Takaful Insurance Report

8/3/2019 Takaful Insurance Report

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TAKAFUL INSURANCESubmitted by:

Group 8

1 2010033 Prasant Kumar Singh

2 2010035 Pratish Thali

3 2010061 Abhinit Kulkarni

4 2010047 Sidharth Patel

5 2010148 Mayank Gorla

6 2010085 Kalpak Iyer

What is Takaful?

All human activities are subject to risk of loss from unforeseen events. To alleviate this burdento individuals, what we now call insurance has existed since at least 215 BC. This concept hasbeen practiced in various forms for over 1400 years. It originates from the Arabic word Kafalah,which means "guaranteeing each other" or "joint guarantee". The concept is in line with theprinciples of compensation and shared responsibilities among the community.

Takaful originated within the ancient Arab tribes as a pooled liability that obliged those whocommitted offences against members of a different tribe to pay compensation to the victims ortheir heirs. This principle later extended to many walks of life, including sea trade, in whichparticipants contributed to a fund to cover anyone in a group who suffered mishaps on seavoyages.

In modern-day conventional insurance, the insurance vendor (the insurance company) sellspolicies and invests the proceeds for the profit of its shareholders, who are not necessarilypolicyholders. There is therefore a clear disjunction between policyholders and shareholders.Payouts to policyholders may vary depending on financial performance, but a minimum positivereturn is always contractually guaranteed.

Takaful is commonly referred to as Islamic insurance; this is due to the apparent similaritybetween the contract of kafalah (guarantee) and that of insurance.

However, takaful is founded on the cooperative principle and on the principle of separationbetween the funds and operations of shareholders, thus passing the ownership of the Takaful(Insurance) fund and operations to the policyholders. Muslim jurists conclude that insurance inIslam should be based on principles of mutuality and co-operation, encompassing the elementsof shared responsibility, joint indemnity, common interest and solidarity.

In takaful, the policyholders are joint investors with the insurance vendor (the takaful operator),who acts as a mudarib a manager or an entrepreneurial agent for the policyholders. Thepolicyholders share in the investment pool's profits as well as its losses. A positive return onpolicies is not legally guaranteed, as any fixed profit guarantee would be akin to receivinginterest and offend the prohibition against riba.


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For some time conventional insurance was considered to be incompatible with the Shariah thatprohibit excessive uncertainty in dealings and investment in interest-bearing assets; both areinherent factors in conventional insurance business.

However, takaful complies with the Shariah (which outlines the principles of compensation and

shared responsibilities among the community) and has been approved by Muslim scholars.There is now general, health and family (life) takaful plans available for the Muslim communities.

Gambling and Insurance

Gambling and insurance are two distinct and different operations. Gambling is speculative in itsrisk assessment whereas insurance is a pure risk and is non-speculative. In gambling, one maywin or lose by creating that risk. In insurance, the risk is already there and one is trying tominimise the financial effects of that risk. Insurance shifts the impact of that risk to someoneelse and relieves the person of risk. The risk nevertheless still remains.

While gambling promotes dissension, ruin and hatred, insurance based on cooperativeprinciples, enables the insured to lessen the financial impact without which it could drive theindividual and his dependents to poverty, thereby weakening their place in the society. There isnothing in Islam that prevents individuals from making a provision for their dependents. Seencollectively for large groups of insured population, insurance strengthens the financial base ofthe society.

Islamic scholar, Yusuf Ali, in his translation of The Holy Quran, comments on Sura (chapter) Al-Baqara, ayat (verse) 219, "Insurance is not gambling, when conducted on business principles.Here the basis for calculation is statistics on a large scale, from which mere chance iseliminated. The insurers charge premium in proportion to the risks, exactly and scientificallycalculated".

Prohibitions of Gharar, Maysir and Riba

Gharar:An insurance contract contains gharar because, when a claim is not made, one party(insurance company) may acquire all the profits (premium) gained whereas the other party(participant) may not obtain any profit whatsoever. Ibn Taimiyah, a leading Muslim scholar,further reasoned "Gharar found in the contract exists because one party acquired profit whilethe other party did not". The prohibition on gharar would require all investment gains and lossesto eventually be apportioned in order to avoid excessive uncertainty with respect to a return onthe policyholder's investment.

Maysir:Islamic scholars have stated that maysir (gambling) and gharar are inter-related. Where

there are elements of gharar, elements of maysir is usually present. Maysir exists in aninsurance contract when; the policy holder contributes a small amount of premium in the hope togain a larger sum; the policy holder loses the money paid for the premium when the event thathas been insured for does not occur; the company will be in deficit if the claims are higher thatthe amount contributed by the policy holders.

Riba:Conventional endowment insurance policies promising a contractually-guaranteedpayment, hence offends the riba prohibition. The element of riba also exists in the profit ofinvestments used for the payment of policyholders claims by the conventional insurance


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companies. This is because most of the insurance funds are invested by them in financialinstruments such as bonds and stacks which may contain elements of Riba.

Basis and Principles of Takaful

Islamic insurance requires each participant to contribute into a fund that is used to support oneanother with each participant contributing sufficient amounts to cover expected claims.

The underlying principles of Takaful may be summarised as follows:

Policyholders co-operate among themselves for their common good.

Every policyholder pays a part of the contribution as a donation to help those that needassistance.

Losses are divided and liabilities spread according to the community pooling system.

Uncertainty is eliminated in respect of subscription and compensation.

It does not seek to derive advantage at the cost of others.

Theoretically, Takaful is perceived as cooperative insurance, where members contribute acertain sum of money to a common pool. The purpose of this system is not profits but to upholdthe principle of "bear ye one another's burden."

Why No to Conventional Insurance

In modern business, one of the ways to reduce the risk of loss due to misfortunes is throughinsurance. The concept of insurance where resources are pooled to help the needy does notnecessarily contradict Islamic principles.Three important differences distinguish conventional insurance from Takaful:

1. Conventional insurance involves the elements of excessive uncertainty (gharar) in thecontract of insurance;

2. Gambling (maysir) as the consequences of the presence of excessive uncertainty thatrely on future outcomes

3. Interest (riba) in the investment activities of the conventional insurance companies;4. Conventional insurance companies are motivated by the desire for profit for the

shareholders;5. Conventional system of insurance can be subject to exploitation. For example, it ispossible to charge high premium (especially in monopolistic situations) with the fullbenefit of such over-pricing going to the company.

The key difference between Takaful and conventional insurance rests in the way the risk is

assessed and handled, as well as how the Takaful fund is managed. Further differences are


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also present in the relationship between the operator (under conventional insurance using the

term: insurer) and the participants (under conventional it is the insured or the assured). Takaful

business is also different from the conventional insurance in which the policyholders, rather than

the shareholders, solely benefit from the profits generated from the Takaful and Investment

assets.

How does Takaful Work

All participants (policyholders) agree to guarantee each other and, instead of paying premiums,they make contributions to a mutual fund, or pool. The pool of collected contributions createsthe Takaful fund.

The amount of contribution that each participant makes is based on the type of cover theyrequire, and on their personal circumstances. As in conventional insurance, the policy (TakafulContract) specifies the nature of the risk and period of cover.

The Takaful fund is managed and administered on behalf of the participants by a Takaful

Operator who charges an agreed fee to cover costs. These costs include the costs of sales andmarketing, underwriting, and claims management.

Any claims made by participants are paid out of the Takaful fund and any remaining surpluses,after making provisions for likely cost of future claims and other reserves, belong to theparticipants in the fund, and not the Takaful Operator, and may be distributed to the participantsin the form of cash dividends or distributions, alternatively in reduction in future contributions.

Operating Principles

An Islamic insurance company must have the following operating principles:

a) It must operate according to Islamic co-operative principles.

b) Reinsurance commission may be paid to, or received from, only Islamic insurance andreinsurance companies.

c) The insurance company must maintain two funds: a participants/policyholders' fund and ashareholders' fund.

The Policyholders' Fund

a) The assets of the policyholders' fund consist of:

Insurance premiums received Claims received from re-insurers Such proportion of the investment profits attributable to policyholders as may be

allocated to them by the Board of Directors. Salvages and recoveries Consultancy and other receipts.


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b) All the claims payable to the policyholders, reinsurance costs, technical reserves,administrative expenses, etc., excluding the expenses of the investment department, shall bemet out of the policyholders' fund.

c) The balance standing to the credit of the policyholders' fund at the end of the year representstheir surplus. The General Assembly may allocate the whole or part of the surplus to the

policyholders' special reserves. If a part, the balance will be distributed among thepolicyholders.

d)When the policyholders' funds are insufficient to meet their expenses, the deficit is fundedfrom the shareholders' fund.

e)The shareholders undertake to discharge all the contractual liabilities of the policyholders'fund, but this liability does not exceed their equity in the company.

The Shareholders' Fund

a) The assets of the shareholders' fund consist of: Paid-up capital and reserves attributable to shareholders Profit on the investment of capital and shareholders' reserves Such proportion of the investment profit generated by the investment of the

policyholders' fund and technical and other reserves as is attributable to them Miscellaneous receipts

b) All the administrative expenses of the investment department are deducted from theShareholders' Fund.

c) The balance of the shareholders' surplus, if any, is distributed among them.

Investment of Funds

The company may invest its funds only on a profit-and-loss-sharing basis, as approved by theShari'ah.

Products and Services Offered by Islamic Insurance Companies

Islamic insurance companies may offer competitively priced products, without curtailing thescope and benefit of insurance coverage made traditionally available to the public byconventional insurance companies.

As regards life insurance facilities, Islamic insurance companies have developed Islamic TrustFunds for social sol idarity, mortgage protection, student protection and employers' protection.

Models of Takaful

There are various models of takaful according to the nature of the relationship between thecompany and the participants. There are wakalah (agency), mudarabah and a combination ofthe two. In the Sudanese takaful model, every policyholder is a shareholder in it. An Operator


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runs the business on behalf of the participants and no separate entity manages the business.Shari'ah experts consider this preferable. In other Islamic countries, the legal framework doesnot allow this arrangement and takaful companies work as separate entities on the basis ofmudarabah (in Malaysia) and wakalah (in the Middle East).

In the mudarabah model practised mainly in the Asia Pacific region, the policyholders receive

any available profit on their part of the funds only. The Shari'ah committee of a takaful companyapproves the sharing ratio for each year in advance, most of the expenses being charged to theshareholders.

In the wakalah model, the surplus of policyholders' investments net of the management fee orexpenses - goes to the policyholders. The shareholders charge the wakalah fee fromcontributions and this covers most of the expenses of the business. The fee is fixed annually inadvance in consultation with the company's Shari'ah Supervisory Board. The management feeis related to performance.

Pricing Transactions linked to Interest-rate Benchmark

There are continuing debates on whether the spirit of Shari`ah is being violated by the practice

of "benchmarking" linked interest rate benchmark such as London Interbank Offered rate

(LIBOR) plus an agreed mark-up in also pricing returns on Islamic finance transactions . At a

very fundamental level, the reason for the debates is the lack of understanding to clearly discern

the difference between the use of LIBOR as a benchmark for pricing and the use of non-

Shariah compliant assets as a determinant for returns.

However, benchmarking touches upon the integrity of Islamic Finance as a whole, and the

concept of Shariah-compliance vs Shariah-based approach in particular. There are practical

challenges delaying a switch to participation-based structures, such as Musharakah andMudarabah, that require financiers to participate in the underlying asset in a financing

transaction.

Retakaful or Reinsurance

Frequently, the scale of insurance risks underwritten is too great for one insurer to carry safely.In these circumstances, companies use reinsurance to mitigate their own risk exposure. Wheninsurers insure a risk again with another company, it is called reinsurance which allows theinsurance industry to spread its losses, lessening the impact of claims on any one company. Most insurance companies have to spread their liabilities among other insurance companies,

which are called reinsurance companies. The reinsurance contract, for Islamic companies, mustbe contracted in conformity with the Shari'ah.

There is currently a shortage of retakaful capacity and the lack of companies in the marketpresents a challenge as well as an opportunity. The challenge is to have a large enough takafulmarket to justify retakaful business. There is also a global need for strong and credible retakafuloperators to assist the growth and expansion of takaful business. Shariah scholars haveallowed takaful operators to reinsure conventionally when no retakaful alternative is available,although retakaful is strongly preferred.


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However, this conventional reinsurance represents a dilemma, as it is contrary to the customerspreference of seeking cover on Islamic principles. Structurally retakaful operating principles aresimilar to the takaful operating principles, and the same Shariah principles apply.

Preference must be given to Islamic reinsurance companies. The aim should be to end relations

with conventional commercial reinsurance companies as soon as possible.

Shari'ah Authenticity

Shaikh Yusuf Talal DeLorenzo, Islamic scholar, position is that unless a financial product orservice can be certified as Shariah compliant by a competent Shariah supervisory board, thatproduct's authenticity is dubious. At that point, it will be the responsibility of the individualinvestor or consumer to determine on his or her own that the product complies with theprinciples and precepts of the Shariah.

Status of Takaful

As Islamic finance continues to expand, there is likely to be a huge takeoff of other productssuch as pensions, education, marriage and health Takaful plans. There is also a huge scope formortgage Takaful.

Islamic principles strong emphasis in Takaful on the economic, ethical, moral and socialdimensions, to enhance equality and fairness for the good of society as a whole should alsohave appeal for the ethically minded.

In modern society, insurance has become a necessity to trade and industry. Life insurance hasbecome the most effective vehicle for mobilising savings, for capital formation and for long-terminvestment, as well as for making provision for old age and bereavement in the case ofindividuals.

In the west, the insurance sector is the largest single contributor to the capital market. Banksand insurance companies now form international alliances for mutual benefit.

There is an increasing demand for a Shari'ah-compliant insurance system. Until recently, therehas been a low demand for insurance in Islamic countries, because Muslims believe thatinsurance is un-Islamic. The development of Islamic insurance, therefore, requires extensiveeducation of the Muslim public, besides development of resources and expertise, a legalframework for it, the harmonization of practices, development of new Shari'ah-compliant

instruments, accounting standards, and arrangements for retakaful.

Takaful Insurance Report

Documents

Transcript of Takaful Insurance Report