takaful

ECON 3430 - Islamic Banking and Finance

Topic 6 - Takaful 1


Takaful

Outline

• Types of Risk

• Concept of Insurance

• Why conventional insurance is not Shari’ah-compliant

• Takaful

• Comparison between takaful and insurance

• Types of takaful

• Takaful models

• Selected Takaful Issues


Topic 6 - Takaful 2

Two Types of Risk

Fluctuations in market

value of trade goods

Death, fire, accidentExamples

Common risk

management

method

Origin of Risk

Nature of Outcome

Use of derivativesInsurance

By deliberate choice of

action

For the most part,

unavoidable

Loss / GainLoss / No Loss

Speculative RiskPure Risk

The Concept of Insurance

• Transfer of pure risk from the individual to the insurance

operator

• Insurance operator indemnifies the insured of a defined loss in

exchange for premium payments

• Insure against pure risk only, not speculative risk

– E.g., no insurer will underwrite general business failure

– Notion of insurable risk

• Predictable, measurable, spread over large geographic

area, acceptable to insurer

• Law of large numbers, use of statistics and actuarial science

• Insurance as a business, with profit-maximization objectives

– Profit (Underwriting Surplus) = Total premium – Total claims

paid out

• Total premium – Primarily sales and marketing output

• Total claims – To a certain extent is left to uncontrollable

factors (will of God / chance)


Topic 6 - Takaful 3

Why is conventional insurance not Shari’ah-compliant?

• Element of uncertainty (gharar)

– There is uncertainty of what the insurance policy-holder is “buying”

or paying for

• If no loss occurs � Policy-holder receives nothing

• If loss occurs � Policy-holder gets compensation in varying

amounts

Insurance

Company

Insurance

Policy-holder

Premium

Coverage

• Element of gambling (maysir)

– The insurance company is gambling that total premiums collected

will exceed total claims and thus producing underwriting surplus

(profit)

– Total claims is predominantly affected by chance (will of God)

• Element of riba

– Insurance fund commonly invested in interest-bearing securities

Takaful

• The Islamic alternative to conventional insurance is takaful

• Takaful is a form of mutual help (ta’awun) in furthering good/virtue by

helping others who are in need or in hardship

• Shari’ah basis of takaful

– Al-Qur’an

• “Help (ta’awun) one another in furthering virtue (birr) and God

consciousness (taqwa) and do not help one another in

furthering evil and enmity.” [Al-Maidah 5:2]

• Encouragement to assist one another for a good cause

– Hadith

• “…tie the camel, then submit (tawakkal) to the will of God.”

• Importance of risk mitigation

– Islamic Legal Maxim

• “al darar yuzal ” – “damage/harm is removed”

• If damage has occurred, efforts should be made to remove it


Topic 6 - Takaful 4

Takaful (2)

• Takaful participants contribute to a takaful fund based on the

concept of mutual assistance

• The contribution is done via reciprocal/mutual donation (tabarru’at)

and does not represent a commercial “sale of coverage”

• Takaful entails a unilateral, charitable contract (tabarru’at) in

contrast with the conventional insurance contract which is a

bilateral exchange contract (mu’awadat)

• Gharar is tolerated in a charitable unilateral contract

Takaful

Operator

Takaful Participants

Takaful FundContribute via

unilateral

contract

(tabarru’at)

Manages fund for a fee or share in

profits on investment

Takaful (3)

• The prohibited elements are absent / averted in takaful

– Gharar � Uncertainty is tolerated because there is no

commercial (sale) contract

– Maysir � Return to takaful operator not a result of a gamble,

but rather from (i) charging of a fee to manage the takaful fund,

or (ii) a share in profits of the invested takaful fund

– Riba � Takaful funds are invested in Shari’ah-compliant

instruments only

• Today there are 7 takaful operators in Malaysia

– Syarikat Takaful Malaysia Berhad

– Takaful Nasional Sdn Bhd

– MAA Takaful Berhad

– Takaful Ikhlas Sdn Bhd

– CIMB Aviva Takaful Berhad

– HSBC Amanah Takaful (Malaysia) Sdn Bhd

– Prudential BSN Takaful Berhad

– Hong Leong Tokio Marine Takaful Berhad


Topic 6 - Takaful 5

Takaful vs. Insurance

Insurance company makes a profit when there is an underwriting surplus

Takaful operator earns a return

- for rendering a service of managing the

takaful program

- from the mudarabah profit sharing scheme

as mudarib

No clear valid countervalue. Source of profit

is anticipating (hoping) that the uncertain

future will be in their favour (that total

premiums will exceed total claims)

Countervalue (‘iwad) is effort and/or

undertaking of risk

Indemnification component is a bilateral

contract

Indemnification component is a unilateral

contract

Insurance company seeks to profit by

exploiting people’s need to manage risk

Takaful operator helps to manage a scheme

of mutual assistance based on brotherhood,

and is rewarded for that effort

There is a clear insurer-insured relationshipThere is no insurer-insured relationshipbetween takaful operator and participants.

Participants at both the insured and the

insurer simultaneously

Indemnification component is a commercial

relationship between insurance company and

the insured

Indemnification component is based on

mutual contribution, reciprocal donation

(tabarru)

Conventional InsuranceTakaful

Two Types of Takaful

• General Takaful

– Typically it is short term, but renewable periodically

– Common types of general takaful includes vehicle takaful, fire takaful,

health takaful

• Family Takaful

– Typically long term in nature, loosely comparable to conventional life

insurance

– Contributions comprise two components

• “Insurance” (Special Participant Account)

– In the event of loss, participant will be compensated according to a pre-agreed formula

• Investment (Participant Account)

– Underwriting surplus invested in Shari’ah approved securities

– If participant dies prematurely, family gets

• Amount in Participant Account + dividends

• Amount in Special Participant Account as if he continued contribution until maturity

– If participant withdraws from takaful program, he gets

• Amount in Participant Account


Topic 6 - Takaful 6

Possible Models for Takaful

• Contract among takaful participants

– Tabarru’ (mutual indemnity)

• Contract between takaful participants and takaful operator

– Mudarabah

• Takaful participants are capital providers (rabbal-mal),

takaful operator is the entrepreneur (mudarib)

• Profits are shared according to pre-agreed ratio, losses

borne by takaful participants

– Wakalah

• Takaful participants appoint the takaful operator as their

agent to manage the takaful fund (insurance and

investment activities)

• Takaful operator charges a fee for its services

– Ju’alah

• Same principle of agency used (as in wakalah) except that

payment to the takaful operator is based on performance

(commission-like payment)

Mudarabah Model – General Takaful

Participants’

Contributions

(tabarru’)

Takaful

Fund

Investment returns

SurplusClaims

Expenses

( less )

Takaful

Operator

managed by

Investments

Make investments

manage

investments

Share of surplus

/ investment

returns (x%)

Profit sharing ratioRabbal-mal : mudarib

x : y

Share of surplus/ investment

returns (y%)


Topic 6 - Takaful 7

Wakalah Model – General Takaful

Participants’

Contributions

(tabarru’)

Takaful

Fund

Investment returns

Takaful

Operator

managed by

Investments

Make investments

manage

investments

Surplus

Claims

Expenses( less )

Wakalahfee

Selected Takaful Issues

• Basis for mudarabah profit sharing

– Underwriting surplus, or

– Profit made on invested underwriting surplus

– To address this issue, some takaful operators employ

the arrangement of wakalah (agency with fee) instead of

mudarabah

• Takaful operator gets paid for managing the takaful

program and investing surplus funds


Topic 6 - Takaful 8

Selected Takaful Issues (2)

Total Takaful Fund RM100m

Underwriting Surplus RM20m

Total Indemnification

Payments RM80m

Invest Profit @ 10% : RM2m

Illustration : Basis for mudarabah profit sharing

Issue : should mudarabah profit sharing be based on RM20m or

RM2m?

Selected Takaful Issues (3)

• Ethical considerations in the marketing of takaful products

– Sale of takaful products beyond customers’ genuine needs

– Exploitation of spiritual motivations for commercial purposes

• Re-takaful

– In conventional insurance, it is common for insurance operators to collectively share the risks they have taken on

– These risks are “transferred” to an even larger pool of risks, managed by a larger insurance operator

– This process is known as the re-insurance process

– It is a means for further mitigating risk exposure

– Issue

• Takaful operators have been known to resort to re-insurance as a

method of risk management

• The re-insurance process is executed by conventional re-insurance companies, hence Shari’ah principles of takaful are not observed

• This is due to the lack of sufficiently large takaful operators to

adequately provide re-takaful

– Best Re, Munich Re, Swiss Re, MNRB Re-takaful Bhd beginning to venture into re-takaful

takaful

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