Insurance is a risk transfer mechanism in which one party transfers the risk to another party. It is based on a mutual agreement where the insurer (party accepting the risk) indemnifies the loss of the insured (person who transfers his/her risk) on the happening of a certain event as per the terms of the contract. Insurance is classified into Life Insurance and Non-Life Insurance based on the subject matter. This is followed by a majority of the countries of the world.
Apart from these two classifications, there is another type called Takaful Insurance which is based on the principles of Islamic law, the Shariah. While the conventional type of insurance is familiar, Takaful Insurance is quite a vague phenomenon not known to many. Keeping this in mind, this White Paper is an effort to give a broad idea of the concepts, operations, and processes involved in Takaful Insurance.
Meaning of Takaful
Takaful, an Arabic word, meaning ‘guaranteeing each other’, is a form of Islamic insurance based on the principle of Ta’awon in Quaran, meaning ‘mutual assistance’. Takaful means mutual help among the group i.e. each member of the group pools efforts to support the needy within the group. It is believed that Takaful was put into practice during the time of Prophet Mohammed when Muslims contributed to a common fund called ‘Al-Kanz’ under the system of aqila. The purpose of this contribution was to help the members of their community at times of crisis.
Takaful insurance is not only guaranteeing each other but also guaranteeing each other in compliance with the Shariah, the Islamic religious law. It is a mutual risk transfer mechanism that involves parties namely participants and operators. In Takaful, the person or the institution managing the Takaful fund is called the “Takaful Operator” and the members taking part are called as “Takaful participant”.
Features of Takaful Contract
In Takaful, the risk from individuals or organizations is spread or shared with other individuals or organizations that are similar in nature. The characteristics of a Takaful Contract is as follows:
• Identify and analyze the risk
• Follow proper underwriting practice to ensure the adequacy of funds to pay losses and at the same time investment of funds in accordance with the principles of the Shariah
• Ensure proper sharing of risks among participants
• Re-Takaful to share losses above the limits of the Takaful operators
Takaful contracts may be either for protection or for savings or for both. Companies divide the contribution into two parts namely:
• Contribution for meeting mortality liability i.e. risk of death or disability and
• Contribution for investment
Both the funds are invested in avenues in compliance with the Shariah. The returns earned out of the protection fund are put back into the fund to indemnify the fellow participants. The return of the savings fund is returned to the participants along with the contribution to their credit in the savings fund at the end of the term or earlier.
Principles excluded from Takaful Contract fits
Takaful does not allow Gharar, Maisir, and Riba. These three are considered as areas that are against the preaching of Prophet Mohammed and their religious laws.
• Gharar — Which means uncertainty or speculation
• Maisir — Which means gambling
• Riba — Which means interest
Gharar (Uncertainty) Uncertainty is a fact of human life. Risk has become part and parcel of all living things, always around us, wherever we are and whatever we do. Islam does not ignore this fact and does not prohibit people from safeguarding themselves and their dependants from such risks and uncertainties that life has in store.
What is not allowed or prohibited is the exchange of a transaction with something that contains uncertainty or Gharar. It is not possible to always predict whether the agreed event will happen or not and what would be the quantum of loss, etc.
In order to avoid Gharar, the Takaful contract should be clear and explicit and should disclose all the facts known to both the parties, i.e. the Takaful participant and the Takaful operator. Takaful contracts are not allowed if there is an unknown element with regard to the subject matter.
Maisir (Gambling) Gharar and Maisir go hand in hand in a contract. Where there is Gharar, there will be Maisir (Gambling or Speculation). Gambling is against the basic principles of Muslim law and religious practice. Maisir or gambling is rejected under Islam, as it can create ill-feeling to one party or the other.
Maisir (gambling) is regarded as the excessive side of the Gharar. The participants (insured) may have an insurable interest in the subject matter, if the risk transfer (risk-sharing in Takaful) involves any speculative element, then it amounts to Maisir and is strictly prohibited under Takaful.
Riba (Taking and Charging Interest) Allocation of interest results in appropriation of other person’s property without giving him anything, because the one who gives the other a penny gets extra for nothing. Islam advocates that allowing Riba amounts to discourage people from working and from doing good to one another. Islam firmly believes that if interest-earning is prohibited in a society, people will start helping each other at times of need with goodwill.
Thus, Riba is totally prohibited in Islam as it creates unfair treatment resulting in exploitation of one party by another. Because of this, the rich get richer and the poor become poorer and the gap between the rich and the poor gets widened. Difference between Conventional Insurance and Takaful.
To avoid or eliminate the prohibited elements from Takaful contracts, the Takaful contract is designed in such a manner to avoid Gharar, Maisir, and Riba. This is clearly evident from the design of the contract.
The difference between Takaful and Conventional insurance is the way the risk is assessed and how Takaful funds are managed. The differences are highlighted in the table given below.
The process involved in Takaful Contract
The Takaful contract is the most essential part, which differentiates Takaful insurance from Conventional insurance. As the risk is uncertain and Islam prohibits sales or transactions containing uncertainty, Takaful contracts cannot be like normal sales contracts.
In addition to Gharar, Maisir, and Riba, Islam also prohibits the following:
• Buying and selling unlawful property or rights
• Investment in unlawful portfolio either containing Riba or unlawful activities
• Gambling or the game of chance
• Manipulation and unjust practice
Takaful contracts involve Offer and Acceptance like any other Conventional insurance contracts. The ‘Offer / Proposal’ as called in Conventional insurance is termed as ‘Ijab’ (Proposal) and ‘Acceptance’ as in conventional insurance is termed as ‘Quabul’ (Acceptance) in Takaful contracts.
Ijab or Proposal
Ijab is a written application for insurance. It is an explicit disclosure of the willingness of one party to ensure the risk to which he /she is subject to and their acceptance to abide by the terms and conditions/provisions of the contract. Generally, every Takaful operator is free to design the proposal form.
Quabul or Acceptance
After analyzing the inherent risk of the Takaful participant, the Takaful operator decides to accept or reject the Ijab. Once accepted by the Takaful operator, the contract would be complete and both the parties are bound to follow the terms and conditions of the contract
Quabul (Acceptance) of Ijab (Proposal) can take the forms of:
• Issuance of Takaful certificate
• Issuance of temporary cover note
• Issuance of an official receipt for the first payment of contribution
Models of Takaful Contract
The Takaful Operators follow various models of Takaful Contracts. Some of them are listed below.
This is a contract between the Takaful operator and Participant. This is also called as Capital Provider since he makes contributions to the scheme. Both the parties to the contract agree to share the profits in the pre-agreed ratio which will be printed in the schedule of the contract. Loss, if any, will be fully borne by the participant.
Contract of Musarakah (Joint Venture)
In this type of contract, both the Operator and the Participant make capital contributions. The profits of the scheme are shared between them depending on the amount of capital contributed by the parties or based on mutual agreement. And losses, if any, are shared in the same proportion as that of the capital contribution.
Kafalah Contract (surety-ship)
Kafalah means an obligation to another obligation. It is like a surety given for a surety. In the case of a joint surety, each one of them is liable for the entire debt. A guarantor to become the surety in the event the debtor fails to honor their obligation towards the creditor.
Wakalah Contract (contract of agency)
In this model of Takaful insurance, one party, the Operator acts on behalf of the other party i.e. the participant for a fixed fee which is called as ‘Wakalah fee’. The quantum of the Wakalah fee will be decided with the mutual consent of both parties before the completion of the contract. In this model, the surplus generated by way of investment is paid to the participant after deducting management fees and expenses. Wakalah fee is charged out of the contributions received from the participants.
Types of Takaful Business
Takaful Business can be broadly classified into types:
• Family Takaful
• General Takaful
Family Takaful falls into the Life insurance category of insurance providing insurance to human lives. This caters to the needs of the community requiring insurance as a savings element. Policies issued under Family Takaful business are generally for a longer duration with a definite period.
The contributions of the participants are pooled to indemnify the participants who suffer a loss due to death, disablement, etc. The basis of profit-sharing is agreed between the Operator and the Participant. The Participant’s share of the surplus is credited to their account.
Types of Family Takaful
Insurance Companies have come out with various products under the gamut of Family Takaful business. Some of them are as listed below:
• Family Takaful Plan for Education
• Investment-linked Takaful
• Family Takaful Mortgage Plan
• Group Family Takaful Plan
Benefit Structure of Family Takaful Business
Benefits applicable under Family Takaful Business can be categories as follows:
• Death Benefit
• Maturity Benefits
• Surrender Benefits
All these benefits may or may not be applicable, based on the type of product.
In the event of the death of the participant before the policy end date, they are eligible for the following Takaful benefits:
• Total contribution received as Takaful installment from the date of inception to date of death
• The participants share of profits for the investment portion of their contribution
• Contribution which would have been received for the remaining period had the participant survived. This would be equal to the contribution multiplied by the balance period (Policy period less period lapsed from date of inception to date of death). This amount is normally paid out of the Participants Special Account.
In the event of the participant surviving the term of the policy, he/she is eligible for the following as Maturity benefits:
• Total contribution paid by the participant during the policy term
• Share of profits from the investment portion of the contribution, credited to the participant’s account • Surplus allocated to the participant’s special account as shown in the last valuation of the participant’s special accounts
Termination of the contract during the policy term is called Surrender. If a participant opts to withdraw from a Family Takaful plan prior to the policy end date, he/she is eligible for the following as Surrender benefits:
• Portion of participant’s contribution credited to his account
• Share of investment profits
But the amount that has been allocated towards risk contribution will not be refunded.
Allocation of the Contribution
Every contribution paid by the participant under any of the Family Takaful Plan is divided and credited into two separate accounts, namely:
• Participants’ Special Account or Participants’ Tabarru Fund
• Participants’ Account
The Participants’ Special Account (PSA)
A defined proportion of the contribution is credited into the PSA on the basis of Tabarru’, which is nothing but the risk premium. The amount depends on the age of the participant, cover period, etc. Claims are met out of this fund.
The Participants’ Account (PA)
The balance of the contribution goes into the ‘PA’ which is meant for savings and investments only. This fund is paid fully to the participants during maturity or death claims.
General Takaful Business
General Takaful business deals with insurance of material loss of any kind. This type of contracts normally run for a period of 12 months.
The contribution paid by the participant is fully credited to the Tabarru fund, In other words, whatever a participant pays as a contribution is considered as a contribution towards risk coverage and pooled into a common fund. The amount in this fund is invested in avenues approved by the principles of Shariah. The return earned out of this investment is placed into the same fund.
The losses suffered by the participants on the happening of the agreed event are met out of the Tabarru fund. At the end of the period, if there is a surplus in the fund after appropriating for expenses and management fees, the same will be shared by the Takaful operator and the Participant. The ratio for sharing the profit would be agreed upon mutually by both parties in accordance with the principle of al-Mudharabah. Sharing of profit is done based on the participant satisfying one condition, that is, they should not have received any benefits out of the fund by way of claims during the policy period.
The types of General Takaful Scheme provided by the Takaful operators include:
• Fire Takaful Scheme
• Motor Takaful Scheme
• Accident / Miscellaneous Takaful Scheme
• Marine Takaful Scheme
• Engineering Takaful Scheme, etc
Given the scope of its coverage, taking into consideration all the vital principles proclaimed in the Shariah devoid of even an iota of gambling, the concept has gained the confidence of all the community. This is evident by the fact that, of late, it is being preferred in many countries and many IT solution providers have initiated processes in providing an integrated solution to tackle Takaful Insurance along with the conventional insurance.
Takaful Insurance is more sought after in the Middle East, African, and South Asian regions. With the latest spread of its concepts, it is sure to expand further and become a regular part in tandem with conventional insurance in the near future.