The Need For Protection

Every member of the community in his day-to-day life is invariably exposed to the possibility of encountering catastrophe, disaster and mishap which may give rise to all sorts of misfortune and tragedy such as death, fire, burglary, motor accident, etc. For a Muslim he must believe in the catastrophe or disaster befalling him as `qada’ and qadar’ from Allah. In this respect he must face these unfortunate events with resilience, both spiritually and physically, with the strength of faith and patience. Nevertheless it is also the duty and responsibility of every Muslims to find ways and means to strive hard to avoid such catastrophe and disaster wherever possible, as well as to lighten his or his family’s burden in the event of such ill luck occurring.

Indeed it is the possibility of having to cope with such catastrophe and disaster that has made us realise the need to be adequately and fully prepared, in particular in terms of financial resources, should such event occur despite him striving hard to avoid it. Obviously to most people it would quite natural to wish that they would be able to provide their dependents and loved ones a certain the sum of money in the event of their death. They would feel secure in their knowledge as that sum of money would help to alleviate the misery and hardship that their dependents and loved ones may face resulting from such tragedy. For example, a person who is exposed to the dangers of his house catching fire or his motor vehicle meeting with an accident would always wish that he would have enough money to repair his house or his motor vehicle should such disaster did actually take place.

Perhaps one way to cope with such an eventuality is by way of personal savings. However, such measure may not always be sufficient as the sum of money required might be substantial and it takes time to save, whilst a catastrophe or disaster may strike at any time. Although personal savings are essential, in most cases it may be sufficient. Hence additional assistance and financial resources are critical.

Therefore it becomes necessary for us to be prepared. As a matter of fact, Islam encourages Muslims to do their utmost to be prepared and seek protection or cover in their activities as is clear in the following hadith “The Prophet (s.a.w) told a Bedouine Arab who left his camel untied to the will of Allah: Tie the camel and then leave it to the will of Allah” (Reported by Al-Tarmizi and Ibn Majah).

Until recently, one form of protection which a Muslim can avail himself as a means of cover against the consequences of catastrophe and disaster is through the insurance policies provided by conventional insurance companies. Basically, these companies offer two types of policy namely life insurance which essentially covers losses against death, and general insurance which covers losses against fire, motor vehicle, accident and the like.

However, the participation by Muslims in these insurance policies has raised doubts from the viewpoint of Syariah. In view of this, Muslim scholars had conducted a thorough and comprehensive study on the operations of the conventional insurance. Arising from this study, the generally accepted view of the scholars is that the operation of the conventional insurance does not in its present form comply and conform to the rules and requirements of the Syariah. It is indeed important to stress at the outset that it is not the concept but its practice which does not meet the rules and requirements of Syariah. On the contrary, the concept insurance which simply means pooling of common resources to help the needy is very much in line with the teachings of Islam which propagate solidarity, mutual help and cooperation among members of the community. Therefore insurance is not a practice to challenge the will of Allah or having little faith of His mercy.

As a matter of fact, the essence of insurance could be seen in the system of mutual help in relation to the custom of blood money or `diyah’ under the Arab tribal custom. Under this system, the victim would be compensated by the members of the community whose action had resulted in the loss of life or impairment of the victim. Therefore, the principle of compensation and group responsibility was accepted by Islam and the holy Prophet. Muslim scholars acknowledged that the basis of shared responsibility in the system of `aqila’ as practised between Muslims of Mecca (Muhajirin) and Madinah (Ansar) laid the foundation of mutual insurance. It is the pooling of common resources to help the needy, a scheme which is very much in line with the principle of compensation and shared responsibility among the community.

Although as a concept, insurance does not contradict the practices and requirements of Syariah, Muslim scholars however have generally concluded that it is the practice and operation as provided by the conventional insurance companies which do not conform to the rules and requirements of Syariah. Towards this end, in June 1972 the National Fatwa Committee resolved that the present-day life insurance business provided by the conventional insurance companies was not in line with the principles of Syariah. Similarly, in a comprehensive deliberation, the Fiqh Academy of the Organisation of Islamic Conference (OIC), at its gathering in December 1985 resolved that no form of insurance, life or general, conformed to Islamic principle.

How is Profit Shared In Takaful

In consideration for participating in the takaful programme which forms the basis of a joint-guarantee and mutual help among the takaful participants through various products provided by the takaful operator, the participants would pay a certain sum of fees, like a subscription, called takaful contribution which is then credited into a special fund known as the takaful fund. It represents a risk-pooled fund and accounting wise is separated from any other fund of the operator. Like an investment scheme, the takaful contribution on the one hand is almost similar to an investment capital which generates returns or income to the participants if the takaful business makes money. Unlike the premium paid under the conventional insurance practise, takaful contributions cannot simply be treated as direct and outright expenditure in view of the contractual arrangement of a certain return to the participant upon expiry of the period of cover. On the other hand under the conventional practise, the only `return’ to the policyholder from the premium paid for the price of insurance cover will be confined to the claim proceeds in the event of a catastrophe or disaster inflicted upon the policyholder.

On the contrary, return on the takaful contribution is an entitlement guaranteed under the takaful practise in accordance with the al Mudharabah contract which simply means the right to profit sharing. In this respect the parties entitled to the profit sharing arrangement are the takaful participants on the one hand and the takaful operator on the other. Arising from this unique structure, takaful participants would have the opportunity over a period of time to enjoy at least one period of free cover, in particular for takaful products of one year period of cover. This is seen to be possible through the savings of profit earned out of a number of years of participating in a takaful product. For example, Takaful Malaysia has been declaring not less than 35% p.a. profit for its short-term takaful products such as motor takaful scheme, fire takaful scheme and personal accident. Assuming that the takaful contribution paid by the participant each year is of the same amount, he would therefore have accumulated sufficient sum of money from the profit shared every year over the past three years of his participation to pay the takaful contribution fourth consecutive year. At the same time like an insurance policy, the participant shall be entitled to any claim benefit should he suffer a loss resulting from a misfortune as defined in the al Mudharabah contract. In other words, claims or no claim the participant would have something in return in consideration for his cost of insuring under the takaful practice.

Therefore it is clear that by participating in the takaful programme, participants are not only entitled to certain financial benefits in the event of a loss due to a misfortune but also the right to sharing the profit. The characteristic of the contract is that the takaful participant in his capacity as the provider of capital or fund, termed as `sahibul-mal’ would pay the takaful contribution, called `ra’sul mal’ to the takaful operator acting as the entrepreneur or `mudharib’ who is responsible and entrusted for providing and managing a business project or venture. The rate of contribution can follow the insurance premium as adopted by the market, based on the principle of `uruf’ or common market practice. In the case of takaful, the entrepreneur provides and manages the takaful business as prescribed under the Malaysian Takaful Act 1984.

Apart from the profit sharing provision or entitlement, the al Mudharabah contract also specifies and spells out the obligations and responsibilities of both parties of the contract. In the case of profit sharing, the profit, if any, to be shared is based on a predetermined ratio agreed by the parties concerned upon the inception of the contract. However, the right to profit sharing comes only after all the obligations under the contract have been recognised and fully undertaken. In other words, the fulfilment of takaful needs must be given top priority to ensure that the loss suffered by a participant is rightly and justly compensated. After all the basic purpose for any participant using the takaful programme is to avail himself of cover as a facility to mitigate his financial sufferings should he suffer a loss due to a misfortune or mishap. Therefore, profit can only be determined and shared after all claims and its related expenses are paid to the unfortunate participant.

As provided under the Takaful Act 1984, there are two types of takaful business, namely Family Takaful and General Takaful that a takaful operator can provide. In this regard, the profit-sharing structure varies from one type of business to another. For this purpose, it is obviously imperative to know first what profit is to be shared between the takaful participants and the operator.

In the first place, there must be distinction between profit or loss of the takaful operator itself as reflected in the shareholders’ fund and eventually be distributed as dividends to the shareholders, and profit, if any, of the takaful funds which is to be shared between the operator and takaful participants. A clear definition of these two sets of profit is crucial to ensure the profit sharing is calculation is undertaken correctly. Nevertheless, in any business venture profit-sharing can only take place if the business makes money. Therefore it is essential for the operator to manage the takaful business profitably.

In the case of general takaful of which its products are short-term in nature, usually for a period of cover of one year and subject to renewal, profit is defined as balance of the total aggregate of takaful contributions paid by participants to the general takaful fund, less payment of claims paid and incurred, the cost of retakaful and the provision of appropriate reserves. In insurance jargon this is generally termed as underwriting surplus. Together with the overall returns on the investment of the general takaful fund, the surplus shall be declared as the profit of the general business which is then subject to profit sharing between the participants and the operator under the al Mudharabah contract.

In line with the characteristic of the al Mudharabah contract, profit is shared at the gross level and not after charging expenses of the operator. Sources of income to the shareholders’ fund are essentially its share of profit under the al Mudharabah contract and returns on the fund’s investment. The surplus of income as declared in the shareholders’ fund after paying all the operating expenses shall be the profit of the operator.

Profit Sharing For General Takaful

The Mudharabah or profit-sharing principle which forms the basis of the takaful contract provides additional incentive to takaful participants. From the consumer perspective this is the value added feature of takaful business. By the profit-sharing arrangement which is guaranteed under the contract, the takaful contribution paid in consideration for participating in the takaful product will generate a certain return to its participants. In contrast to premium as the price for buying an insurance policy, takaful contribution on the one hand is like an investment fund giving income to the provider of the fund. As a matter of fact, the Mudharabah contract is one of the major differences between takaful and conventional insurance.

profit sharing
profit sharing

Essentially, the basic purpose of insurance is to avail of cover wherein an adequate financial compensation is ensured in the event of a loss or damage due to a tragedy or misfortune. Mitigating such loss as a means of relieving the financial hardship of the aggrieved victim is also the bedrock of takaful. Under takaful, the compensation comes from the sum of `tabarru’ or donation made out of the takaful contribution of all participants. The creation of a defined fund, known as the takaful fund, arising from the expression of solidarity and joint-guarantee in the event of misfortune is in fact established through the payment of takaful contribution. On the other hand, the compensation under the conventional system is the only point of exchange for buying the insurance cover. Should there be compensation free, the premium will be an outright cost to the buyer. No other forms of return are shared with the buyer

In the same manner, neither discount nor special rebate be given to the buyer upon renewal of the contract except in motor policy. For motor policy `No-Claim Bonus (NCB)’ is usually given as an automatic discount on the renewal premium for policyholders who have not made or incurred claims. NCB is not profit-sharing, it is merely an up-front price discount for good drivers. Therefore it should not be equated with profit-sharing as in the Mudharabah contract of takaful. For the purpose of recognising good drivers, similar NCB system is also given in takaful. Thus besides profit-sharing which comes upon expiry of the contract, discount on the takaful contribution is also provided upon the commencement of cover. In this regard, profit-sharing as guaranteed under takaful must not confused with the provision of NCB. Being a common market practice NCB is applicable both in takaful as well as conventional insurance.br>
Currently, Malaysia is the only country having a special law to licence and supervise takaful operation. The Takaful Act 1984, amongst others provides the definition of takaful, the requirement for establishing Religious Supervisory Council as well as the types of takaful business that a licensed operator may provide. In the same way as the conventional system, there are two types of takaful business an operator may transact and each requires a separate licence. For instance, in the case of Takaful Malaysia as a composite operator, it provides both the Family Takaful and General Takaful. The former is roughly comparable with the conventional life insurance and the latter is akin to non-life or general insurance.

Products under general business, called takaful schemes, are short-term in nature, usually for a period of one year and may be renewed. Like insurance policies, these schemes are meant to provide cover or protection against material loss or damage to assets such as buildings, houses, motor vehicles, stocks and other related interests. In essence, any individual or organisation may participate in any of the takaful schemes to cover their belongings. Acceptance of participation by takaful operator is usually formalised through the submission of a proposal by a participant.

The agreement entered between the participant and the operator is the mudharabah contract, and not of “buying-and-selling”. Within the Mudharabah contract there is a supplementary agreement incorporated as a sub-contract to enable every participant to give away as tabarru’ his or her takaful contribution in the event of a claim. For general takaful, the tabarru’ amount cannot be determined upon the commencement of the contract. Its actual amount would depend upon the actual loss suffered by the participant.

All sums of takaful contribution paid by participants will be credited into the defined fund: the general takaful fund. The fund is invested and returns on the investment will go back to the fund. Thus the fund would be enhanced from the investment income. Should a participant suffer a material loss, claims are paid from the fund out of the tabarru’ portion. This is joint-guarantee in practice as seen in the mutuality concept. Other expenses deducted from the fund are costs related to retakaful which would help to stabilise the fund and other related reserves. As can be seen, operating expenses or management costs such as overheads, rentals and alike are not charged to the fund. These expenses are borne by the shareholders’ fund.

Assuming that a sum of RM10 million is the total takaful contribution collected in a given year say from 5,000 takaful participants, under the general business. Investment of the fund has generated an income of RM1 million. Hence the fund would increase to RM11 million. At the same time, a sum of RM5 million has been provided for claims paid and incurred to 1,000 participants, whilst an additional RM1 million has been set aside as reserves.

Therefore the fund would post a balance of RM5 million which is profit of the general business. In line with the profit-sharing contract of al Mudharabah, the profit will then be shared in accordance with agreed ratio. If it is 50:50, based on the above illustration, RM2.5 million will be distributed to the participants, excluding those who have received claim benefits whilst the balance of RM2.5 million will be credited to the shareholders’ fund as profit attributable to the operator. Obviously claims would be the most influential factor affecting profit. However, based on the Mudharabah contract as practised by Takaful Malaysia rates of profit paid to participants range between 30% to 40% p.a., an opportunity for participants to enjoy returns on their expenditure.

Family Takaful As An Alternative To Life Insurance

It is human nature that anything new would not normally be easily and readily accepted as a matter of course. When takaful was first introduced as an alternative for Islamic insurance in the early eighties, there was strong reservation that it would not be viable, and what more profitable. In fact similar reservation was expressed on the viability of a banking operation without interests when Islamic banking was first introduced. In the same breath takaful was perceived to be a non-starter for the simple reason that its profit ought to be shared with the policyholder. The reservation probably stemmed from the general scenario on the difficulty of insurance industry as a whole at that time to make money out of the insurance operation. Most companies suffered poor underwriting results. Without the support of investment, it was likely that most of these companies would not make profit. Given such a scenario there was bound to be question on how would takaful shareholders able to reap their rewards from their financial sacrifices and faith in investing in the takaful project.

Now, the takaful system developed, and evolved to be the Malaysian model, has turned out to be viable to both participants as users or consumers, and shareholders as investors in term of the financial benefits that they have been enjoying. Right from inception, participants of all takaful products under both the Family Takaful Business and General Takaful Business have been receiving returns on their contributions or premium. In the case of General Takaful, taking the performance of Takaful Malaysia as a practical example, the rate of return for yearly renewable products such as takaful schemes for motor, fire, personal accident payable to participants is on the average has not been less than 35% p.a. In the same manner, shareholders have been enjoying dividends ever since it was first declared and paid in the fourth year of Takaful Malaysia’s operation.

As a system, takaful is steadily gaining popularity and this in fact has posed a challenge to the takaful operators. Measures have to be taken to reach out efficiently and effectively to the consumers in order to satisfy their insurance needs. In this respect, the pace of product development for takaful has been relatively fast. All in, takaful products would now be available to meet the insurance needs of all sectors of the community, both at the individual as well as the corporate levels. Perhaps taken a step further, there are takaful products designed specifically to cater for the needs of a particular sector of the community, normally considered to be of a low priority from the standpoint of conventional insurance. As an example, Takaful Malaysia provides two different products, namely Takaful Rumah Desa and Skim Takaful Baitul Saadah for the purpose of covering houses or private residences in the rural areas and including their owners. These are traditional houses usually built of wooden structure that are not normally readily accepted under the conventional insurance policy.

The diversity of takaful is further illustrated from its ability to cater for the long-term financial needs as usually provided under a life-insurance type of product. This demonstrates takaful would be able to satisfy both the financial benefit due to early death of a breadwinner as well as savings for old age. Under takaful, these are long term family products that are essentially fixed term financial planning programme. Participants of the family product shall agree to participate in a takaful plan with a fixed period of maturity of their choice. For this purpose, a participant may choose a minimum term of 5 years or a maximum of 40 years. In consideration, the participant shall also agree to pay the takaful contribution in instalment monthly, quarterly, half-yearly or yearly within the term as long as he or she is alive. To ensure that the participation shall be in force at all times and the benefits would be payable in the event of a misfortune, the contribution must be paid on time according to the schedule of payment.

As the transactional aspect of takaful is not based on the contract of buying and selling, contrary to a conventional life insurance policy, the family plan does not charge a premium. To a policyholder the price of buying a life policy would be the premium charged, usually depending upon the former’s age. The older the policyholder the higher would be the premium. This does not happen in takaful. In a sense, there is no compulsion in terms of the amount of contribution to be paid. Therefore, the question of financial capacity or affordability on the part of the participant does not arise.

Once the participant has chosen the term of the plan, the next decision he has to make would be his choice of the amount of contribution. For this purpose, for most people it should not exceed 10% of their income. The operator, however, as a matter of policy would set the minimum amount.

The contribution paid shall be credited into the Family Takaful Fund which is sub-divided into two accounts, namely Participant’s Account (PA) and Participants’ Special Accounts (PSA). A huge portion of the contribution that represents the core savings of the participant is in the PA, whilst the balance is for the PSA designed to assume the mortality liability of all participants.

How much of the contribution meant for the PSA shall be based on the mortality table and other actuarial requirements as certified by a qualified actuary in accordance with the Takaful Act 1984. This approach would not be contrary to Shariah as the assumption is merely a sound technical strategy to ensure good governance in the management of takaful operation that would create confidence among participants. In general, mortality basis is relatively low. Thus the corresponding rate of the contribution for the PSA would be relatively small. For Takaful Malaysia the rates range between 3% to 13% depending upon the age of the participant at the inception as well as the term of the family plan.

What is important from the contractual point of view is that the amount credited into the PSA is made as tabarru’ or donation by the participant. The total aggregate of the tabarru’ paid by all participants in the PSA would be the benevolent fund that provides certain benefits in the event of death of a participant. The death benefit from the PSA would be calculated from the date of death to the date of maturity of the plan based on the amount of contribution paid.

Both the PA and PSA are invested and returns thereof shall be subject to profit-sharing under the mudharabah contract between the participant and the operator. Again the sharing is at the gross profit before deducting the operator’s management expenses. The profit attributable to the participant shall be credited into the PA and PSA accordingly.

Upon expiry, the participant shall be paid the maturity benefits comprising of the total balance in his PA. In addition, he shall be paid a certain percentage of the actuarial surplus, if any, out of the PSA. It is noteworthy to mention that in contrast to the conventional system, the takaful operator shall not be entitled to share any of the actuarial surplus. In this regard, like a conventional life policy, the family plan would be able to fulfil the financial needs of the individual either for the purpose of relieving the financial burden in case of early death of a breadwinner or accumulating savings for retirement.

Should a participant have to break the contract and therefore surrender his plan, he shall be refunded of all the contributions in the PA including investment returns thereof at any time. In other words, there is no forfeiture in takaful under which a participant would loose his money if he has to cancel his policy. However the tabarru’ contribution that he has donated in the PSA shall remain in the Fund.

The thrust of marketing takaful products therefore should not be focussed solely on the issues of Shariah. Takaful operator must able to demonstrate that the respective products would be able to meet the specific needs and financial objectives of modern-day consumers. From the dearth of interests shown on the Malaysian model, both at home and abroad, takaful looks poised to steadily becoming a force within the Islamic financial sector in particular, and insurance industry in general.

The Need to Standardise Takaful Operation

The unveiling of the Financial Sector Masterplan (FSMP) by Bank Negara on 1st March last year, underlines a strong manifestation and a firm commitment of the Government to ensure an orderly development as well as a vibrant and resilient financial system in Malaysia that would be able to withstand competition and liberalisation arising from globalisation. In a nutshell, FSMP charts the future direction of the system over the next 10 years. In line with the policy of a dual financial system, a special chapter is devoted in the FSMP on Islamic financial sector covering both banking and takaful. All round, the focus is to establish a dynamic and comprehensive Islamic financial system that would contribute meaningfully towards the effectiveness and efficiency of the financial sector whilst meeting with the economic needs of Malaysia.

Among the critical milestones set out in the FSMP include targets of transforming Malaysia to be the regional center for the development and promotion of Islamic banking and finance, and that both Islamic banking and takaful are to capture 20% of the overall market share of banking and insurance respectively by 2010. As for the takaful sector, should the trend of strong growth continued as seen from its main business indicators of double-digit growth, the goal of capturing the 20% market share looks optimistic. For example, contributions income of takaful against total premiums of the insurance industry rose to 9.1% last year, compared with 3.8% the year before.

Nevertheless, steps towards attaining the target would depend a great deal on the direction taken within the takaful sector itself. As expressed in the FSMP, new takaful licenses are to be issued to suitable parties as a measure to accelerate market penetration of takaful business. It is estimated at present less than 15% of Muslims bumiputra are covered by life insurance, indicating a huge market potential for takaful, especially the family products. Certainly the penetration is far below the overall rate of around 35% for the country as a whole. But increasing the number of operators would not necessarily mean higher market penetration. The market share cannot be enhanced should a divergence of practice in terms of operational structure exist. Although diversity is acceptable in Islam, that in a way underscores its greatness of flexibility, due to difference interpretations among Islamic scholars on matters relating to trade and commerce including finance, unity of practice on the other hand would be the preferred choice in the interest or maslahah of the public. Certainly it would not augur well for the growth of takaful sector in particular, and Islamic financial system in general if the operators were to adopt various models of operation simply for the cause of business. It would create a lot of confusion among the public.

The takaful operation as successfully developed and practised in Malaysia is based on the profit sharing contract of al Mudharabah combined with the donation or tabarru’ agreement. The objective of tabarru’ is to enable takaful participants to establish a kind of a defined benevolent fund to provide financial assistance to fellow participant who may suffer a loss in the event of a defined misfortune. This mutual assistance resembles the practise of aqila, a system of joint-guarantee and mutual help founded by the Prophet following his `hijra’ from Mecca to Madinah. Under the system, a defined fund, al-kanz, was formed wherein every member of the community, both from the migrants (muhajirin) of Mecca and the locals (ansar) of Madinah contributed to the fund

Obviously from the practical perspective, there would be variation in terms of profit-sharing basis and the application of tabarru’ between family takaful and general 0takaful. In the case of family, actual investment returns of the fund are defined as profit that shall be subject to profit-sharing between the participants and the operator. For general takaful, profit of the business that shall be subject to similar basis of sharing would be the underwriting surplus plus its investment returns.

As for the tabarru’, the rates for family products are made known to the participants at the outset and would remain the same until maturity of the products based on a certain mortality table as prescribed by an actuary. On the contrary due to its nature of operation, tabarru’ rates cannot be pre-determined or set aside beforehand under general takaful. The tabarru’ amount shall only be known once a claim is finally settled and paid to the claimants or aggrieved participants. In other words tabarru’ shall be contingent upon the occurrence of a defined misfortune.

The Malaysian model which has been in operation for almost 20 years now following the incorporation of Takaful Malaysia has from time to time undergone refinements and modifications in line with changing standard requirements of accounting, reserving, valuation that are equally applicable to conventional insurance sector. With its foundation firmly established, the Malaysian model has proven to be both viable as a business venture as well as profitable to consumers and investors alike. The fact that expenses of the operator are fully borne by the shareholders’ fund and cannot be charged to the respective takaful funds makes the model more credible in terms of upholding the principles of fairness and good virtue in a contractual obligations. The expected cash outflow from the takaful funds would thus be relatively limited mainly confined to claims and other related reserves. Hence profit-sharing would be fairly significant. For example for yearly renewal products under general takaful, the rate of profit payable to participants by Takaful Malaysia has been averaging around 36% p.a. over the last five years.

The Malaysian model is also practised by takaful operators in Brunei. It is reported that the operators there have been paying almost a similar rate of profit to their participants. In fact, takaful as well as Islamic banking have been extremely successful in making a strong impact in Brunei as it is understood their respective market share has exceeded 30%. The model is highly flexible. Softening the burden of having to shoulder a fairly heavy management expenses by the operator especially in the initial years of operation can easily be structured by adjusting the profit-sharing ratio to be slightly favouring the operator without directly affecting the interest of participants.

On the other hand there are takaful operators, in the Middle East and some African countries in particular, practising the al-wakalah or agency model. It is based on the premise that the operator is the agent of participants. Being the agent, the operator is permitted to charge on the contributions paid by participants to pay for overheads or other management expenses, including agency remuneration in consideration for the services rendered by the former. As takaful funds are also required to meet other essential takaful obligations such undertaking payment of claim benefits, retakaful costs and reserve provisions, the outflow of expenses from the funds would be comparatively higher under the wakalah model. In practical terms the model usually allows for substantial tabarru’ rates to be charged on the contributions to enable sufficient allocations be taken to cover the operator’s expenditure. For this reason it is quite common that the agency system as a marketing strategy is practiced under the model. In a way its modus operandi is almost similar to the conventional structure wherein management expenses of an insurer including commissions paid to agents are charged on the premium.

Although profit-sharing is also provided in the wakalah model, by and large the profit rate, if any, is no where comparable to the Mudharabah model. This is largely due to the heavy outflow of cost, resulting in a relatively small amount of profit left. In most instances the operators are confronted with the dilemma of not only unable to share profit with their participants but also ending up with insufficient sum of money to cover its own expenditure.

Notwithstanding the above, wakalah or agency is a practice acceptable in Islam. Nevertheless the practice ought to take into account certain fundamental characteristics that are essential in ensuring fairness, equitability and caring, virtues strongly advocated in Islam, especially on the part of the operator who is the trustee in managing funds belonging to others. Consent must first be obtained from participants before their contributions are deducted by the operator. Above all the principle of muayan has to be strictly observed and upheld, so that participants would know exactly the expences to be charged as well at its amount. The need to be specific as required under this principle is paramount to ensure participants would not be short-changed. By this principle therefore the specific purpose both in terms of types expense item as well as its absolute figure has to be spelt out and made known to the participants. Specifically the amount should also be reasonable. At the same time, Islamic scholars generally do not favour the practice of charging expenses up front whilst obligations and responsibilities under the contract have not been fully performed by the operator.

It is therefore imperative to have a common standard of operation for takaful operators in Malaysia. Since the Malaysian model has worked well and as a result Malaysia has been recognised to be the world leader in takaful, with several countries now seeking Malaysia’s assistance, existing and would be takaful operators do not have to look east or west for a suitable model. Dropping a theory is easy but certainly risky to experiment. Takaful sector must not be perceived to be different from the conventional system merely by changing certain terms.

Cash Accounting Makes Fair Profit Sharing

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.

Investment Avenues For Takaful

In essence, takaful operation can be segregated into two principal activities. On the one hand, it acts as the conduit for providing financial benefits in the event of a misfortune through the various types of takaful product that may be participated by both individuals as well as corporate bodies. Technically, the product is similar to an insurance. From straight-forward personal lines such as motor vehicle cover to the very complex requirements of the corporate sector, takaful products would fulfil the demand of all. A long-term family takaful plan would one way or another satisfy the life insurance need of an individual; whilst the industrial all risks scheme would meet the insurance need of a sophisticated manufacturing plant belonging to a huge conglomerate.

Takaful investment
Takaful investment

In all, as consideration for using these products, takaful participants whether individuals or corporate bodies, shall pay a certain sum of takaful contributions to the takaful funds managed by the takaful operator. Depending upon the types of product, contributions in respect of family products shall be credited into the Family Takaful Fund, whilst contributions for general products shall be paid into the General Takaful Fund. Essentially, these takaful funds belong to all participants. The basic function of the funds is to provide financial assistance, in the form of claim benefits to any participant who suffers a loss due to a defined misfortune. In this sense, takaful assumes the role of helping one another at times of need by participants. Proceeds from the claim benefits would come from the pooled contributions accumulated in the respective takaful funds; and not from any other fund.

In this respect it is extremely important for the takaful operator to ensure at all times that the takaful funds would not in anyway be harmed or unduly exposed to undesirable risks. Underwriting skills and technical knowledge would therefore be critical. This is a process of checking and filtering unwanted risks from being absorbed by takaful. On the other hand, underwriting would not be considered as vital if the system allows all participants to make good by paying additional contributions in the event of a shortfall of the takaful funds due to large payment of benefit. Certainly this alternative would not be practical. At worst takaful would lose its economic value because its cost would be higher. Apart from proper underwriting the funds have to be strongly supported by other means that would ensure its regular streams of income. Thus investment is the other important principal activity of takaful operation.

From the standpoint of profit sharing investment is certainly more vital under takaful. After all one of the elements that distinguishes takaful from conventional insurance is the profit-sharing contract. One of the components of the profit is the return on investment. In fact, for family takaful, investment returns would be the only source to be shared as profit. In other words, the higher the returns on investment, the bigger would be the profit sharing. Similarly, a significant part of the total income to the shareholders fund is also heavily dependent upon profit from investment. It is profit of the shareholders fund that would be taken into account as the overall profit of the operator. Dividends to shareholders are paid from this project.

As an Islamic system, all facets of the takaful operation must therefore comply with Shariah principles, including its investment. Shariah compliance here covers not only how but where the fund is invested; whether the return and the purpose of the investment are permitted by Shariah. Over and above this the investment must also comply with the regulations and guidelines of the authority.

It has been acknowledged the rejection by Shariah of conventional insurance is due partly to the non-Shariah way of the investment of the premium. On this note, it is worth mentioning that Muslims generally tend to be sensitive profoundly concerned on matters related to investment. As long as they can be assured and certain that Shariah-compliance, they would not mind even the return would be marginally lower.

Being a relatively new sector, investment avenues for Islamic finance including takaful are rather limited. But Malaysia has been in the forefront in developing and promoting new Islamic investment instruments and avenues; thanks to the players, scholars and regulatory agencies. Compared to ten years ago, Islamic finance now has wider options through a more diversified avenue of investment. This illustrates the importance of having the players first before designing the game. Once the players are familiar to the game improvement and modification would be easy, and perhaps new game may be introduced. ‘Doing’ is more effective than ‘talking’.

Islamic investment instruments began to be developed and ensured of its practicality in Malaysia following the debut of Islamic banking around twenty years ago. When takaful came into being not long after that, the foundation for investment had at least been established.

As trustee and custodian of participants’ money, the hallmark of a takaful operator’s investment philosophy should always be based on reasonable returns to the participants and shareholders whilst at the same time upholding the principle of safety and security. Greater care and prudence in fact has to be exercised under the trusteeship structure.

To begin with, one of the first such instruments introduced as an alternative to the statutory requirement for takaful funds to invest in interest-based treasury bills was the Malaysian Government Investment Certificate (MGIC). It was created and introduced when Islamic banking came into operation following the establishment of Bank Islam in 1983. The first of its kind anywhere MGIC, briefly, is based on the Islamic principle of ‘Qardhul-Hassan’. It is a benevolent loan type of transaction and in this case the borrower is the Government. Islamic investment instrument or papers such as MGIC are also subscribed by non-Islamic financial institution. As such it is always in great demand.

Other avenues of investment include deposit at Islamic banking institution. To guarantee sufficient liquidity a takaful operator should prudently ensure adequate level of the deposit be maintained so that should any urgent payment be required in the event of a misfortune the money would be readily available.

Investment in properties especially commercial buildings that would generate a steady and reasonable return to the operator would be another attractive avenue. But it is crucial for these properties to have tenancy because the rental income would be critical to ensure a steady flow of return to the funds. Furthermore ownership of properties is an investment permitted in Islam. In the case of Takaful Malaysia, for example it has properties practically in all major towns in the country. Being part of Bank Islam group tenancy normally would not pose a major problem.

Takaful operator may also invest in the equity market. Buying and selling of shares and any gains secured thereof is permissible in Islam as long as the equity concerned is a Shariah approved counter. There are more than 600 Shariah compliance counters in the Malaysian bourse that Islamic financial institutions have the option to deal with. The list is published from time to time by regulatory bodies such as the Securities Commission.

It is also possible for the takaful operator to utilise part of the takaful funds for the purpose of providing credit facility to selected clients as long as it is undertaken prudently. The financing transaction must certainly be on Islamic basis. Usually, financing of this nature is granted to a borrower to enable him to acquire or purchase fixed assets of which the repayment shall be made over a certain fixed period. By this transaction, the party that provides the facility shall purchase the assets required and re-sell it to the borrower at a price plus profit. It is usually structured based on the principle of al-Bai Bithaman Ajil (BBA). Granting of such financing facility ought to have appropriate collateral as security. This is part of the steps taken to protect the participants’ money in case of default. Investment of this nature usually would be in the form of syndication with Islamic banking.

The progress of Islamic finance in general has enabled Islamic financial institution in Malaysia to develop numerous investment papers through the securitisation of debts usually out of the BBA transaction. In this manner, financial institution has the opportunity to diversify its investment avenues further. Out of this development Islamic bonds now are gaining wide acceptance. It is reported that more than 60% of the bonds issued in Malaysia are Shariah compliance. In addition, there are Islamic bills known as Islamic Acceptance Bill (IAB) issued by Islamic banking. A takaful operator may purchase these papers or instruments as part of its investment activity for both the takaful funds and the shareholders fund.

The ‘Islamicness’ of takaful must not only be in terms of its operation but also its investment. To oversee this requirement there is the Shariah supervisory council at the operator’s level as well at the regulatory agencies.

Management Expenses On Takaful Contribution

Participants of the takaful business would have the opportunity to enjoy ‘free cover’. Perhaps it may sound strange as it would imply that takaful is just like another charitable organisation. No business would give away its products or services for free except on the occasion of special event. From the context of insurance it looks more awkward because the core activity of insurance after all is to provide some kind of financial guarantee in order to compensate against loss or liability in the event of a misfortune. What more the quantum of guarantee may exceed the premium paid in the first place in the event of a huge misfortune.

general takaful
general takaful

Nevertheless, through the profit-sharing contract of al-Mudharabah, as provided by takaful such an opportunity is no more a dream. Taking the performance of Takaful Malaysia as an example, where participants have been enjoying a rate of profit averaging at around 35% p.a. for the general takaful business over the last five years, participants who have been sticking to takaful in terms of their insurance needs would fully appreciate the meaning of ‘free cover’. With the total aggregate of the three consecutive years profit it would obviously be more than sufficient to pay for the fourth year renewal contribution (premium), assuming that the amount of contribution each year has been the same throughout. But profit is something which is not guaranteed or assured.

On the other hand, whether such level of profit rate could be sustained would depend on the claim experience as well as the accounting practice adopted by a takaful operator. Certainly, in the event of big claims the financial benefits paid from the takaful fund would be correspondingly high. This would decrease the balance of the fund and hence would affect its underwriting results. Should the amount of claims exceeds contributions the underwriting performance would suffer a deficit. Hence there would be no profit.

From the technical standpoint, takaful, to all intents and purposes, is no difference from insurance. It therefore follows that the art of evaluating or underwriting a risk would also be no difference from the principles commonly and universally practised by insurance, so long as these principles do not contravene the Shariah rules. After all Islam calls for good governance and excellent management, particularly in a situation where one is entrusted as custodian or trustee to manage and handle money. In a contract, the parties involved have to uphold certain obligations and responsibilities to ensure fairness, transparency and equitibality. Honesty and sincerity are essential hallmarks to check one side from taking undue advantage at the unfair expense of the other resulting to unjust loss and injury not only to the other side, but others as well who at the same time may be having joint financial interest in the same contract. This is where the ‘utmost good faith’, a doctrine strongly advocated in Islam, should strictly be adhered to as a way to prohibit all parties in a takaful contract not to conceal any material fact either at the point of inception of the contract or upon the happening of a misfortune leading to claim.

Since it in the best interest of the parties concerned to safeguard the takaful fund from any undue exposure due to unwarranted practices, it would rest upon the shoulder of the takaful operator to see and ensure that proper professional management is in place. After all, the fund which is built from the tabarru’ or donation portion of the contributions paid by the participants is for their common benefit. Together with the operator as trustee and manager on the one hand, and the participants as the `insurers’ and ‘insured’ at the same time on the other must protect the takaful fund from undesired claims. Towards this end, every strategy adopted in ensuring good management of an insurance company would also be relevant in ensuring good management of takaful. If insurance requires professional skills and strong technical know how in the areas of underwriting, risk management and claims evaluation, so would takaful. However in the case of takaful an appreciation of Shariah would help to enhance towards better understanding of its operation.

The accounting practice adopted is also a critical factor in determining the profit. For practical reason, it is generally accepted by Shariah that cash accounting would be a suitable basis for any contract. Although it is not strictly an issue of Shariah, it is however argued that any profit to be shared must be based on actual or realised figure. To distribute profit which has been not realised is simply not practical. In this respect for the type of takaful operation with profit-sharing arrangement, as practised by Takaful Malaysia, for example, the most appropriate accounting policy would be on cash basis. By this policy, only the recognition of income is on cash basis, but liabilities and expenses are accrued.

Following this practice, participants who pay their takaful contributions early, ideally on the day the takaful contract is incepted would have the opportunity to receive relatively higher amount of profit from late paymasters. Profit is calculated from the day contribution was paid. Therefore any delay in the settlement of the contribution would mean an opportunity due to relatively less amount of actual profit received. For example a participant who pays the contribution on the same day the takaful commences would enjoy a full year profit upon the expiry of cover. On the contrary if payment is made three month later, the amount of profit distributed would be equivalent only to three quarter of the full year’s profit.

The other critical feature commonly adopted as part of the accounting policy under the Mudharabah practice is on the treatment of the operator’s management expenses. In this respect, a distinction has to be made between costs of takaful, such as payments of claim, retakaful and reserve which are borne by the takaful fund, from the management expenses of the operator which are charged to the shareholders’ fund. In terms of the takaful contract, participants of general takaful agree that the operator would pay on their behalf claims to their aggrieved fellow participants and other related costs including retakaful and reserve as tabarru’ or donation from their contributions. Like insurance, due to the nature of general takaful, tabarru’ amount can only be known when a misfortune occurs. For the purpose of profit sharing therefore, the contribution recognised as the Mudharabah capital would be the balance after deducting the tabarru’ amount. And investment profit will be added back to the capital.https://www.investmortgageloan.com/wp-admin/tools.php

Takaful Is For Non-Muslims Too

The universality of Islam as a religion is clearly reflected in its financial system. Products and services of the system are not meant only for a particular sector of the society. Needless to say, to Muslims these products are undoubtedly essential in fulfilling the obligations required upon them as a religious duty. In this manner they would be free from dealing at least with riba and gharar, two of the elements that are strictly prohibited in Islam, in their financial transaction. Nonetheless, no matter how critical these divine features may be, the system would certainly be of no practical use if it would not able to meet specific objectives or needs of its users. No matter how Islamic would the system be and how impeccable the track record as well as the credentials of its provider or operator, it would not create the appetite for the demand of the system if it is not consumer oriented. After all, it has been the universal wish of Muslims in general to have a workable Islamic financial system in place that can fulfil their financial needs and satisfy their day-to-day business and commerce in accordance with the Islamic injunction. In other words being Islamic alone would not be sufficient unless the system can satisfy the modern-day financial requirements of both individuals as well as corporate bodies.

takaful concept
takaful concept

Financial transactions cannot be separated from the process of trade or commerce. Banking and insurance are two relevant examples of modern-day financial services that would facilitate and boost trade and commerce. It is a fact that modern-day trade and commerce would not flourish and thrive as can be witnessed today without the financial services of banking and insurance. As trade and commerce in general are essential to all, and therefore practised by Muslims and non-Muslims alike, the need for financial services to facilitate activities of trade and commerce are thus universal. But Muslims are compelled to ensure that these services in the first place, are based on the requirements and practices of Shariah. In the area insurance, it is therefore incumbent upon Muslims to establish a system acceptable to these rules. Hence following the introduction and development of Islamic banking, takaful came into being as an Islamic alternative to the conventional insurance system that can complement Islamic banking.

Nevertheless unlike specific obligations required to be performed and strictly adhered to by Muslim individuals as a sacred religious duty, Islamic financial system, including takaful, is open to all. In this respect, it is essential to clarify and make clear at the outset to non-Muslims, that takaful products are not solely meant for Muslims.

Towards this end, any person who requires insurance cover, may participate in any of the takaful products that would satisfy his needs. For example a car owner may participate in a motor takaful scheme, a house may be protected against fire under the fire takaful scheme and an individual may effect a family takaful plan as a means to avail of a certain financial benefit for his family in the event of his early death. What is important as participant or user of the product he must agree and abide by the terms and conditions of the contract that are based on the rules of Shariah. These terms and conditions shall be applicable to both Muslim and non-Muslim participants. Thus a non-Muslim cannot request for exemption even he may not agree to any of the terms and conditions simply on the grounds that he is not practising the Islamic faith. In other words a contract of any takaful product that applies to one shall apply to all. From the standpoint of the contract, obligations and responsibilities between and among the relevant parties are similar and equally applicable to all. Upholding this contractual principle is critical to ensure takaful is as creditable as any form of financial system. Above all, as an insurance product, takaful ought to be at par and at the level playing field with conventional insurance in terms of what it can offer. Yet having said this, takaful has proven to be consumer friendly. Indirectly the profit-sharing agreement as well as the adoption of the financial policy of not charging the operator’s overhead and management expenses on the participant’s contribution demonstrate the principle of putting the interest of consumers first.

Reflecting further this universal value, there is also no discrimination in terms of individuals who may be accepted to participate in takaful. Essentially, any individual who desires for the product and has the capacity as well as the means to fulfil the financial obligations required by takaful in accordance with its contract may participate. However, specifically for family products that provide benefits similar to conventional life insurance policies, the question that may arise would be related to how would extra contributions be calculated for `impaired life’ in view that no payment equivalent to premium is charged under takaful. It is common knowledge in the conventional practise, loading would be charged as extra premium on a policyholder who suffers from certain sickness or disability. Obviously, the concept of paying extra `price’ would be possible in the conventional system as it is based on a buying-selling transaction.

On the contrary, the money paid by a participant in respect of a family product is his instalments for the long-term savings, which also include his share of donation towards a common mortality fund called the Participants’ Special Accounts (PSA). The total sum of donation accumulated in the PSA would be used to pay compensation or benefit in the event of death of a participant before the maturity or expiry of his family plan. For this purpose PSA would be similar to insurance.

In view that the donation portion of the instalment, made in accordance with the Islamic principle of tabarru’, is based on a certain mortality table and other actuarial principles, how would therefore takaful consider and evaluate a proposal from an individual with an `impaired life’ to participate in a family plan. As trustee, the operator is responsible to ensure that the takaful fund, especially the PSA should not be unjustly over exposed simply due to undercharging, incorrect or inadequate amount of tabarru’. In a worst-case scenario the PSA may face a position of deficit, should its assets be determined insufficient to meet it expected liabilities.

As a system that practises joint-guarantee among participants, in the event of loss due to a misfortune, takaful should also be viewed from the perspective of partnership. Hence at the point of entry all participants should be considered as equal partners in terms of their physical health. Any change in this partnership status due to a fortuitous event or a misfortune inflicting upon a participant leading to the payment of benefit or compensation from the PSA is what takaful trying to strive for.

It therefore follows that if it is made known a participant is suffering from a certain disease or disability at the point of entry he is therefore considered to be an unequal partner to other normal participants. To enjoy the benefit provided by the PSA in line with the contract of takaful, he would be required to donate as tabarru’ a relatively higher sum in comparison with normal participants. In other words his savings portion would be correspondingly lower by the relatively extra amount of tabarru’ that is required upon him. Again in this regard the additional tabarru’ rate would be determined on the actuarial basis. In this manner takaful is transparent, fair and more importantly seen as steadfastly upholding the principle of equity which would pave the way for all individuals irrespective of their physical conditions the opportunity to participate in its products.