Takaful insurance is based on the principle of Ta’awun or mutual assistance. It provides mutual protection and joint risk sharing in the event of a loss by one of its members. This evolved from the Islamic practice of Aqilah, or blood money. This was practiced by Arab tribes before the advent of Islam and was approved by the Prophet Muhammad (SAW).
In the event of death caused by someone from another tribe, the members of the offender’s tribe would share the ‘blood-money’ to provide for the family of the victim. Without this sharing, the person inadvertently causing the death would face great hardship in paying the blood money.
Takaful insurance also evolved from Muslim businessmen making long journeys by sea for trade. They would collect money from each merchant and use this to compensate those among them who incurred a loss of ship or merchandise from the journey.
From the Quran
The need for insurance is shown in the following verse of the Quran:
“Those of you who die and leave widows should bequeath for their widows a year’s maintenance and residence” (2:240).
Qada’ and Qadar
It is a Muslim’s belief that everything that happens in this world is by the will of Allah (qada’ and qadar). Thus it may be argued that whatever accident, misfortune or catastrophe occurs should be accepted, not eliminated through insurance. Although it is true that we should accept whatever “misfortune” which may occur, we are also taught to avoid or reduce the possibility of these “misfortunes” by taking positive steps.
From the Hadiths
One day the Prophet (SAW) saw a Bedouin leaving a camel and he asked the Bedouin, “why don’t you tie down your camel?” The Bedouin answered, “I put my trust in Allah.” The Prophet said, “Tie your camel first, then put your trust in Allah.” (Al-Tarmizi and Ibn Majah).
This active role in risk reduction is also shown in the Prophet’s strong support for the Al-Fudoul Confederacy (just prior to the Islamic period) which was formed to suppress violence and injustice, and vindicating the rights of the weak and the destitute. (Ar-Raheeq Al-Makhtum, Biography of the Noble Prophet, Maktaba Dar-us-Salam Pub., Saudi Arabia 1995).
Scholars are not in agreement as to whether insurance is permissible (Halal) or prohibited (Haram). Since insurance as it is being practiced now did not exist during the Prophet’s time, there is nothing in the Quran or Sunnah directly mentioning it. Ijtihad (reasoning) is therefore used to determine whether it is permissible or not. This also explains why there are variations in the model used for Takaful insurance in various countries as well as within a single country.
Although Takaful Insurance Companies have been active since the early 1980’s, real interest in Takaful has just started to swell, with more and more insurers seeing a need to enter this market. This translate to the potential for increased market share for some, but potential lost in market share for others. Also, experience of some of the earlier companies have shown that with the wrong models and risk management tools, business losses could occur, as well as stagnant sales and lack of critical size to operate effectively.
Large untapped market for insurance/savings in compliance with shariah laws.
The operator must be completely shariah compliant in every aspect, while at the same time being able to compete with the international players operating in the region.
The development of a model and products fitting the shariah requirement in Saudi Arabia, while at the same time being competitive with the international players and giving an acceptable profit/risk profile.
- Development of detailed prospections for submission to the shariah council and regulatory authorities.
- Assistance in other aspects such as system design and testing, reinsurance, distribution issues, and staffing/outsourcing needs.
Takaful Insurance or insurance for Muslims is designed to adhere to Islamic laws and is based on the principles of fairness and equity among the participants (policyholders). Modern religious scholars have declared that traditional insurance is unacceptable by majority of scholars due to the type of investment traditional insurance companies’ use as well as the uncertainty involved in traditional insurance contracts. In Takaful insurance there is no transfer of risk to a third party (i.e. stockholders) but a sharing of risk among participants.
Takaful insurance companies avoid investing in interest bearing securities as well as investing in unethical and immoral business (such as alcohol manufacturers, gambling casinos). The rewards in an Islamic investment should be profit or fee based. Typical investments include lease and rental instruments, real estate financing contracts, and venture capital funds. These investment types are largely untapped at the present moment.
Islamic law forbids the use of contracts that contain uncertainty. Thus it is not possible to have an insurance contract as that which exists between a conventional insurance company and a policyholder as that contract contains elements of uncertainty.
For example in a term insurance policy, not only is the timing of the payment of the death benefit not known, but whether any payment will be made (as the policyholder can survive the duration of the policy). However, it is acceptable in Islam to go into arrangements for mutual assistance. Based on this concept, Takaful insurance exists mainly as a cooperative or mutual arrangement.
From the Islamic perspective, traditional proprietary insurance companies contain elements of gambling in that the profit of shareholders depend on the misfortunes of the policyholders, for example annuities. With Islamic insurance there are joint guarantees among members, with risk sharing and mutual cooperation. The focus is on the community, not shareholders. Reinsurance is needed as in traditional companies, although preferably with the Islamic companies (re-Takaful).
Risks and Pitfalls
Where events repeat themselves often enough, they can be anticipated and consequently managed. For example although death is inevitable, it does not mean that we should not prepare ourselves for this eventuality. Within a group of people, no one can anticipate who would survive from year to year. However, the number of people who would die out of a large enough group can be estimated closely enough (i.e. law of large numbers ). With this estimation, each individual in the group can manage this eventuality by agreeing to pool their resources to help the dependents of its members who die early. This is the concept of Takaful.
In conventional insurance the actuary determines the appropriate premium to collect such that the predetermined sum assured can be paid on death. This amount may or may not be sufficient. The difference between the two being the total premium collected and the total death benefit payout (whether positive or negative) is underwritten by the insurance company. In Takaful, the Takaful Operator does not underwrite the difference between the contributions collected and the sum covered. Any difference, called the surplus or deficit, is shared among all participants.
There is therefore, still a role for an actuary in Takaful. For example his role may be to quantify the initial contribution to be collected at the outset. For the same amount covered the contribution from a 30 year old participant will necessarily be lower than for a 70 year old participant. To expect the same contribution irrespective of age of the participant would be unfair to the younger participants.
Thus the actuary uses his skills to quantify the risk brought into the Takaful pool by each Takaful participant. This risk expresses as a contribution rate. Similarly, any surplus or deficit arising after benefits have been paid should be apportioned to the participants based on an actuarial methodology.
Quantifying risk is only one of the skills an actuary can bring into the organization. Ultimately by understanding how the various aspects of the operation interact with each other the actuary is able to manage risk prudently and effectively.
Capital Requirement Analysis
Management of risk includes how much capital is needed to run the company and what controls should be in place. Indeed, determining the appropriate level of capital and control is the role of the Takaful Regulator. Too much capital requirement and too much control can stifle the development of the Takaful Industry. The Regulator can therefore also use the services of an actuary.
Response to Competition
The earliest Takaful companies, set up in the 1970’s and 1980’s, were done to satisfy the needs of the muslim population. The concept of competition was not an issue as Takaful was new to industry experts and consumers alike.
Today, the concept of Takaful is well known in many markets, making the decision to switch to Takaful to be very much based on competition. If a competitor has recently switched to Takaful or is in the process of switching, the competitor may gain significant market share at your expense.
There are many factors that will determine the actual loss in market share of not switching to takaful and this would include the success of the competitor in launching Takaful as well as the perception of Takaful in the marketplace. If you expect to be the first Takaful company in your market, there could be many competitive advantages including increase in market share.