For purpose of proper description of various transactions under Islamic finance and the underlying principles governing its contract, Arabic terms are generally adopted. These terms had been commonly used in the past by Muslims to express their contractual obligations and dealings in respect of trade and commerce including finance as described in numerous writings and books written by various Muslim scholars. For this reason it can be seen that Muslims in different parts of the world, now practicing Islamic finance are adopting the same approach. Steadily, the terms are becoming universal. Certainly this would help to further accelerate the expansion of Islamic finance at the international level. In the same manner, efforts towards converging and harmonising of various operations and practices would be more conducive.
In the case of insurance, right at the outset `takaful’ is the preferred term instead of `Islamic insurance’. The distinction is clearly seen from the fact that takaful is based on the concept of trusteeship and cooperation in line with Islamic teachings. It is an Arabic word stemming from the verb `kafal’ which simply means to take care of one’s needs. This is an Islamic way of mutual assistance to deal with uncertainties of life. Members or participants of a takaful programme agree to jointly guarantee among themselves against loss or damage caused by specified or defined perils. In other words it is a legally binding mutual agreement among participants to pay or provide financial help to any fellow participant who suffers a loss upon being inflicted by a specified peril as defined in the agreement. The underlying obligations of the agreement illustrate that the entire participants, as a cohesive group would assist the unfortunate to alleviate of his sufferings due to a loss or damage, by providing him with financial help. Therefore it is not a ‘buying and selling’ contract that forms the basis of the underlying principle of the conventional insurance contract. The policyholder or insured would purchase an insurance cover from an insurer as seller and in consideration would pay the price in the form of insurance premium. In return the insured would receive a certain monetary benefit as compensation from the insurer in the event of a loss or damage.
Despite the operational aspects of takaful are subject to Islamic practices and requirements, it is most appropriate ‘Islamic insurance’ is not the term used to describe it. This in itself would help to dispel the notion or thinking that the operation is merely a process to `Islamise’ the conventional system. It is not simply playing with words.
From the standpoint of a community pooling system, any surplus or deficit of the takaful fund, as a source of social security, has to be shared by all participants. But when takaful operates on a commercial venture, within the private sector, providing opportunities and rights of choice to participants in accordance with their financial needs then the contract shall be based upon the principle of al-Mudharabah or profit sharing between participants and the operator as trustee managing the operation. With the incorporation of tabarru’ contract, it allows participants to give or to relinquish or to donate a specific portion of the takaful fund for the purpose of providing financial help to the unfortunate ones.
Certainly by way of profit-sharing principle of al-Mudharabah, investors as shareholders would have the opportunity to earn returns, if any, on the takaful operation. Needless to say, any venture that essentially provides a kind of financial guarantee covering a myriad of risks would require a fairly substantial start-up capital, particularly in the initial period of operation before adequate level of participation is secured that would steadily enhance the takaful fund. Currently insurers in Malaysia are required to have a paid-up capital of at least RM100 million. This should also be applicable to takaful operator to ensure its financial capability would be on the same level playing field. For this reason, it is common now for stock company to be established under which a group of investors would fund the capital. Hence the establishment of takaful companies.
The investors among them would enter into a joint-venture based on the principle of al-musyarakah for the purpose of establishing the takaful company. Returns on the venture would normally be dividends paid to them in proportion to their respective shareholdings. In this respect, the formation of the company is not an issue from the standpoint of Islam. In fact Islam not only reccognises the formation of companies; it categorises them into different types. Each type has its own characteristics. Like most limited stock companies, the formation of takaful operator as a company falls under the type of ‘syarikat-ul-iman’. Shareholders as owners do not assume the task and responsibility of managing and overseeing the day-to-day running of the company. On the contrary a special body of employees are engaged for this purpose. In consideration they would be given remuneration based on the principle of al-ujra.
In reality, managers as professionals in various disciplines would be entrusted to ensure not only that the operation would be profitable as a commercial venture in satisfying the insurance needs of the public but more importantly it is conducted within the confine of Islamic teachings. On this note, where necessary, takaful has developed its own conventions. A practical example can be seen in the accounting practice where the traditional convention would have difficulty in ensuring fairness in the operation.
In order to truly reflect the contractual obligations under the profit-sharing principle, the most appropriate accounting policy would be on cash basis. Profit to be shared has to be based on the actual sum. The rate of profit calculated would then show a true picture as it takes into account only actual contributions received by the operator. Should the accounting policy be on accrual basis, unrealised profit would have to be taken into account in the calculation. Thus distributing the actual profit may not be possible in view that the profit account may have insufficient fund.
Probably the only downside of cash accounting would be the question of bad debt. Cash accounting usually does not recognise bad debt. However, in insurance operation this would not pose a major problem. What constitutes bad debt would be the non-payment or outstanding premium. Takaful operators, like insurers, are required to evoke the warranty condition in case of non-payment of contribution. Cover would cease automatically upon expiry of the warranty period. Therefore, bad debt arising from outstanding contribution would not be significant. On the other hand cash accounting basis helps both participants and operator. Participants should pay the contributions on the day the takaful is effected as in the requirement of cash-before-cover to have the benefit of earning maximising returns. Profit takes into account when the payment is made. Obviously, the sooner the contributions are settled, the higher would be the profit payable.
In order to denote its unique mode of operation, takaful operators world wide have adopted its own terms. It helps to distinguish between the conventional system. Therefore, by merely engaging premiums or insurance funds in investment avenues acceptable in Islam would not tantamount to cleansing or making insurance Islamic.