Takaful – Need and some Shariah related Aspects BY Muhammad Ayub
Insurance? • Sale of an indemnity for a premium: a sale or transfer of risk for a price, company liable to indemnify; • Exchange of premium payments now for future indemnity in case of specified events. It implies: • Insurance – a commutative contract! Vs. non commutative / one-sided transfers (Tabrru‘ or voluntary contributions) • Relationship between operator and the policy holder; • Risk? Shariah rules on risk! • Gharar – absolute uncertainty
Gaps in Islamic Finance • Assets underlying Islamic banking contracts need to be insured (legal requirement) e.g. Car Ijarah, Shipment of Goods etc. • Costumers criticize: Islamic Banking products avoid Riba, assets are insured by Conventional Insurance companies which again is prohibited in Islam. • Also need for Life Insurance e.g. Housing Finance etc. as well as to offer savings and protection related Takaful products to its customers. • Takaful is a prerequisite to complete the cycle of Islamic Finance.
Basic Human Rights? • To protect religion (belief) • To protect life • To protect Mal (wealth) • To protect posterity • To protect intellect / talent
Takaful? • Takaful – AAOIFI Definition: Collective undertaking by the participants to donate, not simply an individual donation; • Takaful: A legalistic structure: Two or more parties providing support to each other; • Risk sharing instead of risk transfer; • Indemnity? Each participant has an opportunity to be indemnified form T. Fund (not from outside); • Takaful operator: an insurer / indemnity provider? • Manager of T. operations for providing protection to the members of a group in the society: • Underwriting: Process of examining, accepting, or rejecting insurance risks;Operator ’d write under risk; acceptance of risk; from? • Risk calculation • Claim processing & payments • Investments • Profit distributor • Corporate governance and R management
Takaful? • Human beings exposed to possibility of meeting catastrophes and disasters; • Muslims’ belief in Qadha-o-Qadr; but allowed to avoid such catastrophes and disasters; • Conventional Insurance an option; but • Involvement of Riba,Maisir (gambling) and Gharar • Takaful: social solidarity, cooperation; Every policyholder pays his subscription in order to assist those of them who need assistance; • Waqf, Mudarabah, Tabarru´ (conditional donation) and mutual sharing of losses. • Conditional gift for a Consideration: Donation to a risk pool subject to the condition that policy holder will get compensation for defined / specified losses from the pool. • Full or partial compensation? Takaful pool can run into a deficit; who to bear it? Operator or participants; Participants: from where?
Main Takaful Rules • Takaful Payments: donation for protection, and Investment saving Parts; • Investment: returns distributed on the basis of Mudaraba or Wakalah; • Protection part: Takaful Fund (for claims) • Underwriting Surplus / loss • Qard –e Hasan by Shareholders in case of need. • Mortality tables and other actuarial requirements • Policyholders :Takaful partners • No Takaful coverage for Shariah banned activities / assets.
Takaful Rules • The participants agree to help one another out of their contributions at the time when any of them faces any catastrophe or incurs any defined loss. • The operator and the partners who take any policy contribute to the Takaful Fund. Claims are paid from the Takaful Fund and the underwriting surplus or deficit is shared by the participants. • In life policies a part of the contribution is also kept as investment fund. • An economic institution whereby the losses of the unfortunate few are shared by the contribution of the fortunate many who are exposed to the same risk on co-operative risk sharing basis.
Deciding Factors • Uncertainty is a factor? • Nature of business: Commutative or non-commutative; relationship between parties: • Exchange Contracts: must be free from uncertainties in the counter values; • Premiums – Contributions; • Claims; • Investments • Underwriting surplus or deficit; • Rights and liabilities – in mutual framework. • Liquidation of Company: all reserves pertaining to TF must be spent on charity (AAOIFI, 26: 5/6).
Covering the Deficits • Participants get indemnity out of the risk pool collectively owned by all of them; • Technically, compensation has no relationship with the donation • Participants – commitment to pay further contributions! • Shariah issue: is it voluntary donation? • Principle of mutuality - members also agree to pay further contributions if needed. • Loan by TO: to be paid out of contributions; • Wakalah fee on the part set aside for repayment of the loan? • Provision of loan – rating and capitalization purposes • Trust concept for such Reserve Account – invoked only in case of deficit of TF.
Shariah Basis • Al Nahad or Al Nihad as discussed by Imam Bukhari (RA) • ‘Aaqilah’, - an arrangement of mutual help or indemnification customary; to contribute something until the loss indemnified • Aaqilah in respect of blood money • Islam accepted principle of reciprocal compensation and joint responsibility. • OIC Fiqh Academy approved Takaful system in 1985; exact method of operation left to Shariah scholars and practitioners
Risk Mitigation in Shariah • “ Tie your camel and then have Tawakkal in Allah” • “To leave your hairs wealthy is better than to leave them helpless asking people for their needs” • “Love your brothers as you love yourself” • “Believers support one-another” • Hoarding of wealth is a disliked act; • Savings allowed – at least, no Shariah ruling against it.
AAOIFI’s 9 principles & Shariah Bases Clause 5 of Standard on T’meen al Islami (Takaful): • Donation of contribution and return thereon to TA for indemnity; undertaking to bear any deficit; • T.O. maintaining 2 separate Accounts; • T.O. as agent in managing T Account and as Mudarib / Agent for investments • TA is entitled to T assets / should bear liabilities • Surplus for participants; T.O. not entitled to any share; • In case of liquidation, TF reserves must be spent on charity; • Policy holders to participate in management– rep. in BoD • Adherence to the Shariah tenets; No coverage for Shariah banned items and activities; • Formulation of S Board- opinion binding on the company; internal unit for monitoring and audit.
Takaful Process • The contribution in Life Takaful is divided into ‘protection part’ (for Takaful Fund / payment of claims) and the saving / investment part in case the Company is working as Mudarib; • if the Company is working on Wakalah basis, contributions would be divided into three parts, i. e. a part as management fee, protection part and the investment part. • The protection part works on donation principle; individual rights are given up in favour of the Waqf. • In the investment part, individual rights remain intact under Mudarabah principle • In case of general Takaful, the whole contribution is considered as donation for protection and the participants relinquish their ownership right in favour of the Takaful Fund • The UWS / UWL belongs to the participants.
Main Takaful Products • Life insurance – Family Takaful: • Whole Life policies • Endowment policies: payable to the insured if he/she is still living on the maturity date, or to a beneficiary / inheritor otherwise. • Retirement, marriage, education and protection to the general public and the corporate clients (While whole life policies promise the face value of the policy whenever the insured dies, endowment policies are confined to limited periods). • General / Composite Insurance • Marine, Fire, and Accident (Motor Vehicles, Ships, Aero planes, etc)
HOW IT IS DIFFERENT FROM INSURANCE • Concept of “Risk Manager” Not “Risk Taker” • Mutual help and Equitable Sharing of results; • Underwriting Surplus belong to Participants – Pool is the owner of all surplus – could be distributed back to the participants. • Underwriting Deficit is shared by participants and Takaful Fund members. • Risk Management • Underwriting as usual but not owned by the operator • Ensure Risk premium adequate – not commercially driven • Retakaful Pool instead of Reinsurance • Interest free loan by SH (Qard Hasnah) • Investments compatible with Shariah based on Profit Sharing principles.
TAKAFUL IN THE WORLD Profile of Global Takaful Industry • The first Takaful company was established in 1979 - the Islamic Insurance Company of Sudan. Malaysia started in 1984. • Presently 150 Takaful companies in 25+ countries worldwide offering General and Family Takaful with estimates of Takaful contributions at over $ 5 billions globally. Australia Bahrain Bangladesh Brunei Egypt Ghana Indonesia Iran Jordan Kuwait Luxembourg Malaysia Pakistan Qatar Saudi Arabia Senegal Singapore Sri Lanka Sudan Trinidad & Tobago Tunisia Turkey United Arab Emirates Yemen
MODELS OF TAKAFUL • Following three types of models are available: • Mudarabah Model: TO sharing in investment returns as also UWS (in family Takaful); but can TO share the UWS? – a Shariah issue. • Wakalah Model: Upfront fee for TO based on grass contributions; Performance related bonus from UWS? • Combination of the above two: Wakalah for management and Mudarabah for investment. • Wakalah with Waqf Model –Shariah Scholars Ijmah in Pakistan offered some refinements within the Wakalah Model to address some religious concerns related to the Wakalah model.
Waqf? • Three Types: Religious Waqf, Philanthropic Waqf and the Family Waqf. • Retention of a property for the benefit of a charitable or humanitarian objective, or for a specified group of people such as members of the donor’s family. • A separate entity which has the ability to accepting or transferring the ownership • Waqf property cannot be sold; only the usufruct is assigned to the beneficiaries • A member of a Waqf (donor) can also benefit from the Waqf
WAKALAH WITH WAQF MODEL TAKAFUL OPERATOR FEES FOR ADMINISTRATION EXPENSES 25% TO 30% MANAGEMENT EXPENSES OF COMPANY PROFIT / LOSS ATTRIBUTABLE TO SHAREHOLDERS COMPANY SHARE OF PROFIT FOR THE COMPANY 40% PROFIT SHARING ON MUDARABHA BASES INITIAL DONATION BY SHAREHOLDERS TO CREATE WAQF FUND PROFITS FROM INVESTMENT WAQF INVESTMENT BY FUND 60% WAQF FUND 75% TO 70% SHARE OF SURPLUS FOR THE PARTICIPANT 100% DONATION PAID BY PARTICIPANT PARTICIPANT WAQF FUND OPERATIONAL COST OF TAKAFUL /RETAKAFUL SURPLUS
Issues in Mudarabah Model • The relationship: based on Tabarru´ and not Mudarabah; Profit sharing cannot be applied here. Donation cannot be the Mudarabah capital at the same time. • Sharing in UWS makes the Takaful contract essentially the same as conventional insurance in which the SHs become the risk takers; Mudarabah based Takaful is rather worse because the Takaful operators / SH take only UWS, but not bear UWL, if any. • In non-life Takaful, the paid premiums are not returned: In Mudarabah; has to be returned net of loss. • A Mudarib cannot be a guarantor to the financier; Qard Hasan by SH not commensurate with Mudarabah rules
Difference between Conv. Proprietary Insurance and Takaful Proprietary Insurance Transferring risk in return for a premium – gharar, maisir and riba • Subject matter is an indemnity provided by the insurer Responsibility of policy holders • Pay premium, liability of the insurer • Obligation to pay the claims with insurer • Profit or loss to the operator Takaful: • Company: Manager of the risk portfolios, not risk bearer • Combination of Tabarrue and mutual sharing of losses between individual policy holders and the pool (T. Fund) on the basis of Wakalah and/ or Mudarabah; Responsibility: with the T. F. Premium as contribution; • US / UD – participants (practices vary: Some companies also take share in US – do not bear UD (Mudarabah Model)
Difference…………(Contd.) Liability of Insurer: • Liable to pay claims from premiums; if needed from the Shareholders funds Access to capital: • Share capital and debt; Investment of Funds • No restriction except for prudential reasons • Takaful operator simply acts as a manager / admtr of T. Fund and as a Mudarib for investment part of contributions In L T policies • Cab be legally obliged to ensure solvency of Takaful by giving interest free loan in case of UWL • Loan to be paid back from future contributions • Access to share capital, but not to debt – only interest free loan to the Fund; Investment: Only in Shariah compliant avenues
Difference…………(Contd.) Life insurance policies: • Whole life policies • Saving products: Endowment policies and pension plans • Only endowment policies – a maturity date, specific benefit in case of death before maturity;
Shariah bases & Opportunities • Find lots of groups and individuals not taking insurance due to religious reasons. • Significant increase in the leasing/Ijara and Home Mortgages • Personal lines insurances: Property and Casualty insurance for an individual as opposed to a business • Increase in demand due to the need for security. • More suited for a Takaful operator due to the religious apprehensions related to insurance by individuals. • Islamic Banks need to complete the cycle.
TAKAFUL MARKET AND COMPETITION • Six full fledge banks working on Islamic basis (Meezan, Albaraka, BIP, DIBP, EGIB, Daud Commercial). • Twelve conventional banks’ IB operations. • IBBs – 551 branches by end of September, 09. • Share of Islamic banking in Banking system: 5.1% • Islamic banks: Rs. 313 billion • Islamic Banks have a mandated requirement / moral obligation to insure assets from a Takaful company once available. • This would provide an automatic market for Takaful business.
Challenges • Raising awareness among various stakeholders; Ulama – the mind maker and the public; • Misconceptions need to be dispelled; • HR – E & T; more in-depth understanding of the system particularly, the Shariah related aspects • Marketing / Distribution– Sale of policies; presently: highly defective and exploitative. • Developing a fair distribution channel; • Challenge for Islamic banks
Let’s Discuss Takaful • Meaning • Model • Wakalah fees / Sharing Ratio • Surplus • Investments • Covering Underwriting deficit • Shariah Board. • Annual Shariah Audit.
Takaful in Brief • Takaful Company must present a competitive product/service in terms of price, quality of coverage and delivery time. • Competition against the established conventional insurance companies and survival. • Professionalism and avoiding malpractices is critical. Takaful fund belongs to the Participants and NOT to Shareholders. • Consumers need to support Takaful companies as well as to ensure that they are competitive and operations are Shariah compliant in all respects. • Only consumers could ensure that Takaful operators operate in the spirit of mutuality which Takaful is all about.