Takaful
Islamic Principles
Takaful insurance is based on the principle of Ta'awun or mutual assistance. It provides mutual protection and joint risk sharing in the event of a loss by one of its members. This evolved from the Islamic practice of Aqilah, or blood money. This was practiced by Arab tribes before the advent of Islam and was approved by the Prophet Muhammad (SAW).
Origins
In the event of death caused by someone from another tribe, the members of the offender's tribe would share the 'blood-money' to provide for the family of the victim. Without this sharing, the person inadvertently causing the death would face great hardship in paying the blood money.
Takaful insurance also evolved from Muslim businessmen making long journeys by sea for trade. They would collect money from each merchant and use this to compensate those among them who incurred a loss of ship or merchandise from the journey.
From the Quran
The need for insurance is shown in the following verse of the Quran:
"Those of you who die and leave widows should bequeath for their widows a year's maintenance and residence" (2:240).
Qada' and Qadar
It is a Muslim's belief that everything that happens in this world is by the will of Allah (qada' and qadar). Thus it may be argued that whatever accident, misfortune or catastrophe occurs should be accepted, not eliminated through insurance. Although it is true that we should accept whatever "misfortune" which may occur, we are also taught to avoid or reduce the possibility of these "misfortunes" by taking positive steps.
From the Hadiths
One day the Prophet (SAW) saw a Bedouin leaving a camel and he asked the Bedouin, "why don't you tie down your camel?" The Bedouin answered, "I put my trust in Allah." The Prophet said, "Tie your camel first, then put your trust in Allah." (Al-Tarmizi and Ibn Majah).
This active role in risk reduction is also shown in the Prophet's strong support for the Al-Fudoul Confederacy (just prior to the Islamic period) which was formed to suppress violence and injustice, and vindicating the rights of the weak and the destitute. (Ar-Raheeq Al-Makhtum, Biography of the Noble Prophet, Maktaba Dar-us-Salam Pub., Saudi Arabia 1995).
Ijtihad
Scholars are not in agreement as to whether insurance is permissible (Halal) or prohibited (Haram). Since insurance as it is being practiced now did not exist during the Prophet's time, there is nothing in the Quran or Sunnah directly mentioning it. Ijtihad (reasoning) is therefore used to determine whether it is permissible or not. This also explains why there are variations in the model used for Takaful insurance in various countries as well as within a single country
Risk and pitffall
Acruarrial concept and priciples use in takafuk insurance
Where events repeat themselves often enough, they can be anticipated and consequently managed. For example although death is inevitable, it does not mean that we should not prepare ourselves for this eventuality. Within a group of people, no one can anticipate who would survive from year to year. However, the number of people who would die out of a large enough group can be estimated closely enough (i.e. law of large numbers ). With this estimation, each individual in the group can manage this eventuality by agreeing to pool their resources to help the dependents of its members who die early. This is the concept of Takaful.
Determining Equitability
In conventional insurance the actuary determines the appropriate premium to collect such that the predetermined sum assured can be paid on death. This amount may or may not be sufficient. The difference between the two being the total premium collected and the total death benefit payout (whether positive or negative) is underwritten by the insurance company. In Takaful, the Takaful Operator does not underwrite the difference between the contributions collected and the sum covered. Any difference, called the surplus or deficit, is shared among all participants.
There is therefore, still a role for an actuary in Takaful. For example his role may be to quantify the initial contribution to be collected at the outset. For the same amount covered the contribution from a 30 year old participant will necessarily be lower than for a 70 year old participant. To expect the same contribution irrespective of age of the participant would be unfair to the younger participants.
Quantifying Risk
Thus the actuary uses his skills to quantify the risk brought into the Takaful pool by each Takaful participant. This risk expresses as a contribution rate. Similarly, any surplus or deficit arising after benefits have been paid should be apportioned to the participants based on an actuarial methodology.
Managing Risk
Quantifying risk is only one of the skills an actuary can bring into the organization. Ultimately by understanding how the various aspects of the operation interact with each other the actuary is able to manage risk prudently and effectively.
Capital Requirement Analysis
Management of risk includes how much capital is needed to run the company and what controls should be in place. Indeed, determining the appropriate level of capital and control is the role of the Takaful Regulator. Too much capital requirement and too much control can stifle the development of the Takaful Industry. The Regulator can therefore also use the services of an actuary.
Takaful insurance is based on the principle of Ta'awun or mutual assistance. It provides mutual protection and joint risk sharing in the event of a loss by one of its members. This evolved from the Islamic practice of Aqilah, or blood money. This was practiced by Arab tribes before the advent of Islam and was approved by the Prophet Muhammad (SAW).
Origins
In the event of death caused by someone from another tribe, the members of the offender's tribe would share the 'blood-money' to provide for the family of the victim. Without this sharing, the person inadvertently causing the death would face great hardship in paying the blood money.
Takaful insurance also evolved from Muslim businessmen making long journeys by sea for trade. They would collect money from each merchant and use this to compensate those among them who incurred a loss of ship or merchandise from the journey.
From the Quran
The need for insurance is shown in the following verse of the Quran:
"Those of you who die and leave widows should bequeath for their widows a year's maintenance and residence" (2:240).
Qada' and Qadar
It is a Muslim's belief that everything that happens in this world is by the will of Allah (qada' and qadar). Thus it may be argued that whatever accident, misfortune or catastrophe occurs should be accepted, not eliminated through insurance. Although it is true that we should accept whatever "misfortune" which may occur, we are also taught to avoid or reduce the possibility of these "misfortunes" by taking positive steps.
From the Hadiths
One day the Prophet (SAW) saw a Bedouin leaving a camel and he asked the Bedouin, "why don't you tie down your camel?" The Bedouin answered, "I put my trust in Allah." The Prophet said, "Tie your camel first, then put your trust in Allah." (Al-Tarmizi and Ibn Majah).
This active role in risk reduction is also shown in the Prophet's strong support for the Al-Fudoul Confederacy (just prior to the Islamic period) which was formed to suppress violence and injustice, and vindicating the rights of the weak and the destitute. (Ar-Raheeq Al-Makhtum, Biography of the Noble Prophet, Maktaba Dar-us-Salam Pub., Saudi Arabia 1995).
Ijtihad
Scholars are not in agreement as to whether insurance is permissible (Halal) or prohibited (Haram). Since insurance as it is being practiced now did not exist during the Prophet's time, there is nothing in the Quran or Sunnah directly mentioning it. Ijtihad (reasoning) is therefore used to determine whether it is permissible or not. This also explains why there are variations in the model used for Takaful insurance in various countries as well as within a single country
Risk and pitffall
Acruarrial concept and priciples use in takafuk insurance
Where events repeat themselves often enough, they can be anticipated and consequently managed. For example although death is inevitable, it does not mean that we should not prepare ourselves for this eventuality. Within a group of people, no one can anticipate who would survive from year to year. However, the number of people who would die out of a large enough group can be estimated closely enough (i.e. law of large numbers ). With this estimation, each individual in the group can manage this eventuality by agreeing to pool their resources to help the dependents of its members who die early. This is the concept of Takaful.
Determining Equitability
In conventional insurance the actuary determines the appropriate premium to collect such that the predetermined sum assured can be paid on death. This amount may or may not be sufficient. The difference between the two being the total premium collected and the total death benefit payout (whether positive or negative) is underwritten by the insurance company. In Takaful, the Takaful Operator does not underwrite the difference between the contributions collected and the sum covered. Any difference, called the surplus or deficit, is shared among all participants.
There is therefore, still a role for an actuary in Takaful. For example his role may be to quantify the initial contribution to be collected at the outset. For the same amount covered the contribution from a 30 year old participant will necessarily be lower than for a 70 year old participant. To expect the same contribution irrespective of age of the participant would be unfair to the younger participants.
Quantifying Risk
Thus the actuary uses his skills to quantify the risk brought into the Takaful pool by each Takaful participant. This risk expresses as a contribution rate. Similarly, any surplus or deficit arising after benefits have been paid should be apportioned to the participants based on an actuarial methodology.
Managing Risk
Quantifying risk is only one of the skills an actuary can bring into the organization. Ultimately by understanding how the various aspects of the operation interact with each other the actuary is able to manage risk prudently and effectively.
Capital Requirement Analysis
Management of risk includes how much capital is needed to run the company and what controls should be in place. Indeed, determining the appropriate level of capital and control is the role of the Takaful Regulator. Too much capital requirement and too much control can stifle the development of the Takaful Industry. The Regulator can therefore also use the services of an actuary.
Setting up of Takaful Insurance
Takaful Insurance
Takaful is an Islamic insurance concept which is grounded in Islamic muamalat (banking transactions), observing the rules and regulations of Islamic law. This concept has been practised in various forms for over 1400 years. [1] Muslim jurists acknowledge that the basis of shared responsibility in the system of aquila as practised between Muslims of Mecca and Medina laid the foundation of mutual insurance.
Setting up a Takaful Operation can be both challenging and very rewarding. The amount of work required will depend on whether you are starting with a conventional insurance company or starting fresh. The amount of work will also depend on the insurance rules and regulations in your country.
Develop the Model
The first step will be development of the Takaful model. This model will be used to distribute surplus to the participant (policyholder) as well as to define the treatment of expenses and payments to operators (shareholder). The type of model used would depend on the Shariah council as well as market conditions.
Develop the Products & Projections
Once the model is determined, the various insurance products to be sold will be developed. They will need to be designed to be profitable, competitive and acceptable to the Shariah council. As part of this exercise, detailed projections will be made to determine the expected profitability of the operations. This is best done using an independent actuarial advisor. This advisor must be well versed in the technical, financial, and religious aspects of Takaful insurance in order to give advice on the various options and methods available to you.
Set up the Organisation
If you are starting fresh, you have to set up a company. This includes the technical aspects such as underwriting, claims and marketing and also includes compliance with all applicable regulations as well as the setup of the computer system. This is best done with the help of an existing Takaful company or another insurance company active in your country. Normally this would work on a fee for service basis, in return for reinsurance for your company, or in return for shareholdings in your company.
Get Approval
Setting up of a Takaful company would also require the approval from your board of directors, your shariah council, and the applicable regulators.
Setting up a Takaful Operation can be both challenging and very rewarding. The amount of work required will depend on whether you are starting with a conventional insurance company or starting fresh. The amount of work will also depend on the insurance rules and regulations in your country.
Develop the Model
The first step will be development of the Takaful model. This model will be used to distribute surplus to the participant (policyholder) as well as to define the treatment of expenses and payments to operators (shareholder). The type of model used would depend on the Shariah council as well as market conditions.
Develop the Products & Projections
Once the model is determined, the various insurance products to be sold will be developed. They will need to be designed to be profitable, competitive and acceptable to the Shariah council. As part of this exercise, detailed projections will be made to determine the expected profitability of the operations. This is best done using an independent actuarial advisor. This advisor must be well versed in the technical, financial, and religious aspects of Takaful insurance in order to give advice on the various options and methods available to you.
Set up the Organisation
If you are starting fresh, you have to set up a company. This includes the technical aspects such as underwriting, claims and marketing and also includes compliance with all applicable regulations as well as the setup of the computer system. This is best done with the help of an existing Takaful company or another insurance company active in your country. Normally this would work on a fee for service basis, in return for reinsurance for your company, or in return for shareholdings in your company.
Get Approval
Setting up of a Takaful company would also require the approval from your board of directors, your shariah council, and the applicable regulators.
What are the Crucial Elements that define a Takaful System
At bottom, there are five (5) elements that must co-exist to establish a proper framework for a Takaful system; namely:
1.Ne'aa or utmost sincerity of Intention for knowingly following the guidance and adhering to the rule and purposes of Takaful - cooperative risk sharing and mutual assistance.
2. Integration of Sharia conditions, namely risk sharing under Ta'awuni principles, coincidence of ownership, participation in management by policyholders, avoidance of Riba and prohibited investments, and inclusion of al Mudharaba and/or al Wakalah principles for management practices .
3. Presence of Moral Value and Ethics whereby business is conducted openly in accordance with utmost good faith, honesty, full disclosure, truthfulness and fairness in all dealings.
4. No Unlawful Element, that contravenes Sharia and strict adherence to Islamic rules for commercial contract, namely:
o Parties have legal capacity and are mentally fit
o Insurable interest
o Principle of indemnity prevails
o Payment of premium is consideration (offer and acceptance)
o Mutual consent which includes voluntary purification
o Specific time period of policy and underlying agreement
5.Appointment of Sharia Advisory Council or Committee to oversee the development and Islamic auditing of the takaful operation
The bedrock differences between conventional insurance as currently practiced and Islamic cooperative risk-sharing can be briefly summarized in three points: (A) Takaful is an ethical system with absolute rather than normative values revealed by God (Allah - swt) that are not subject to periodic reinterpretations, (B) Takaful's main drivers are:
o Piety {meaning individual purification};
o Brotherhood {via Ta'awun or mutual assistance};
o Charity {Tabarru or donation};
o Mutual Guarantee; and
o Self-sustaining Operations as opposed to profit maximization.
And (C) Cooperative risk-sharing and profit-sharing prevails throughout in the primary insurance level as well as in any Re-Takaful arrangements, as opposed to using a brokerage fee-based relationship common in re-insurance.
It should be understood that one fundamental motivating factor for Muslims to utilize a Takaful system is to perform acts of piety%u2026 using Tabarru (donation) and Ta'awun (mutual assistance ) to promote community well being as well as achieve individual purification.Additional recent initiatives include: Soar Al-amane, Senegal (1998), Amana Takaful Ltd., Sri Lanka (1999), the Bangladesh Islamic Insurance Co. (1999), plus 3 new Takaful licenses approved in Kuwait (2000), a Takaful Taawuni (Family/Life) program sponsored by Bank Aljazira in Saudi Arabia to be launched in early fall 2001 and at least one license under review in Egypt. Further takaful licenses are being considered in Malaysia .
As more progress occurred and primary Takaful operators aggregated risks on commercial property (General Takaful) and on persons (Life/Family Takaful), there emerged a concomitant need to share these risks with other insurers, commonly called reinsurance. However, Islamic insurance companies are required to reinsure their risks on a Re-Takaful basis. According to the Islamic Banking and Insurance Encyclopedia (IIBI, London 1998) due to the meager reinsurance capacity of Retakful operators, latitude has been granted by Shariah Advisors to cede primary Takaful premiums to conventional re-insurers. Such dispensation is understood to be for a temporary period and lay down the challenge to Takaful and Retakaful operators alike to work towards for a swift resolution of these anomalies.
The evolution of primary Takaful operators has naturally spawned creation of Retakaful entities:
o Sudan (1979) - National Reinsurance
o Sudan (1983) Sheikan Takaful Company
o Bahamas (1983) - Saudi Islamic Takaful and Retakaful Company
o Bahrain/Saudi Arabia (1985) , Islamic Insurance and Reinsurance Company
o Malaysia (1996), ASEAN Takaful Group which evolved into ASEAN Retakaful International (ARIL) in 1997, Labuan
o Tunisia (1985), Beit Ladat Ettamine, Sauodi Takafol, Ltd. (BEST Re)
o Malaysia (1993) - Takaful Nasional, part of the Malaysian National Insurance (MNI) Group.
Collectively, these Retakaful operators write approximately $35 - $75 million of premiums annually. Their staff is estimated to be about 750 and their paid-up capital ranges between $80 - $100 million. A thumbnail sketch of the reinsurance industry may assist us to become more familiar with their traditional counterparts. Global reinsurance premiums in 1998 grew 10% to $76 Billion. Five OECD nations dominate this sector with 77% of worldwide reinsurance:
1. Germany
2.USA
3.Switzerland
4. UK
5. Japan
The reinsurance business overall was profitable in 1988 with Pre-Tax profits of $3.9 Billion {vs. $7.0 Bil. in 1997}. The industry Loss Ratio was 73.6% vs. 71% {1997 was the lowest in 10 years}.
A quotation from the Journal of Commerce, USA(September 19, 1999) is very informative: "At the beginning of the decade (1990) a reinsurer was consider strong if it had capital and /or surplus of $50 Million. Today, capital of 10 times that is considered barely adequate with several companies having many billions." Examples are: Gen RE, $505 Bil; Employers RE,$4.0 Bil; American RE $1.8 Bil. There are massive stock corporations with substantial capital assets and a global reach.
Taking the 15 countries with dominant Muslim populations
Bahrain, Brunei, Egypt, Indonesia, Jordan, Kuwait, Morocco, Pakistan, Qatar, Singapore, Tunisia, Turkey, Saudi Arabia and UAE.
There are today Life and Non-Life insurance premiums written annually of $24.5 Billion (of these 50% is in ASEAN countries). Assuming that over the next ten years, the Insurance Penetration Rates (i.e., Per Capita usage increases - refer to the section following in this paper) and the local market share of Takaful coverage rises to approximately 15% then the Gross Premiums Written could climb to $3.75 Billion. Further, if 33% of this were to be ceded to Retakaful operators, then $1.2 Billion of Retakaful revenues could result as reinsurance business, which would require a capital base of between $600 Million and $1 billion. This compares with the existing (estimated) global capital base for Retakaful companies of less than $100 Million (1999).
How does a Conventional Insurer Make Money?
There are five ways that a traditional risk-sharing/insurance operation makes money and profits:
1.Bearing risk - acceptance of risk exposures on behalf of or alongside policyholders and keeping the result from premium revenues less underwriting losses (claims) less operating expenses (ie. Surplus).
2.Managing a spread - surplus/profit comes from the difference between the cost of funds and the uses to which they can be put.
3. Processing information - processing transactions, administering financial products and programs for a fee.
4.Aggregating money - funds under management long term without acceptance of investment risk, where the magnitude of funds magnifies the management fees and/or the performance fees as a share of positive returns.
5. Distribution - selling financial services at a mark-up or brokerage fee.
Given the above baseline principles, then what are the allowable ways that Takaful Operators can make money? In contrast to the conventional insurers, Takaful operators do not directly Bear Risk (a), which falls uniquely on the Participants (Policyholders ). Takaful Operators charge a fee for their management services on behalf of the Participants and will make profits by (a) managing their expenses within the fee/profit sharing structure and (b) Aggregating Money under management fee and/or performance or profit sharing arrangements.Although we can see in the next section some takaful operators using the Mudharaba model in addition to charging for recovery of management expenses also share in the underwriting results/surplus along with participants in accordance with a profit sharing arrangement .
1.Ne'aa or utmost sincerity of Intention for knowingly following the guidance and adhering to the rule and purposes of Takaful - cooperative risk sharing and mutual assistance.
2. Integration of Sharia conditions, namely risk sharing under Ta'awuni principles, coincidence of ownership, participation in management by policyholders, avoidance of Riba and prohibited investments, and inclusion of al Mudharaba and/or al Wakalah principles for management practices .
3. Presence of Moral Value and Ethics whereby business is conducted openly in accordance with utmost good faith, honesty, full disclosure, truthfulness and fairness in all dealings.
4. No Unlawful Element, that contravenes Sharia and strict adherence to Islamic rules for commercial contract, namely:
o Parties have legal capacity and are mentally fit
o Insurable interest
o Principle of indemnity prevails
o Payment of premium is consideration (offer and acceptance)
o Mutual consent which includes voluntary purification
o Specific time period of policy and underlying agreement
5.Appointment of Sharia Advisory Council or Committee to oversee the development and Islamic auditing of the takaful operation
The bedrock differences between conventional insurance as currently practiced and Islamic cooperative risk-sharing can be briefly summarized in three points: (A) Takaful is an ethical system with absolute rather than normative values revealed by God (Allah - swt) that are not subject to periodic reinterpretations, (B) Takaful's main drivers are:
o Piety {meaning individual purification};
o Brotherhood {via Ta'awun or mutual assistance};
o Charity {Tabarru or donation};
o Mutual Guarantee; and
o Self-sustaining Operations as opposed to profit maximization.
And (C) Cooperative risk-sharing and profit-sharing prevails throughout in the primary insurance level as well as in any Re-Takaful arrangements, as opposed to using a brokerage fee-based relationship common in re-insurance.
It should be understood that one fundamental motivating factor for Muslims to utilize a Takaful system is to perform acts of piety%u2026 using Tabarru (donation) and Ta'awun (mutual assistance ) to promote community well being as well as achieve individual purification.Additional recent initiatives include: Soar Al-amane, Senegal (1998), Amana Takaful Ltd., Sri Lanka (1999), the Bangladesh Islamic Insurance Co. (1999), plus 3 new Takaful licenses approved in Kuwait (2000), a Takaful Taawuni (Family/Life) program sponsored by Bank Aljazira in Saudi Arabia to be launched in early fall 2001 and at least one license under review in Egypt. Further takaful licenses are being considered in Malaysia .
As more progress occurred and primary Takaful operators aggregated risks on commercial property (General Takaful) and on persons (Life/Family Takaful), there emerged a concomitant need to share these risks with other insurers, commonly called reinsurance. However, Islamic insurance companies are required to reinsure their risks on a Re-Takaful basis. According to the Islamic Banking and Insurance Encyclopedia (IIBI, London 1998) due to the meager reinsurance capacity of Retakful operators, latitude has been granted by Shariah Advisors to cede primary Takaful premiums to conventional re-insurers. Such dispensation is understood to be for a temporary period and lay down the challenge to Takaful and Retakaful operators alike to work towards for a swift resolution of these anomalies.
The evolution of primary Takaful operators has naturally spawned creation of Retakaful entities:
o Sudan (1979) - National Reinsurance
o Sudan (1983) Sheikan Takaful Company
o Bahamas (1983) - Saudi Islamic Takaful and Retakaful Company
o Bahrain/Saudi Arabia (1985) , Islamic Insurance and Reinsurance Company
o Malaysia (1996), ASEAN Takaful Group which evolved into ASEAN Retakaful International (ARIL) in 1997, Labuan
o Tunisia (1985), Beit Ladat Ettamine, Sauodi Takafol, Ltd. (BEST Re)
o Malaysia (1993) - Takaful Nasional, part of the Malaysian National Insurance (MNI) Group.
Collectively, these Retakaful operators write approximately $35 - $75 million of premiums annually. Their staff is estimated to be about 750 and their paid-up capital ranges between $80 - $100 million. A thumbnail sketch of the reinsurance industry may assist us to become more familiar with their traditional counterparts. Global reinsurance premiums in 1998 grew 10% to $76 Billion. Five OECD nations dominate this sector with 77% of worldwide reinsurance:
1. Germany
2.USA
3.Switzerland
4. UK
5. Japan
The reinsurance business overall was profitable in 1988 with Pre-Tax profits of $3.9 Billion {vs. $7.0 Bil. in 1997}. The industry Loss Ratio was 73.6% vs. 71% {1997 was the lowest in 10 years}.
A quotation from the Journal of Commerce, USA(September 19, 1999) is very informative: "At the beginning of the decade (1990) a reinsurer was consider strong if it had capital and /or surplus of $50 Million. Today, capital of 10 times that is considered barely adequate with several companies having many billions." Examples are: Gen RE, $505 Bil; Employers RE,$4.0 Bil; American RE $1.8 Bil. There are massive stock corporations with substantial capital assets and a global reach.
Taking the 15 countries with dominant Muslim populations
Bahrain, Brunei, Egypt, Indonesia, Jordan, Kuwait, Morocco, Pakistan, Qatar, Singapore, Tunisia, Turkey, Saudi Arabia and UAE.
There are today Life and Non-Life insurance premiums written annually of $24.5 Billion (of these 50% is in ASEAN countries). Assuming that over the next ten years, the Insurance Penetration Rates (i.e., Per Capita usage increases - refer to the section following in this paper) and the local market share of Takaful coverage rises to approximately 15% then the Gross Premiums Written could climb to $3.75 Billion. Further, if 33% of this were to be ceded to Retakaful operators, then $1.2 Billion of Retakaful revenues could result as reinsurance business, which would require a capital base of between $600 Million and $1 billion. This compares with the existing (estimated) global capital base for Retakaful companies of less than $100 Million (1999).
How does a Conventional Insurer Make Money?
There are five ways that a traditional risk-sharing/insurance operation makes money and profits:
1.Bearing risk - acceptance of risk exposures on behalf of or alongside policyholders and keeping the result from premium revenues less underwriting losses (claims) less operating expenses (ie. Surplus).
2.Managing a spread - surplus/profit comes from the difference between the cost of funds and the uses to which they can be put.
3. Processing information - processing transactions, administering financial products and programs for a fee.
4.Aggregating money - funds under management long term without acceptance of investment risk, where the magnitude of funds magnifies the management fees and/or the performance fees as a share of positive returns.
5. Distribution - selling financial services at a mark-up or brokerage fee.
Given the above baseline principles, then what are the allowable ways that Takaful Operators can make money? In contrast to the conventional insurers, Takaful operators do not directly Bear Risk (a), which falls uniquely on the Participants (Policyholders ). Takaful Operators charge a fee for their management services on behalf of the Participants and will make profits by (a) managing their expenses within the fee/profit sharing structure and (b) Aggregating Money under management fee and/or performance or profit sharing arrangements.Although we can see in the next section some takaful operators using the Mudharaba model in addition to charging for recovery of management expenses also share in the underwriting results/surplus along with participants in accordance with a profit sharing arrangement .
Takaful Market
The beginning
Although Takaful Insurance Companies have been active since the early 1980's, real interest in Takaful has just started to swell, with more and more insurers seeing a need to enter this market. This translate to the potential for increased market share for some, but potential lost in market share for others. Also, experience of some of the earlier companies have shown that with the wrong models and risk management tools, business losses could occur, as well as stagnant sales and lack of critical size to operate effectively.
Takaful operator:
Bank al-Jazeera
Market:
Saudi Arabia
Prospects:
Large untapped market for insurance/savings in compliance with shariah laws.
Requirements:
The operator must be completely shariah compliant in every aspect, while at the same time being able to compete with the international players operating in the region.
Solutions:
The development of a model and products fitting the shariah requirement in Saudi Arabia, while at the same time being competitive with the international players and giving an acceptable profit/risk profile.
1.Development of detailed prospections for submission to the shariah council and regulatory authorities.
2.Assistance in other aspects such as system design and testing, reinsurance, distribution issues, and staffing/outsourcing needs.
Takaful operator:
Bank al-Jazeera
Market:
Saudi Arabia
Prospects:
Large untapped market for insurance/savings in compliance with shariah laws.
Requirements:
The operator must be completely shariah compliant in every aspect, while at the same time being able to compete with the international players operating in the region.
Solutions:
The development of a model and products fitting the shariah requirement in Saudi Arabia, while at the same time being competitive with the international players and giving an acceptable profit/risk profile.
1.Development of detailed prospections for submission to the shariah council and regulatory authorities.
2.Assistance in other aspects such as system design and testing, reinsurance, distribution issues, and staffing/outsourcing needs.
Comparison
It is beyond the scope of this paper to present the features of each model and the Shariah arguments for or against. However, the key structural issues to be examined and understood - especially to fully appreciate differences between conventional insurance and Takaful - are the following items:
1.Sources of Capital and Returns to Capital
2.Organizing principle; i.e. Relationship among participants themselves and between Participants and the Takaful Operator.
3.Treatment of Expenses and Liability for Claims
4.Zakat and Charitable features - how to cleanse profits
5.Funds management - pooled or unitized
6. Investment of Premiums in accordance to Sharia
7.Dissolution - who ends up with any surplus capital
8. Regulations, Taxation and Auditing
A comparison is made below to highlight the salient differences between conventional insurance (excluding mutual companies that share many aspects in common with Takaful companies) and Takaful companies:
Takaful Insurance or insurance for Muslims is designed to adhere to Islamic laws and is based on the principles of fairness and equity among the participants (policyholders). Modern religious scholars have declared that traditional insurance is unacceptable by majority of scholars due to the type of investment traditional insurance companies' use as well as the uncertainty involved in traditional insurance contracts. In Takaful insurance there is no transfer of risk to a third party (i.e. stockholders) but a sharing of risk among participants.
Investments
Takaful insurance companies avoid investing in interest bearing securities as well as investing in unethical and immoral business (such as alcohol manufacturers, gambling casinos). The rewards in an Islamic investment should be profit or fee based. Typical investments include lease and rental instruments, real estate financing contracts, and venture capital funds. These investment types are largely untapped at the present moment.
Contract Uncertainty
Islamic law forbids the use of contracts that contain uncertainty. Thus it is not possible to have an insurance contract as that which exists between a conventional insurance company and a policyholder as that contract contains elements of uncertainty.
For example in a term insurance policy, not only is the timing of the payment of the death benefit not known, but whether any payment will be made (as the policyholder can survive the duration of the policy). However, it is acceptable in Islam to go into arrangements for mutual assistance. Based on this concept, Takaful insurance exists mainly as a cooperative or mutual arrangement.
Inherent Guarantees
From the Islamic perspective, traditional proprietary insurance companies contain elements of gambling in that the profit of shareholders depend on the misfortunes of the policyholders, for example annuities. With Islamic insurance there are joint guarantees among members, with risk sharing and mutual cooperation. The focus is on the community, not shareholders. Reinsurance is needed as in traditional companies, although preferably with the Islamic companies (re-Takaful).
1.Sources of Capital and Returns to Capital
2.Organizing principle; i.e. Relationship among participants themselves and between Participants and the Takaful Operator.
3.Treatment of Expenses and Liability for Claims
4.Zakat and Charitable features - how to cleanse profits
5.Funds management - pooled or unitized
6. Investment of Premiums in accordance to Sharia
7.Dissolution - who ends up with any surplus capital
8. Regulations, Taxation and Auditing
A comparison is made below to highlight the salient differences between conventional insurance (excluding mutual companies that share many aspects in common with Takaful companies) and Takaful companies:
Takaful Insurance or insurance for Muslims is designed to adhere to Islamic laws and is based on the principles of fairness and equity among the participants (policyholders). Modern religious scholars have declared that traditional insurance is unacceptable by majority of scholars due to the type of investment traditional insurance companies' use as well as the uncertainty involved in traditional insurance contracts. In Takaful insurance there is no transfer of risk to a third party (i.e. stockholders) but a sharing of risk among participants.
Investments
Takaful insurance companies avoid investing in interest bearing securities as well as investing in unethical and immoral business (such as alcohol manufacturers, gambling casinos). The rewards in an Islamic investment should be profit or fee based. Typical investments include lease and rental instruments, real estate financing contracts, and venture capital funds. These investment types are largely untapped at the present moment.
Contract Uncertainty
Islamic law forbids the use of contracts that contain uncertainty. Thus it is not possible to have an insurance contract as that which exists between a conventional insurance company and a policyholder as that contract contains elements of uncertainty.
For example in a term insurance policy, not only is the timing of the payment of the death benefit not known, but whether any payment will be made (as the policyholder can survive the duration of the policy). However, it is acceptable in Islam to go into arrangements for mutual assistance. Based on this concept, Takaful insurance exists mainly as a cooperative or mutual arrangement.
Inherent Guarantees
From the Islamic perspective, traditional proprietary insurance companies contain elements of gambling in that the profit of shareholders depend on the misfortunes of the policyholders, for example annuities. With Islamic insurance there are joint guarantees among members, with risk sharing and mutual cooperation. The focus is on the community, not shareholders. Reinsurance is needed as in traditional companies, although preferably with the Islamic companies (re-Takaful).
Principal of Takaful
The principles of Takaful are as follows:
Policyholders co-operate among themselves for their common good.
Every policyholder pays his subscription to help those that need assistance.
Losses are divided and liabilities spread according to the community pooling system.
Uncertainty is eliminated in respect of subscription and compensation.
It does not derive advantage at the cost of others.
Theoretically, Takaful is perceived as cooperative insurance, where members contribute a certain sum of money to a common pool. The purpose of this system is not profits but to uphold the principle of "bear ye one another's burden." Commercial insurance is strictly not allowed for Muslim as agreed upon by most contemporary scholars because it contains the following elements: i) Al-Gharar (Uncertainty) ii) Al-Maisir (Gambling) iii) Riba (Interest)
Every policyholder pays his subscription to help those that need assistance.
Losses are divided and liabilities spread according to the community pooling system.
Uncertainty is eliminated in respect of subscription and compensation.
It does not derive advantage at the cost of others.
Theoretically, Takaful is perceived as cooperative insurance, where members contribute a certain sum of money to a common pool. The purpose of this system is not profits but to uphold the principle of "bear ye one another's burden." Commercial insurance is strictly not allowed for Muslim as agreed upon by most contemporary scholars because it contains the following elements: i) Al-Gharar (Uncertainty) ii) Al-Maisir (Gambling) iii) Riba (Interest)
Takaful Model
There are three (3) models and several variations on how takaful can be implemented.
1. Mudharabah Model
2. Wakalah Model
3. Combination of both
The Mudharabah Model (Profit Sharing)
By this principle, the entrepreneur or al-Mudharib (takaful operator) will accept payment of the takaful installments or takaful contributions (premium) termed as Ra's-ul-Mal from investors or providers of capital or fund (takaful participants) acting as Sahib-ul-Mal. The contract specifies how the profit (surplus) from the operations of takaful managed by the takaful operator is to be shared, in accordance with the principle of al-Mudharabah, between the participants as the providers of capital and the takaful operator as the entrepreneur. The sharing of such profit may be in a ratio 50:50, 60:40, 70:30, etc. as mutually agreed between the contracting parties.
In order to eliminate the element of uncertainty in the takaful contract, the concept of tabarru (to donate, to contribute, to give away) is incorporated. In relation to this a participant shall agree to relinquish as tabarru, certain proportion of his takaful installments or takaful contributions that he agrees or undertakes to pay thus enabling him to fulfill his obligation of mutual help and joint guarantee should any of his fellow participants suffer a defined loss.
In essence, tabarru would enable the participants to perform their deeds in sincerely assisting fellow participants who might suffer a loss or damage due to a catastrophe or disaster. The sharing of profit or surplus that may emerge from the operations of takaful, is made only after the obligation of assisting the fellow participants has been fulfilled. It is imperative, therefore, for a takaful operator to maintain adequate assets of the defined funds under its care whilst simultaneously striving prudently to ensure the funds are sufficiently protected against undue over-exposure. Therefore the provision of insurance cover as a form of business in conformity with Shariah is based on the Islamic principles of al-Takaful and al-Mudharabah.
Al-Hari Rayais the pact among a group of people, called participants, reciprocally guaranteeing each other; while Al-Mudharabah is the commercial profit-sharing contract between the provider or providers of funds for a business venture and the entrepreneur who actually conducts the business. The operation of takaful may thus be envisaged as the profit-sharing business venture between the takaful operator and the individual members of a group of participants who desire to reciprocally guarantee each other against a certain loss or damage that may be inflicted upon As a matter of deep faith, Muslims believe that there is unity in diversity. One expression of this is that no single "best" model exists for Takaful. Shariah scholars worldwide concur on fundamental components that characterize a Takaful scheme, yet in their judicial opinions (fatwas) operational differences are tolerated that do not contradict essential religious tenets.
As such, Takaful Models may be separated into three categories: (A) Non-Profit Model, includes social-governmental owned enterprises and programs operated on a non-profit basis (such as Al Sheikhan Takaful Company - Sudan), which utilize a contribution that is 100% Tabarru (donation) from Participants who willingly give to the less fortunate members of their community. (B) Al Mudharaba Model, whereby cooperative risk-sharing occurs among Participants yet the Takaful Operator shares also in any operating surplus as a reward for its careful underwriting on behalf of Participants. Examples of this Model include Takaful Malaysia (STM - Malaysia), Takaful Nasional (Malaysia) and Takaful International (Bahrain). (C) Al Wakala Model, whereby cooperative risk-sharing occurs among participants with a Takaful Operator earns a fee for services {as a Wakeel or Agent} and does not participate or a share in any underwriting results as these belong to Participants as Surplus or Deficit, under the Al Wakala Model, the operator may also charge a funds management fee and a performance incentive fee (as Bank Aljazira does).
Again it must be stressed that the overriding purpose of the Takaful system is cooperative risk sharing for community well being and not profit maximization. Of course, there exists a realization that for Takaful programs to be spread widely there must be a degree of "commercialization" and marketeering using proven sales and marketing techniques.Moreover the necessity for operators to develop and promulgate Takaful programs to provide Muslims with alternatives to conventional "haram" insurance, demands that these operators be rewarded justly for their efforts proir investments, and business risk exposures. Yet profits perse are not the end goal.
any one of them.
1. Mudharabah Model
2. Wakalah Model
3. Combination of both
The Mudharabah Model (Profit Sharing)
By this principle, the entrepreneur or al-Mudharib (takaful operator) will accept payment of the takaful installments or takaful contributions (premium) termed as Ra's-ul-Mal from investors or providers of capital or fund (takaful participants) acting as Sahib-ul-Mal. The contract specifies how the profit (surplus) from the operations of takaful managed by the takaful operator is to be shared, in accordance with the principle of al-Mudharabah, between the participants as the providers of capital and the takaful operator as the entrepreneur. The sharing of such profit may be in a ratio 50:50, 60:40, 70:30, etc. as mutually agreed between the contracting parties.
In order to eliminate the element of uncertainty in the takaful contract, the concept of tabarru (to donate, to contribute, to give away) is incorporated. In relation to this a participant shall agree to relinquish as tabarru, certain proportion of his takaful installments or takaful contributions that he agrees or undertakes to pay thus enabling him to fulfill his obligation of mutual help and joint guarantee should any of his fellow participants suffer a defined loss.
In essence, tabarru would enable the participants to perform their deeds in sincerely assisting fellow participants who might suffer a loss or damage due to a catastrophe or disaster. The sharing of profit or surplus that may emerge from the operations of takaful, is made only after the obligation of assisting the fellow participants has been fulfilled. It is imperative, therefore, for a takaful operator to maintain adequate assets of the defined funds under its care whilst simultaneously striving prudently to ensure the funds are sufficiently protected against undue over-exposure. Therefore the provision of insurance cover as a form of business in conformity with Shariah is based on the Islamic principles of al-Takaful and al-Mudharabah.
Al-Hari Rayais the pact among a group of people, called participants, reciprocally guaranteeing each other; while Al-Mudharabah is the commercial profit-sharing contract between the provider or providers of funds for a business venture and the entrepreneur who actually conducts the business. The operation of takaful may thus be envisaged as the profit-sharing business venture between the takaful operator and the individual members of a group of participants who desire to reciprocally guarantee each other against a certain loss or damage that may be inflicted upon As a matter of deep faith, Muslims believe that there is unity in diversity. One expression of this is that no single "best" model exists for Takaful. Shariah scholars worldwide concur on fundamental components that characterize a Takaful scheme, yet in their judicial opinions (fatwas) operational differences are tolerated that do not contradict essential religious tenets.
As such, Takaful Models may be separated into three categories: (A) Non-Profit Model, includes social-governmental owned enterprises and programs operated on a non-profit basis (such as Al Sheikhan Takaful Company - Sudan), which utilize a contribution that is 100% Tabarru (donation) from Participants who willingly give to the less fortunate members of their community. (B) Al Mudharaba Model, whereby cooperative risk-sharing occurs among Participants yet the Takaful Operator shares also in any operating surplus as a reward for its careful underwriting on behalf of Participants. Examples of this Model include Takaful Malaysia (STM - Malaysia), Takaful Nasional (Malaysia) and Takaful International (Bahrain). (C) Al Wakala Model, whereby cooperative risk-sharing occurs among participants with a Takaful Operator earns a fee for services {as a Wakeel or Agent} and does not participate or a share in any underwriting results as these belong to Participants as Surplus or Deficit, under the Al Wakala Model, the operator may also charge a funds management fee and a performance incentive fee (as Bank Aljazira does).
Again it must be stressed that the overriding purpose of the Takaful system is cooperative risk sharing for community well being and not profit maximization. Of course, there exists a realization that for Takaful programs to be spread widely there must be a degree of "commercialization" and marketeering using proven sales and marketing techniques.Moreover the necessity for operators to develop and promulgate Takaful programs to provide Muslims with alternatives to conventional "haram" insurance, demands that these operators be rewarded justly for their efforts proir investments, and business risk exposures. Yet profits perse are not the end goal.
any one of them.
Statistic
According to the world Bank Development Report 2000, the earth's human population is approaching 6 billion, of which upwards of 25% are practicing Muslims who adhere to one of the ancient Abrahamic faiths-Islam. Pressures from rapidly expanding air travel, globalization of industry and trade, 24/7 news media and global 'chat" are compounded by instantaneous satellite telecommunications via the worldwide web to forge a collective consciousness that all peoples are part of "global village". Yet paradoxically, these same contemporary pressures are revealing ethic diversity as never before and this revelation serves to empower affinity groups worldwide.
In the burgeoning field of financial services, the fastest growing segment is Islamic Banking - particularly because it seeks to address needs of an underserved affinity group. Individuals and business in +40 countries with Muslim-majority population and another + 15 countries with Muslim-minority communities share a common value system. IslamiQ.com reports that as of June 2001, the global Islamic Banking sector manages USD$200 Billion in ways that conform to Islamic principles (called the Shariah) with a growth rate of 15% annually. While no definitive data exists, it is believed that this represents 10% to 15% of Muslim-owned fungible assets worldwide. Islamic banking and financial products are attractive for Muslims precisely because of their combination of financial efficacy, religious correctness and spiritual rewards. Every Muslim is held accountable for how s/he manages wealth, invests or borrows funds and cleanses profits by giving a portion for any gains annually to charity (Zakat).
In the burgeoning field of financial services, the fastest growing segment is Islamic Banking - particularly because it seeks to address needs of an underserved affinity group. Individuals and business in +40 countries with Muslim-majority population and another + 15 countries with Muslim-minority communities share a common value system. IslamiQ.com reports that as of June 2001, the global Islamic Banking sector manages USD$200 Billion in ways that conform to Islamic principles (called the Shariah) with a growth rate of 15% annually. While no definitive data exists, it is believed that this represents 10% to 15% of Muslim-owned fungible assets worldwide. Islamic banking and financial products are attractive for Muslims precisely because of their combination of financial efficacy, religious correctness and spiritual rewards. Every Muslim is held accountable for how s/he manages wealth, invests or borrows funds and cleanses profits by giving a portion for any gains annually to charity (Zakat).
How Do Muslims Save for the Future
Today's Muslims share similar challenges with non-Muslims as they progress through life phases how to finance education, marriage and the demands of family formation, as well as how to save for retirement or an emergency fund to defray expenses that may arise from prolonged illness, or : tragic misfortune. Such important yet mundane needs are typically addressed by conventional life insurance and associated long-tem savings instruments that commonly contain elements that are not permissible for practicing Muslims. Islamic scholars declared conventional life insururance
1. Fatwa issued in Judicial Conference held in Mekkah in Shaban 1398 AH
2. Unanimous decision by Muslim Scholars in seminar held in Morocco on May 6, 1972
3.Fatwa issued by National Religious Council of Malaysia in 1972
4. Verdict of the Supreme Court of Egypt on Dec.27, 1926
unlawful many decades ago and reconfirmed as such in:
Unanimous resolutions and fatwa by Ulama in the Muslim League Conference in Cairo in 1965. Among the elements that makes life insurance, as presently practiced, prohibited are:
1. Severance of a balanced risk-sharing relationship between policyholders and shareholders.
2.Presence of prohibited elements (a) Al Riba (excess or interest on loans), (b) Al Maisir (wagering, speculation) and (c) Al Gharar (uncertainty), deception and unclear terms) and
3. Investment of premiums by insurers into non-Shariah compliant securities
For several hundred years, Muslims around the world were taught the common idea that insurance programs (especially Life insurance) are prohibited because they violate Islamic principles. The adherence to such misinformation has contributed to retardation in natural growth of Islamic societies by restricting capital formation and the spectrum of available long-term investment and savings vehicles. Even the advent of Islamic Banking in 1972 has accomplished but a blunt impact to redress the popularized views about insurance and risk-taking generally. In fact, some 80% of Islamic banking assets are managed in short-term instruments such as Murabaha (cost-plus financing) and virtually risk-free time deposits. This prevalent aversion to investing funds long-term is partly a result of the Islamic banker's lack of familiarity with acceptable risk hedging mechanisms, including Takaful schemes.
Financing or investing beyond short-term clearly involves risk whereby both the return to capital as well as the return of capital is uncertain. Clearly, one dominant method by which conventional investors choose to hedge risk and/or transfer risk is through the purchase of insurance. What options are open to a practicing Muslim to properly confront such risks and engage in longer-term financial transactions? To address this question fully, we should first revisit the origins of cooperative risk sharing in Islam.
1. Fatwa issued in Judicial Conference held in Mekkah in Shaban 1398 AH
2. Unanimous decision by Muslim Scholars in seminar held in Morocco on May 6, 1972
3.Fatwa issued by National Religious Council of Malaysia in 1972
4. Verdict of the Supreme Court of Egypt on Dec.27, 1926
unlawful many decades ago and reconfirmed as such in:
Unanimous resolutions and fatwa by Ulama in the Muslim League Conference in Cairo in 1965. Among the elements that makes life insurance, as presently practiced, prohibited are:
1. Severance of a balanced risk-sharing relationship between policyholders and shareholders.
2.Presence of prohibited elements (a) Al Riba (excess or interest on loans), (b) Al Maisir (wagering, speculation) and (c) Al Gharar (uncertainty), deception and unclear terms) and
3. Investment of premiums by insurers into non-Shariah compliant securities
For several hundred years, Muslims around the world were taught the common idea that insurance programs (especially Life insurance) are prohibited because they violate Islamic principles. The adherence to such misinformation has contributed to retardation in natural growth of Islamic societies by restricting capital formation and the spectrum of available long-term investment and savings vehicles. Even the advent of Islamic Banking in 1972 has accomplished but a blunt impact to redress the popularized views about insurance and risk-taking generally. In fact, some 80% of Islamic banking assets are managed in short-term instruments such as Murabaha (cost-plus financing) and virtually risk-free time deposits. This prevalent aversion to investing funds long-term is partly a result of the Islamic banker's lack of familiarity with acceptable risk hedging mechanisms, including Takaful schemes.
Financing or investing beyond short-term clearly involves risk whereby both the return to capital as well as the return of capital is uncertain. Clearly, one dominant method by which conventional investors choose to hedge risk and/or transfer risk is through the purchase of insurance. What options are open to a practicing Muslim to properly confront such risks and engage in longer-term financial transactions? To address this question fully, we should first revisit the origins of cooperative risk sharing in Islam.
origins of Takaful
Origins of Takaful : Upon close examination of the primary sources of guidance for Muslims (Holy Quran Sunnah and Hadith), it becomes apparent that members of the first Islamic community 14 centuries ago practiced successful schemes of cooperative risks sharing that originated even before the advent of Takaful. Early precursors were developed in response to perils and risks associated with long-distance trade via caravans or sea voyage and included: hilf (confederation), aqila (pooling of resources), and daman al tarik (surety) that gradually evolved into a system of community self-help and financial assistance, which Prophet Muhammad (PBUH) validated as Takaful. In the early period of community building in Medinah (Hijrah 1 thru 20) there were three instances in which Prophet Muhammad (PBUH) employed an insurance mechanism to solve daily societal issues. In the first constitution in Medinah of 622 BC, there were codified references to social insurance replying upon practices such as al-diyah and al-aqila (wergild or blood-money to rescue an accused in accidental killings), fidyah (ransom of prisoners of war) and cooperative schemes to aid the needy, ill and poor.
Founded upon these and other findings within primary Islamic sources, religious scholars have issued numerous judicial opinions and Fatwas confirming that Takaful as cooperative risk sharing is acceptable for Muslims. For example:
1. Fatwa issued by Higher Council of Saudi arabia in 1397 AH (1976 CE) in favor of Islamic model
2. Fatwa issued by the Fiqh Council of Muslim World League in 1398 AH in favor of Islamic insurance
3. Fatwa issued by the Fiqh Council of the Organization of the Islamic Conference in 1405 AH in favor of insurance under Islamic model
4. The Grand Counsel of Islamic Scholars in Mekkah, Maja Al-Fiqh, approved the Takaful system in 1985 as the correct alternative to conventional insurance in full compliance with Shariah.
5. Takaful Act of 1984 authorized by the Ulama and Government of Malaysia
Founded upon these and other findings within primary Islamic sources, religious scholars have issued numerous judicial opinions and Fatwas confirming that Takaful as cooperative risk sharing is acceptable for Muslims. For example:
1. Fatwa issued by Higher Council of Saudi arabia in 1397 AH (1976 CE) in favor of Islamic model
2. Fatwa issued by the Fiqh Council of Muslim World League in 1398 AH in favor of Islamic insurance
3. Fatwa issued by the Fiqh Council of the Organization of the Islamic Conference in 1405 AH in favor of insurance under Islamic model
4. The Grand Counsel of Islamic Scholars in Mekkah, Maja Al-Fiqh, approved the Takaful system in 1985 as the correct alternative to conventional insurance in full compliance with Shariah.
5. Takaful Act of 1984 authorized by the Ulama and Government of Malaysia
by OCT
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