Takaful Insurance Lecture (3)

Takaful Insurance Lecture (3)
Ibrahim A. Shahid

Table of contents Takaful Insurance Takaful Reference in Quran
Takaful Reference in Hadith Takaful through time Takaful Basic elements Takaful main drivers Takaful objections to the conventional Insurance Takaful business Models Takaful products Takaful operators visive Conventional Insurers Issues and Challenges facing Takaful Comparison between Takaful and Conventional Sources

Takaful Insurance The concept of Takaful is derived from the Arabic work KAFALA meaning guarantee, bail, warrant or an act of securing one’s need. Takaful means joint guarantee whereby a group of participants agree to mutually guarantee each other against a defined loss. hence the doctrine of Takaful embraces the element of mutual protection and shared responsibility. In Takaful system there is no policyholder, The beneficiary is called Participant in the Takaful Fund. The principal of Takaful is that all transactions must be carried out among all parties must be strictly in accordance with the Islamic Shariah compliance.

Takaful Insurance Many Fuqhaa have dealt with the conventional insurance as not Sharia Compliance. The objection, is it on the concept? or on the way conventional Insurance is practiced?? Is it the lack of an alternative? The concept of insurance, Is it acceptable to Islam? Mixing up between the concept and practices

Takaful Reference in Quran
Help (ta’awan ) one another in furthering virtue “ BIRR” and ALLAH consciousness “ TAQWA and do not help one another in furthering evil and enmity “Al maidah verse 2 ( 5:2)”. Takaful is a form of mutual help “ Ta’awan” in furthering good/virtue by helping others who are in need/ hardship. There are also lots of verses in Quran that supports protecting the capital and developing it for the best interest of the community. Also the wholly book makes it obligatory not to give those who are not competent the freedom to manage their own money.

Takaful Reference in Hadith
Tie the camel first, then submit ”TAWAKAL” on the will of Allah The Hadith implies a strategy to mitigate the risk of losing the camel. Another example is the story of the old man who want to pay out “ Tabaroua” with all his money, prophet Mohamed ( P.B.U.H.) did not agree, then half of it, Prophet Mohamed (P.B.U.H) also did not endorse , then one third, Prophet Mohamed (P.B.U.H) agreed even reluctantly . The believers in their affection , mercy and sympathy to each other ,are like the body, if one part of its organs suffers and complains, the entire body responds with insomnia and fever, another Hadith.

Takaful Reference in Hadith
Another Hadith when PBUH implied that it is better to leave money to your family instead of leaving then with nothing Takaful provides a strategy of risk mitigation/reduction by virtue of collecting risk taking that distributes risks and losses to a large number of participants. This mitigates the otherwise very damaging losses if borne individually.

Takaful Historical Background
Origin in the first constitution of Madina in 622 It continued in one form or the other throughout the Abbasid period and even later in the Ottoman empire. Mohamed Abdou said insurance transaction is like the transaction of ‘Mudarabah’ financing and life insurance is legal Serious efforts were made in modern times and in 1970’s to come up with an Islamic alternative to conventional Insurance.

Takaful historical Background
The first Takaful company was set in Sudan late seventies followed by Bahrain ESIH was the first Takaful company in Egypt, Now there are more than 200 companied operating in more than 40 countries. Yet in most of the Islamic countries, the markets are still predominated by conventional insurance and as it stands now, we are talking about 80% conventional.

Takaful historical Background
Malaysian market controls more than 30% of the Takaful premium followed by Indonesia. Takaful sector has continued to expand at a very strong pace of 28% annually between 2007/2010 . The Takaful market share of overall insurance sector in Muslim countries has more than doubled from 2004 to Now it is around 7.5%. The penetration rate of Takaful in the Muslim countries is still very low and do not go in line with the economical developments. Non Muslim are opting for Takaful for merely economical benefits.

Takaful Basic elements
Mutuality and cooperation. Takaful contract pertains to Tabarru’at as against mu’awadat’in Conventional Insurance. Payments made in the intention of Tabarru ( contribution). Eliminated the objections against conventional insurance, Gharrar, Maisir and Riba. Wakalah/ Mudharabah basis of operation. Joint guarantee/indemnity amongst participants/ Shared responsibility. Constitution of separate participants fund. Constitution of Sharia supervisory committee/ board. Sharia compliance investment policy.

Takaful Main drivers Individual purification.
Mutual assistance” brotherhood”. Charity” tabarru’ or contribution. Mutual guarantee. Community well being not profit maximization.

Takaful Insurance Objections to the Conventional Ins. ‘Gharar’
Scholars view the Insurance contract as an exchange contract, money is exchanged with money over a period of time. This created the problems of Uncertainty (Gharrar), Gambling( Maisir) and Interest (Riba). Gharar is an Islamic term describing risky or hazardous sale where details about the sale item are unknown or uncertain. Gharar is generally prohibited under Islam which explicitly forbids trades that are considered to have excessive risk due to uncertainty.

Takaful Insurance Objections to the Conventional Ins. ‘Gharar’
The concept of Gharar has been broadly defined by scholars in two ways First it implies uncertainty Second it implies deceit Quran has clearly forbidden all business transactions which cause injustice. Gharar in insurance contracts pertains to “ deliverability” of subject matter, i.e. uncertainty:- Will the insured get his promised compensation ?. How much he will get?. When will the compensation be paid?.

Takaful Insurance Objections to the conventional Ins. ‘Gambling/Maisir’
Gambling means a definite cost in exchange for a possible pain or Gain. Insurance is a contract upon a speculation. The insured loses the amount of the premium paid when the event insured does not occur, also the company shall be in deficit if the claims are higher than the premium.

Takaful Insurance Objections to the Conventional Ins
Takaful Insurance Objections to the Conventional Ins. Interest/Riba( USURY) The word Usury in Arabic means literally an increase or addition In Islamic Fiqh, There are two kinds of usury:- Riba Al-Doyoun” Debt Usury” is an unjustified increment in borrowing or lending money, paid in kind or in money above the amount of loan as imposed by the lender or voluntarily by the borrower. Riba Al-Fadl, or Riba Al-Buyu “Trade usury” is an unjustified increment gained by the seller or the buyer if they exchanged goods of the same kind in different quantities.

Takaful Insurance Objections to the Conventional Ins
Takaful Insurance Objections to the Conventional Ins. Interest/Riba( USURY) Usury prohibition in Quran was made on three different phases:- Firstly, Allah firstly gave a warning that Usury earning shall be wiped out while charity will be rewarded more than they have spent. Secondly, Believers have been ordered, and warned , never to take Usury at compound rates. Thirdly, Usury was utterly condemned in all forms and those cared not for its prohibition were threatened a war to be waged against them by Allah and his messenger. It was also made clear that Usury transaction is different than trade. Insurance funds are invested in financial investments which contain element of Usury.

Takaful Business Models
Takaful has three key features:- It separates participants (policyholders) funds from the operators( shareholders) funds. It adheres to a Shariah –compliant investment strategy by avoiding the payment of interest and refusing to do business with firms engaged in forbidden activities. It requires an independent internal supervision board/committee of shariah scholars. Takaful products are usually sold by companies set up as fully Islamic firms ( shariah Compliant).

In some cases regulators allows Takaful products to be sold by conventional insurers through Islamic windows. Takaful products may be purchased by both Muslims and non Muslims Usually life insurance is referred to as Family Takaful, and non life insurance is referred to as General Takaful Reinsurance in the Takaful model referred to as Retakaful wherein all participants are Takaful operators

The main types of Takaful models are: Wakalah (agency) Model Takaful companies act as pure operating agents for the participants The operating agent receives a pre agreed upon fee, usually a fixed proportion of the contributions paid by the participants The operating agent neither has any share in the underwriting surplus and investment profits nor incur any underwriting or investment loss If however the Takaful fund runs a deficit, the operating agent has to provide an interest free loan( Qard Hassan) to the Takaful fund and to be repaid when the fund has a surplus The operating company can only make a profit if its operating expenses are below the income. Since they do not carry underwriting risk, they might be tempted to maximize the contributions without properly assessing the risks This is why one of the variant in this model is to offer incentives to the operating agent in order to adopt adequate risk assessment policy to address the concern On the other hand forcing the operating company to provide Interest free loan (Qard hassan) , in case of deficit, incentivize for a disciplined risk assessment

Mudarabah Model It is a profit- sharing model in contrast to the Wakalah model. In addition to their actual administrative fees, The operator receives an agreed upon proportion of the surplus generated by the participants fund and the profits earned on earned on the investments activities. As under Wakalah , the operating company shall provide interest free loan ( Qard Hassan) to the participants fund if a deficit occurs. Operator can only make profit if operating expenses are lower than the operators share in the underwriting surplus and investment income combined. Efficient fund management and proper risk assessment are in the operator’s best interest. Volatile income from underwriting and investments can be a challenge particularly during the start up phase.

Hybrid Model It combines elements of Wakalah and Mudarabah models. The operating agent receives a pre agreed upon share of the contributions paid by the participants plus a share of the profits earned on the investment activities. Some financial regulators and international organizations recommended the hybrid model since it leverages the strengths of both Wakalah and Mudarabah models Applying Mudarabah model to investment activities helps mitigate principle –agent problems, whereas the use of Wakalah model allows the operator to recover the administrative costs of underwriting

Wakalah- Waqf Model Waqf in Arabic language means to stop, contain or preserve In islamic term , Waqf refers to a religious endowment, i.e voluntary and irrevocable dedications of ones wealth or a part of it in cash or in kind, and its disbursements for Shariah compliant projects Under this model the operating agent sets up a cash waqf by providing a cash donation The participants make contributions to the tabarru part of the waqf fund which is then used to settle claims The operating agent earns a fixed underwriting fee ( Wakalah fee) Participants may receives share of the surplus after paying all claims. The surplus can also be used to build up reserves and to make donations The operating agent , as in Wakalh model, provides interest free loan in case of a deficit in the fund The incentives for the operator are very similar to Wakalah model , but Waqf model addresses a key Shariah issue about the ownership of participants’ contributions in the Wakalah model

Allocation of surplus amongst participants. There are two ways:- Each Takaful product is considered as a separate funds All Takaful products are considered as one fund Advantages and disadvantages of each method

Takaful Products As mentioned earlier we have:-
Family Takaful which refers to life assurance General Takaful which refers to non life insurance

Takaful Products Family Takaful Term life Takaful Whole life Takaful
Endowment Takaful Universal Takaful, shaped by many events Marriage Takaful Education plan Banacatakaful

Takaful Products General Takaful Property Takaful Marine Takaful
Motor Takaful Miscellaneous Takaful

Takaful Operators VS. Conventional Insurers
Are there any differences in the underwriting procedures between Takaful and conventional? Are there any difference in the technical terms and conditions of the products? Differences in the organizational chart Accounting Shariah compliance board

Accounting System Takaful models makes it a must to have two separate sets of accounts, one for the participants and the other for the operators/ investors The main objective of this segregation is to segregate the technical profits from the investment ones for each Takaful product separately and for the entire book of business Any profits generated from the investment of the contributions is added to the technical surplus or profit. Isn’t there in the conventional???

Shariah supervisory Board SSB main role is to ensure that all transactions carried out in the Takaful company are strictly in compliance with Shariah. The number ranges from 3 to 5. . They are suppose to be well qualified in the Islamic transactions, hopefully with an insurance background SSB is annually appointed by the general assembly on a yearly basis They attend the board meetings There are stand a lone companies which perform the rule of the SSB without being physically present in the offices

Shariah supervisory Board cont. The main functions of the SSB are:- Ensure that all technical aspects of the company, underwriting, reinsurance, claims, investment policy etc. are in full compliance with Shariah Respond to any queries either from the board or the employees relating to the Shariah matters Review any new products before putting in the market to ensure it is stictly in compliance with Shariah Watching carefully all related Fatwas from others and keep the board of director and the company full ware of such Fatwas and its impact upon the company’s products or market share Give new ideas based on their experience Give proper training on Shariah issues to the staff Review the annual statements of accounts and endorse it as Shariah complaint in the same manner as the external auditor

Issues and Challenges Facing Takaful Industry
Key issues and challenges: Lack of consumer awareness , Many consumers are still unaware of Takaful as an alternative Downplaying the importance of security and retirement planning and many rely heavily on the social security systems Similar to conventional , Takaful products is a proposition that needs to be sold to consumers not bought by them Scarcity of human resources with both insurance and Shariah expertise Most operators tends to be driven by conventional thoughts and solutions and as a result limited original thinking in the industry The Shortage of Shariah Scholars with appropriate experience not only in Islamic Jurisdiction but also in Insurance.

Key issues and challenges (Cont.) Lack of standardization in the industry that is due to shariah interpretations The inconsistency of Shariah-compliant can be seen in the following issues:- Issues that are due to regional differences. In the consumer attitude. In Malaysia they are more liberal in comparison to the ME Issues relating to the choice of model. KSA, Egypt. In Iram for example since the whole system is Islamic they consider the conventional insurance as Shariah compliant The source of Capital. Is it a must that the source of capital must also be shariah compliant or only the usage of the capital in order not to lose the international capital Types of risks deemed acceptable for example if there are very few number of large risks does it fit inot the Takaful concept. Governmental risks? Wakalh fees, how much money can the operator get? Can he get the cost of the capital? Diverging regulatory approaches and lack of centralized regulatory body, the industry is relying heavily on the opinion of SSB subject to any local regulatory constraints

Key issues and challenges (Cont.) Solvency and capital requirements. In most regulatory frameworks the capital requirements for Takaful operators are similar to those of the conventional insurers, without taking into consideration the specific aspects to Takaful Treatment of the interest free loan in determining the solvency requirements since Qard may be a potential additional capital for Takaful fund Consideration to whether level playing field is sustainable in the long term for takaful Consideration to the distribution of surplus, and contingency reserves which may result in a lower capital requirements Consideration to the treatment and approach of rating agencies towards Takaful entities

Key issues and challenges (Cont.) Corporate governance The relationship between the BOD and SSB is based on deep trust and integrity There should always be a written guidelines of the scope and responsibilities of SSB that capture all aspects, underwriting, model adopted, surplus distribution, products offered, investments, Takaful, product wording and marketing materials At present the industry does not have compliance manuals and standard terms of reference for SSB In most of the cases SSB focuses on the Shariah related issues, ignoring all technical aspects

Shortage of Shariah compliance assets. The key challenges faced by operators in respect of investments are:- The lack of suitable investment vehicle particularly those with longer term duration The limited range of Shariah compliant assets leads to concentration of asset risk Lack of Shariah compliant products restricts innovation because of the liquidity and mismatching risk as well as lower returns There is a risk to invest in assets not denominated in the same currency as the liability

Technical issues and challenges Treatment of the interest free loan. It is unclear whether Shariah sanctions such loans or whether this is an expectation created within the industry Uncertainty regarding the repayment out of the surplus , amount and timing On what basis the need for the loan is decided? Are there cross subsidy between various pools? This also affects the way the surplus is allocated Uncertainty, Who is gong to pay the deficit? Are they the same participants? Is it from the surrender values? What about property Takaful for example? Uncertainty, In case of continuous losses? Who is going to pay the Qard? Will participants continue in the same pool/ fund

Technical issues and challenges (contd.) Treatment of underwriting and claims management, Similar ot the conventional with some differences have to be addressed:- There is no change whatsoever in the pricing process. For example substandard participants are charged fully?????? Consider this within the concept of Takaful. Exclusion of specific industries or group life policies , ( Alcohol, Tobacco, ) which is considered forbidden Exclusions they are more or less the same in the conventional insurance. What about Suicide during the first year?? Which is permissible under Shariah in some regions Ex gratia claims, who authorises them? Its impact upon the surplus distribution

Technical issues and challenges (contd.) Determination and distribution of surplus. Since there is no risk transfer , in isalm or takaful insurance, any surplus or profit is also prohibited, therefore there are different views on how to allocate the surplus generated from the underwriting it reflects sound underwriting/ risk management, therefore the operator must have a share Since no risk transfer , the operator should not get any portion of such surplus Surplus reflects the will of GOD therefore neither the operator nor the participants should get any portion. Surplus goes to Charities In practice all those options are all available , but also there is the option of holding the surplus wholly or partially in the form of Contingency reserves

Technical issues and challenges (contd.) Determination and distribution of surplus. The principles of surplus determination and distribution needs to be revisited in order to ensure timely and equitable treatment of participants In Takaful schemes many shall allocate surplus for maturing policies, or time of death? , what about the terminated policies Treatment of contingency reserve. It is at the end of the day part of the surplus which is retained to to be used as a buffer against adverse losses or to allow building self sustaining capital . This in built capital can be used to buy out shareholders and move towards the true Takaful concept. Also it can be used instead of getting Qard. This is a clear conflict of interest between the operator and the participants at least the current one.

Technical issues and challenges (contd.) Treatment of contingency reserve. Currently there is no formula that determine how much of the surplus can be retained as a contingency reserve Employing an actuary has become a must and in fact it is in many countries in order to evaluate such a need Treatment of participants pool Ideally pools have to capture large number of homogenous risks There are always the Takafulf family and property Takaful pools The choice of the number of participants of the pool is driven by the need to have a homogeneity within each pool,. This is the job of an actuary What about having a pool for each property takaful, Family Takaful?? The relationship with Licensing?

Technical issues and challenges (contd.) Issue surrounding Retakaful/ Retrocession All Retakaful reinsurance are applying exactly the same conventional reinsurance metohods. May be there are some changes in the terminologies but that it Retor Takaful Capacity is not there Dealing with conventional reinsurers, retrocessionariare If lloyd’s are establishing lloyd’s syndicate , one has to ask ,who is managing it, the source of income, its investment, its entire operation, does it have anything which is Shariah compliance? Same goes to the international companies having what they Call shariah window

Technical issues and challenges (contd.) Treatment of converting from Conventional reinsurer to a retakaful Might be of less importance in Property Takaful What about family Takaful

Comparison Between Takaful and Conventional
The contract, Risk transfer visa vi risk sharing Objectives, Profit maximization visa vi mutual interest/ joint guarantee Insurance company role, Insurer visa vi operator Ethical framework, codes of conducts of business visa vi Islamic business ethics, social responsibility Underwriting policy, insurability, profit making, underwriting teqniques visa vi haram business otherwise very similar

Comparison Between Takaful and Conventional
Investments, no restrictions as long as within the governing commercial law, visa vi Shariah compliant investments, Interest free Surplus, Shareholders account via vi sharing system ,or participants or none Deficit to be carried by the shareholder, visa vi participants but to be covered with interest free ( Qard hassan) loan Laws, Secular regulations visa vi Shariah regulations Premium, Calulated on a conventional basis of pricing the risk and it is the money of the insurer, visa vi Tabaru’at or contribution

Takaful Insurance Sources Principles of Takaful, BIBF
Risk and insurance, Dr Shawky Saif El Nasr Cairo univercity Islamic (Takaful) concept, challenges and opportunities Milliman research report Other free readings

Takaful Insurance Lecture (3)

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