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ISLAMIC ECONOMICS & FINANCIAL ISSUES FROM ISLAMIC PERSPECTIVES ECON 6864

GROUP PAPER: SHARI’AH & FINANCIAL ISSUES OF TAKAFUL

SEMESTER: STUDENT:

SEM 1 2013/2014 ISHAM SHAFARIN BIN ISHAK (G1128403) MOHAMAD HAIDIR HASHIM (G1116671) MOHD ASHRAF BAHARIN (G1212709) ROBIATUL ADAWIYAH SAFRUDDIN (G1312514)

EXAMINER:

DR. MUSTAFA OMAR MOHAMMED

TABLE OF CONTENTS
CHAPTER ONE: INTRODUCTION / BACKGROUND......................................... 3 CHAPTER TWO: LITERATURE REVIEW ............................................................ 5 CHAPTER THREE: TYPE AND STRUCTURE OF TAKAFUL .......................... 8 CHAPTER FOUR: SHARI’AH & FINANCIAL ISSUES OF TAKAFUL ............ 12 CHAPTER FIVE: CONCLUSIONS / RECOMMENDATIONS ........................... 20 BIBLIOGRAPHY ....................................................................................................... 22

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except that tranquility will descend upon them. Muslims do this out of their piety and love to each other. He who makes easy what is difficult.w) asked a Bedouin who had left his camel untied. angels will surround them. This is due to the teaching of Islam that enjoins Muslims to help each other in times of difficulty. This is due to their confusion and lack of knowledge on the concept of predestination and the concept of risk in Islam. until now. It draws inspirations from two concepts from Islamic heritage.CHAPTER ONE: INTRODUCTION / BACKGROUND Contemporary takaful is a combination of a social security system and a risk management. reciting the Book of Allah and studying together. Allah will make easy a path to Paradise. due to the strength of the Islamic brotherhood. Back then. Allah will relieve his hardship on the Day of Judgment.a. food. should one fall sick or face hardship. In the time of the Prophet and His Companions. his neighbours and other Muslim brothers would surely offer their assistance. He who conceals the faults of a Muslim. This spirit is gloriously enshrined in both Quran and the Prophetic traditions. “I put my trust in Allah” the Prophet then said. mercy will cover them. for a people do not gather together in the houses of Allah. the social security was very strong in the community. He who travels a path in search of knowledge. and Allah will mention them to those with Him. Allah will conceal his faults in the world and the Hereafter. However. “Tie up your camel first then put your trust in Allah” (Tirmidhi) 3 . Allah will make it easy for him in the world and the Hereafter. it is a common belief to some Muslims that it is not allowed to mitigate risk hence all type insurances are impermissible. “Why do not tie your camel?” the Bedouin answered. for Allah helps the servant so long as he helps his brother. As narrated in one hadith: “He who relieves the hardship of a believer in this world. physical effort or others.”(Sahih Muslim) With regard to risk management. be it in monetary. one only needs to look to the following hadith to know that managing risk has been allowed if not encouraged by the Prophet himself: Prophet Muhammad (s. the Islamic brotherhood and the risk management in Islam. and he who is slow to good deeds will not be hastened by his lineage.

The third one will discuss on the type and structure of existing takaful in the market. The first chapter is the introduction and background of takaful. modern Takaful was born from the applications of these two concepts. Thus. Although it seems that Muslims have been very receptive and supportive of the application of risk management via takaful. in this study we attempt to identify and discuss the issues of the existing practice of takaful in the market. the takaful policyholders are the owner of the pooled fund and appoint a takaful operator as a wakil (representative) to manage their fund at a fee. is our conclusions and recommendations out of this study. 4 . In short. there are still issues and challenges about it. this paper will be organized into five (5) chapters. Next. in subsequent chapters. Therefore. which we will discuss further. we will move to the main body of this paper discussing the point that we have identified as Shari‟ah and financial issues of takaful. Mudarabah and Wakalah contracts. For the ease of reading. The second chapter is the literature review where we will summarize some articles and literatures produced by others on takaful or Islamic risk management. In the Mudarabah contract the takaful operator establishes an investment partnership with the takaful policyholders and works as their mudarib (operator) to manage the investment. we can conclude that Islam not only encourages Muslims to help each other and do charity but also to manage their risks.From these two evidences. In the second model. the working principle of takaful is not far off from the principle of mutual funds. And last but not least. whether from the viewpoints of Shari‟ah or financial. The most common form of takaful in the market currently are two.

2001).1 RISKS AND RISK MANAGEMENT Papers pertaining aforementioned topic such as “Risk Management: An analysis of issues in Islamic Financial Industry” (Khan & Ahmed. or risk management and Maqasid al-Shari‟ah or takaful and objectives Shari‟ah. either they talk about risk management in takaful. takaful. 2012) and “Takaful Review” (A. 2013) presents takaful from Shari‟ah and legal regulatory considerations in the Gulf Cooperation Council countries. “International Takaful Report 2012-2013: Shari‟ah and Legal Analysis” (Khan & Hasan. 2. Again. 2011) provide 5 . Most of the articles discuss and analyse either all of the aforementioned topics separately emphasizing on a particular issue pertaining major topic.Best. risk and risk management.M. takaful and insurance takaful and Maqasid al-Shari‟ah. 2012) and “Risks in Islamic banks: description and analysis” (Meshaal. 2. “Risk Management and Mitigation Techniques in Islamic Finance A conceptual framework” (Kumaran. “Enterprise Risk Management (ERM) Practices Among Government-Linked Companies (GLCs) in Malaysia” (Yazid. we categorize the literature into the following themes:     risk and risk management. there are reports about takaful industry. 2013) provide overview of risks and risk management in Islamic financial industry.2 TAKAFUL AND INSURANCE First of all. takaful and objectives Shari‟ah. For proper literature review. & Hussin. “The World Takaful Report” (A MEGA Brand. all of these articles do not mention takaful at all or mention only in passing.CHAPTER TWO: LITERATURE REVIEW There is a lot of literature focusing on risk management. 2008) discusses relatively new phenomenon of ERM. Wan Daud. most fully emphasizing on Islamic banks only.

& Zuki. all discussion concludes that Islamic insurance concept is in line with Maqasid al-Shari‟ah. 2012). provide overview of Islamic finance and its operations. “Insurance Solvency Supervision. 2010). “Takaful: An Innovative Approach To Insurance And Islamic Finance” (Masud. & Ismail. Other articles such as “Problems and Prospects of Islamic Banking: a case Study of Takaful” (Ahmad. 2010) talk about solvency of Islamic insurance companies. taking into account all the main topics regarding it as well as risk management. “Takaful and Retakaful: Advanced Principles and Practices” (Frenz & Soualhi. 2010). TAKAFUL AND MAQASID AL-SHARI’AH 2. However. but again it is general review of and retakaful without referring to risk management and objectives of Shari‟ah. takaful and objectives Shari‟ah. “Fundamentals of Takaful” (Yusof. in its turn. However. “Islamic Insurance and Reinsurance: Theory and Practice” (Mulhim & Sabbagh). 2013) and “Takaful From A Maqasid Al-Shari‟ah Perspective” (Abdullah S. Ahmad. 2008). “Islamic Financial System: Principles & Operations” (ISRA. these topics are discussed separately and in general manner. 6 . covering such topics as takaful operations and models. they are silent on objectives of Shari‟ah topic. .3 “Fulfilment of Maqasid al-Shari‟ah via Takaful” (Abdul Aziz & Mohamad. 2010b) and “The concept of takaful” (DarAlTakaful. 2010). Odierno. Masood. “Insurance and Takaful” (Salleh. 2009) articles discuss mainly issues regarding investment activities of Islamic insurance companies in Malaysia. Islamic finance and Islamic financial contracts. European Regulation And Takaful Products” (Dreassi. 2011) generally review takaful. “The Concept and Challenges of Takaful Investment in Malaysia” (Abdullah. 2013) and “A Shari‟ah Compliance Review On Investment Linked Takaful In Malaysia” (Noor. markets. Laldin. retakaful as well as risks in takaful. & Abdullah. Ali. 2009) and “Solvency of Takāful Fund: A Case of Subordinated Qard” (Onagun. showing financial strengths of the companies as well as discussing issues pertaining industry. & Khan. 2011).global report of Islamic insurance industry. without referring to the techniques of risk management in and them being in line with Shari‟ah objectives. Abdullah. Books such as “Essential Guide to Takaful (Islamic Insurance)” (Engku Ali. However. “Takaful Models and Global Practices” (Akhter. 2013) have a broader coverage. also the subjects related to Islamic insurance starting with explanation of Islam. Wan Ismail. 2012b) are one of the rare articles discussing takaful and Maqasid al-Shari‟ah.

4 TAKAFUL. 2011) cover risk and risk management aspect of takaful industry. in other words are the techniques and concepts used by takaful operators in harmony with the concept of objectives of Shari‟ah? 7 . takaful and objectives Shari‟ah together. 2012).2. To be more precise. & Abu Talib. 2012a). 2010a). & Yakob. except “Risk Management via Takaful from a Perspective of Maqasid of Shari‟ah” (Abdullah S. . It is obvious from literature review that there is no literature that discusses all three aspects. “Risk and Risk Management of Takaful Industry” (Aris. even this article just shows that risk management is a concept that lies within the spirit of Shari‟ah in general and in takaful in particular. “Risk Management in Takāful” (Akhter. namely risk management. RISK AND RISK MANAGEMENT “The Parameter Of Permissible Risks In Takaful” (Ahmad & Hashim. Therefore there is a gap in research. “Takaful and Mutual Insurance: Alternative Approaches to Managing Risks” (Gönülal. Ismail. which this paper will cover. Radam. 2013) and “Risk management efficiency of conventional life insurers and Takaful operators” (Yusop. Nonetheless. Tapsir. 2011). Although these articles and books analyse methods and techniques of risk management in Islamic insurance industry as well as the efficiency of the companies unlike the articles from previous section they are silent about Maqasid alShari‟ah. there is no literature that discusses aspects of risk management in takaful from Shari‟ah objectives perspective.

Tabarru‟ fund is reserved for any participants who face financial difficulties or losses within the time period in the insurance policy. 2. The sum assured depends on the amount of the tabarru‟ account. 8 . In short. the shareholder has to top up the fun. Consent must be granted by the policyholder to the shareholder for investing on the Shari‟ah compliant instruments. In the event of a loss. to incentivize them to search for better investment opportunity. Both the policyholder and the shareholder share the direct investment income. Many Shari‟ah scholars have concern on the risk contract in which the underwriting surplus being treated as mudarabah profits. The tabarru‟ account generally under the jurisdiction of the shareholder. There are a few concerns from Shari‟ah perspective on this practice: 1. Thus the takaful should not be called mudarabah contract since a portion of it is donation. The shareholder only shares in the investment return. the policyholder and the shareholder operate on a joint venture basis. Technically the contributions in tabarru‟ (donation) and it is not mudarabah (profit sharing). and upon cancellation. The policies separate a proportion of the premiums paid into tabarru‟ (donation) account for the risk coverage and the investment account. Mudarabah & Wakalah. There is concern that effectively the policyholder contributes their premium directly to the shareholder because it is the shareholder who controls the usage of the fund. Contribution to the tabarru‟ fund is considered as a oneway transaction in which the contributor has no right to take any benefits from it. first by Syarikat Takaful Malaysia (STM) in 1984. all cumulative capital plus profit must be returned to the capital provider less administrative expenses. in term of percentage. and the performance of the investment fund. 3. The mudarabah contract is cancellable.CHAPTER THREE: TYPE AND STRUCTURE OF TAKAFUL There are two major model of takaful currently in practice in the market.1 Mudarabah Model Mudarabah originates in Malaysia.

In a typical wakalah. in wakalah model. distribution of profit is via investment profit.2 Wakalah Model This model is commonly applied in gulf countries. In mudarabah contract generally. Wakalah is a contract of agency. retakaful etc. Same with mudarabah. the shareholders are appointed as a representative by the policyholders. to manage the takaful fund for a defined fee. Under this model. tabarru (donation) remains under the property of the policyholder. Another generational issue is the compulsory qard al-hasan for the shareholder in the case of deficit in the Tabarru fund. 9 . This contribution supposed to be returned by the future generations. This might be giving problems and issues such as inheritance and zakat in which it is not possible to calculate the share of the surplus in the pool at time of death. In takaful operation. will be used for investments and distributions among the policyholders. The practice of top-up interest free capital which is called qard al-hasan is not in line with the mudarabah concept. 3. but the future generations are not the one who has given rise to the deficit. 2. The shareholders. a percentage share of the underwriting surplus is paid as a performance incentive for the operator. the ownership of the takaful fund remains with the policyholder. reserves. and expenses) 4. 3.3. This profit is not the same as surplus (excess of premiums over claims. There are a few concerns from Shari‟ah perspective on this practice 1. Basically the policyholder appoints a company owned by shareholders to manage his affairs. technical reserves. The balance or normally known as underwriting surplus. This might lead to taking advantage of the lack of information from policyholder perspective to mislead them to pay a higher premium in return of lesser coverage & benefits. claim reserves. will deduct the fund from its operating expenses which include the management fee.

One of the best-run mutual insurance companies is Folksam in Sweeden. The date that they have collected also enable Folksam to identify most safe and environmentally friendly car. By its definition. mutual insurance is a „not for profit‟ company in which collects monthly premium in exchange for protection against risk for all its members. „takaful is a cooperative system of reimbursement in case of loss. and they use this data to give incentive in term of lower insurance premiums for the car owners. According to Wikipedia. It target is not making money. as “a response to great injustices”—the inability of ordinary people on low incomes to be able to obtain the sort of insurance protection relevant for them. but rather service and affordability were the main concerns. Folksam also takes initiatives in various fields such as engagement with the companies whose share it holds to influence the companies to do ethical business and reduce environment unfriendly activities. Rather than just concentrating on insurance. compensated out of a fund to which they agree to donate small regular contributions managed on behalf by a Takaful operator‟. they have put effort in the last 30 years to reduce the number of road accidents by investing in road safety research. a mutual insurance company is an insurance company owned entirely by its policyholder. it is closely connected to the cooperative and trade union organizations in Sweden. Mutual Insurance Company operates by the principle that the monetary loss per member is smaller. According to Wikipedia. The profit doesn‟t go to shareholders. it stays within the company and benefits us all … Our vision [is] that People should feel secure in a sustainable world. In other words.” Folksam was founded in 1908. meaning our customers are also our owners. Until today. paid to people and companies concerned about hazards. Takaful was conceived in the late 1970s out of the need for Islamic banks to have insurance coverage consistent with Muslim principles. in its own words.3 Mutual Insurance & Takaful Mutual insurance is the oldest from of insurance that still exists until today. For example. Any profit earned by a mutual insurance company is rebated to policyholders in the form of dividend distributions or reduced future premiums. Takaful should be 10 . The best way to explain mutual insurance is by looking at the real life example. Folksam has also taken a few significant initiatives that are very successful in bettering the life of its policyholders. the larger the company is. They also push for gender equality remuneration policies and equal presence on the board level. As its website puts it.3. “Folksam is a mutual company. Besides road safety.

This will surely implies that takaful will be closer to stock insurance rather than mutual. But in its current structure and manifestation. sharia scholars may differ in opinion on the following: 1. In the today world. Whether the takaful shareholders are entitled to a share of any underwriting profits 2. These investors surely require return for the capital that they have putted in. 11 . the minimum size requirements and regulations in minimum capital for insurance-based company including takaful requires takaful companies to seek investors to provide for the initial funds. Whether the tabarru‟ (risk premiums) should be paid into a waqf (trust fund) Thus it is very hard to agree on the most rightful implementation of takaful in the modern times. Thus we believe that the most easiest way out for takaful operators is to follow mostly the conventional way of running insurance with a few exceptions to ensure Shari‟ah compliance. Takaful operators run takaful for profits and its objective is to provide a good return of investment to its shareholders. How any surplus on a winding up of a takaful fund(s) should be allocated 3. It would be almost impossible for a truly mutual insurance to be set up with the current requirements and regulations still in place.run like a mutual insurance in which its main objective is the security and benefits to its members. This situation arises because of several factors. Also sometimes difference interpretation of sharia law and the lack of global standards at how sharia applies to takaful resulting in the difference of practices between jurisdictions. For example.

Furthermore. This is supposed to 12 . In such case. but not in the loss. This might lead to insufficient portion of the contribution to the claim in the situation of a crisis or bad situation. Operator of takaful in the current structure also has a share in the profit of surplus. the operator will not be penalized for this. this investment might turn out to be bad and depleted the policyholder fund. The fees structure also favors operator since the participants has no say. other than comparing with a few operators. It is also not fully in accordance to the wakalah or agency contract in which the agent is entitle to a predetermined & quantifiable fee. it is arguable that agent will be incentivize to increase turnover through poor underwritings and improper premiums. Some scholars see it as permissible as an incentive for good performances. the operator as the agent may seek to maximize profit by minimizing expenses. the agent or the operator in such bad situation in which the fund allocated for claim is insufficient. But then also. This is also true for mudarabah based takaful. The surplus is also has to be invested in a proper way in a Shari‟ah compliance companies. high-risk investment. income is defined as a percentage of premium income collected.1 Principal-Agent Issue In economics theory and real life situation. In a bear market condition. which inadvertently can affect service to the policyholders. is not liable to provide the extra fund for the claim. In term of Shari‟ah community is also divided. In an agent-principal relationship such in takaful. Normally surplus is invested in Shari‟ah compliance investment products. the operator will be has an incentive to invest in a high return. it is expected that the focus is on customer service rather than profits alone. Without proper control. Surplus distribution also determined by the operators.CHAPTER FOUR: SHARI’AH & FINANCIAL ISSUES OF TAKAFUL 4. thus corporate governance is an important issues in takaful. This is not easily monitored. Another difference between mutual the takaful is that in mutual. agents will try to maximize their fee income. In the current wakalah structure. for example when a major disaster like tsunami and typhoon affects a majority of the policyholders. some sees it as contrary to the concept of mutuality.

the donor loses all rights to the donation. has switch to quest for profits. As profit was not a prime consideration. the word Takaful originates from the Arabic word of Kafalah which means “guaranteeing each other” or “joint guarantee”. When a surplus transpires. once an amount has been donated. The issue relates to the finality of donations: specifically. However. out of the desire of banks to obtain insurance that are in accordance to Shari‟ah law. and some decisions that they made is arguable. there will be surplus in terms of investment and underwriting. how far does the contemporary takaful activity really meet the main objective? Similar to Islamic banking system. Indeed. sharia scholars are rarely versed in the technicalities of insurance. According to Wikipedia. Indeed. As sharing the investment surplus or profits between participants and takaful operators is a nonissue.2 The Driver of Takaful Operator: Profit The main objective of takaful is to share risks among participants and it is one of the available ways of managing risk. the participants will not a refund of part of their contributions because they have given up their equity. However. For example. All surpluses remained in the fund. from providing alternatives for banking activities for Muslims. one disagreement is in the application of tabarru‟. In the previous era. 4. should any of his fellow participants suffer a defined loss. in their early days. in takaful business. or give away"). contribute. The purpose of this concept is not to generate profit but to uphold the principle of “bear ye one another‟s burden”1 or to help each others. tabarru‟ means participant agrees to relinquish a certain proportion of his takaful installments that he agrees or undertakes to pay. and actual expenses were charged to the risk fund. however. takaful operators were set up on pure cooperative principles. the sharing of underwriting surplus is debatable. it is considered unacceptable in Islamic point of view in the other part of the world. On the 1 Galatians 6:2 (King James Version) 13 . This is the principal reason why participants in takaful do not have equity in the risk pool. Profit for the operator was purely on investment income generated by capital. unlike policyholders of mutual insurers. It is acceptable in Malaysia to share underwriting surplus. takaful operators were first developed in the Middle East. which literally means ("to donate.be advised and monitored by a Shari‟ah board.

both under profitable or losing conditions. Then. the Takaful contribution made by a participant will go to Taawuni Account Pool and Investment Account. Management expenses were paid out of the profits shared with the operator. must be return back to the capital provider. as investment income for such plans was insufficient to cover expenses. and thus surplus was treated as “profit” under the mudarabah model. the first takaful operator in Malaysia (Syarikat Takaful Malaysia) was established in 1984 to support the operations of the owner that is Bank Islam Malaysia2. If there is any surplus out of Taawuni 2 Malaysian Takaful Industry 1984-2004. as general takaful and yearly group takaful developed. The most important part is that. Please refer the diagram below to have a clear flow of how takaful operates on Mudarabah concept: Family Takaful based on Mudarabah concept Participant’s contribution Personal Investment Account Personal Risk Investment AccountGeneral Risk Net Investmen t Income Taawuni Account Pool Expense Fund Surplus administrat ion charge Risk Fund Surplus Balance Special Fund If risk fund is insufficient Investment Fund *source : Takaful Ikhlas Net Surplus According to the diagram above. in which the operator and the participants shared the profit from investments of capital (operator only) or policyholder funds (operator and participants). underwriting surplus was also shared. Syarikat Takaful Malaysia used a mudarabah model for its family takaful (life insurance) operations. Based on the model. Bank Negara Malaysia 14 . participant is the capital provider while the Takaful operator is the trustee.other hand. In the beginning. Mudarabah model is an equity contract in which the profit will be distributed proportionately while the loss will be born solely by the capital provider. The distribution of underwriting surplus under Mudarabah model has brought the criticisms from Shari‟ah scholars. This was a practical consideration. the remaining principal capital.

which is put together for groups of participants to 3 Taylor. the definition of surplus in mudarabah is the profit not the principal. Admittedly that the basis for takaful. and not the principal. Nonetheless. competition has been aggressive with respect to fees. takaful operations has been slightly slipped from its initial objective that is to help each other against possible losses. the surplus. Under mudarabah contract. and in some markets. will be distributed between the participant account and the operator. However. as mentioned before. a Takaful operator is entitled for a wakalah fee (i. resolved that there are three main principals to be met for takaful operators to be considered Islamic. the operator is entitled for the profit but not the remaining principal. that is. it will be credited as surplus. III. Under wakalah-jua‟lah model. The current practice is that. The markets for takaful are growing and interest continues to grow mainly in line with the development of Islamic banking in many Muslim-majority countries and Muslim-minority countries. Later. whichever model is used. “To Be or Not to Be (Takaful). Expense Fund) and later also entitled for jua‟lah fee if there is any surplus.Account Pool. generally. n. and profits. as reserves or charitable donations3. Thus. and it includes the balance principal. Thus. it can be so if profit was to be the main goal. surplus should be profit. The discussion did not mention about whether any underwriting surplus can be shared between the participant and the operator or whether it should be distributed solely to the participants or be used for some other purpose. either profitable or not.e. which possess lesser Shari‟ah-compliance risk. which are: In accordance to Shari‟ah ruling Charitable Donation (tabarru‟) Cooperative principles I. charges. That Is the Question. The operator‟s portion is called SAC (Surplus Administration Charge).” 15 . takaful operators could operate based on other concepts such as wakalahjua‟lah model. II. The takaful operator sets up a takaful fund. jua‟lah is a fee imposed on performance basis.d. however. We are of the view that profit seeking is not immoral. The growing interests is surely attractive for profit-seekers. emanating from a meeting of the Organization of the Islamic Conference in Jeddah in December 1985. Dawood. the surplus is anything left after the total risk fund is deducted with claims. in contemporary Islamic finance environment. The issue here is about the definition of the surplus. clarified by the Islamic Fiqh Academy.

that can be sold on short notice in the secondary market. However. which needs to comply with religious principles4. which is run by a stock insurer for a fixed fee. especially for long term family takaful business. Strong competition.assist each other in times of need. Conventional insurance companies have access to a wider array of highly liquid assets. 4 16 . 2010). In the absence of credible experience data. Takaful is similar in structure to a mutual insurance company. this could easily be managed through an appropriate retakaful arrangement. therefore. Though long-term investment is potentially more profitable than shortterm investment. operators are faced with a potentially more volatile and less diversified portfolio in view of the small market place. Hassan Scott. The direct link between contributors and those in need is not present. but takaful Hybrid Insurance Structures: Reciprocals. 4. do not earn profits. Malaysian takaful companies have access to a fairly well developed sukuk market. which allows them similar facilities. Moreover. the takaful operator has to maintain a sufficient amount of liquid assets in the takaful funds to be able to pay out arising claims. The lack of clams experience data poses a challenge when it comes to establishing loss reserves. operating in a new segment of the universe of insurance models. takaful can be considered a mutual insurance hybrid. but also to a faith-based insurance company. On the other hand. takaful operators having Shari‟ah Supervisory Board have higher financial expenses comparing to conventional counterparts.3 Underwriting and Liability Risk Issue The liability risk could be lower than for conventional insurance if the takaful operator stays away from providing contribution guarantees. There is less focus on religion and religious observance. such as bonds. together with lower economies of scale and lower investment returns. could result in mispricing or underpricing and premium insufficiency. Shari‟ah compliance together with the salaries of Shari‟ah Supervisory Board reduces the income of takaful operators. although a sharia council carefully reviews the practices of these firms to ensure compliance. Hybrid Mutual Insurers and Takaful – Zainal Abidin. Eventually. which do not need this board. The takaful operator as an investor faces a challenge in matching assets to liabilities. Sabbir Patel. more conservative assumptions need to be used for reserving (Frenz & Soualhi. The problem with fully liquid assets is that they are not invested and. Therefore.

they need to take into account the amounts and timings of the takaful liabilities and. 17 . With takaful being at a young stage. However.4 Operational Risk Issue Operational risk is all risks other than market. 2012a) emphasizes that takaful operators must formulate policies for prudent fund management in order to avoid any adverse impact. 4. “The Guidelines on Takāful Operational Framework” (BNM. It not only needs to manage the shareholders‟ fund. Therefore. In dual markets. it is naturally subject to higher operational risks for various reasons: • Evolving takaful regulations and accounting standards resulting in uncertainty and potentially additional compliance costs. This could result in. Abdullah.companies outside Malaysia are handicapped in this regard (Abdullah. and enjoy lower economies of scale and potentially lower investment returns. 2012a). takaful operators are often less well capitalised. a separate entity from the company‟s fund. e. based on that. Having realized the importance of proper asset-liability management in a financial institution. regulations detailing how to ensure intergenerational equity in surplus sharing. To do so. o • and potential conflicts due to dual supervision by both regulator and Shari‟ah board.g. but also the takaful fund. 2013). Laldin. Potential mismanagement: o o • Conflict between Shari‟ah compliance and professional risk management might result in sacrificing one for the other. & Zuki. changes expected in: o o valuation requirements and RBC. Lack of takaful professionals and Shari‟ah scholars is a natural source of mismanagement. which is currently at the discretion of the operator or appointed actuary. the study views this duty as very challenging to the takaful operator. the takaful operator must ensure transparent reporting in the asset and liability management that ensures segregation of the two funds. Ahmad. Ali. credit and underwriting risks. choose investments commensurate with the particular fund‟s tolerance of risks (BNM. there is fierce competition with conventional insurers for market share.

failure to adhere to underwriting and claims guidelines for the sake of increasing the top line. the lack of any control mechanism for the funds invested by the fund manager. or wakalah (investment agent). there is no standardized parameter regulating the policy. IT framework used by Islamic insurance companies is still the same that used by conventional insurers. either mudarabah (al-mudarib yudarib. It calls to develop own IT framework. except a general provision in the “BNM Shari‟ah Standard on Mudarabah”. which gives an option to the mudarib to assign the capital under his management to another mudarib or another manager (as agent).e.o o • under-pricing or expense overrun. which are continuously reviewed by the respective authorities such as the Securities Commission. Among the most important duties of the fund manager appointed as a sub-investment manager is to stay updated on the Shari‟ah compliant investment avenues. 2010). it is often lacking in takaful contracts. 2012b). The proper and continuous mechanism of control is important to ensure that all funds are invested in a Shari‟ah compliant manner and Shari‟ah compliant instruments. This study is of the view that the outsourcing service policy adopted by the operators with their fund managers must clearly spell out the nature of the contract between them. a sub-investment manager). or ijarah „ala al-„amal (a hire of service) and their 18 . Risk of mis-selling: o o Although transparency is an objective of takaful. Not only that. The issue becomes potentially critical in a subsidiary structure where the investment duties are outsourced to the parent or to other companies in the same group or to a third-party fund manager against an agreed fee. As mentioned above. i. To date. The shared-service practice or outsourcing will result in a Shari‟ah non-compliance issue if the outsourced investment activities involve non-permissible investment avenues. This is due to the fact that most of the investment activities are assigned to an external fund manager whose activities are governed by the operator‟s outsourcing service policies. which is clearly not the case. particularly securities. The perception is often that takaful is the same as insurance. which will take into account features pertaining takaful business (Frenz & Soualhi.. There is also a general lack of takaful understanding amongst agents and the public. subject to the conditions agreed to by the capital provider (BNM.

prudent management of the Investment Fund in a way that accumulates profits is another indicator of a solvent takaful operator. The outsourcing service agreement should also clearly define the method of fee calculation. Abdullah. the two are referred to as the same item and the terms are used interchangeably. While „profit‟ may also be referred to. Therefore. the financial report should separately disclose the profit from the Investment Fund (PIF) and the underwriting surplus from the Risk Fund (PRF) in detail before the Shari‟ah committee and the board for their further deliberation. & Zuki. which needs serious investigation is how surplus and profit are each defined in the surplus and profit management policy and. consequently. and they may be managed under different contracts that impose different rights and liabilities upon the takaful operator as the party managing the funds. A close scrutiny of the internal surplus and profit management policy in various takaful operators may reveal that. purification and remedial processes in the outsourcing policy and the agreement with the fund manager. in the context of takaful. The outsourcer (takaful company) should also have ways to review and examine the investment undertaken by the subcontractor (fund manager) so as to ensure that such activities do not involve prohibited transactions which may taint the company‟s halal income. The issue. The takaful operator can provide the requirements on the screening. Ahmad. how they are recorded in the financial report. each results from a different fund. 2013). 19 . constant Shari‟ah review of the Surplus and Profit Management Policy and the Annual Financial Report must be carried out to ensure continuous standardization and transparency in the takaful operator‟s reporting. in many instances. linguistically. In addition to the Risk Fund surplus. As such. which must be consistent with the type of contract adopted. Laldin. Ali.respective rights and obligations as reflected by the unique principles of the defined contract (Abdullah. Even if the Risk Fund is invested. as a „surplus‟. its profit portion must be separately reported from that of the Investment Fund.

the human capital involved in the industry and the systemic matters of concept. is currently facing numerous regulatory and technical challenges. surplus determination. structure and directions of an Islamic financial system. Actuarial expertise and knowledge in the management of mutual insurance business can be adopted within takaful to enhance its success. Actuarial principles and practices in the conventional insurance context such as embedded value calculations. With the conventional insurance industry moving towards a risk-based capital assessment regime. and distribution methodologies have direct application to the takaful industry. It must also survive side-by-side with the conventional insurance industry. substantial works should be employed not only in the foundational area of takaful but also in 20 . asset liability management. although the IFSB has issued takaful consultation papers in an attempt to achieve some consistency in the industry. and with the current changes in the global accounting standards. The industry is constantly seeking improvements in its effort to improve competitiveness and to meet Shari‟ah requirements as well as treating policyholders and takaful operators fairly. Mutuality or cooperative is a concept that has existed for centuries in the insurance world. Obviously. considerations need to be given to their application to takaful. sometimes compromising Maqasid al-Shari‟ah. enterprise risk management. The lack of suitable human resources means that actuaries can add significant value to assist takaful operators in tackling these current issues faced by the industry.CHAPTER FIVE: CONCLUSIONS / RECOMMENDATIONS The takaful industry. There are three main points that should be kept in mind to develop Islamic finance: formal issues related to appropriate products and instruments to serve the goals. paradigm. The takaful industry is continuously striving to develop best practices in the management and valuation of the business. goals. there are difficulties in developing global takaful standards or regulations. capital management. In addition to technical challenges. Actuaries can work closely with the regulators to develop a framework that is appropriate and relevant to takaful. with its rapidly evolving landscape. Due to the varying degrees of Shari‟ah interpretation. there are also regulatory challenges within the industry. which is in line with Maqasid al-Shari„ah. The problems of development of new prospects of Islamic finance at the conceptual and practical levels still exist.

Still. however. in other words the paper describes concepts and practices in general without going deep into details. takaful will be able to provide genuine Islamic alternatives to contemporary insurance practices. For this purpose. there are more researches can be done in the future covering each aspect of risk management in takaful from both theoretical and practical aspects.the operational area. because of lack of willingness of the people from industry to help the research. calls for closer collaboration of academicians with the industry. 21 . a clear and coherent philosophical foundation that originates from an Islamic worldview is required. The study is limited to general overview. This. As a result. which merely was achieved during this research.

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