ECON 3430 - Islamic Banking and Finance

Topic 6 - Takaful 1
ECON 3430 - Islamic Banking and Finance
• Types of Risk
• Concept of Insurance
• Why conventional insurance is not Shari’ah-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
Origin of Risk
Nature of Outcome
Use of derivatives Insurance
By deliberate choice of
For the most part,
Loss / Gain Loss / No Loss
Speculative Risk Pure Risk
The Concept of Insurance
• Transfer of pure risk from the individual to the insurance
• 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 Shari’ah-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
• Element of gambling (maysir)
– The insurance company is gambling that total premiums collected
will exceed total claims and thus producing underwriting surplus
– Total claims is predominantly affected by chance (will of God)
• Element of riba
– Insurance fund commonly invested in interest-bearing securities
• The Islamic alternative to conventional insurance is takaful
• Takaful is a form of mutual help (ta’awun) in furthering good/virtue by
helping others who are in need or in hardship
• Shari’ah basis of takaful
– Al-Qur’an
• “Help (ta’awun) 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 (tabarru’at)
and does not represent a commercial “sale of coverage”
• Takaful entails a unilateral, charitable contract (tabarru’at) in
contrast with the conventional insurance contract which is a
bilateral exchange contract (mu’awadat)
• Gharar is tolerated in a charitable unilateral contract
Takaful Participants
Takaful Fund
Contribute via
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 Shari’ah-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
Indemnification component is a unilateral
Insurance company seeks to profit by
exploiting people’s 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
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
– 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 Shari’ah 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
– Ju’alah
• 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
Investment returns
( less )
managed by
Make 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
Investment returns
managed by
Make investments
( less )
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
• 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
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 Shari’ah 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