By : Atiquzzafar Khan
Insurance is the most important sector in present day modern economies after banking. In fact, banking and insurance go Hand-in-Hank and greatly complement and support each other’s operations. Almost all large scale business activities are bound to arrange insurance cover in one way or the other. Insurance business is an important contemporary issue which has attracted so many debates and discussions. Muslim scholars have been writing on this issue since the introduction of this business in the Muslim societies. In sixties and seventies the issue of insurance business came on the agenda of many conferences and seminars and consensus was emerged after long discussions that although the concept of insurance is not contradictory to Islamic principles but its present practice involves some elements such as interest, Gharar, Unlawful appropriation of others’ property etc. which are forbidden in Islam. Cooperative insurance has been suggested as an alternate to the present commercial insurance. Some scholars presented the concept of Takaful as an alternative scheme for running the insurance business in private sector. Involvement of Mudarabah and Tabarru’ (gift) in this scheme removes the objectionable elements from the business. On these lines many Islamic insurance (Takaful) companies were established in eighties and nineties in various Muslim countries and performing their business successfully.
The objective of this paper is to give an introduction of Islamic insurance (Takaful) business by mentioning its objectives, principles and operational mechanism. The arrangement of the paper is follows: The second section of the paper provides a brief introduction of contemporary insurance. Section three analysis the major points for and against commercial insurance to determine its Shariah position. Section four lists the basic Shari’ah principles of business in general and insurance business in particular and gives a brief introduction of Takaful scheme. The final section describes the operational mechanism of Takaful business in the light of Takaful experience of Malaysia.
Contemporary Insurance: Nature, History and Management
2.1. Introduction of Conventional Insurance and its Mechanism:
All human activities are subject to risk, which may lad to financial or physical losses to him. Insurance is a device to covers the loss arise due to occurrence of some undesired event. There are many possible ways of handing the risk. We can briefly mention some important ones as follows:
1. Risk Avoidance 4. Risk Transfer
2. Risk Retention 5. Risk Sharing
3. Risk Reduction
The last two methods provide the possibility of insurance business and naturally the third method is also used by insurance companies through instructing the policy holders to adopt suitable safety measures for reducing the risk.
Insurance is a complicated and intricate mechanism, and it is consequently difficult to define. However, in its simplest, it has two fundamental characteristics.
Transferring or shifting risk from one individual to a group.
Sharing losses by all members of the group on some equitable basis.
The term insurance, in its real sense, is community pooling to alleviate the burden of the individual, lest is should be ruinous to him. More precisely it can be defined as, “The simplest and most general conception of insurance is a provision made by a group of persona, each singly in danger of some loss, the incidence of which cannot be foreseen, that when such loss shall occur to any of them it shall be distributed over the whole group.”1
Insurance has a very long history. There is evidence of many practices resembling insurance in the ancient world. As early as 3000 B,C. Chinese merchants utilized the technique of sharing risk..2 The practices similar to insurance were in vogue in pre-Islamic Arab Society. 3 Some of the known practices were A’qila, Qasama Mawalat, and Willa’. The institutions were allowed to work in Islam due to there usefulness and some other institutions of the similar nature were established under Islamic state. Although these were insurance of sort, the modern insurance business did not begin until the commercial revolution in Europe. Marine insurance appears to have been started in Italy sometime during the thirteenth century. 4 Fire insurance in the modern era can be traced to Germany, where a fire association known as the Feuer Casse was organized in 1591. In 16666 the great fire of London broke out and an English Physician named Nicholas Barbon formed a stock company in 1680 with several associates called “The first life insurance policy was issued on June 18, 1536 by a group of underwriters in London.
Objectives of Insurance Business
The major objectives of insurance business, as gi en in the printed material of insurance, are the following:
Provision for the necessities of life of heirs as a result of sudden death of head of the family.
Security from economic loss in case of some accident such as fire, burglary etc.
Provision beforehand for the payment of any unforeseen financial liability or penalty.
Provision for inevitable needs of the future like after retirement, Provision beforehand for children’s education or marriages.
Increase in capital.
Provision against unforeseen business loss due to sudden fluctuations in money market, international market, or stock market etc.
Insurance business is broadly classified into two groups: Life insurance and General insurance. The latter has three main branches Marine, Fire, and Accident. The last mentioned type includes insurance of Motor Vehicles and Aero plane etc. Life insurance is also broadly classified as Whole Life policies and Endowment policies. Annuities come in the later group. Annuity in periodic payment to commence at a stated or contingent date and to be continued to be paid, to a designated persons(s), for a fixed period or for the life or lives of the person or persons entitled to receive payment
Classification of Insurance Business
The pricing of insurance policies is same as pricing policies for other commodities. In either case the seller must charge enough to cover all his costs and give some reasonable profit. But beyond this basic similarity there are some major differences. Two of them are particularly important: First, when an insurer sells a policy it has no way of knowing what its costs for that particular policy will be. It cannot just add up the cost of labor, rent, and so forth. Instead, the insurer must estimate the cost, basing its estimate upon what it has cost to provide similar policies in the past. The second difference is that the cost to the seller depends partly on who the buyer is. The insurer’s cost depends largely upon whether or not the policy buyer has losses and, it so, how many and how large they are. Of course, this is the reason that different people are charged different prices for policies providing the same kind and amounts of insurance. It is among the statutory requirements that the insurance rates must “discriminate fairly”, which means that proper distinctions should be made among various insured’s. Those who are alike should be charged the same rate; those who are different should be charged different rates.
There are three basic elements that premium must cover. The first component, the amount needed to pay policyholders’ losses, is the pure premium. The second part of the premium pays for the operating expenses of insurance company. These include the sales commission and other marketing costs, administrative costs, taxes, and the cost of handling claims. The third part of the premium is classed the margin, which includes an allowance for (a) contingencies, and (b) underwriting gain or profit.
Premiums, Rates, and Exposure Units:
As we know, insurance price is called premium; premiums are based on rates; and rates are prices per unit of exposure. As total price for any commodity is determined by multiplying the price per unit times the number of units of that commodity, the premium in case of insurance policy is the rates times the number of exposure units.
Pure Premium = rates * exposure units
Where exposure units
are the quantitative units used in insurance pricing. As gallons are the quantitative units in gasoline pricing, the quantitative units in automobile insurance are cars; the rates apply on a per car basis. In life insurance, for instance, the rates apply per $1,000 of insurance, and in workers’ compensation the rates apply per $100 of payroll.5
The final premium that the insured pays is called the gross premium or gross rate. For converting the pure premium into a gross rate requires addition of the loading, which is intended to cover the expenses of operation. The final gross rate is derived by dividing the pure premium by a permissible loss ratio, defined as t he percentage of the premium that will be available to pay losses after provision of expenses. It is equal to (1 – Expense ratio). Thus gross rate is defined as,
Gross Rate = Pure Premium /(1 – Expense ratio) 6
Arguments For and Against Insurance
Muslim scholars are writing on the issue of insurance and their opinion is sharply divided on the issue. Generally these views of the Muslim scholars could be classified into three groups:
Both the concept and the practice of insurance is contradictory to Islamic principles. According to them insurance involves Riba gambling and uncertainty, and is opposed to the concept of predestination (Taqdeer).This view is held by Dr. Hussain Hamid Hussan7 , Mufti Wali Hasan8 , Sheikh Abu Zahra9 and many other Shari’ah scholars.
Other group while appreciating the philosophy and rationale of insurance disapprove most of the forms of insurance contracts undertaken by commercial insurance companies. They see in them elements of risk, uncertainty, ignorance, usury which are inalienably associated with contemporary insurance. Among the prominent scholars of this group are Muft Muhammad Shafi10, Maulana Maudui11, Sheikh Ahmad Ibrahim12, Mustafa Zaid713, Sheikh Mohammad Bakheet14,, Issa Abduho15, Ahmad Fahmi16, Dr. Muslehuddin17, Dr. Mustafa Sayyad18 and many other distinguished scholars.
Third group of Muslim scholars maintains that insurance is permissible since it is based upon the principles of mutual assistance an reciprocal responsibility which Islam wants to promote among the Muslims. Further, the uncertainty involved in insurance is not of a sufficiently high degree to warrant its prohibition. This viewpoint is held by Mustafa Zarqa19, Sheikh Ali al Khafif20, Dr. Yousuf Musa21, Muhammad Ali Bahi22, Dr. Nijatullah Siddiqui23, Ahmad Taha Al-Sannusi24. Gharib Jamal25, and some other scholars.
In this section we ill briefly present the major arguments of both the proponents and the opponents of existing insurance in some detail and evaluate them in the light of Shari’ah
3.1. Arguments of opponents
Shari’ah scholars have raised many objections in contemporary insurance business. Some major objections are as follows:
3.1.1. Elements of Gharar (Uncertainty)
According to various Ahadith of the Prophet (SAW) any sale involving Gharar is prohibited whereas the insurance contract involves an element of Gharar of a high degree. The attribute of Gharar exists in insurance in four kinds.
Gharar in existence:
The existence of the amount of compensation is doubtful since it is paid only at the occurrence of the event which is uncertain.
Gharar of quantum:
The insured does not know at the time of the contract how much compensation he will get in case of any damage to his property.
Gharar with regard to time of payment:
It suggests that the time of payment of compensation in case of insurance is unknown and uncertain.
3.1.2. Element of Gambling
: In the contracts of insurance the insured loses his premium if the event does not happen, and in the other situation the company pays his several time more than what he has paid as premium. This clearly amounts to gambling as one party loses by more chance and the other gains undeservedly.
3.1.3. Element of Interest:
The opponents argue that the element interest is found in insurance in two ways. The first is that insurance companies invest the collected amounts in interest-oriented government securities and businesses for earning purposes. The second is the difference between what company receives from the policy holders and what it pays back as compensation as contractual objection comes under the definition of Riba.
3.1.4 Unlawful Appropriation of Other’s Properties
Islam enjoins upon believers not to devour other people’s properties wrongfully. 25 In most contracts of insurance the insured does not get anything from the company because the event never occurs during the period of contract. The premium money is thus wasted without any material benefit. All the money on account of premium goes to the company without any effect on its part..
3.2. Arguments of the Proponent
We also find scholars who consider contemporary insurance desirable from Islamic point of view and they don’t see any major problem into this business. There arguments are briefly stated below.
3.2.1 Principle of Mutual Assistance
Insurance encourages and promotes mutual assistance and reciprocal responsibility which are an indispensable part of the teachings and value system of Islam. 26
3.2.2. Non Resemblance with Gambling
The advocates of insurance deny the presence of gambling in insurance. They distinguish between the risk taken by the gambler and the risk in insurance which is a necessary part of living. The gambler takes up a risk voluntarily. The hope for gain is the only motivation of the taking of risk in his case. This risk contained in insurance, on the other hand, is indispensable and a useful social process conducive to productivity. 27 The objective of the insured person behind insurance is not to gain the amount of compensation. He does not intend the event to happen. His interest lies in the incident not taking place. He contracts only for peace of mind derived from the knowledge that whenever a catastrophe takes place, he will be indemnified. Gambling upsets the normal system based on work and reward and is inimical to equitable distribution of income and wealth, whereas insurance protects the disruption of the system by accidents and events beyond human control.28
3.2.3. Low degree of Gharar:
Insurance does not contain a high degree of Gharar. An insurance company can predict the chance of actual occurrence. The law of large number helps the company to calculate the number of likely happenings with some accuracy. This law points to the fact that some quantities which are uncertain and changing in individual cases, being different for each one, are certain and remain constant for a large group of similar persons. There, the element of Gharar is negligible in the contracts of insurance.
3.2.4. Analogy between Insuracne and the Institution of A’qila:
It is argued by the supporters of insurance that insurance resembles the institution of A’qila of early Islam. A’qila is an adult and sane male clan of an offender or convict from whom he receives help to pay blood money in culpable homicide.29
3.2.5. Insurance and Suretyship of Unknown Thing or Event:
It is allowed for a person in Shari’ah to be surety for an unknown and unspecified thing30. In insurance each policy holder becomes a surety for the other for an uncertain happening. The company also assumes the role of surety and compensates the loss incurred by a policy holder by way of being a surety.
3.3. Evaluation of the Argumetns:
If we examine the arguments of both the groups, we reach the conclusion that the insurance business as it is practiced today b the insurance companies, contains elements of uncertainty, deceit, usury and many other objectionable features. It contains Gharar of the highest degree. The elements of gambling and interest are also present in the contracts of insurance. The claim of the proponents that the element of uncertainty is negligible since the company has the ability to predict for event with some accuracy does not carry much weight. The event may be certain for the company but it remains quite uncertain for the policy holder. It is also a fact that a large amount of collected money by the company is invested in interest bearing assets. It does not resemble “Aqila of the early ages of Islam, since the purpose of the institution is to help and assist a person and share his burden by way of assistance, sympathy, benevolence, whereas the objective of insurance company is to earn profit. It is also not analogous to kafala contract because kafala is a contract of Tabarru’ and mutual assistance and not a contract to gain money.
As regards the concept and philosophy of insurance there seems to bean agreement of opinion among Muslim jurists, which emerged after many conferences and discussions at various forums, that the concept and objectives of insurance business in no way opposed to the injunctions and value system of Islam since it promotes mutual help, assistance, and cooperation. We can trace from the practice of the Prophet (SAW) and the companions (RAA) that all the needs mentioned in previous section under objectives of insurance, were recognized by Shari’ah.31 There is no doubt about the utility of the institution for society. The only thing required to be done is that the business of insurance should be brought in conformity with the tenets of Shari’ah. The elements of uncertainty, ignorance, gambling, and usury inherent in the business of insurance, need to be removed. The best method to run this business, as suggested by a large number of scholars, is to run this business on the basis of mutual suretyship and reciprocal responsibility. Islamic models of investment such as Musharaka and Mudharaba should be observed while investing the money collected by the company. Mutual insurance has been commonly suggested as a substitute for commercial insurance.32
Section 4: Islamic Guiding Principles4.1. General Principles governing Financial Contracts
Before discussing the Islamic model of insurance it will be quite appropriate to first mention the fundamental Islamic principles governing contracts in general. These principles are as follows:
1. The subject matter of the contract should not be unlawful in Islam.
2. The intended objectives of the contract should not be contradictory to the will of
the law- giver.
3. The contract should be free from the following elements,
i) Qimar (Gambling),
ii). Gharar (Aleatory),
Hi). Ghaban-al-Fahish (Grave Deception), and
iv). Ikrah (Coercion)
4.2. Principles Governing the Islamic Insurance Businessi). It should be based on Mutual Guarantee and Co-operation.
The objectives for which the institution of insurance initially started were very noble. The philosophy underlying insurance was that the consequences of an unhappy event will be shared by a large number of people and will not be left for a single individual to bear. It goes without saying that mutual guarantee and solidarity are integral parts of the value system of Islam.
The present state of this institution is that it does not contain any attribute of mutual co-operation, and guarantee. It is now a business through which a small group of capitalists attempts to attract the wealth of the society to use it for its own benefit and to shift the losses to others. Mufti Muhammad Shaft highlights this situation in the following words:
The prevalent insurance system cannot be described as a cooperative one. It is a misleading device to let the nation face the ill effects of interest-based insurance and speculation. If we analyze this system it will be established that insurance and speculation are in fact the supplements of the same interest- based business by means of which we try to feather our own nest without caring for the profit and loss of the entire nation. It is also used as a means of diverting one’s impending liabilities towards others through the cleaver use of the pharases of “national solidarity” and “cooperatives.^ Therefore, it is suggested that the Islamic insurance should be established on mutual or cooperative bases and preferably run by the government for keeping the spirit of solidarity and cooperation alive. Even if it is in the private sector, help should be provided from a common pool (a Trust fund), meant for this purpose and not for earning profits. The company can earn profits by investing the amount given in investment account
ii) Islamic Modes of Investment should be adopted.
At present many types of investments are being employed in the insurance business without any distinction between the lawful modes and forbidden ones. Most of them contain the element of Riba which is strictly prohibited in Islam. Some of these are founded on gambling and Gharar. Quite apparently all these three elements are unlawful according to Shari’ah. As such, any business or forms of investment which contains any one of these, will be unlawful in Islamic Shari’ah.
An Islamic insurance company is supposes to invest the funds in Islamically approved investments, such as stocks of companies, real estate, and participatory financing (Musharakah, Maudarabah).
Section 5: Islamic Alternative to insurance business:
Muslim Jurists have devoted much time and energy in their efforts to find an Islamic alternative to the existing insurance business. They have discussed the issue in a number of conferences. After extensive deliberations they have reached the conclusion that cooperative insurance provides the Islamic substitute for the prevalent unlawful insurance practices because profits are shared by the policy holders themselves. But this suggestion waslittle restrictive as it did not allowed the private sector to perform any role. Some Muslim scholars offered the scheme of Takaful, based on the elements of Tabarru1 and Mudharabah as the basis for a lawful insurance business35. The word Takaful1 means joint guarantee. The objective of Takaful is cooperation and mutual help among the members of a defined group. In a practical sense Takaful can be visualized as a method of joint guarantee among a group of members or participants against loss or damage that may inflict upon any of them. The members of the group agree to guarantee jointly that should any of them suffer a catastrophe or disaster, he would receive certain sum of money to meet the loss or damage. All members of the group pool together their efforts to support the needy 35.
Under Takaful scheme the participants deposit annually an agreed sum of money with the company. This contribution is divided into two parts. A larger portion goes into investment fund and remains the property of the contributor. The other part which is nearly 2 to 5 percent of the contribution goes into a Waqf fund and considered as Tabarru1 (Donation). The company invests the available funds in mudarabah ventures or some other approved modes. The profits, if any, are added into the investment and Waqf funds according to the previous ratios. The purpose of Takaful may be life insurance and it may also be risk insurance of property. If the insured person dies before the end of the covered time in case of life insurance or if an insured risk on the property materializes, then the company will pay back the amount deposited in investment account by the policy-holder along with profits earned during that period. The other component of compensation will come from the Waqf fund to satisfy the need or to make the compensation up to a certain level.
As company uses Islamically approved modes of investment and distribute profit among the policy holders, element of Riba is eliminated. The other objectionable element, Gharar is still there but as the company manages a separate Waqf fund from donationes of the policy holders, for providing support to the needy member(s) of the group, this Gharar will not invalidate the insurance contract. According to Malki Fuqaha Gharar in Uqood al Tabarru1 (Donation contracts) is acceptable and does not invalidate the contract. The other objectionable elements such as violation of Islamic law of inheritance, confiscating the previously deposited money after a non payment of contribution etc. can easily be corrected as they are not the integrated part of the contract. This is a brief introduction of Takaful scheme suggested as a substitute for commercial insurance. There are many Takaful companies operating in various Muslim countries. To have a better understanding of this scheme it would be appropriate to see the actual functioning of a Takaful company. For this purpose, the structure and functioning of Sharikat Takaful Malaysia is presented as follows.
5.1. Sharikat Takaful Malaysia Sendirian Berhad
In Malaysia the operation of Takaful is licensed and regulated by the Takaful Act 1984. Sharikat Takaful Malaysia Sendirian Berhad was incorporated on 29 November 1984, with an authorized capital of RM 100 million and a paid-up capital of RM 10 million. It officially commenced business operation on 1 August 1985. Sharikat Takaful Malaysia is a subsidiary of the Malaysian Islamic Bank, Bank Islam Malaysia Berhad with, 87.15% of its equity held by the Bank. Other shareholders are States Islamic Councils and Bait-ul-mals of various states in Malaysia. Types of Takaful Business
The commercial activity of Takaful is reflected in two basic types of business that it undertakes,
Family Takaful Business (Islamic life insurance)
General Takaful Business (Islamic general insurance)
The fundamental objective and basic working operation differ between these two types of business. Under the Family Takaful Business, Sharikat Takaful Malaysia provides various types of Family Takaful Plan, which generally, are long-term al-Mudharabah contracts. Basically, a Family Plan provides cover of mutual aid among its members or participants expressed in the form of financial benefits paid from a defined fund should any of its members be inflicted by a tragedy.
For the General Takaful Business, Sharikat Takaful Malaysia manages various types of General Takaful Scheme, such as Fire Takaful Scheme, Motor Takaful Scheme, Marine Takaful Scheme, and Engineering Takaful Scheme etc, usually on a short-term basis. These schemes provide protection in the form of mutual financial help to compensate its members or participants for any material loss, damage or destruction suffered out of any catastrophe, disaster or misfortune that falls on a member’s property or belongings.
Working of the Takaful BusinessTakaful Business is based on the concepts of Al-Mudarabah and Tabarru1. Involvement of these two Islamic forms of business eliminates the elements of Riba and Gharar from the insurance contract.The operational details of different Takaful Businesses are as follows:
Family TakafulAny individual between the ages of 18 to 55 years can participate in the Family Takaful business. Participants are required to pay Sharikat Takaful Malaysia regularly. The Takaful installments are then credited into a defined fund known as the Family Takaful Fund. Each Takaful instalment is divided and credited into two separate Accounts namely, the Participants’s Account (PA) and the Participants Special Account (PSA). A substantial proportion of the installments is credited into the PA solely for the purpose of savings and investment. The balance of the installments is credited into the PSA as tabarru1 for Sharikat Takaful Malaysia to pay the Takaful benefits to the heir(s) of any participant who may die before the maturity of the Family Takaful Plan. The amount accumulated in the PA is invested in various businesses according to Islamic financing techniques, and the resultant profits are divided betweer the Sharikat and the participants according to an agreed ratio, e.g., 30-70. The participants’ shares are calculated according to their individual shares in the PA, and credited into their respective accounts, the PA and the PSA.
In case of occurrence of some unfortunate event like death or disability, the
Sharikat makes payment to the policy holder or his heirs. The amount deposited in the
PA along with the profits plus some amount from the PSA according to a formula is paid
by the company. For example if the person die or suffer permanent and the total
disability (PTD) in the fifth year of participation, Takaful benefits will be paid in the
i. From Participant’s Account RM 4,890.00
= RM 978 x 5 (i.e. installments paid by the Participant
in his Participants Account from the date of entry
up to the date of death or suffering of PTD) together
with profit, if any, which have been earned from
investment for during the same period, say RM 400.00
ii. From Participants Special Accounts RM 5,000.00
= RM 1000 x 5 yearly payment (i.e. outstanding
amount of Takaful installments that would have been
paid should the Participant survive).
Total Takaful Benefit Payable ( i + ii ) RM 10,290.00
For the Permanent Total Disability (PTD) cover Takaful benefit shall be paid in ten equal installments annually.
If the Participant is still alive at maturity of his FTP, payment of Takaful benefit will be
made to him as follows:-
i. From his Participant’s Account RM 9,780.00
= RM 978 x 10 (i.e. total amount installments credited into his Participant’s Account from date of entry to the maturity) together with the profit from investment if any, accumulated during the same period. RM 1,800.00
ii. From Participants Special Accounts, RM XXXX
Total Takaful Benefit = RM 11,580.00 + surplus as determined by Sharikat Takaful.
General Takaful Business
In consideration for participating in the various schemes of General Takaful Business, participants agree or undertake to pay Takaful contributions as tabarru1 for the purpose of creating a defined asset as illustrated in the ‘General Takaful Fund’. The amount of Takaful contributions will vary according to the value of property or asset to be covered under the Scheme. It is from this Fund that mutual compensation would be paid to any participant who suffers a defined loss or damage arising from a catastrophe or disaster affecting his property or belonging.
As the Mudharib, Sharikat Takaful Malaysia will invest the Fund. All returns on the investment will be pooled back to the Fund. In line with the virtues of mutual help, shared responsibility, and joint guarantee as embodied in the concept of Takaful, compensation or indemnity will be paid to any participant who suffers a defined loss or damage consequent upon the occurrence of a catastrophe or a disaster. Other operational costs to manager the General Takaful Business such as the cost for arranging retakaful programme and setting-up of reserve shall also be deducted from the Fund.
After satisfying all the claims and deducting the operational costs, if the Fund registers a surplus shall be shared between the participants and Sharikat Takaful Malaysia. The sharing of such surplus will be at an agreed ratio as expressed in the principle of al-Mudharabah such as 6:4, 5:5, etc. Profits attributable to the participants are paid on expiry of their respective General Takaful Schemes provided they have not received or incurred claims during the period of participation.
The General Takaful Business is different from Family Takaful, as all the payments are credited to only Tabarru account, and not divided into two separate accounts. One problem which we can feel here is the distribution of surplus among the policy holders. If the payments were given as Tabarru, then they should not bring any profit and if these were given as loan even then providing any share from the profit will not be appropriate and bring the element of Riba in the contract. Therefore, the company should divide the available funds into two separate accounts as the case of Family Takaful Business. If due to short period of policy it is not feasible to make investment and earn some profit then the payments from the policy holders should be considered as Tabarru and no return should be given to them. If the Fund registers surplus, the management can decide to reduce the amount of premium for the renewal of policy which will indirectly help and encourage the policy holders.
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