Takaful: Concept and Model by Atiquzzafar Khan

Takaful: Concepts and ModelsByAtiquzzafar KhanIIIE, IIUIMay 31, 201113th Distance Learning Courseon Islamic Finance

Main Topics• Introduction of Modern Insurance• Evaluation of Insurance Businessfrom Islamic Point of View• Islamic Alternative: (Review ofExisting Experiences of Takaful)• Performance of Takaful Industry

Risk and Insurance:Risk and uncertainty are fundamentalfacts of life. All human activities aresubject to risk, which may lead tofinancial or physical losses to him.Insurance is a device to cover thelosses arise due to occurrence ofsome undesired event.

Definition of InsuranceInsurance is an economic devicewhereby the individual substitutesa small certain cost (premium) fora large uncertain financial loss(the contingency insured against)that would exist if it were not forthe insurance.

Socio-Economic Benefits of InsuranceRisk CoverageHabit of ThriftSafe and Profitable InvestmentSecure working environment forBusinessesPlanning for life stage needsCapital formation in the Economy

Nature of Insurance ContractGeneral InsurancePremiumCompensationPremiumLife InsuranceCompensation

Shariah Position of InsuranceOpinion of Shariah scholars is dividedon insurance. We can classify theminto three major groups.– Those who consider both theconcept and practice of commercialinsurance un-Islamic.– Those who are in agreement withthe present insurance and findnothing wrong in it.– Those who accept the concept ofinsurance, but find prohibitedelements in its present practice.

Rulings of Collective FiqhiBodies about Insurance– Islamic Research Institute of Al-AzharAzharUni.– Council of Grand Ulama of Saudi Arabia– Majlis Tahqiqat-e-Shari'yah Lucknow,India– Islamic Fiqh Academy of Rabita al-Aa'lam-e-Islami– Al Majma’ Al-Fiqhi Al- Islami of OIC– Council of Islamic Ideology, Pakistan

Major Arguments AgainstInsuranceAccording to these Fiqhi bodies ConventionalInsurance is unlawful because of involvement ofprohibited elements like,– Riba (Interest)– Qimar (Gambling)– Gharar (Uncertainty, Doubt, Risk)– Unlawful appropriation of others’ property– Violation of law of inheritance in case of life insurance.

Islamic Substitute These Fiqhi bodies suggested that that anscheme based on the concept of mutualcooperation and Joint responsibility maybe considered as Islamic Substitute forconventional Insurance. That alternate is introduced under thetitle of Takaful in the recent past.

Takaful Pioneers Takaful started some 30 years ago in Sudanand Middle East in 1979 with theestablishement of:– The Islamic Arab Insurance Co. (IAIC) in theUAE and– The Islamic Insurance Co. of Sudan But it took some time for the movement totake shape.

Takaful Pioneers Later in 1984, Malaysia played a pioneeringrole in setting the first Legal frameworkspecific to Takaful (Takaful Act Malaysia). This was instrumental in the successfullaunching of the Takaful movement inMalaysia and in other countries of SouthEast Asia.

Other Islamic/ Takaful Legislations Other markets such as the Sudanand Iran have Islamic regulatoryenvironments and became naturallyTakaful markets. In Pakistan Takaful Act is enforced in2005 and Pak-Kauwait Takaful Co.started its operation. In the Gulf countries specific Takafullegislations are coming through inBahrain and in Saudi Arabia

Takaful Today From a handful of operators two decadesago the Takaful movement has blossomedinto a fast growing phenomenon in manyMuslim countries with very promisingprospects in other countries with a largeMuslim community.

Takaful driversThis movement is driven by–a a strong demand from a publicwho would not insureotherwise (because of religiousbeliefs); and–The successful development ofIslamic banking institutionsproviding capital and Islamicfinancial instruments for assetmanagement and investment.

Takaful Drivers Islamic banks and financialinstitutions play a strategic andimportant role in the distributionof Takaful products (especiallyLife Takaful Products). Just as Bancassurance played animportant role in the distributionof personal lines insuranceproducts Bancatakaful is animportant driver for Takaful.

Takaful OperatorsThe number of Takaful operatorsworldwide is now estimated at: 150 Takaful companies operating in40 countries 10 Retakaful companies 6 Islamic windows by ConventionalReinsurance companies

Takaful Premium Takaful is one of the fastest growingsegments in insurance (at around20% pa. on average) World Takaful contributions areconservatively estimated at aroundUS$ 10 billion, of which:– 60% General Takaful– 40% Family Takaful

Takaful Geographical SpreadSouth& East Asia : 56%Middle East : 36% Africa: 7% Europe, USA & Others: 1%

Definition of TakafulThe word Takaful means joint guarantee. The objectiveof Takaful is cooperation and mutual help among themembers of a defined group.In a practical sense Takaful can be visualized as amethod of joint guarantee among a group of members orparticipants against loss or damage that may inflict uponany of them. The members of the group agree toguarantee jointly that should any of them suffer acatastrophe or disaster, he would receive certain sum ofmoney to meet the loss or damage. All members of thegroup pool together their efforts to support the needy.

WORKING OF THE TAKAFULBUSINESS: The Malaysian Case Takaful Business is based on the concepts ofMudarabah and Tabarru. Involvement ofthese two Islamic forms of business eliminatesthe elements of Riba from insurance contractand convert Gharar into tolerable form. In Family Takaful each Takaful installment isdivided and credited into two separateAccounts namely, the Participants'Account(PA) and the Participants’ SpecialAccount(PSA). A substantial proportion of theinstallments is credited into the PA solely forthe purpose of savings and investment.

The balance of the installments is credited intothe PSA as `tabarru' for Sharikah TakafulMalaysia to pay the Takaful benefits to theheir(s) of any participant who may die beforethe maturity of the contract. The amount accumulated in the PA is investedin various business according to Islamicfinancing techniques, and the resultant profitsare divided between the company and theparticipants according to the agreed upon ratio,e.g., 30-70. The participant's share is calculated accordingto their individual share in the PA, and creditedinto their respective accounts, the PA and thePSA.

Mudarabah ModelFamily TakafulProfit AttributedTo ShareholdersCompanyShare ofProfit onS.H. capitalShare ofProfit forMudaribCompany’s Admin& Manag. ExpensesTakaful Contractbased on MudarabahInvestmentProfitParticipantPAFTFPAPayment toThe Family fromPA & PSAPSAPSACost of Re-takafulAnd Other DirectBusiness Expenses

Payment of claimsShould the Participant die or sufferPermanent and Total Disability in the fifthyear of participation, Takaful benefit willbe paid in the following manner:- i. From Participant's Account =RM 4,890(RM978 x 5)profit if any, say RM 400 ii. From Participants Special RM 5,000Accounts (RM1000 x 5) Total Takaful Benefit Payable RM 10,290

In case the Partcipant survivedShould the Participant survive untilthe maturity of his FTP, payment ofTakaful benefit will be made to himas follows:-i. From his Participant's Account = RM 9,780(RM978 x 10)profit from investment RM 1,800ii. From Participants SpecialRM XXXXAccountTotal Takaful Benefit = RM 11,580 +surplus determinedby Sharikah Takaful.

Mudarabah ModelGeneral TakafulTakafulOperatorShare of profitOn S.H. CapitalShare of SurplusFor the OperatorAdministration& ManagementExpansesProfit forShareholdersTakafulContractOn MudarabaBasisInvestmentProfit40%Participant4 contributionGTFGTFOperationalCost OfTakafulSurplus60%Share of Surplus forThe Participants

Shariah Concerns regarding Mudaraba ModelMudaraba is a commercial contract, hence not suitable for adonation (Tabarru) based scheme.Donation given by the participants can not become capitalfor Mudaraba at the same time.Distribution of surplus among the participants in proportionof their contributions is like a conditional gift(Hiba bis-Sawab) which is not allowed.Sharing of surplus in case of General Takaful(instead ofprofit) makes the contract essentially the same asconventional insurance contract.Provision of Qard-e-Hasan from the Share holders fund incase of deficit is not correct as Mudarib is not a guarantor.

Wakalah ModelFamily TakafulProfit AttributedTo ShareholdersCompanyWakalah Fee25 to 35 %Share ofProfit onS.H. capitalShare ofProfit forMudaribCompany’s Admin& Manag. ExpensesTakaful Contractbased on WakalahInvestmentProfitParticipantPSAFTFPSAPayment toThe Family fromPA & PSAPA65 to75%PACost of Re-takafulAnd Other DirectBusiness Expenses

Wakalah ModelGeneral TakafulCOMPANYTAKAFUL ADMIN & MARKETINGEXPENSES 25% TO 35%SHARE OF PROFITFOR THE COMPANYMANAGEMENTEXPENSES OFCOMPANYPROFIT / LOSSATTRIBUTABLE TOSHAREHOLDERSTAKAFULCONTRACT BASEDON PRINCIPLE OFAL-WAKALAHINVESTMENTBY FUND40%PROFITS FROMINVESTMENT60%PARTICIPANTTAKAFULCONTRIBUTION PAID BYPARTICIPANTGENERALTAKAFULFUND65% TO 75%GENERALTAKAFULFUNDOPERATIONAL COSTOF TAKAFUL /RETAKAFULOPERATIONAL COSTOF TAKAFULOPERATIONAL COSTOF TAKAFULSURPLUS(PROFIT)SHARE OFSURPLUS FORTHE PARTICIPANT100%

Shariah Concerns regarding Wakalah ModelWakalah model is free from many objections raised againstMudaraba model but some shariah concerns are still therewhich are as follows:Distribution of surplus among the participants in proportionof their contributions is like a conditional gift(Hiba bis-Sawab) which is not allowed.Provision of Qard-e-Hasan from the Share holders fund incase of deficit is not correct as Wakeel is not a guarantor.

Waqf Model

Definition of Waqf Waqf is an Arabic word and it meansto stop to withhold and not to let go. In technical meaning Waqf means toallocate or donate some property orcash for a specific purpose to getpleasure of Allah and not to let it gothrough consumption or sale. The Waqf property comes intoownership of Allah (SWT) and Waqifwill have no property rights on it.

Cont… Waqif has right to set the rules for waqfand manage the waqf. Waqf may be general purpose or specificpurpose, like Waqf ‘Ala al Aulad orWaqf ‘Ala al Aqarib. In Islamic Law Waqf is a legal entity

Waqf ModelCOMPANYTAKAFUL OPERATOR FEES FORADMIN & MARKETING EXPENSES25% TO 35%SHARE OF PROFITFOR THE COMPANYMANAGEMENTEXPENSES OFCOMPANYPROFIT / LOSSATTRIBUTABLE TOSHAREHOLDERS40%INITIAL DONATION BYSHAREHOLDERS TOCREATE WAQF FUNDPROFIT SHARING ONMUDARABHA BASESWaqfWaqfINVESTMENTBY FUNDPROFITS FROMINVESTMENTTAKAFULCONTRACT BASEDON PRINCIPLE OFAL-WAKALAHPARTICIPANTTAKAFULCONTRIBUTIONPAID BYPARTICIPANTWAQF FUND65% TO 75%60%WAQF FUNDOPERATIONAL COST OFTAKAFUL /RETAKAFULOPERATIONAL COST OFTAKAFULSURPLUS(PROFIT)SHARE OFSURPLUS FORTHE PARTICIPANTOPERATIONAL COST OFTAKAFUL100%

A Waqf Fund would basically be aseparate legal entity to which theShareholders would initially make adonation to establish the Waqf Fund. The donation can be of any reasonableamount (Shariah Board may specify suchan amount). The objectives of the Waqf fund would beto provide relief to participants againstdefined losses as per the rules of theWaqf fund.

Cont….In this modified Wakala Model with Waqf, therelationship of the participants and of theoperator is directly with the Waqf fund. TheOperator is the Wakeel of the Waqf Fund andthe participants pay one sided donation tothe WAQF fund (not conditional) which alsoeliminates the issue of Gharar. The WAQFfund rules may define the sharing of surplusand other rules under which it would operatebut there is no obligation to distributesurplus. Further the Qard would be given bythe shareholders to the WAQF entity and notto individuals as in the typical Wakalahmodel.

The Challenges ahead Despite a remarkable breakthrough and adynamic and sustained growth, there arechallenges facing the Takaful industry whichare:1) Human Rsources 4) Asset Management2) Product Development 5) Re-Takaful3) Distribution 6) Governance & Risk

The business model dilemma The existence of three business models:Mudharabah (Profit & Loss sharing)Wakala (agency contract with aperformance fee element to replacesurplus sharing)Wakala with Waqf model Could create an uneven / unfair businessenvironment to operate Need to reach a consensus internationallyon a common and standard Takafulbusiness model

Future OutlookDespite the remarkable growth raterecorded by the Takaful industry,penetration is still far below theenormous market potential offeredby the Muslim community worldwide(23% of the total world population).

Growth Outlook World Muslim population is estimatedat 1.5 billions, of which around 97%are based in Asia and Africa. A two-digit growth in the range of15% to 20% can be reasonablysustained for at least the next 10years in the existing markets (Farand Middle East).

New Takaful Frontiers Markets like Europe, North and LatinAmerica, Central Asia, Australiawhere large Muslim communities liveare huge untapped reservoirs; The recent opening towards “Islamicwindows” in the banking sector inEurope is likely to be followed by“Takaful windows” initiatives.

Takaful Products to Non-Muslims Takaful Products are not exclusive toMuslims. Competitively priced and soldthrough the right channel it couldattract any consumer irrespective oftheir origin or faith (e.g. SriLanka).

Conclusions Despite the challenges facing this“new” industry, exciting times areahead once the latent potential isunleashed. The success of Takaful largelydepends on that of Islamic Financialinstitutions on a global basis.

Questions & Commentsatiquzzafar@iiu.edu.pk