Decoding Malaysia’s Unique Dual Insurance System and Regulatory Framework

Episode Summary

Malaysia’s insurance market is one of Southeast Asia’s most developed, with total gross written premiums for general insurance totaling 23.1 billion Malaysian ringgit — approximately $5.8 billion — in 2024, representing year-on-year growth of 6.9%. In this episode of Skadden’s global series on prudential solvency requirements, host Robert Chaplin and colleague Caroline Jaffer examine the country’s distinctive dual financial system, which covers onshore and offshore insurance, as well as Malaysia’s landmark risk-based capital framework that is scheduled to be implemented in January 2027, the Sharia governance framework governing Takaful operators, the new Digital Insurers and Takaful Operators framework and the offshore regime on the island of Labuan.

Key Points

• Dual Regulatory Framework: Malaysia operates a unique dual system in which conventional insurance regulation runs alongside a comprehensive Islamic insurance framework known as Takaful. Each is governed by separate primary legislation: the Financial Services Act 2013 and the Islamic Financial Services Act 2013. Onshore insurance is supervised by Bank Negara Malaysia (BNM), the country’s central bank, while offshore business conducted on the island of Labuan falls under the Labuan Financial Services Authority.
• RBC2, a Landmark Reform: BNM issued an exposure draft in June 2024 proposing significant changes to its risk-based capital framework (RBC2), with implementation targeted for 1 January 2027. The reform draws on concepts from the Insurance Capital Standard (ICS) issued by the International Association of Insurance Supervisors while preserving features of Malaysia’s existing framework.
• Takaful and Sharia Governance: Every licensed Takaful operator must maintain an internal Sharia committee, with BNM’s prior written approval required for all appointments. Crucially, noncompliance with Sharia is a statutory criminal offense under the IFSA — a feature with no real parallel in conventional insurance regulation globally.
• The DITO Framework: With approximately 90% of the Malaysian population underinsured, the BNM’s Digital Insurers and Takaful Operators (DITOs) framework aims to close that protection gap. 

Voiceover (00:01):
From Skadden, The Standard Formula is a Solvency II podcast for UK and European insurance professionals. Join us as Skadden partner Robert Chaplin leads conversations with industry practitioners and explores Solvency II developments that matter to you.

Rob Chaplin (00:18):
Welcome back to The Standard Formula. This episode continues our global series on Prudential requirements, forming part of our forthcoming encyclopedia of Prudential solvency. In today’s episode, we turn our attention to Malaysia, a jurisdiction with one of the most sophisticated and distinctive insurance regulatory architectures in the Asia-Pacific region. Malaysia’s insurance market is one of Southeast Asia’s most developed, with total gross written premiums for general insurance totaling 23.1 billion Malaysian Ringgit, U.S. dollars, 5.8 billion in 2024, representing a year-on-year growth of 6.9%. The life insurance market is estimated to have reached 10 to 13 billion U.S. dollars in gross written premiums for 2024. Insurance and Takaful penetration currently stands at 4.4% of GDP with Bank Negara Malaysia, or BNM, the central bank and prudential regulator in Malaysia, targeting an increase to approximately 5% by 2026.

(01:21):
What makes Malaysia particularly distinctive from a practitioner’s perspective is its dual financial system, which covers both onshore and offshore insurance. Here, conventional insurance regulation operates alongside a comprehensive Islamic insurance known as Takaful, and each is governed by separate primary legislation. Onshore insurance is supervised by BNM. While offshore insurance conducted in the federal territory of Labuan falls under the Labuan Financial Services Authority.

(01:51):
Malaysia is also in the midst of a landmark reform. BNM issued an exposure draft in June 2024, setting out proposed changes to its risk-based capital framework, or RBC2, with implementation targeted for the 1st of January 2027.

(02:08):
Joining me today is my colleague, Caroline Jaffer. Before we begin, our thanks go out to our good friends, Christopher & Lee Ong for their input and feedback on today’s podcast. Let’s start with the foundations. Caroline, can you walk us through the primary legislation governing insurance and Takaful in Malaysia and the role of BNM as the prudential regulator?

Caroline Jaffer (02:30):
Of course, Rob. Let’s look at onshore insurance first. The primary legislation governing conventional insurance in Malaysia is the Financial Services Act 2013, or the FSA. And for Islamic insurance, the primary legislation is the Islamic Financial Services Act 2013, or the IFSA. Both pieces of legislation were given royal ascent on the 18th of March 2013 and came into force on the 30th of June 2013. The FSA consolidated several predecessor statutes, these being the Banking and Financial Institutions Act 1989, the Insurance Act 1996, the Payment Systems Act 2003 and the Exchange and Control Act of 1953. The IFSA similarly consolidated the Islamic Banking Act 1983 and the Takaful Act of 1984. BNM is established under Central Bank of Malaysia Act 2009. Its principal regulatory objective under the legislation is to promote financial stability, including (1) the safety and soundness of financial institutions, (2) the integrity of financial markets, and (3), the protection of financial consumers.

(03:32):
A critical structural feature is that there is no separate conduct regulator. BNM combines both prudential and conduct supervision in a single body.

Rob Chaplin (03:39):
That’s an important structural point. Caroline, can you tell us what the key distinctions are between the FSA and IFSA in practice, and how this dual framework affects insurers operating in Malaysia?

Caroline Jaffer (03:52):
Certainly. The FSA and IFSA are parallel frameworks deliberately designed to allow conventional and Islamic financial institutions to operate on a level playing field. Approximately 75% of the provisions between the two acts overlap. The critical departure is part four of the IFSA, which creates a comprehensive statutory Sharia governance framework. Under the IFSA, Takaful operators must ensure their operations comply with Sharia at all times, with noncompliance being a statutory criminal offense. The BNM, through its Sharia Advisory Council, established under the Central Bank of Malaysia Act 2009, holds wide powers to assess, intervene, direct and penalize for breaches. This statute of enforcement architecture has no real parallel to Insolvency II, or indeed for the most comparable international frameworks, as it is the threshold consideration for any practitioner advisee on the Takaful market entry. We’ll discuss the Sharia governance framework in more detail later in this episode.

(04:48):
Two structural constraints flow from the FSA and the IFSA. First, insurers are no longer permitted to operate under composite licenses. Life in general business must be separately licensed. The same applies to Takaful operators where family to Takaful and general Takaful require separate licensed entities, with limited exceptions for professional reinsurers and re-Takaful operators. Second, minimum paid up capital for conventional life and general insurers and for Takaful operators in each case is 100 million Malaysian Ringgit. It’s about $25 million. Professional re-insurers and re-Takaful operators face higher thresholds reflecting their larger risk footprint. License applications are made to the BNM, and the license itself is granted by the Minister of Finance. Foreign insurers must also obtain approval from their home regulator exercising consolidated supervision. Rob, could you take us through Malaysia’s capital requirements?

Rob Chaplin (05:42):
Of course. BNM’s risk-based capital framework applies to all licensed insurers, including professional re-insurers, with a parallel framework for Takaful and re-Takaful operators. The central metric is the Capital Adequacy Ratio, or CAR, calculated as total capital available divided by total capital required. The supervisory target CAR is set at 130%. Total capital required is the sum of capital charges across four risk categories: credit risk, market risk, liability risk and operational and expenses risk. This is determined separately for each fund maintained by the insurer, the insurance fund and the shareholders fund. Caroline, what are the supervisory intervention levels and what enforcement powers does BNM hold where a licensed insurer falls below the required CAR?

Caroline Jaffer (06:35):
The current framework provides two explicit trigger levels. Firstly, the supervisory action level at 130% CAR, and secondly, a lower mandatory control level that triggers more prescriptive intervention. Beyond the CAR framework, BNM holds extensive powers under the FSA and IFSA, including the ability to remove directors, chief officers and senior officers, reduce share capital, and appoint a receiver and manager, and also, in extremists, assume control of the institution. It may also order share transfers or share issues. These powers were significantly strengthened by the FSA and IFSA compared to the predecessor legislation. Policy holders benefit from the Takaful and insurance benefits protection system administered by the Perbadanan Insurans Deposit Malaysia. Approximately 95% of all policy holders are protected up to 500,000 Malaysian Ringgit or around $125,000 in respect of Ringgit denominated policies. By contrast, the Takaful RBC framework has structurally distinct architecture. Most Malaysian Takaful operators use the Wakalah model, an agency arrangement under which the operator manages Takaful funds on behalf of participants.

(07:45):
Receiving an agency fee charged to the participant’s fund plus a performance incentive linked to the fund’s investment or underwriting surplus. The participant’s risk fund is separate from the participant’s investment fund and separate from the operator’s own shareholders fund. The Takaful RBC framework requires that the operator hold sufficient capital in the shareholder’s fund to support any shortfall in the participant’s risk fund with CAR calculations performed at the fund level. In a shortfall scenario, the operator may be required to provide a Qard Hasan, which is an interest-free loan, to the participant’s risk fund. The Qard Hasan is not a conventional debt instrument, and its treatment in the capital framework is a uniquely Takaful feature with no direct parallel in conventional insurance. Rob, we have mentioned RBC2 before. Can you give us the background to RBC2 and talk us through some key features of the proposed framework?

Rob Chaplin (08:35):
Certainly. On the 28th of June 2024, BNM issued its exposure draft on the RBC2 framework. Targeting implementation from the 1st of January 2027 with parallel reporting from the 1st of January 2026. BNM’s stated objectives are fourfold. One, to ensure the framework appropriately reflects underlying risk exposures. Two, to ensure capital adequacy is commensurate with risk profile at all times. Three, to promote consistent measurement across the insurance and Takaful sector. And four, to achieve greater alignment with the Insurance Capital Standard, or ICS, issued by the International Association of Insurance Supervisors, calibrated to Malaysian market conditions. RBC2 draws on ICS concepts, while preserving features of the existing Malaysian framework. In other words, it’s a considered local response to the development of a global solvency standard and not a wholesale transposition. The most substantial change for general insurers and general Takaful operators is the introduction of a catastrophe risk charge, an entirely new risk module requiring capital calculations specifically for catastrophe perils, including floods, earthquakes and windstorms.

(09:54):
Gross losses are reduced by reinsurance recoveries to produce the net losses on which the capital charge is based. From 2027 onwards, reinsurance treaty structures and counterparty selection will directly affect capital adequacy ratios. For life insurers and family Takaful operators, RBC2 enhances how insurance liabilities are valued, moving towards greater risk sensitivity in liability measurement, and drawing on ICS concepts, including more forward-looking cashflow assessments and a more granular risk margin treatment. RBC2 also introduces a unified approach to the CAR formula across both insurers and Takaful operators, promoting greater comparability of capital adequacy measurement across the two sectors. This is a significant conceptual development, given that two frameworks have previously retained certain structural differences despite their shared architecture. BNM also conducted a quantitative impact study, or QIS 2, as part of the exposure draft process. Requesting responses from licensed persons by the 31st of December 2024. QIS 2 results will inform the final calibration of RBC2 before it comes into force.

(11:08):
Individual risk charges are generally arising under the proposals. Operators with less-diversified risk profiles or significant catastrophe exposure are likely to see reductions in their capital adequacy ratios. International re-insurers should pay close attention to the RBC2 treatment of counterparty default risk on reinsurance recoveries, which introduces specific requirements for how capital charges are calculated, where reinsurance recoveries are relied upon. For Takaful operators specifically, BNM’s January 2025 policy document on Hajah and Darurah respectively, meaning need and dire necessity, clarifies when Takaful operators may use conventional reinsurance on grounds of necessity, where re-Takaful capacity or expertise is insufficient, or where risks undermine Takaful fund stability. This is directly relevant to RBC2 implementation, given the importance of reinsurance in managing catastrophe risk capital charges and the limited depth of the re-Takaful market.

(12:11):
Let’s shift gears now and look more closely at the distinctive features of the Takaful framework. Caroline, can you start us off please with an overview of the Sharia governance requirements that apply to Takaful operators?

Caroline Jaffer (12:24):
Of course, the IFSA establishes a comprehensive statutory Sharia governance framework that goes considerably further than most comparable international frameworks. Every licensed Takaful operator must maintain an internal Sharia committee, with the BNM’s prior written approval required for all appointments and reappointments. The committee’s rulings bind the institution. B&M’s Sharia Advisory Council sits above. This is the apex national authority with rulings binding on all Islamic financial institutions. A Takaful operator’s legal risk profile therefore includes not only conventional regulatory and contractual exposures, but live criminal liability exposure if its operations are found to be Sharia noncompliant. International practitioners entering the Takaful market must appreciate this at the outset and ensure specialist Sharia governance advice is built into energy diligence or structuring exercise. On operating models, as mentioned earlier, Takaful operators in Malaysia operate predominantly under either the Wakalah model, which is an agency arrangement, or secondly, under a hybrid Wakalah-Mudharabah model, which is a hybrid agency profit-share model, under which the operator additionally acts as an investment manager and shares in the investment profits of the fund. This is known as the Mudharabah.

(13:34):
BNM’s Takaful Operational Framework policy document sets out the permissible models and their specific governance requirements. The choice of operating model has direct prudential implications. It determines the structure of the Takaful funds and the flows between them, as well as affecting how the RBC calculations apply, particularly regarding the agency fee as a liability risk charge. It also determines how the Qard Hasan obligation is triggered in a shortfall scenario. Practitioners advising on Takaful Group structures or on the acquisition of Takaful operators must work through these fund flow implications carefully. Malaysia is not only managing major capital reform, it is simultaneously opening its market to a new category of digital operator. Rob, can you tell us about the BNM’s digital insurers and Takaful Operators Framework?

Rob Chaplin (14:18):
Gladly. On the 9th of July 2024, BNM issued its framework for Digital Insurers and Takaful Operators, or DITOs, which came into effect on the 2nd of January 2025. Formal DITO license applications are being accepted from the 2nd of January 2025 through 31st of December 2026. The framework aims to close Malaysia’s significant protection gap. Approximately 90% of the Malaysian population are underinsured, and over 85% of small and medium enterprises have inadequate coverage. DITOs undergo a foundational phase of between three and seven years from commencement of operations. The most significant regulatory flexibility is a lower minimum paid up capital of 30 million Malaysian ringgit, approximately $7.5 million. At entry and throughout the foundational phase, compared with 100 million Malaysian ringgit or approximately $25 million, for established conventional insurers and Takaful operators. At the end of the foundational phase, a DITO must demonstrate to the satisfaction of BNM that it has reached and is maintaining a minimum paid-up capital of 100 million Malaysian ringgit.

(15:37):
The assessment criteria built around three core value propositions. First, inclusion, demonstrating how the business model enhances financial resilience for unserved or underserved consumers.

(15:50):
Second, competition, introducing innovative products for diverse protection needs.

(15:55):
And third, efficiency, delivering a convenient, seamless and cost-efficient consumer experience.

(16:02):
Importantly, BNM has removed its previously indicated cap of five DITO licenses, leaving the market in principle open to all qualifying applicants. BNM requires a seven-year business plan, including an exit plan, and DITOs must be prepared to voluntarily surrender their license and wind up if their business model becomes unsustainable during the foundational phase. Digital Takaful operators licensed as DITOs under the IFSA are also subject to exactly the same Sharia governance obligations as conventional Takaful operators. There’s no relaxation of Sharia compliance requirements during the foundational phase. A DITO applying for a digital Takaful license must have a fully operational internal Sharia committee from the point of licensing with Sharia compliant products and operations from day one.

(16:56):
Fintech and Insuretech applicants seeking to operate in the Takaful space must demonstrate robust Sharia governance infrastructure, including qualified Sharia scholars for the internal Sharia committee and appropriate Sharia audit and risk management functions, alongside their digital and Prudential capabilities.

(17:15):
Let’s now turn to governance and disclosure. What are the key governance and risk management expectations BNM places on licensed insurers and Takaful operators? Caroline?

Caroline Jaffer (17:27):
Thanks, Rob. BNM adopts a risk-based supervision approach calibrating supervisory intensity to each institution’s individual risk profile. The FSA and IFSA contain detailed governance provisions applicable to all licensed persons, including requirements on board composition, senior management suitability, internal control functions and risk management. BNM’s prior written approval is required for the appointment or reelection of the chairman, directors and chief executive officer of any licensed insurer or Takaful operator. The BNM also has the power to remove directors and senior officers where it considers this necessary to protect the soundness of the institution or in the interests of policyholders. The RBC framework requires insurers to establish links between their risk and solvency capital management activities with robust enterprise risk management frameworks proportionate to the size and complexity of the business and dedicated independent control functions. Financial groups are subject to consolidated supervision through the financial holding company, or FHC, framework introduced under the FSA and IFSA.

(18:32):
An FHC holding more than 50% of the shares in a licensed entity must be approved by the BNM and is subject to prudential requirements under the IFSA. Insurers must also submit RBC reports to the BNM on a regular basis, certified by the appointed actuary and chief executive officer, the actuary’s central certification role being a defining feature of the Malaysian reporting framework. The BNM may require more frequent reporting where it considers this appropriate given the institution’s risk profile. Takaful operators are subject to similar requirements. On market conduct, the BNM has introduced policies requiring insurers to publish on their website reasons for changes in premium, following significant medical inflation pressures in the Malaysian market from 2024 onwards. The BNM has mandated that premium increases be staggered over a minimum of three years, and has capped annual health insurance premium increases at 10% for the years 2024 to 2026.

(19:27):
In early 2026, the BNM also announced that it will strengthen regulatory requirements for all medical and health products, alongside the introduction of a standardized base Medical and Health Insurance/Takaful, or MHIT plan. The base MHIT plan offered on a voluntary basis is scheduled for pilot implementation in the second half of 2026, with a full rollout targeted for early 2027, coinciding with the expiry of the BNM’s interim measures on medical insurance repricing. Policyholders facing repricing will have the option to switch seamlessly to the base plan with their current insurer without new medical underwriting.

Rob Chaplin (20:03):
Thanks, Caroline. No discussion of insurance regulation in Malaysia is complete without its offshore dimension. Labuan is a federal territory island off the coast of Sabah and is home to the Labuan International Business and Financial Center, or Labuan IBFC. It operates under an entirely separate regulatory regime from the onshore market supervised by the BNM. Established in 1990, the Labuan IBFC is regulated by the Labuan Financial Services Authority, or Labuan FSA, with a separate statutory mandate to the BNM. The primary legislation here consists of the Labuan Financial Services and Securities Act 2010, and the Labuan Islamic Financial Services and Securities Act 2010. A defining feature is that Labuan insurance businesses transacted in foreign currency and expressly excludes domestic insurance business. Labuan insurers and re-insurers may access certain permitted Malaysian risks, including marine, aviation and transit, subject to regulatory approval and may reinsure Malaysian domestic business. The Labuan IBFC offers a business-friendly, low-tax and inefficient environment for various financial services, including banking, insurance and wealth management.

(21:18):
Caroline, can you tell us how the licensing structure works under the offshore framework?

Caroline Jaffer (21:24):
Certainly, Rob. Licenses include direct insurers and re-insurers, general and life captive insurers, insurance managers, underwriting managers, insurance brokers and Islam equivalents, such as Takaful operators, re-Takaful operators and related intermediaries. The offshore framework continues to allow composite licenses, which enable a single insurer or re-insurer to conduct both life and general insurance business. Takaful and re-Takaful windows, allowing a conventional licensee to offer Islamic products from the same entity are available without a separate license. This is a pragmatic feature distinguishing Labuan from most comparable offshore jurisdictions. The captive market is a particular draw for multinationals with Asia-Pacific risk exposures. Available structures span across single-parent captives, group association and multi-owner captives, renter captives and master renter capitals, and Protected Cell Companies, or PCCs, where legislation ring fences each sell assets and liabilities and which may be used for both conventional and Sharia compliant business.

(22:24):
Minimum paid-up capital requirements vary depending on the type of captive structure. For pure or single captive and group captives or association captives, the minimum is 300,000 Malaysian Ringgit or around $75,000. Whereas renter-captive and PCC structures require a higher minimum of 500,000 Malaysian Ringgit or around $125,000. The solvency margin is calculated at the higher of, one, the required working fund amount, two, 10% of the net premium income for the preceding year. Three, 10% of the provision for outstanding claims for the preceding year for general business, or four, 2.5% of the actual valuation of liabilities for life business. We’ll discuss offshore insurance regulation in Labuan IBFC in more detail in the chapter accompanying this podcast.

Rob Chaplin (23:12):
Caroline, we’ve covered a great deal of ground today. What would you say are the headline takeaways from the Malaysian prudential solvency framework that our listeners should know about?

Caroline Jaffer (23:23):
I would highlight three. Firstly, the dual offshore and onshore framework featuring both conventional and Islamic regulation is unique globally, and requires careful navigation by any insurer or reinsurer entering or operating in Malaysia. The prohibition on composite licenses and minimum capital thresholds are structural constraints that shape group architecture from the outset. (23:43): Second, RBC2 comes into force on the 1st of January 2027 and will substantially order the capital landscape. Operators need to be modeling its impact now and engaging with the QIS2 outcomes when published, with parallel reporting commencing from the first of January of this year.

(24:00):
Thirdly, the DITO framework represents a genuine liberalization opportunity. It’s one of the very few markets globally where digital insurance newcomers can enter with a proportionate capital regime, a 30 million Malaysian ringgit, around $7.5 million, and a clear regulatory pathway to scale. Additionally, one other thing is the Sharia governance requirement under the IFSA is significantly more prescriptive than most international practitioners expect.

(24:24):
The statutory enforcement of Sharia compliance, including criminal liability for noncompliance is a feature with no real parallel in the conventional insurance world. This therefore demands specialist advice for any institution wishing to participate in the Takaful market, whether as a licensed Takaful operator or a re-insurer providing capacity to a Takaful fund, or an investor in a Takaful group.

Rob Chaplin (24:44):
Caroline, that’s really excellent. That brings us to the end of today’s episode on prudential regulation in Malaysia. Thank you to Caroline for joining me for this rich and detailed discussion. Please join us next time, where we continue our global series with another major Asia-specific jurisdiction.

Voiceover (25:01):
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