1 Introduction to Takaful 1.
1 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 thecommunity is what upholds the concept of Takaful. It is a co-operative system ofreimbursement or repayment in case of loss, organized as an Islamic or Shari’ahcompliant alternative to conventional insurance. “Takafuloriginated within the ancient Arab tribes as a pooled liability that obligedthose who committed offences against members of a different tribe to paycompensation to the victims or their heirs. This principle later extended toserve other purposes, including sea trade, in which participants contributed toa fund to cover anyone in a group who suffered casualties on sea voyages”(Instituteof Islamic Banking and Insurance, n.
d.). Before this, Takafulwas mostly implemented in Islamic-practicing countries such as Saudi Arabia,Bahrain and Jordan. In fact, Faleel Jamaldeen (2012) stated the first Takaful companywas established in Sudan as The Islamic Insurance Company of Sudan in 1979. Theindustry has been growing since and by the end of 2011, Takaful industrycontributes to $12 billion as compared to $4 trillion for the conventionalinsurance and global Takaful premium is expected to rise up to $20 billion bythis year (Babu Das Augustine, 2002). One of the latest report shows that thisyear the total contribution of the Takaful industry already reached $25 billionglobally (Middle East Insurance Review, 2017). This shows the rising magnitudeof the industry it is today.
For some time conventional insurance was considered tobe incongruous with the Shari’ah that prohibits excessive uncertainty indealings and investment in interest-bearing assets, where in this case both areintrinsic factors in conventional insurance business. However, Takafulcomplies with the Shari’ah (which outlines the principles of compensation andshared responsibilities among the community) and has been approved by Muslimscholars. There are now general, health and family Takaful plans available forthe Muslim societies.Basically, there are three main concepts that apply toconventional insurance which contradict with Islamic teachings and lead to theintroduction of Takaful. In Arabic terms, those are Al-Gharar (uncertainty),Al- Maysir (gambling) and Riba (interest). 1.
2 Constraintof Gharar, Maysir and Riba1.2.1 Gharar: “An insurance contract contains Gharar (uncertainty)because, when a claim is not made, one party namely the insurance company mayacquire all the profits gained which in this case are premiums collectedwhereas 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 Taimiyahreasoned that “Gharar found in the contract exists because one party acquiredprofit while the other party did not”. The prohibition on Gharar wouldrequire all investment gains and losses to eventually be apportioned in orderto avoid excessive uncertainty with respect to a return on the policyholder’sinvestment (Institute of Islamic Banking andInsurance, n.d.). 1.2.
2 Maysir: It can be seen that Maysir (gambling) and Gharar areinter-related and often comes together as they are closely related to oneanother. Where you can find elements of Gharar, elements of Maysir are oftenpresent as well. “The word Maysir is derived from theroot ‘yasara’, means to become gentle, to draw lots by arrows or ‘yasaar’,means affluence because Maysir brings about profit or yusr, that isconvenience, ease because it is an earning without toil and exertion or yasr,means dividing a thing into a number of shares and distributing them amongthemselves” (Sultan, 2015, p.10). Maysir exists in an insurance contract when the policy holdercontributes a small amount of premium in the hope of gaining a larger sum.
Thisis somehow quite similar to gambling in a way.”Gambling is speculative in its risk assessment whileinsurance is a pure risk and non-speculative. In gambling, one may win orlose by creating that risk. In insurance, the risk is already present and oneis trying to minimise the financial effects of that risk. Insurance acts as amedium that shifts the impact of that risk to someone else and relieves theperson 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 premiumwhen the event that has been insured for does not occur and on the other side thecompany will be in deficit if the claims are higher than the amount of premiumcontributed by the policyholders.1.2.3 Riba: Conventional endowment insurance policies promises acontractually-guaranteed payment, hence it offends the Riba (interest) prohibition.The element of Riba also exists in the profits made of investments used for thepayment of policyholders’ claims by the conventional insurance companies. Thisis because most of the insurance funds are invested by them in the financialmarkets such as bonds and stacks which may contain elements of Riba as theygain surpluses in terms of interest from these investments. “The prohibition of Riba essentiallyimplies that the fixing in advance of a positive return on a loan as a rewardfor waiting is not permitted by the Shari’ah. It makes no difference whetherthe return is big or small, fixed or variable, an absolute amount to be paid inadvance or on maturity, or a gift or service to be received as a condition forthe loan.
It also makes no difference whether the loan was taken forconsumption or business purposes” (Sultan, 2015, p. 3).2 Principles and Structure of Takaful Inessence, Takaful is perceived as cooperative or mutual insurance. Generally,the members or also called as participants agree to contribute a certain sum ofmoney to a common pool. This is an alternative instead of paying premiums as inconventional insurance. The amount they would have to contribute are based onthe type of cover they require and on their personal circumstances such astheir wealth. Also, just as conventional insurance, Takaful policies specifiesthe nature of risk and the period it will cover for each participant. The purposeof this system is not to gain profits, but to share the burden with each otherand uphold the principle of “bear ye one another’s burden”(Wikipedia,retrieved 2017).
2.1 Principles of Takaful insurance The principles of Takaful are asfollows:· Policyholderscooperate among themselves for their common good. · Policyholderscontributions are considered as donations to the fund (pool) · Everypolicyholder pays his subscription to help those who need assistance. · Lossesare divided and liabilities spread according to the community pooling system. · Uncertaintyis eliminated concerning subscription and compensation.
· Itdoes not derive advantage at the cost of others.(International Cooperative and MutualInsurance Federation, 2016)”The Takaful fund is managed and administeredon behalf of the participants by a Takaful Operator who charges an agreed feeto cover the costs associated. These costs include the costs of sales andmarketing, 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 theclaim are paid out of the Takaful fund. If there are any remaining surpluses,after making provisions for the likely cost of future claims and otherreserves, 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 theform of cash dividends or distributions, alternatively in the reduction infuture contributions (Institute of Islamic Bankingand Insurance, n.d.). “This shared responsibility can be viewed as a practice of Tabarru(“donation” or “contribution”). As discussed later in thepaper, this practice requires the policyholders to agree to contribute acertain proportion of their premiums, which the insurer, as a facilitator, willuse should any of the participants suffer a defined loss.”(Kwon, 2007, p.
62) This is one of the main difference of Takaful withconventional insurance, as conventional insurance distributes the profits toshareholders which are not necessarily policyholders as well.As for an Islamic insurance company,they must have the following operating principles:· Itmust operate according to Islamic co-operative principles.· Reinsurance commission may be paid to, orreceived from, only Islamic insurance and reinsurance companies.
· Theinsurance company must maintain two funds: a participants/policyholders’ fundand a shareholders’ fund.(Institute of Islamic Banking and Insurance, n.d.) Asseen above, the funds in an Islamic insurance company are divided into twoseparate groups, the policyholder fund and the shareholders fund. Forthe policyholders’ fund, the assets of the fund consists of Insurance premiumreceived, claims received from reinsurers, proportion of the investment profitsattributable to policyholders, salvages and recoveries as well as consultancyand other receipts. The fund should essentially meet all the claimsthat 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’ fundat the end of the year represents their surplus. The General Assembly mayallocate the whole or part of the surplus to the policyholders’ specialreserves.
If only a part are held in reserves, the balance will be distributedamong the policyholders. However, if there is insufficient funds to meet theirexpenses, the deficit is then be funded from the shareholders’ fund. Theshareholders undertake to discharge all the contractual liabilities of thepolicyholders’ fund, but this liability does not exceed their equity in thecompany (Institute of Islamic Bankingand Insurance, n.d.).As for the shareholders’ fund, it consists of paid-upcapital and reserves attributable to shareholders, profit on the investment ofcapital and shareholders’ reserves, proportion of the investment profitgenerated by the investment of the policyholders’ fund (which complies toShari’ah laws) and technical and otherreserves as is attributable to them as well as miscellaneous receipts. All the administrative expenses of the investment departmentare 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 thereare many kind of Takaful models implemented by different countries andfinancial institutions. However, they are all mostly based on the two mainmodel of Takaful insurance which are the Mudharabah model and the Wakalah model.”Thereare various models of Takaful according to the nature of the relationshipbetween 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.) “Foran example, in the Sudanese Takaful model, every policyholder is a shareholderin it. An Operator runs the business on behalf of the participants and noseparate entity manages the business. Shari’ah experts consider thispreferable. In other Islamic countries though, the legal framework does notallow this arrangement and Takaful companies work as separate entities on thebasis of mudharabah such as in Malaysia and wakalah as can be seen in theMiddle East.” (Institute of Islamic Bankingand Insurance, n.d.
).”Takafuloperations in the primary insurance market can be broadly classified into oneof the three models: a mudharabah model, a Wakalah model and a hybrid model. Withthe mudharabah model, both the policyholder and the insurer share profits fromTakaful operations. With the Wakalah model, there is a complete separationbetween the insurer’s capital and the policyholder’s fund and the insurerreceives a fixed fee for managing/investing the fund on the policyholders’ behalf;that is, all profits from Takaful operations less fixed fees for underwritingand investment services belong exclusively to policyholders.10 Under the hybridplan, the insurer may use a mudharabah model for underwriting activities and a Wakalahmodel for investment activities (e.g., Pakistan).”(Kwon, 2007, p.
62).2.2.1 Mudharabah modelThe Mudharabah model shows a kind of relationship inwhich one party or in this case the Takaful participants supplies the funds andthe 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).”A separatefund is created with the name of General Takaful Fund for the purpose ofinvestment. Similar to the conventional insurance, a contract details are madethat how the surplus and investment profits are shared between operator andparticipants. This model is based on profit-loss sharing between the Takafuloperator and the policy holders. The operator runs all the activities andoperation in return for a share of the surplus on underwriting and a share ofprofit from investment.” (Pasha & Hussain,2013, p.
25).Thepolicyholders receive any available profit on their part of the funds only. TheShari’ah committee of a Takaful company approves the sharing ratio for eachyear in advance, most of the expenses being charged to the shareholders. As anexample, according to the rules in Saudi Arabia, 10% of the surplus frominsurance operations is distributed to the policyholders (Billah & Basodan,2017, p.
21). This model is practised mainly in theAsia Pacific region.”In pure Mudharabah concept, boththe Takaful company and the participant will only share the direct investmentincome, in which the participant is entitled to a 100% of the surplus with nodeduction 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 treatedmore or less like employees of the insurer because they are compensated by apackage salary, plus their share of the operating profit at the time ofdistribution.” (Kwon, 2007, p.
64).Basically,in the pure Mudharabah model, the participants which in this case are thepolicyholders lends money to the operator who manages the fund sincerelywithout any intention of making any profit or gaining any benefit whatsoever.Since the participants are also regarded as policyholders, they thus also havethe power of control and management.
“It is very important toacknowledge that the contribution paid is actually based on the principles ofTabarru` (ta’awun). A Tabarru` (ta’awun) concept is rather a one-waytransaction in which once the contribution is made, the contributor has noright to take any benefits out of it. The fund is used for any participant whofaces difficulties within the time period as agreed on insurance policy.
Whenthe participant contributes to the fund, he is indirectly applying the goldenprinciple of ‘bear ye one another’s burden’.” (Billah & Basodan, 2017, p. 22).2.2.2 Wakalahmodel The word Wakalah inArabic basically means agency. Therefore for this structure, an agency kind ofrelationship will be present between two parties with a certain businessconduct underlying the agreement. For this model, an operator is assigned asthe agent that will manage the participants in a variety of Takafulproducts 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 whichis payable from the contribution paid by the participants. In this sense,management expenditures can be charged to the Takaful fund as upfront chargesand this is also how the operator earns its revenue.However, there are also operators practising the above model who chargedperformance fees on its roles and services of managing the investment of the Takafulfund (Islamic Banker, 2011). It is also important to understand that under thismodel, the operator doesn’t receive any share of the income generated from theinvestments of the Takaful fund. “Al- Wakalah is a contract ofagency. According to this principle, a person (A) will delegate his right orbusiness to other people (B) to act as his representative. B is known as theagent 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 acontractual relationship.
In Takaful operation, a Takaful company as the insurer/operatorhas the right to employ the agent either on a full-time or part-time basis. Theagent is presenting his/her company in which these selected people have topromote and develop the products offered by their company as they are bound tothe contract of al-Wakalah.” (Billah & Basodan, 2017, p. 24).”Thesurplus of policyholders’ investments which already netted the management feeor expenses goes to the policyholders. The shareholders charge the wakalah feefrom contributions and this covers most of the expenses of the business.
Thefee is fixed annually in advance in consultation with the company’s Shari’ahSupervisory Board. The management fee is related to the performance of thecompany.” (Institute of Islamic Bankingand Insurance, n.d.)