BYMuhammad Ayub

Takaful – Need and some Shariah related Aspects

Insurance?Sale of an indemnity for a premium: a sale

or transfer of risk for a price, company liable to indemnify;

Exchange of premium payments now for future indemnity in case of specified events. It implies:

Insurance – a commutative contract! Vs. non commutative / one-sided transfers (Tabrru‘ or voluntary contributions)

Relationship between operator and the policy holder;

Risk? Shariah rules on risk!Gharar – absolute uncertainty

Gaps in Islamic Finance

Assets underlying Islamic banking contracts need to be insured (legal requirement) e.g. Car Ijarah, Shipment of Goods etc.

Costumers criticize: Islamic Banking products avoid Riba, assets are insured by Conventional Insurance companies which again is prohibited in Islam.

Also need for Life Insurance e.g. Housing Finance etc. as well as to offer savings and protection related Takaful products to its customers.

Takaful is a prerequisite to complete the cycle of Islamic Finance.

Basic Human Rights?To protect religion (belief)To protect life To protect Mal (wealth)To protect posterityTo protect intellect / talent

Takaful?Takaful – AAOIFI Definition: Collective undertaking by

the participants to donate, not simply an individual donation;

Takaful: A legalistic structure: Two or more parties providing support to each other;

Risk sharing instead of risk transfer;Indemnity? Each participant has an opportunity to be

indemnified form T. Fund (not from outside);Takaful operator: an insurer / indemnity provider?Manager of T. operations for providing protection to

the members of a group in the society: Underwriting: Process of examining, accepting, or rejecting

insurance risks;Operator ’d write under risk; acceptance of risk; from?

Risk calculationClaim processing & paymentsInvestmentsProfit distributorCorporate governance and R management

Takaful? Human beings exposed to possibility of meeting

catastrophes and disasters; Muslims’ belief in Qadha-o-Qadr; but allowed to avoid

such catastrophes and disasters; Conventional Insurance an option; but Involvement of Riba, Maisir (gambling) and Gharar Takaful: social solidarity, cooperation; Every

policyholder pays his subscription in order to assist those of them who need assistance;

Waqf, Mudarabah, Tabarru´ (conditional donation) and mutual sharing of losses.

Conditional gift for a Consideration: Donation to a risk pool subject to the condition that policy holder will get compensation for defined / specified losses from the pool.

Full or partial compensation? Takaful pool can run into a deficit; who to bear it? Operator or participants; Participants: from where?

Main Takaful Rules

Takaful Payments: donation for protection, and Investment saving Parts;

Investment: returns distributed on the basis of Mudaraba or Wakalah;

Protection part: Takaful Fund (for claims) Underwriting Surplus / lossQard –e Hasan by Shareholders in case of

need.Mortality tables and other actuarial

requirements Policyholders :Takaful partnersNo Takaful coverage for Shariah banned

activities / assets.

Takaful RulesThe participants agree to help one another out

of their contributions at the time when any of them faces any catastrophe or incurs any defined loss.

The operator and the partners who take any policy contribute to the Takaful Fund. Claims are paid from the Takaful Fund and the underwriting surplus or deficit is shared by the participants.

In life policies a part of the contribution is also kept as investment fund.

An economic institution whereby the losses of the unfortunate few are shared by the contribution of the fortunate many who are exposed to the same risk on co-operative risk sharing basis.

Deciding Factors

Uncertainty is a factor? Nature of business: Commutative or non-

commutative; relationship between parties:Exchange Contracts: must be free from

uncertainties in the counter values;Premiums – Contributions;Claims;InvestmentsUnderwriting surplus or deficit;Rights and liabilities – in mutual framework.Liquidation of Company: all reserves

pertaining to TF must be spent on charity (AAOIFI, 26: 5/6).

Covering the DeficitsParticipants get indemnity out of the risk pool

collectively owned by all of them;Technically, compensation has no relationship

with the donationParticipants – commitment to pay further

contributions!Shariah issue: is it voluntary donation?Principle of mutuality - members also agree to

pay further contributions if needed.Loan by TO: to be paid out of contributions; Wakalah fee on the part set aside for

repayment of the loan?Provision of loan – rating and capitalization

purposesTrust concept for such Reserve Account –

invoked only in case of deficit of TF.

Shariah BasisAl Nahad or Al Nihad as discussed by Imam

Bukhari (RA)‘Aaqilah’, - an arrangement of mutual help

or indemnification customary; to contribute something until the loss indemnified

Aaqilah in respect of blood moneyIslam accepted principle of reciprocal

compensation and joint responsibility. OIC Fiqh Academy approved Takaful system

in 1985; exact method of operation left to Shariah scholars and practitioners

Risk Mitigation in Shariah“ Tie your camel and then have Tawakkal in

Allah”“To leave your hairs wealthy is better than

to leave them helpless asking people for their needs”

“Love your brothers as you love yourself”“Believers support one-another”Hoarding of wealth is a disliked act;Savings allowed – at least, no Shariah ruling

against it.

AAOIFI’s 9 principles & Shariah BasesClause 5 of Standard on T’meen al Islami (Takaful):Donation of contribution and return thereon to TA for

indemnity; undertaking to bear any deficit;T.O. maintaining 2 separate Accounts;T.O. as agent in managing T Account and as Mudarib /

Agent for investmentsTA is entitled to T assets / should bear liabilitiesSurplus for participants; T.O. not entitled to any share;In case of liquidation, TF reserves must be spent on

charity;Policy holders to participate in management– rep. in BoDAdherence to the Shariah tenets; No coverage for

Shariah banned items and activities;Formulation of S Board- opinion binding on the company;

internal unit for monitoring and audit.

Takaful ProcessThe contribution in Life Takaful is divided into

‘protection part’ (for Takaful Fund / payment of claims) and the saving / investment part in case the Company is working as Mudarib;

if the Company is working on Wakalah basis, contributions would be divided into three parts, i. e. a part as management fee, protection part and the investment part.

The protection part works on donation principle; individual rights are given up in favour of the Waqf.

In the investment part, individual rights remain intact under Mudarabah principle

In case of general Takaful, the whole contribution is considered as donation for protection and the participants relinquish their ownership right in favour of the Takaful Fund

The UWS / UWL belongs to the participants.

Main Takaful ProductsLife insurance – Family Takaful:

Whole Life policies Endowment policies: payable to the insured if he/she is still

living on the maturity date, or to a beneficiary / inheritor otherwise.

Retirement, marriage, education and protection to the general public and the corporate clients

(While whole life policies promise the face value of the policy whenever the insured dies, endowment policies are confined to limited periods).

General / Composite InsuranceMarine, Fire, and Accident (Motor Vehicles, Ships,

Aero planes, etc)

HOW IT IS DIFFERENT FROM INSURANCE

Concept of “Risk Manager” Not “Risk Taker”Mutual help and Equitable Sharing of results;Underwriting Surplus belong to Participants –

Pool is the owner of all surplus – could be distributed back to the participants.

Underwriting Deficit is shared by participants and Takaful Fund members.

Risk Management• Underwriting as usual but not owned by the

operator• Ensure Risk premium adequate – not

commercially driven• Retakaful Pool instead of Reinsurance• Interest free loan by SH (Qard Hasnah)

Investments compatible with Shariah based on Profit Sharing principles.

TAKAFUL IN THE WORLDProfile of Global Takaful Industry The first Takaful company was established in 1979 -

the Islamic Insurance Company of Sudan. Malaysia started in 1984.

Presently 150 Takaful companies in 25+ countries worldwide offering General and Family Takaful with estimates of Takaful contributions at over $ 5 billions globally.

AustraliaBahrainBangladeshBruneiEgyptGhanaIndonesiaIranJordanKuwaitLuxembourgMalaysia

PakistanQatarSaudi ArabiaSenegalSingaporeSri LankaSudanTrinidad & TobagoTunisiaTurkeyUnited Arab EmiratesYemen

MODELS OF TAKAFUL

Following three types of models are available:Mudarabah Model: TO sharing in investment

returns as also UWS (in family Takaful); but can TO share the UWS? – a Shariah issue.

Wakalah Model: Upfront fee for TO based on grass contributions; Performance related bonus from UWS?

Combination of the above two: Wakalah for management and Mudarabah for investment.

Wakalah with Waqf Model – Shariah Scholars Ijmah in Pakistan offered some refinements within the Wakalah Model to address some religious concerns related to the Wakalah model.

Waqf?Three Types: Religious Waqf,

Philanthropic Waqf and the Family Waqf. Retention of a property for the benefit of

a charitable or humanitarian objective, or for a specified group of people such as members of the donor’s family.

A separate entity which has the ability to accepting or transferring the ownership

Waqf property cannot be sold; only the usufruct is assigned to the beneficiaries

A member of a Waqf (donor) can also benefit from the Waqf

PROFIT / LOSSATTRIBUTABLE TO

SHAREHOLDERS

INVESTMENT BY FUND

PROFITS FROM INVESTMENT

DONATIONPAID BY

PARTICIPANT

WAQF FUND

75% TO 70%

WAQF FUND

OPERATIONAL COST OF

TAKAFUL /RETAKAFUL

SHARE OF SURPLUS FOR

THE PARTICIPANT 100%

SURPLUS

COMPANY

PARTICIPANT

60%

SHARE OF PROFIT FOR THE

COMPANY

40%

MANAGEMENTEXPENSES OF

COMPANY

WAQF

INITIAL DONATION BY SHAREHOLDERS TO CREATE WAQF

FUND

TAKAFUL OPERATOR FEES FOR

ADMINISTRATION EXPENSES25% TO 30%

PROFIT SHARING ON MUDARABHA BASES

WAKALAH WITH WAQF MODEL

Issues in Mudarabah Model The relationship: based on Tabarru´ and not

Mudarabah; Profit sharing cannot be applied here. Donation cannot be the Mudarabah capital at the same time.

Sharing in UWS makes the Takaful contract essentially the same as conventional insurance in which the SHs become the risk takers; Mudarabah based Takaful is rather worse because the Takaful operators / SH take only UWS, but not bear UWL, if any.

In non-life Takaful, the paid premiums are not returned: In Mudarabah; has to be returned net of loss.

A Mudarib cannot be a guarantor to the financier; Qard Hasan by SH not commensurate with Mudarabah rules

Difference between Conv. Proprietary Insurance and Takaful

Proprietary Insurance

Transferring risk in return for a premium – gharar, maisir and riba

Subject matter is an indemnity provided by the insurer

Responsibility of policy holders

Pay premium, liability of the insurer

Obligation to pay the claims with insurer

Profit or loss to the operator

Takaful: Company: Manager of

the risk portfolios, not risk bearer

Combination of Tabarrue and mutual sharing of losses between individual policy holders and the pool (T. Fund) on the basis of Wakalah and/ or Mudarabah;

Responsibility: with the T. F.Premium as contribution; US / UD – participants

(practices vary: Some companies also take share in US – do not bear UD (Mudarabah Model)

Difference…………(Contd.)Liability of Insurer: Liable to pay claims from

premiums; if needed from the Shareholders funds

Access to capital: Share capital and debt;

Investment of Funds No restriction except for

prudential reasons

Takaful operator simply acts as a manager / admtr of T. Fund and as a Mudarib for investment part of contributions In L T policies

Cab be legally obliged to ensure solvency of Takaful by giving interest free loan in case of UWL

Loan to be paid back from future contributions

Access to share capital, but not to debt – only interest free loan to the Fund;

Investment: Only in Shariah compliant avenues

Difference…………(Contd.)Life insurance policies:Whole life policiesSaving products:

Endowment policies and pension plans

Only endowment policies – a maturity date, specific benefit in case of death before maturity;

Shariah bases & Opportunities

Find lots of groups and individuals not taking insurance due to religious reasons.

Significant increase in the leasing/Ijara and Home Mortgages

Personal lines insurances: Property and Casualty insurance for an individual as opposed to a business

• Increase in demand due to the need for security.

• More suited for a Takaful operator due to the religious apprehensions related to insurance by individuals.

Islamic Banks need to complete the cycle.

TAKAFUL MARKET AND COMPETITION

Six full fledge banks working on Islamic basis (Meezan, Albaraka, BIP, DIBP, EGIB, Daud Commercial).

Twelve conventional banks’ IB operations. IBBs – 551 branches by end of September, 09.Share of Islamic banking in Banking system:

5.1%Islamic banks: Rs. 313 billion Islamic Banks have a mandated requirement /

moral obligation to insure assets from a Takaful company once available.

This would provide an automatic market for Takaful business.

ChallengesRaising awareness among various

stakeholders; Ulama – the mind maker and the public;

Misconceptions need to be dispelled;HR – E & T; more in-depth understanding of

the system particularly, the Shariah related aspects

Marketing / Distribution– Sale of policies; presently: highly defective and exploitative.

Developing a fair distribution channel;Challenge for Islamic banks

Let’s Discuss Takaful

MeaningModelWakalah fees / Sharing RatioSurplusInvestmentsCovering Underwriting deficitShariah Board.Annual Shariah Audit.

Takaful in BriefTakaful Company must present a competitive product/service

in terms of price, quality of coverage and delivery time.

Competition against the established conventional insurance companies and survival.

Professionalism and avoiding malpractices is critical. Takaful fund belongs to the Participants and NOT to Shareholders.

Consumers need to support Takaful companies as well as to ensure that they are competitive and operations are Shariah compliant in all respects.

Only consumers could ensure that Takaful operators operate in the spirit of mutuality which Takaful is all about.

Thanks