Takaful or Islamic Insurance
Financial Services Professionals serving multicultural markets and clients will encounter Takaful or Islamic Insurance. Takaful originates from Arabic word Kafalah, which means “guaranteeing each other or joint guarantee”. In principle, the Takaful system is based on mutual co-operation, responsibility, assurance, protection and assistance between groups of participants. It is a Shariah compliant alternative to conventional insurance. In the United States and the United Kingdom we use conventional insurance for our population’s personal and commercial wealth protection. The Islamic countries use Takaful. Under Takaful, policyholders agree to jointly indemnify each other against loss or damage, thereby offering crucial protection against risk while at the same time being Shariah compliant. Takaful (Islamic insurance) is set for strong growth as the world populations experience growth in personal wealth and assets. The need to protect this growth in an absolute Shariah compliant manner is why Takaful (Islamic insurance) has become a robust industry.
Conventional Insurance Violates Sharia
All human beings are invariably exposed to the possibility of meeting catastrophes and disasters giving rise to misfortunes and sufferings such as death, loss of limbs, accident, destruction of business or wealth, etc. In countries such as the United States –USA and The United Kingdom –UK insurance is compensation or a promise of compensation for specific potential future losses in exchange for a periodic payment. Insurance is designed to protect the financial well being of an individual, company or other entity in the case of unexpected loss. Agreeing to the terms of an insurance policy creates a contract between the insured and the insurer. In exchange for premium payments from the insured…the insurer agrees to pay the policy holder a sum of money upon the occurrence of a specific event. Muslims all over the world also desire insurance to protect assets and wealth. From the Islamic point of view, conventional insurance violates Sharia.
Sharia
Sharia deals with many aspects of day to day life, including politics, economics, banking, business, contracts, family, sexuality, hygiene, and social issues. Sharia is the body of Islamic law which public and private aspects of life are regulated. This is the code of law based on the Koran sometimes called Qur’an. This is the sacred book of the Muslims. Shariah scholars believe conventional insurance violates Sharia. The Shariah scholars believe that it is unlawful due to involvement of Riba (interest), Maisir (gambling) and Gharar (uncertainty.
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Sharia Principle
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Governs:
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Riba
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Interest
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Masir
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Gambling
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Ghara
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Uncertainty
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Takaful…An Alternative to Conventional Insurance
It is also a generally accepted view that Islamic insurance was first established in the early second century of the Islamic era. This was the time when Muslim Arabs started to expand their trade to India, Malay Archipelago and other countries in Asia. Over the lands as they travel, the Arabs incurred huge losses because of misfortunes or robberies along the way. Based on the Islamic principle of mutual help and cooperation in good and virtuous acts, they got together and mutually agreed to contribute to a fund before they started their long journey. The fund was used to compensate anyone in the group who suffered losses through any mishap. The Europeans copied this concept of indemnity…which was later known as marine insurance. Marine insurance is the oldest type of insurance in the United States and The United Kingdom. Out of it grew non-marine insurance and reinsurance. The modern origins of marine insurance law were in the law merchant, with the establishment in England in 1601 of a specialised chamber of assurance separate from the other Courts.
Takaful Means Guaranteeing
Takaful, means guaranteeing each other. This is the basis of insurance. It represents the concept of insurance based on mutual cooperation of people by participating in a plan driven by takaful design. It is critically important Takaful Insurance companies or agencies company conduct all its affairs in a manner that meets the Islamic Shari’ah Principles whether it is to do with investing its funds, in carrying out its business in all classes of insurance or in any other related financial field. All operations and contracts are set up to ensure that any element of speculation, uncertainty and gambling is eliminated or minimized from them.
Principles Of Takaful Insurance For Policyholders
The principles of Takaful insurance for policyholders are:
- Policyholders cooperate among themselves for their common good.
- Every policyholder pays his subscription to help those that need assistance.
- Uncertainty is eliminated in respect of subscription and compensation.
- It does not derive advantage at the cost of others.
- Losses are divided and liabilities are spreaded according to the community pooling system.
The Tabarru' Concept
The tabarru' concept is incorporated in Takaful contracts to eliminate the “uncertainty” element. A participant shall agree to relinquish as tabarru', certain proportion of his Takaful contributions that he agrees or undertakes to pay. Consequently, enables him to fulfil his obligation of mutual help and joint guarantee should any of his fellow participants suffer a defined loss. The sharing of profit or surplus that may emerge from the operations of takaful, is made only after the obligation of the assisting the fellow participants is fulfilled. The sharing of profit or surplus that may emerge from the operations of takaful, is made only after the obligation of the assisting the fellow participants is fulfilled. It is imperative for a Takaful operator to maintain adequate assets of the defined funds under its care while simultaneously striving prudently to ensure the funds are sufficiently protected against undue over-exposure.
Shariah Compliant Insurance Services are based two main business models i.e.The Mudaraba Model and The Wakala Model.
The Wakala Model
This model is a contract of agency, which replaces surplus sharing with a performance fee. The takaful operator in this case acts as an agent (Wakeel) for participants and manages the takaful/retakaful fund in return for a defined fee.
The Mudaraba Model
This model is essentially a basis for sharing profit and loss between the takaful operator and the policyholders. The takaful operator manages the operation in return for a share of the surplus on underwriting and a share of profit from investment.
Dato' Mohd Fadzli Yusof Chief Executive Officer, Sharikat Takaful, Malaysia, in a Islamic Institute Banking and Insurance article on Takaful stated that “As generally agreed by Shariah scholars , the form of insurance business acceptable to Islam in essence must contain the virtues of cooperation, solidarity and brotherhood. However, these are mere concepts that cannot simply be equated and therefore cannot be applied as a basis of legal principles in a contract. In fact the scholars further agreed that the contract of takaful must be based on certain `tijari' principles that conform to the basic characteristics of Islamic business transaction. Towards this end, the scholars concluded that the contract may be based either on the principles of Al-Mudharabah or Al-Wakalah.
Although basically under both principles, the sharing of profit between participants and operators is an entitlement embedded in the contract, there is however a structural difference in the way such profit (surplus) is determined. The difference lies in the fact that under the principle of Al-Mudharabah, the operator as the mudharib or entrepreneur, cannot charge its management expenses from the takaful fund. Whereas under the Al-Wakalah, the operator being the agent of the participants, can use part of the fund to cover its management costs. Under the Al-Wakalah too, underwriting surplus of the takaful fund, if any, shall be distributed back to the participants only, based on the premise that the funds, actually belong to the participants.
On the contrary, under the Al-Mudharabah principle, the profit as universally defined by conventional insurance companies, which in the case of general business is taken to mean returns on investment plus underwriting surplus, is then shared according to a mutually agreed ratio, such as 50:50, 60:40 or 70:30 between the participants and the operators. Management expenses of the operator including agency remuneration, if any, shall be borne by the shareholders' fund and not from the takaful funds. Hence, there is a distinct separation between takaful funds and shareholders' fund.
Under the Al-Wakalah principle, the paid-up capital is contributed as donation by the shareholders. Therefore, under this principle the shareholders do not expect and probably do not mind for not receiving any returns on the capital donated. However, it is understood this standpoint has changed in view of opinion expressed by certain scholars that the shareholders (operator) in their capacity as managers should also be entitled to share the profit arising from the takaful business.
From the observation on the performance of takaful operators using the Al-Wakalah principle it was found that their returns to the participants have been comparatively low. On average their rate of profit declared to their participants below 10% p.a. On the other hand, it is also understood that there are even operators, especially newly established ones have not been able to declare any profit to its participants.
Under the Al Mudharabah principle, shareholders as owners of the operator have equal opportunity to enjoy a similarly fair return on their capital. The profit portion attributable to the shareholders is transferred to the shareholders' fund and together with returns on investment of the fund itself shall pay for the management expenses. Any balance therefrom is declared as profit of the operator and dividends are distributed therefrom. Adopting the Al-Mudharabah principle for takaful operation as experienced by Takaful Malaysia would ensure that the cardinal principles of 'al-adl' and 'al-ihsan' under Islamic contractual obligations are constantly upheld as both participants and shareholders are enjoying similar benefits.
As both principles are acceptable to Shariah and currently being used by various operators all over the world, serious efforts should be taken to harmonise the practice. By this harmonization, there would be unity in diversity, and equally important would remove the confusion, if any, among the ummah (community) of a common system but with two different modes of practice. It also paves for convenient practical cooperation among these operators. Towards this end, moves towards establishing an accounting standard for takaful operators that at the same time will harmonise the two practices initiated and undertaken by the `Accounting & Auditing Organization For Islamic Financial Institutions (AAOIFI) should be lauded and strongly supported.”
Examples Of Takaful Insurance Products
Investment
- Retirement, Education Plan, Marriage Plan, Term with Return of Capital,Waqf Plan , Ladies Flexible Plan, Executive Plan and Capital Plan.
Risk Only
- Level Term, Keyman, Reducing Term and Increasing Term.
Group
- Group Credit, Group Retirement and Group Term.
Riders
- Total Permanent Disability, Partial Permanent Disability, Premium Waiver on Disability or Death, Accidental Death, Critical Illness, Family Income Benefit, Term Rider and Top-Up Rider.
Motor Takaful - Three types of Takaful Certificates for motor vehicles
- Motor Takaful for Private Car
- Motor Takaful ForPrivate Motorcycle
- Motor Takaful For Commercial Vehicles.
Resources For You
Islamic Finance Training Institutes
- MII (Malaysia) No 5, Jalan Sri Semantan Satu,, 50490 Damansara Heights, Kuala Lumpur, MALAYSIA
Tel: 603 254 4234; Fax: 603 253 9468
- IIBI (UK) 16, Grosvenor Crescent, London, SW1X 7EP, UK
Tel: 44 207 245 0404; Fax: 44 207 245 9769
Endnotes
Islamic Insurance Under the Al Mudharabah principle