ECON 3430 - Islamic Banking and Finance

Topic 6 - Takaful 1
ECON 3430 - Islamic Banking and Finance
Takaful
Outline
Types of Risk
Concept of Insurance
Why conventional insurance is not Shariah-compliant
Takaful
Comparison between takaful and insurance
Types of takaful
Takaful models
Selected Takaful Issues
ECON 3430 - Islamic Banking and Finance
Topic 6 - Takaful 2
Two Types of Risk
Fluctuations in market
value of trade goods
Death, fire, accident Examples
Common risk
management
method
Origin of Risk
Nature of Outcome
Use of derivatives Insurance
By deliberate choice of
action
For the most part,
unavoidable
Loss / Gain Loss / No Loss
Speculative Risk Pure Risk
The Concept of Insurance
Transfer of pure risk from the individual to the insurance
operator
Insurance operator indemnifies the insured of a defined loss in
exchange for premium payments
Insure against pure risk only, not speculative risk
E.g., no insurer will underwrite general business failure
Notion of insurable risk
Predictable, measurable, spread over large geographic
area, acceptable to insurer
Law of large numbers, use of statistics and actuarial science
Insurance as a business, with profit-maximization objectives
Profit (Underwriting Surplus) = Total premium Total claims
paid out
Total premium Primarily sales and marketing output
Total claims To a certain extent is left to uncontrollable
factors (will of God / chance)
ECON 3430 - Islamic Banking and Finance
Topic 6 - Takaful 3
Why is conventional insurance not Shariah-compliant?
Element of uncertainty (gharar)
There is uncertainty of what the insurance policy-holder is buying
or paying for
If no loss occurs Policy-holder receives nothing
If loss occurs Policy-holder gets compensation in varying
amounts
Insurance
Company
Insurance
Policy-holder
Premium
Coverage
Element of gambling (maysir)
The insurance company is gambling that total premiums collected
will exceed total claims and thus producing underwriting surplus
(profit)
Total claims is predominantly affected by chance (will of God)
Element of riba
Insurance fund commonly invested in interest-bearing securities
Takaful
The Islamic alternative to conventional insurance is takaful
Takaful is a form of mutual help (taawun) in furthering good/virtue by
helping others who are in need or in hardship
Shariah basis of takaful
Al-Quran
Help (taawun) one another in furthering virtue (birr) and God
consciousness (taqwa) and do not help one another in
furthering evil and enmity. [Al-Maidah 5:2]
Encouragement to assist one another for a good cause
Hadith
tie the camel, then submit (tawakkal) to the will of God.
Importance of risk mitigation
Islamic Legal Maxim
al darar yuzal damage/harm is removed
If damage has occurred, efforts should be made to remove it
ECON 3430 - Islamic Banking and Finance
Topic 6 - Takaful 4
Takaful (2)
Takaful participants contribute to a takaful fund based on the
concept of mutual assistance
The contribution is done via reciprocal/mutual donation (tabarruat)
and does not represent a commercial sale of coverage
Takaful entails a unilateral, charitable contract (tabarruat) in
contrast with the conventional insurance contract which is a
bilateral exchange contract (muawadat)
Gharar is tolerated in a charitable unilateral contract
Takaful
Operator
Takaful Participants
Takaful Fund
Contribute via
unilateral
contract
(tabarruat)
Manages fund for a fee or share in
profits on investment
Takaful (3)
The prohibited elements are absent / averted in takaful
Gharar Uncertainty is tolerated because there is no
commercial (sale) contract
Maysir Return to takaful operator not a result of a gamble,
but rather from (i) charging of a fee to manage the takaful fund,
or (ii) a share in profits of the invested takaful fund
Riba Takaful funds are invested in Shariah-compliant
instruments only
Today there are 7 takaful operators in Malaysia
Syarikat Takaful Malaysia Berhad
Takaful Nasional Sdn Bhd
MAA Takaful Berhad
Takaful Ikhlas Sdn Bhd
CIMB Aviva Takaful Berhad
HSBC Amanah Takaful (Malaysia) Sdn Bhd
Prudential BSN Takaful Berhad
Hong Leong Tokio Marine Takaful Berhad
ECON 3430 - Islamic Banking and Finance
Topic 6 - Takaful 5
Takaful vs. Insurance
Insurance company makes a profit when
there is an underwriting surplus
Takaful operator earns a return
- for rendering a service of managing the
takaful program
- from the mudarabah profit sharing scheme
as mudarib
No clear valid countervalue. Source of profit
is anticipating (hoping) that the uncertain
future will be in their favour (that total
premiums will exceed total claims)
Countervalue (iwad) is effort and/or
undertaking of risk
Indemnification component is a bilateral
contract
Indemnification component is a unilateral
contract
Insurance company seeks to profit by
exploiting peoples need to manage risk
Takaful operator helps to manage a scheme
of mutual assistance based on brotherhood,
and is rewarded for that effort
There is a clear insurer-insured relationship There is no insurer-insured relationship
between takaful operator and participants.
Participants at both the insured and the
insurer simultaneously
Indemnification component is a commercial
relationship between insurance company and
the insured
Indemnification component is based on
mutual contribution, reciprocal donation
(tabarru)
Conventional Insurance Takaful
Two Types of Takaful
General Takaful
Typically it is short term, but renewable periodically
Common types of general takaful includes vehicle takaful, fire takaful,
health takaful
Family Takaful
Typically long term in nature, loosely comparable to conventional life
insurance
Contributions comprise two components
Insurance (Special Participant Account)
In the event of loss, participant will be compensated according
to a pre-agreed formula
Investment (Participant Account)
Underwriting surplus invested in Shariah approved securities
If participant dies prematurely, family gets
Amount in Participant Account + dividends
Amount in Special Participant Account as if he continued
contribution until maturity
If participant withdraws from takaful program, he gets
Amount in Participant Account
ECON 3430 - Islamic Banking and Finance
Topic 6 - Takaful 6
Possible Models for Takaful
Contract among takaful participants
Tabarru (mutual indemnity)
Contract between takaful participants and takaful operator
Mudarabah
Takaful participants are capital providers (rabbal-mal),
takaful operator is the entrepreneur (mudarib)
Profits are shared according to pre-agreed ratio, losses
borne by takaful participants
Wakalah
Takaful participants appoint the takaful operator as their
agent to manage the takaful fund (insurance and
investment activities)
Takaful operator charges a fee for its services
Jualah
Same principle of agency used (as in wakalah) except that
payment to the takaful operator is based on performance
(commission-like payment)
Mudarabah Model General Takaful
Participants
Contributions
(tabarru)
Takaful
Fund
Investment returns
Surplus
Claims
Expenses
( less )
Takaful
Operator
managed by
Investments
Make investments
manage
investments
Share of surplus
/ investment
returns (x%)
Profit sharing ratio
Rabbal-mal : mudarib
x : y
Share of surplus
/ investment
returns (y%)
ECON 3430 - Islamic Banking and Finance
Topic 6 - Takaful 7
Wakalah Model General Takaful
Participants
Contributions
(tabarru)
Takaful
Fund
Investment returns
Takaful
Operator
managed by
Investments
Make investments
manage
investments
Surplus
Claims
Expenses
( less )
Wakalah
fee
Selected Takaful Issues
Basis for mudarabah profit sharing
Underwriting surplus, or
Profit made on invested underwriting surplus
To address this issue, some takaful operators employ
the arrangement of wakalah (agency with fee) instead of
mudarabah
Takaful operator gets paid for managing the takaful
program and investing surplus funds
ECON 3430 - Islamic Banking and Finance
Topic 6 - Takaful 8
Selected Takaful Issues (2)
Total Takaful Fund RM100m
Underwriting Surplus RM20m
Total Indemnification
Payments RM80m
Invest Profit @ 10% : RM2m
Illustration : Basis for mudarabah profit sharing
Issue : should mudarabah profit sharing be based on RM20m or
RM2m?
Selected Takaful Issues (3)
Ethical considerations in the marketing of takaful products
Sale of takaful products beyond customers genuine needs
Exploitation of spiritual motivations for commercial purposes
Re-takaful
In conventional insurance, it is common for insurance operators to
collectively share the risks they have taken on
These risks are transferred to an even larger pool of risks, managed by
a larger insurance operator
This process is known as the re-insurance process
It is a means for further mitigating risk exposure
Issue
Takaful operators have been known to resort to re-insurance as a
method of risk management
The re-insurance process is executed by conventional re-insurance
companies, hence Shariah principles of takaful are not observed
This is due to the lack of sufficiently large takaful operators to
adequately provide re-takaful
Best Re, Munich Re, Swiss Re, MNRB Re-takaful Bhd beginning
to venture into re-takaful