Introduction to Takaful
Brief introduction and history
The word, Takaful, originates from the Arabic word al-kafala,
meaning “joint benefit” or “shared responsibility”(Kwon,
2007, p. 62).
The principles of compensation and shared responsibilities among the
community is what upholds the concept of Takaful. It is a co-operative system of
reimbursement or repayment in case of loss, organized as an Islamic or Shari’ah
compliant alternative to conventional insurance.
originated within the ancient Arab tribes as a pooled liability that obliged
those who committed offences against members of a different tribe to pay
compensation to the victims or their heirs. This principle later extended to
serve other purposes, including sea trade, in which participants contributed to
a fund to cover anyone in a group who suffered casualties on sea voyages”(Institute
of Islamic Banking and Insurance, n.d.).
Before this, Takaful
was mostly implemented in Islamic-practicing countries such as Saudi Arabia,
Bahrain and Jordan. In fact, Faleel Jamaldeen (2012) stated the first Takaful company
was established in Sudan as The Islamic Insurance Company of Sudan in 1979. The
industry has been growing since and by the end of 2011, Takaful industry
contributes to $12 billion as compared to $4 trillion for the conventional
insurance and global Takaful premium is expected to rise up to $20 billion by
this year (Babu Das Augustine, 2002). One of the latest report shows that this
year the total contribution of the Takaful industry already reached $25 billion
globally (Middle East Insurance Review, 2017). This shows the rising magnitude
of the industry it is today.
For some time conventional insurance was considered to
be incongruous with the Shari’ah that prohibits excessive uncertainty in
dealings and investment in interest-bearing assets, where in this case both are
intrinsic factors in conventional insurance business. However, Takaful
complies with the Shari’ah (which outlines the principles of compensation and
shared responsibilities among the community) and has been approved by Muslim
scholars. There are now general, health and family Takaful plans available for
the Muslim societies.
Basically, there are three main concepts that apply to
conventional insurance which contradict with Islamic teachings and lead to the
introduction of Takaful. In Arabic terms, those are Al-Gharar (uncertainty),
Al- Maysir (gambling) and Riba (interest).
of Gharar, Maysir and Riba
“An insurance contract contains Gharar (uncertainty)
because, when a claim is not made, one party namely the insurance company may
acquire all the profits gained which in this case are premiums collected
whereas the other party or participant may not obtain any profit whatsoever”(Institute of Islamic Banking and Insurance, n.d.).
Further findings from an Islamic scholar, Ibn Taimiyah
reasoned that “Gharar found in the contract exists because one party acquired
profit while the other party did not”. The prohibition on Gharar would
require all investment gains and losses to eventually be apportioned in order
to avoid excessive uncertainty with respect to a return on the policyholder’s
investment (Institute of Islamic Banking and
It can be seen that Maysir (gambling) and Gharar are
inter-related and often comes together as they are closely related to one
another. Where you can find elements of Gharar, elements of Maysir are often
present as well.
“The word Maysir is derived from the
root ‘yasara’, means to become gentle, to draw lots by arrows or ‘yasaar’,
means affluence because Maysir brings about profit or yusr, that is
convenience, ease because it is an earning without toil and exertion or yasr,
means dividing a thing into a number of shares and distributing them among
themselves” (Sultan, 2015, p.
Maysir exists in an insurance contract when the policy holder
contributes a small amount of premium in the hope of gaining a larger sum. This
is somehow quite similar to gambling in a way.
“Gambling is speculative in its risk assessment while
insurance is a pure risk and non-speculative. In gambling, one may win or
lose by creating that risk. In insurance, the risk is already present and one
is trying to minimise the financial effects of that risk. Insurance acts as a
medium that shifts the impact of that risk to someone else and relieves the
person of that risk. The risk nevertheless still remains” (Institute of Islamic Banking and Insurance, n.d.).
Also, the policy holder loses the money paid for the premium
when the event that has been insured for does not occur and on the other side the
company will be in deficit if the claims are higher than the amount of premium
contributed by the policyholders.
Conventional endowment insurance policies promises a
contractually-guaranteed payment, hence it offends the Riba (interest) prohibition.
The element of Riba also exists in the profits made of investments used for the
payment of policyholders’ claims by the conventional insurance companies. This
is because most of the insurance funds are invested by them in the financial
markets such as bonds and stacks which may contain elements of Riba as they
gain surpluses in terms of interest from these investments.
“The prohibition of Riba essentially
implies that the fixing in advance of a positive return on a loan as a reward
for waiting is not permitted by the Shari’ah. It makes no difference whether
the return is big or small, fixed or variable, an absolute amount to be paid in
advance or on maturity, or a gift or service to be received as a condition for
the loan. It also makes no difference whether the loan was taken for
consumption or business purposes” (Sultan, 2015, p. 3).
Principles and Structure of Takaful
essence, Takaful is perceived as cooperative or mutual insurance. Generally,
the members or also called as participants agree to contribute a certain sum of
money to a common pool. This is an alternative instead of paying premiums as in
conventional insurance. The amount they would have to contribute are based on
the type of cover they require and on their personal circumstances such as
their wealth. Also, just as conventional insurance, Takaful policies specifies
the nature of risk and the period it will cover for each participant. The purpose
of this system is not to gain profits, but to share the burden with each other
and uphold the principle of “bear ye one another’s burden”(Wikipedia,
2.1 Principles of Takaful insurance
The principles of Takaful are as
cooperate among themselves for their common good.
contributions are considered as donations to the fund (pool)
policyholder pays his subscription to help those who need assistance.
are divided and liabilities spread according to the community pooling system.
is eliminated concerning subscription and compensation.
does not derive advantage at the cost of others.
(International Cooperative and Mutual
Insurance Federation, 2016)
“The Takaful fund is managed and administered
on behalf of the participants by a Takaful Operator who charges an agreed fee
to cover the costs associated. These costs include the costs of sales and
marketing, underwriting, and claims management” (Institute of Islamic Banking and Insurance, n.d.).
If a claim is made by a participant, the amount needed to cover the
claim are paid out of the Takaful fund. If there are any remaining surpluses,
after making provisions for the likely cost of future claims and other
reserves, they will be given back to the participants in the fund accordingly,
and not the Takaful Operator. It may be distributed to the participants in the
form of cash dividends or distributions, alternatively in the reduction in
future contributions (Institute of Islamic Banking
and Insurance, n.d.).
“This shared responsibility can be viewed as a practice of Tabarru
(“donation” or “contribution”). As discussed later in the
paper, this practice requires the policyholders to agree to contribute a
certain proportion of their premiums, which the insurer, as a facilitator, will
use should any of the participants suffer a defined loss.”(Kwon, 2007, p. 62)
This is one of the main difference of Takaful with
conventional insurance, as conventional insurance distributes the profits to
shareholders which are not necessarily policyholders as well.
As for an Islamic insurance company,
they must have the following operating principles:
must operate according to Islamic co-operative principles.
· Reinsurance commission may be paid to, or
received from, only Islamic insurance and reinsurance companies.
insurance company must maintain two funds: a participants/policyholders’ fund
and a shareholders’ fund.
(Institute of Islamic Banking and Insurance, n.d.)
seen above, the funds in an Islamic insurance company are divided into two
separate groups, the policyholder fund and the shareholders fund.
the policyholders’ fund, the assets of the fund consists of Insurance premium
received, claims received from reinsurers, proportion of the investment profits
attributable to policyholders, salvages and recoveries as well as consultancy
and other receipts. The fund should essentially meet all the claims
that are payable to policyholders, reinsurance costs, technical reserves,
administration expenses excluding the expenses of the investment department. The balance standing to the credit of the policyholders’ fund
at the end of the year represents their surplus. The General Assembly may
allocate the whole or part of the surplus to the policyholders’ special
reserves. If only a part are held in reserves, the balance will be distributed
among the policyholders. However, if there is insufficient funds to meet their
expenses, the deficit is then be funded from the shareholders’ fund. The
shareholders undertake to discharge all the contractual liabilities of the
policyholders’ fund, but this liability does not exceed their equity in the
company (Institute of Islamic Banking
and Insurance, n.d.).
As for the shareholders’ fund, it consists of paid-up
capital and reserves attributable to shareholders, profit on the investment of
capital and shareholders’ reserves, proportion of the investment profit
generated by the investment of the policyholders’ fund (which complies to
Shari’ah laws) and technical and other
reserves as is attributable to them as well as miscellaneous receipts. All the administrative expenses of the investment department
are deducted from the shareholders’ fund and the balance of the shareholders’
surplus, if any, is distributed among the shareholders (Institute of Islamic Banking and Insurance, n.d.).
2.2 Models of Takaful insurance
Nowadays, we can observe that there
are many kind of Takaful models implemented by different countries and
financial institutions. However, they are all mostly based on the two main
model of Takaful insurance which are the Mudharabah model and the Wakalah model.
are various models of Takaful according to the nature of the relationship
between the company and the participants. There are Wakalah (agency), Mudharabah
(profit-sharing) and a combination of the two.” (Institute of Islamic Banking and Insurance, n.d.)
an example, in the Sudanese Takaful model, every policyholder is a shareholder
in it. An Operator runs the business on behalf of the participants and no
separate entity manages the business. Shari’ah experts consider this
preferable. In other Islamic countries though, the legal framework does not
allow this arrangement and Takaful companies work as separate entities on the
basis of mudharabah such as in Malaysia and wakalah as can be seen in the
Middle East.” (Institute of Islamic Banking
and Insurance, n.d.).
operations in the primary insurance market can be broadly classified into one
of the three models: a mudharabah model, a Wakalah model and a hybrid model. With
the mudharabah model, both the policyholder and the insurer share profits from
Takaful operations. With the Wakalah model, there is a complete separation
between the insurer’s capital and the policyholder’s fund and the insurer
receives a fixed fee for managing/investing the fund on the policyholders’ behalf;
that is, all profits from Takaful operations less fixed fees for underwriting
and investment services belong exclusively to policyholders.10 Under the hybrid
plan, the insurer may use a mudharabah model for underwriting activities and a Wakalah
model for investment activities (e.g., Pakistan).”(Kwon, 2007, p. 62).
2.2.1 Mudharabah model
The Mudharabah model shows a kind of relationship in
which one party or in this case the Takaful participants supplies the funds and
the other party or the Takaful operator offers its expertise and management.
Both parties share the profit of the joint venture with a pre-determined ratio
(Pasha & Hussain, 2013, p. 25).
fund is created with the name of General Takaful Fund for the purpose of
investment. Similar to the conventional insurance, a contract details are made
that how the surplus and investment profits are shared between operator and
participants. This model is based on profit-loss sharing between the Takaful
operator and the policy holders. The operator runs all the activities and
operation in return for a share of the surplus on underwriting and a share of
profit from investment.” (Pasha & Hussain,
2013, p. 25).
policyholders receive any available profit on their part of the funds only. The
Shari’ah committee of a Takaful company approves the sharing ratio for each
year in advance, most of the expenses being charged to the shareholders. As an
example, according to the rules in Saudi Arabia, 10% of the surplus from
insurance operations is distributed to the policyholders (Billah & Basodan,
2017, p. 21). This model is practised mainly in the
Asia Pacific region.
“In pure Mudharabah concept, both
the Takaful company and the participant will only share the direct investment
income, in which the participant is entitled to a 100% of the surplus with no
deduction made prior to the distribution.” (Billah & Basodan, 2017, p. 21).
“When using this model,
the insurer probably depends on exclusive agents. Also, the agents are treated
more or less like employees of the insurer because they are compensated by a
package salary, plus their share of the operating profit at the time of
distribution.” (Kwon, 2007, p. 64).
in the pure Mudharabah model, the participants which in this case are the
policyholders lends money to the operator who manages the fund sincerely
without any intention of making any profit or gaining any benefit whatsoever.
Since the participants are also regarded as policyholders, they thus also have
the power of control and management.
“It is very important to
acknowledge that the contribution paid is actually based on the principles of
Tabarru` (ta’awun). A Tabarru` (ta’awun) concept is rather a one-way
transaction in which once the contribution is made, the contributor has no
right to take any benefits out of it. The fund is used for any participant who
faces difficulties within the time period as agreed on insurance policy. When
the participant contributes to the fund, he is indirectly applying the golden
principle of ‘bear ye one another’s burden’.” (Billah & Basodan, 2017, p. 22).
The word Wakalah in
Arabic basically means agency. Therefore for this structure, an agency kind of
relationship will be present between two parties with a certain business
conduct underlying the agreement. For this model, an operator is assigned as
the agent that will manage the participants in a variety of Takaful
products that are provided by the operator. In return for the operator service,
the operator is permitted to charge a certain fee called the Wakalah fee which
is payable from the contribution paid by the participants. In this sense,
management expenditures can be charged to the Takaful fund as upfront charges
and this is also how the operator earns its revenue.
However, there are also operators practising the above model who charged
performance fees on its roles and services of managing the investment of the Takaful
fund (Islamic Banker, 2011). It is also important to understand that under this
model, the operator doesn’t receive any share of the income generated from the
investments of the Takaful fund.
“Al- Wakalah is a contract of
agency. According to this principle, a person (A) will delegate his right or
business to other people (B) to act as his representative. B is known as the
agent or Wakil. The agent is responsible to contribute his/her knowledge,
skills and ability in performing the task assigned because both A and B have a
contractual relationship. In Takaful operation, a Takaful company as the insurer/operator
has the right to employ the agent either on a full-time or part-time basis. The
agent is presenting his/her company in which these selected people have to
promote and develop the products offered by their company as they are bound to
the contract of al-Wakalah.” (Billah & Basodan, 2017, p. 24).
surplus of policyholders’ investments which already netted the management fee
or expenses goes to the policyholders. The shareholders charge the wakalah fee
from contributions and this covers most of the expenses of the business. The
fee is fixed annually in advance in consultation with the company’s Shari’ah
Supervisory Board. The management fee is related to the performance of the
company.” (Institute of Islamic Banking
and Insurance, n.d.)