ISLAMIC INSURANCE

CRITITIQUE

In compliance to the requirements of

Shariah IV (Islamic Commercial Law)
Mindanao State University - College of Law Iligan Extension
MSU - IIT, Iligan City

Submitted to:

Counselor Insah Mama

 Submitted by:

Anne Leah T. Pilayre

II - Teehankee
“Help each other in righteousness and piety, and do not help each other in sin and aggression.
Fear Allah. Surely, Allah is severe at punishment.” (Surah al-Maidah (5):2)

Introduction

Islamic banking refers to a banking activity or system of banking that is consistent with the
principles of Islamic law (Sharia) and its practical application through the development of
Islamic economics. Sharia prohibits the payment of interest fees for the lending and accepting of
money respectively,(Riba, usury) for specific terms, as well as investing in businesses that
provide goods or services considered contrary to its principles (Haraam, forbidden). These
principles were used as the basis for a flourishing economy in earlier times, but it is only in the
late 20th century that a number of Islamic banks were formed to apply these principles to private
or semi-private commercial institutions around the world. These banks have grown in Muslim
world, but are a very small share of the global world.1

1 Ahmad M. I, et al, 2010. Problems and Prospects of Islamic Banking: a case Study of Takaful, India.
Islamic banking has the same purpose as conventional banking except that it operates in
accordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on
transactions). The basic principle of Islamic banking is the sharing of profit and loss and the
prohibition of riba (usury). Common terms used in Islamic banking include profit sharing
(Mudharabah), safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah), and
leasing (Ijarah).

Islamic banks and banking institutions that offer Islamic banking products and services (IBS
banks) are required to establish a Shariah Supervisory Board (SSB) to advise them and to ensure
that the operations and activities of the bank comply with three (3) Shariah principles. On the
other hand, there are also those who believe that no form of banking can ever comply with the
Shariah. A number of Shariah advisory firms (either standalone or subsidiaries of larger
financial groups) have now emerged to offer Shariah advisory services to the institutions
offering Islamic financial services. Issue of independence, impartiality and conflicts of interest
have also been recently voiced.

Takaful is an alternative form of cover that a Muslim can avail himself against the risk of loss
due to misfortunes. Takaful is based on the idea that what is uncertain with respect to an
individual may cease to be uncertain with respect to a very large number of similar individuals.
Insurance by combining the risks of many people enables each individual to enjoy the advantage
provided by the law of large numbers.

The evolution of Takaful theory

The origins of the concept of Islamic insurance are traced back to the second century of the
Islamic era, when Muslim Arabs started to expand their trade to India, the far east, and other
countries in Asia. The foundation of this insurance was laid down in the system of Aqilah2 ,
meaning a joint guarantee by a group of individuals to help each other in times of disaster or
misfortune. In later centuries, Muslims from the Ottoman Empire used similar mutual help or
indemnification practices in their trade relationships with Spanish merchants (Schoon, 2008).
Cizakca (2004) also refers to the application of Waqf3 funds in providing rudimentary insurance
for members of guilds in the Empire. However, insurance institutions based on indigenous
means failed to develop, either during the Ottoman era, or in other periods during the history of
other Muslim countries. With the onset of Ottoman reform movements and the acceleration of
trade with Europe in the 19th century, the Ottomans adopted a variety of modern financial
institutions (Pamuk, 2004)4 . However, they were all based on Western models (Kuran, 2005).
Transplanted from conventional modes, insurance contracts were also endorsed by Ottomans
around 18395, and by Egyptians in 1845 6. Kuran (ibid.) attributes the stagnation of these
institutions to the rigidity of Islamic law that blocked the evolutionary path of their progress.
Sources of rigidity, in his view, included: “(1) the Islamic law of commercial partnerships,
which limited enterprise continuity; (2) the Islamic inheritance system, which restrained capital
accumulation; (3) the Waqf system, which inhibited resource pooling; and (4) Islam’s traditional
aversion to the concept of legal personhood, which hampered private organizations”. It was only
after the demise of the colonial period and the independence of Muslim countries after World
War II that “Muslims began to rediscover their identities and manifested the desire to regain the
lost values in all aspects of life, especially concerning the economic system” (Zamir & Mirakhor,
2007).

2 Abdul Hamid, M., and M. Sukki Othman. A Study on the Level of Knowledge and Understanding among Muslims Towards the
Concepts, Arabic and Shariah Terms in Islamic Insurance (Takaful). European Journal of Social Sciences, 2009, ʋ 10, pp.
468-478.
3 Abdul Hamid, M., J. Osman, and B. Amin Nordin, Determinants of Corporate Demand for Islamic Insurance in Malaysia,
International Journal of Economics and Management, 2009, ʋ 3, pp. 278-296.
4 Abdul Kader, H.A., M. Adams, and P. Hardwick. The Cost Efficiency of Takaful Insurance Companies, The Geneva papers,
2010, ʋ 35, pp. 161-181.
5 Abdul Rahman, A.R. Islamic Banking and Finance: between Ideal and Realities, IIUM Journal of Economics and Management,
2007, ʋ 15, pp. 123-141.
6 Abdul Rahman, Z., R. Yusof, and M. Shabri Abd. Majid. The Role of Goods, Money and Securities Markets in Promoting Family
Takaful in Malaysia, International Journal of Monetary Economics and Finance, 2009, ʋ 2, pp. 317-335.
The Takaful brand of insurance is a classic example of consumer-driven response to their needs.
For generations, Muslims around the world have grown with a mind set that insurance
(especially life insurance) is taboo because it contravenes some of the Islamic tenets. Life
insurance as sold in conventional way was declared unacceptable in 1903 by some prominent
Islamic scholars in the Arab countries. The search was on for an acceptable alternative ever
since, and not until the 1970's the debate took sufficient momentum to reach a consensus. In
1985, the Grand Counsel of Islamic scholars in Makkah, Saudi Arabia, Majma al-Fiqh,
approved Takaful system as the alternative form of insurance written in compliance with Islamic
Sharia. It is outside the scope of this presentation to explain how the Takaful system works
except to say that it is a concept of protection for the good of society, a concept that was never
an issue in Islam in the first place. The Grand Counsel approved this system as a system of
co-operation and mutual help but the exact method and operation was left to Islamic scholars
and insurance practitioners to resolve develop and implement. Takaful industry is still not past
its formative years and there are many areas unresolved, especially in life insurance. The key
areas to resolve are the global standardization of Takaful terminology, the development of an
acceptable form of life insurance (family Takaful) especially for countries in the Arab regions
and a common consensus for a system to determine profits (or surplus) distributable to
participants and shareholders. There is no unique operating model for Takaful companies, as
each country has its preferred model. However the most widely used models are mudharaba,
wakala and the hybrid model. Mudharaba is known as the profit-sharing model. The
shareholders share in the profit or loss with the policyholder. In the wakala model, the operator
acts as an agent of the participants. In this model, shareholders are paid a pre-agreed proportion
of the contributions paid by the policyholders in return for running the insurance operations of
the Takaful business on behalf of the policyholders. If the policyholders’ fund makes a loss, the
operator provides an interest-free loan to the policyholders’ fund that is repaid out of future
surpluses in the fund.

The growth of insurance in Muslim countries was examined by looking at the past trends and
taking a conservative view on future growth. This provided a consistent pattern of slower growth
in mature markets and higher growth in many of the developing countries. Most of the Muslim
countries have potential to at least double their insurance volumes. One of the main reasons for
low penetration of insurance in these countries is the under-development of life insurance. As
stated earlier, decades of misunderstandings created a mind-set amongst Muslims that did not
help to develop life insurance to any great extent. And yet life insurance is so essential in
providing the vital protection to the family.

Challenges for Takaful operators

The potential for Takaful is beyond question. But there are many hurdles to overcome if this
market is to realise its potential. Human resources pose a major obstacle to growth, as the
market is facing a severe shortage of qualified staff who understand both technical insurance
principles and have an adequate awareness of Shariah finance. One of the biggest challenges is
creating customer awareness. Many Muslims live under the misconception that insurance is
contrary to the principles of Islam, particularly with regard to life insurance. People have to be
made aware that Takaful provides an acceptable religiously validated solution. Similarly,
non-Muslims need to be made aware of why Takaful is ethical. Countries where Takaful is new
also need to set out clear principles on how Takaful business should be taxed, and to create a
regulatory regime that does not treat Takaful less favourably than conventional insurance. In the
UK, Europe and the US, there is also limited experience of how Takaful can be accounted for
and how to run Takaful businesses not only to be Shariah compliant but also to comply with
local national regulatory insurance rules.

The Philippine Setting

As of today, there is no regulatory framework for Takaful Insurance in the Philippines. Takaful
has been defined as “a cooperative system of reimbursement or repayment in case of loss, paid
to people and companies concerned about hazards, compensated out of a fund to which they
agree to donate small regular contributions managed on their behalf by a Takaful operator.”

Takaful insurance, or Islamic insurance, is governed by the Shariah law. Its basic principle is
Ta’awan, or mutual assistance. The word “Takaful” is derived from the Arabic word kafala, or
guarantee. The nearest concept under Philippine insurance law is the concept of mutual
insurance. The creation of a modern Takaful insurance company is relatively new. The first
Takaful insurance company in the world was established only in 1979 in Sudan, followed soon
after by Bahrain. But the concept of Takaful, or mutual assistance, has been in existence since
622 A.D.

As of 2013, it is estimated that Takaful insurance worldwide has total assets of $28 billion.
There are now a total of 281 Takaful insurance companies and 13 re-Takaful companies in 46
countries. Interestingly, non-Muslims are an increasing market for Takaful insurance.
Reinsurance is known as re-Takaful. The total world Islamic finance market is estimated at $2
trillion as of 2014.

Islamic law does not allow conventional insurance, because there are several aspects of
conventional insurance that are considered as un-Islamic. Examples of these would be the
imposition of interest, or Riba (or usury in Western concept); the concept of risk transfer (which
is addressed by the Islamic concept of risk-sharing); and the characteristics of gambling (or
Qamar or Maisir).

Financial and economic activities are governed by Muamalat, or man-to-man activities. It is

believed that human conduct is restricted by three factors: divine restrictions; government
restrictions and ethical restrictions. Shariah, or Divine Law, has several sources. These are the
Koran; Sunnah of the Holy Prophet (his sayings and acts); Ijma (or the consensus of the
Ummah); Qiyas (or by analogy); and Ijtihad.
There are a number of notable economic concepts under Islam that are worth looking into.
Among these are: a) Haram economic dealings, or the general prohibitions; b) Riba (or interest);
c) Gharar (or excessive uncertainty); d) Qimar (or gambling); e) violation of the law of contract;
f) Irtikaaz (or the concentration of wealth); g) Ihtikaar (or hoarding); and h) Iktinaaz (or
concealment of wealth). Indeed, the first hurdle in formulating a Takaful framework is
determining what are the haram activities, or the prohibited activities. Any activity declared to
be haram cannot be the subject of a transaction. Under the concept of Riba-Hadith, the one
paying the interest, the one receiving and the one who records the transaction will all be
cursed. “O you who believe, Fear Allah and give up what remains of your demand for interest if
you are indeed a believer. If you do not, then you are warned of the declaration of war from
Allah and His Messenger; But if you turn back you shall have your principal: Deal not unjustly
and you shall not be dealt with unjustly” (Al Baqarah 278-279, Fourth Revelation).

Under the concept of Takaful, participants “pool” their contributions which are then invested in
Shariah-compliant products, such as securities and sukuk (or bonds). Normally, these
investments are overseen by a Shariah supervisory board. The profits from these investments are
then used to pay the claims, wakalah fees (or agency fee) and other expenses. A part goes to the
insurance company for acting as the mudarib. All the surplus or excess amounts are then used
for contingency reserves, for charity and for distribution to all participants on a pro-rata basis.
As mentioned above, there are at least three different Takaful Models. First, wakalah which
refers to an agency agreement. Second, the Pure Mudarabah (or Mudharabah) Model, where the
participants and the operator enter into a mudarabah contract (profit-sharing). Third, the
Wakalah Model, where an agency agreement is executed between the participants and the
operator on the basis of Wakalah. Saudi Arabia, it is noted, has a unique cooperative model
differing from the pure Takaful model of other countries. The regulatory agency there is known
as the Saudi Arabian Monetary Agency. The leading Takaful markets in the world are Saudi
Arabia, the United Arab Emirates and Malaysia.

Under the Mudharabah Model, the premiums, or ra’s-ul-mal, is received by the Takaful
operator or the al-Mudharib. A profit-sharing agreement is mutually reached between the parties
on how the profits will be divided among them. Claims are paid under the concept of tabarru (or
to donate or contribute), where a participant agrees to give a portion of his or her contributions.
Among the recent developments on Takaful in the international stage is the recent issuance of
RM300 million ($93.8 million) sukuk in an effort to boost the capital of Etiqa Takaful Berhad,
an Islamic insurer and a subsidiary of Malaysia’s largest banking group, Malayan Banking
Berhad (Maybank). In 2013 Oman launched two IPOs for Al Madina Takaful and Takaful Oman
Insurance. Oman’s Muscat Securities Market recently launched Shariah- compliant index for
investors seeking Islamic equities.

From the Asean perspective, the gross Takaful “contribution” was estimated to be $4.2 billion in
2014, from an estimated $3.5 billion in 2013. Malaysia is the biggest market for Takaful, with
71 percent of total gross Takaful contributions in Asean. Indonesia is second at 23 percent, and
the remaining 6 percent distributed among the other Asean countries. In terms of distribution,
the top channels are through brokers, retail agencies and bancaTakaful (their version of bank
assurance). It has been projected by Ernst & Young that for the period 2013 to 2016, global
Takaful market will grow by 14 percent annually.

Challenges ahead

Despite this vast market potential, Takaful operators have some significant challenges to
overcome before these products enter the mainstream in European markets. First and foremost is
the lack of a standardised interpretation of what constitutes Takaful. Currently, each market has
its own set of rules and regulations for Takaful and industry experts recognise the need to make
them more uniform. The Islamic Financial Services Board has recently published an exposure
draft in which it makes recommendations for common governance of the Takaful industry
worldwide.

The absence of an organization to regulate Takaful also makes its implementation more
challenging in European countries, where regulations form the backbone of the financial
industry. Takaful’s adherence to Shari’ah laws and its different approach to accounting practices
such as the distribution of surplus, will require analysis within both the legal and tax structures
of each jurisdiction. One help in this process is the number of major European insurance
companies and banks that have a high degree of familiarity with Islamic financing practices and
the cultural mandates behind them as a consequence of having large operations in predominantly
Muslim countries. AXA in France, Zurich in Switzerland and Allianz in Germany all have high
Takaful exposure, and banks such as HSBC, Crédit Agricole or BNP Paribas understand the
huge potential of Islamic finance, as they all have operations in the Middle East and Asia.
However, in the majority of cases, Takaful remains deeply embedded within the overall financial
operations of these global financial institutions, which typically offer the full range of
conventional as well as Islamic banking services in non-Muslim regions.

Many religious Scholars have termed not only interest but also working in banks as forbidden
(haram). This belief has influenced many people that they avoid doing job in banks and
financial institutions even at very high salaries. They prefer to stay jobless as they consider
being jobless far better than earning from such institutes which are supposedly working in such
a way that is not permissible in Islam (Kamran, R no date).

Controversies and challenges involved in Islamic Banking

Islamic banking has been introduced in 1980 in Pakistan and from now it has achieved a
tremendous growth and now there are many full fledge Islamic banks operating in Pakistan. It is
expected that Islamic Banking will capture 12% of the deposit market by 2012 (Sheik, A,
2007).Even in global perspectives, Islamic banks have achieved an attracted growth during
world financial crisis and many international players are interested in Dual Banking system in
many western countries. However, all is not good; there are certain controversies and challenges
faced by Islamic banks.
As mentioned earlier Shariah is derived from fatwa, the Islamic financial and economic concepts
which are not clearly understood from Quaran and Sunnah are better clarified through Fatwa. As
Islamic financial products have been developed in the light of the fatwa, therefore, fatwa is very
important in Islamic banking. According to Ali (2005), Fatwa is basically a religious ruling on
matter of Islamic laws not clearly mentioned in Shariah. Fatwa is required on those matters
which are uncertain in Islamic banking activities and are not in line with Shariah. The main
problem arises, as far as fatwa is concerned that at present there is no single authority that
governs Islamic financial industry. There is no harmony among the Shariah scholars who give
ruling about Islamic financial products. All the Islamic banks have their own Shariah
Supervisory Board (SSB) who has knowledge of both finance and religion.

According to Briault, C. (2007) the challenge facing Islamic bank is the diversity among the
Shariah scholars, due to which leading consumers and investors are uncertain whether the
particular practice or product, is Shariah compliant. Even common Muslims have unclear
concept about the different products offered by Islamic banking. According to Malik, S et al
(2011), relating to the issue of fatwa, the other major concern for the Islamic banks is the
interpretation of different Shariah rulings. This different interpretation is due to the fact that
there are different sects in Islam and all sects have their own authority or body which provide
guidance and interpretation on Shariah issues. There is always a possibility that the
interpretation on certain Shariah issues given by one sect committee or scholars is different from
the interpretation of other sects, which makes things more complicated. For example, in Jordan a
prominent Muslim scholar criticised the penalty imposed by the Islamic banks in case of client
default in Murabaha and declares that it is a kind of riba. Similarly a famous British scholar
advises against the Islamic mortgage due to the fixing of rent and profit percentage with interest
rates (Asad, I 2009).

According to Patel, I (2010), which clearly describes that Islamic banks are not completely
Shariah compliant in true sense, while the Shariah committee of the banks mentioned in the
annual report that all the affairs of the banking division is carried out in accordance with Shariah
rules and principle. It is a matter of fact that Islamic banking system requires an independent and
specific Islamic banks, and as there is nothing like half Islamic or 75% Islamic. There are certain
bodies and regulatory authorities like IFSB (Islamic Financial Services Board) and AAOIFI
(Accounting and Auditing Organization for Islamic Financial Institution) which are trying to
resolve to resolve the issue of standardization (Ainely et al., 2007). According to SOLE, J.
(2007), one of the main goals of this organization is to design and disseminate accounting and
auditing standards that can be applied internationally by all Islamic institutions. However Malik,
S et al (2011), is of the point of view that without a consensus of religious experts, there can not
be any binding and universal set of Islamic banking rules. Another challenge faced by the
Islamic banks is the shortage of skilled peoples both at operational level as well as there is
shortage of Shariah scholars‟. The people working in conventional banks can easily understand
the operation of Islamic banks but to develop an Islamic product one should know the Shariah
rules and regulations. According to Ainely et al., 2000, there is shortage of knowledgeable
Shariah Scholars with banking experience and knowledge. According to the survey of Khaleej
Times (2008), the number of Shariah scholars is about 250-300 around the world. It has also
been criticized that these Shariah scholars are serving not only more than one Shariah board but
they are also providing the advisory services to direct competitors and earning million of dollars.

Conclusion

After the end of colonial era, some newly formed independent Muslims states reassessed their
economic policies on the basis of Shariah. Islamic Banking concept goes back to as early as the
7th century, but it was commercially implemented in last century. Islamic finance is growing
stronger in Islamic as well as in western markets. Islamic finance is developed under the
umbrella of religious beliefs and its success depends not only on fulfilling the economic goals
but also satisfies the faith. Islamic banks need not to replicate the products of conventional
banks but develop their own products with great innovation which should be in accordance with
Shariah rule and regulation which will ultimately boost the confidence of investors and
consumers. Islamic banks have to 8 provide a greater return to the investor as compared to the
rate to interest, so they need to invest in all sectors which can yield a greater return and that too
in longer term. Islamic banks need more expert people both in field of Shariah and finance and
try to bridge the gap between Shariah scholars and develop a single authority that has the
authority to assure that the product provided by Islamic banks is completely in accordance with
Shariah rule and regulation. The future of Islamic banks depends not only upon innovating and
investing in new products according to the demand of the markets but also upon on satisfy the
faith of the stakeholders.

References:

Abdul Hamid, M., and M. Sukki Othman. A Study on the Level of Knowledge and
Understanding among Muslims Towards the Concepts, Arabic and Shariah Terms in Islamic
Insurance (Takaful). European Journal of Social Sciences, 2009, ʋ 10, pp. 468-478.

Abdul Hamid, M., J. Osman, and B. Amin Nordin, Determinants of Corporate Demand for
Islamic Insurance in Malaysia, International Journal of Economics and Management, 2009, ʋ 3,
pp. 278-296.

Abdul Kader, H.A., M. Adams, and P. Hardwick. The Cost Efficiency of Takaful Insurance
Companies, The Geneva papers, 2010, ʋ 35, pp. 161-181.

Abdul Rahman, A.R. Islamic Banking and Finance: between Ideal and Realities, IIUM Journal
of Economics and Management, 2007, ʋ 15, pp. 123-141.

Abdul Rahman, Z., R. Yusof, and M. Shabri Abd. Majid. The Role of Goods, Money and
Securities Markets in Promoting Family Takaful in Malaysia, International Journal of Monetary
Economics and Finance, 2009, ʋ 2, pp. 317-335.

Ahmed, H. 2002. “Financing Micro Enterprises: An Analytical Study of Islamic Microfinance

Institutions,” Journal of Islamic Economic Studies 9(2).

Ainely,M., Mashayekhi,A., Hicks,R., Rahman,A., and Ravalia, A. (2007) 'IslamicFinance in UK:

Regulation and Challenges' Financial Service Authority, [online]
Ali, (2005). “Islamic Banking” Journal of Islamic Banking and finance, 4:1, 31-56

Ali, S., and Asad, I (2009). Issues in Islamic banking’, available at: www.accountancy.com

Briault, C. (2007) 'London: centre of Islamic Finance?' Financial Service Authority

Kamran, R (no date). Interest (Riba) Religion and Spirituality’ [on line] Available at:
http://www.booksie.com/all/allkamranrifat/interest-(riba)-the-myth-and-reality

Kuran, T (2001). Speculation on Islamic financial alternatives; A response to Bill Maurer‟,

Anthropology today, 17, 3.

Malik, S, M., Malik, A, and Mustafa, W (2011), “Controversies that makes islamic banking
controversial: An Analysis of issues and challenges” American journal of Social and
Management Sciences, 2, 1., 41-46.