator in run-off will be required to notify the AFSA of certain contracts and be restricted from making certain distributions.

TRR 13 - Prudential returns

TRR 13 requires Takaful Operators to prepare and submit to the AFSA the annual, biannual and quarterly prudential returns set out in Schedule 7 (Prudential returns by Takaful Operator).

TRR 14 - Captive Takaful Operators

TRR 14 applies only to Captive Takaful Operators. A Captive Takaful Operators is an Authorised Firm with a Licence to carry on Captive Takaful Business. Captive Takaful Business is defined as the business of effecting or carrying out Takaful Contractsonly for the business or operations of the Group to which the Captive Takaful Operators. Only an Authorised Firm which is incorporated under the laws of the AIFC may apply to the AFSA for a Licence to conduct Captive Takaful Business.

A Captive Takaful Operator may take the form of a Protected Cell Company (PCC) - which is a form of legal entity that will be introduced under planned amendments to the Companies Regulations. PCCs consist of a core and one or more cells which are legally segregated for the purposes of insolvency law. A Captive Takaful Operator incorporated as a PCC may maintain multiple cells, but requires the permission of the AFSA to create a new cell.

The requirements of TRR apply to Captive Takaful Operators either in full or with the modifications set out in TRR 14.3 to 14.14. The key modifications are as follows:

Systems and controls: A Captive Takaful Operator is permitted to outsource its risk management and actuarial functions to a Captive Insurance Manager. This refers to an Authorised Person carrying on the new regulated activity of Captive Insurance Management.

Risk management: A Captive Takaful Operators is required to maintain a Risk Management Strategyand conduct an ORSA in accordance with TRR 3. However, it may apply to the AFSA for a waiver of the requirement to conduct an ORSA.

Capital Adequacy: The requirements of TRR 5 apply to Captive Takaful Operators save for a modified CapitalFloor (the base requirement of the MCR) and modifications relating to the application of the capital requirements to PCCs.

Question:

Do you have any concernsrelating to the proposed regulatory requirements to (re) insurance companies? If so, what are they, and how should they be addressed?