TAKAFUL (ISLAMIC INSURANCE)
Insurance is not a new concept within Islam. The principle of a person protecting himself against loss or misfortune is even described in the Qur’an through stories of some of the prophets (pbut). In Arabic this concept is known as “takaful”. It is acknowledged that the foundation of shared responsibility or Takaful was laid down in the system of “Aaqilah”, which was an arrangement of mutual help or indemnification In case of any natural calamity, every body used to contribute something until the loss was indemnified. Similarly, the idea of Aaqilah in respect of blood money or any disaster was based on the concept of Takaful wherein payments by the whole tribe distributed the financial burden among the entire tribe. Islam accepted this principle of reciprocal compensation and joint responsibility.
It is also a generally accepted view that Islamic insurance was first established in the early second century of the Islamic era. This was the time when Muslim Arabs started to expand their trade to India, Malay Archipelago and other countries in Asia. Due to long journeys/voyages, they often had to incur huge losses because of mishaps and misfortunes or robberies along the way. Based on the Islamic principle of mutual help and cooperation in good and virtuous acts, they got together and mutually agreed to contribute to a fund before they started their long journey. The fund was used to compensate anyone in the group who suffered losses through any mishap. In fact the Europeans copied this, which was later known as marine insurance.
Takaful, means “guaranteeing each other”, is the same as insurance. It represents the concept of insurance based on mutual co-operation and solidarity of people by participating in a takaful scheme. Takaful (which is based on the concept of social solidarity, co-operation and mutual indemnification) satisfies the need for insurers that now need to provide Shariah compliant insurance services as an alternative to the conventional insurance.
Takaful products are based on two main business models:
1. The Mudaraba model: is essentially a basis for sharing profit and loss between the takaful operator and the policyholders. The takaful operator manages the operation in return for a share of the surplus on underwriting and a share of profit from investment. This is commonly used in Malaysia.
2. The Wakala model: is a contract of agency, which replaces surplus sharing with a performance fee. The takaful operator in this case acts as an agent (Wakeel) for participants and manages the takaful/retakaful fund in return for a defined fee. This model is used more in the Middle East region.
Under the Al-Mudharabah principle, the profit as universally defined by conventional insurance companies, which in the case of general business is taken to mean returns on investment plus underwriting surplus, is then shared according to a mutually agreed ratio between the participants and the operators. Management expenses of the operator including agency remuneration, if any, shall be borne by the shareholders’ fund and not from the takaful funds. Hence, there is a distinct separation between Takaful funds and shareholders’ fund.
Whereas, under the Al-Wakalah principle, the paid-up capital is contributed as donation by the shareholders. Therefore, under this principle the shareholders do not expect and probably do not mind for not receiving any returns on the capital donated. However, it is understood this standpoint has changed in view of opinion expressed by certain scholars that the shareholders (operators) in their capacity as managers should also be entitled to share the profit arising from the takaful business.
On a strict interpretation of the Wakalah Model, the surplus of policyholders’ funds investments (net of the management fee or expenses) goes to the policyholders. The shareholders charge Wakalah fee from contributions that covers most of the expenses of business. The fee rate is fixed annually in advance in consultation with Shari’ah board of the company. In order to give incentive for good governance, management fee is related to the level of performance
The theory of a takaful contract is based contracts amongst a group of persons who agree to jointly indemnify the loss or damage that may inflict upon any of them, out of the fund they donate collectively. The takaful contract usually involves the concepts of Mudarabah, Tabarru (to donate for benefit of others) and mutual sharing of losses with the overall objective of eliminating the element of uncertainty.
The fundamental principles of takaful contracts are:
- The policyholders (takaful partners) pay premium to assist and indemnify each other and share the profits earned from business conducted by the Company with the funds.
- Takaful companies normally divide the contributions into two parts, i.e., donations for meeting mortality liability or losses of the fellow policyholders and the other part for investment. Accordingly, the clause of Tabarru is incorporated in the contract.
- As to how much of the contribution is meant for mortality liability and how much for investment account is based on a sound technical basis of mortality tables and other actuarial requirements. Both the accounts are invested and returns thereof distributed on Mudarabah principle between the participants and the Takaful operators.
Takaful contracts may comprise clauses for either protection or savings/investments or both the benefits of protection as well as savings and investment.
(a) The protection aspect of Takaful works on the donation principle according to which individual rights are given up to indemnify the losses reciprocally.
(b) The savings aspect ensures that individual rights are protected under Mudarabah principle and the contributions along with profit (net of expenses) are paid to the policyholders at the end of policy term or before, if required.
The distinction between the conventional insurance and Takaful business is more visible with respect to investment of funds. While insurance companies invest their funds in interest-based avenues and without any regard for the concept of Halal-o-Haram, Takaful companies undertake only Shariah compliant business and the profits are distributed in accordance with the pre-agreed ratios in the Takaful Agreements. Likewise they share in any surplus or loss from the pool collectively. Takaful system has a built-in mechanism to counter any over-pricing policies of the insurance companies because whatever may be the premium charged, the surplus would normally go back to the participants in proportion to their contributions.
The terms “Family Takaful”, “Takaful Ta’awani” or just “Takaful” are generally used for family solidarity in place of conventional life insurances. Other products available in various countries are General Takaful, Education/Medical Takaful, etc. Based on the nature of relationship there are various models like Wakalah (agency) Model, Mudarabah Model and the combination of agency and Mudarabah models. In Mudarabah model the policyholders get profit on their part of funds only if takaful company earns profit. The sharing basis is determined in advance and is a function of the developmental stage and earnings of the company. The Shariah committee approves the sharing ratio for each year in advance. Most of the expenses are charged to the shareholders.
ADHERENCE TO ISLAMIC PRINCIPLES
A Takaful or Retakaful company must strictly adhere to principles of co-operation, protection and mutual responsibility and will avoid acts of interest (riba), gambling (al-maisir) and uncertainty (al-gharar).
The two main principles are the prohibition of Riba and Gharar.
Riba is the main point of distinction between Islamic and non-Islamic financial means. Riba refers to a creditor exploiting a transaction for unfair gain, for example, paying too little for an item or repaying significantly less of a loan than its original value. Very commonly it can occur through applying interest or usury (extortionately high rates of interest) in his/her transactions. This is expressly forbidden in Islam.
Gharar is the selling of items which have an uncertain existence or uncertain characteristics making the transaction risky and similar to gambling.
It is therefore important to distinguish insurance from gambling.
Allama Yusuf Ali, in his translation of Holy Quran, comments on Sura Al-Baqara, ayat 219 –
“Insurance is not gambling, when conducted on business principles. Here the basis for calculation is statistics on a large scale, from which mere chance is eliminated. The insurers charge premium in proportion to the risks, exactly and scientifically calculated”.
In gambling, it is possible to win or lose by creating that risk. In insurance, the risk is already there and the aim is to try to minimise the financial effects of that risk. Insurance shifts the impact of that risk to someone else and relieves the person of risk.
It is imperative that the Retakaful or Takaful company will conduct all its affairs in a manner that meets the Islamic Shari’ah Principles whether it is to do with investing its funds, in carrying out its business in all classes of insurance or in any other related financial field.
All operations and contracts are set-up to ensure that any element of speculation, uncertainty and gambling is eliminated or minimized from them.
Reinsurance of takaful business on Islamic principles is known as retakaful.
Reinsurance is a form of insurance whereby an insurance company or a Lloyd’s syndicate can transfer to another insurer (the reinsurer) all or part of its liabilities in respect of claims arising under the contracts of insurance that it writes. This enables the an insurance company (reinsured or direct insurer) to protect itself against the risk that its total claims costs in any one year maybe so large wiping out its profits, or even cause it to be insolvent. This is the essence of the concept of social solidarity, cooperation and mutual indemnification of losses of members whereby there is joint indemnification of the loss or damage that may occur, out of the fund that is collectively contributed to.
The main problem worldwide is the lack of retakaful companies that are capitalised to the levels required by insurers and more particularly the lack of “A” rated retakaful companies. This has resulted in takaful companies having to reinsure on a conventional basis, contrary to the preferred option of seeking cover on Islamic principles.
The Shari’ah scholars have allowed dispensation to takaful companies to reinsure on conventional basis so long as there are no retakaful alternatives available. Takaful companies therefore actively promote co-insurance. A number of large conventional reinsurance companies from Muslim countries take on retrocession. Therefore a large proportion of risk is placed with international reinsurance companies that operate on conventional basis.
The retrocession from takaful companies ranges from some 10% in the Far East where Takaful companies have relatively smaller commercial risks (so far), to the Middle East where up to 80% of risk is reinsured on conventional basis.
Retakaful companies need to ensure that they are capitalised sufficiently to enable them to:
- protect the financial stability of takaful companies from adverse underwriting results
- stabilise claims ratios from one year to the next
- minimise claims accumulation from losses within and between different classes
- geographically spread risk
- increase capacity
- increase the profitability of insurers through permitting greater flexibility in the size and type of risks accepted
- secure technical support and help
Even though a typical reinsurance transaction is generally based on the principles of al-‘Aqd (contract), the nature of this transaction is quite different from other forms of commercial contracts in conventional reinsurance. Whilst the contract must ensure that the policy is for the purpose of sharing responsibility to provide some material security against unpredicted loss or damage resulting from unexpected risks on both life and property it must also comply with Sharia’ah principles..
Reinsurance contracts must essentially be financial transactions that bind both the reinsurance company and the insurance company on the general principles of al-‘Aqad.
Source : www.reorient.co.uk