Introduction to Islamic Banking and Finance:

Principles and Practice

M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 8

Islamic Insurance (Takaful)

Learning Objectives

Upon the completion of this chapter, the reader should be able

to:
1. Understand the meaning and basic concepts of takaful
as an alternative to conventional insurance with an insight into
its historical development
2. Describe the innovative Sharī‘ah-approved models and
structures of takaful
3. Describe the main takaful products and their expansion
into the global insurance market
4. Analyze the process of determining and allocating
surplus or deficit as proposed by AAOIFI
5. Explain the relevance of reinsurance and retakaful in the
modern practice of takaful business
 Learning Objective 1.1
Understand the meaning
Basic Concepts of Takaful and basic concepts of
takaful as an alternative to
conventional insurance
with an insight into its
historical development

• Takaful - Arabic word originating from the root verb kafalah

–to guarantee, to secure or to be responsible for others
• Literally, takaful means joint responsibility or guarantee
based on mutual agreement
• Three basic concepts of mutuality are embodied in the
takaful model of insurance:
- Mutual help
- Mutual responsibility
- Mutual protection
 Learning Objective 1.1

Basic Concepts of Takaful Understand the meaning

and basic concepts of
takaful as an alternative to
conventional insurance
with an insight into its
historical development

Figure 8.1: Triangular Relationship of the Major Aspects of

Takaful
 Learning Objective 1.1
Understand the meaning
Basic Concepts of Takaful and basic concepts of
takaful as an alternative to
conventional insurance
with an insight into its
historical development

• Takaful: Islamic alternative to conventional insurance

where members contribute financial resources into a pool
based on principles of:
- ta’awun (mutual assistance)
- tabarru’ (donation) where the group undertakes to
share the mutual risk together
An appropriate Sharī‘ah-compliant framework effectively
manages risks in commercial activities as well as other civil
engagements - following the hadith ‘Tie your camel first’
• All prohibitive elements in Islamic commercial transactions
are prohibited in the design of takaful models
 Learning Objective 1.1
Understand the meaning
Basic Concepts of Takaful and basic concepts of
takaful as an alternative to
conventional insurance
with an insight into its
historical development

Main Features of Takaful

1. Cooperative Risk Sharin

2. Clear Financial Segregation

3. Sharī‘ah-compliant Policies and Strategies

 Learning Objective 1.1
Understand the meaning
Basic Concepts of Takaful and basic concepts of
takaful as an alternative to
conventional insurance
with an insight into its
historical development

Main Features of Takaful

1. Cooperative Risk Sharing
• Cooperative risk sharing through the use of donation was
designed to:
- eliminate riba and ghrar elements in takaful
- address issues of social responsibility, solidarity and the
innate need to care for others
• Donations adopted/merged with other frameworks of
Islamic commercial transactions to replace premiums
• Premiums paid by policyholders are considered donations to
assist members who suffer any loss
 Learning Objective 1.1
Understand the meaning
Basic Concepts of Takaful and basic concepts of
takaful as an alternative to
conventional insurance
Main Features of Takaful with an insight into its
historical development
2. Clear Financial Segregation
• In Islamic law: -
Clear segregation between participants and operators
- The role of the insurance company is restricted to an
operator managing the portfolio and investing insurance
contribution on behalf of participants
•  In the conventional practice of insurance business: - - The
insurance company is a profit-making entity which agrees to
bear the financial burden and losses of its policyholders
• The shareholders are entitled to receive profit and bear the
burden of any deficit at the end of the financial year
 Learning Objective 1.1
Understand the meaning
Basic Concepts of Takaful and basic concepts of
takaful as an alternative to
conventional insurance
with an insight into its
Main Features of Takaful historical development

3. Sharī‘ah-compliant Policies and Strategies

• Investment of insurance funds should be made on ethical
businesses that cause no harm to people or the environment

• Ethical considerations in takaful extends to investment in

businesses or products that do not contradict Sharī‘ah. Both
the process and the end-product must be Sharī‘ah-compliant
• Takaful operators are required to put in place a standard
Sharī‘ah governance system to ensure absolute compliance
with the Sharī‘ah
 Learning Objective 1.1
Understand the meaning
Basic Concepts of Takaful and basic concepts of
takaful as an alternative to
conventional insurance
with an insight into its
historical development

Takaful Core Principles

• Ta’awun (mutual assistance)

• Tabarru’ (donation)

• prohibition of riba, gharar and maysir

 Learning Objective 1.1
Understand the meaning
Basic Concepts of Takaful and basic concepts of
takaful as an alternative to
conventional insurance
with an insight into its
historical development

Major Differences Between Takaful and Conventional

Insurance

The major differences between the two frameworks are:

○ Parties to the contract

○ Payment of premiums

○ Investment of insurance funds

 Learning Objective 1.1
Understand the meaning
Basic Concepts of Takaful and basic concepts of
takaful as an alternative to
conventional insurance
with an insight into its
historical development

Specific Differences between Takaful and

Conventional Insurance

Refer to Table 8.1 of your text book for a summary of

specific differences between takaful and conventional
Insurance
 Learning Objective 1.1
Understand the meaning
and basic concepts of
takaful as an alternative to
Basic Concepts of Takaful conventional insurance
with an insight into its
historical development

Historical Development of Takaful

• The Prophet (PBUH) upheld and preserved insurance

protection practices carried out by ancient Arab traders.

• A classical precedent of takaful among the Muslims was

displayed during the incidence of migration of the Prophet
(PBUH) from Mecca to Medina

• The companions of the Prophet promoted mutual assistance

and shared responsibility under the close supervision of the
Prophet (PBUH)
 Learning Objective 1.1
Understand the meaning
Basic Concepts of Takaful and basic concepts of
takaful as an alternative to
conventional insurance
with an insight into its
historical development

Figure 8.2: Timeline of the Development of Takaful

 Learning Objective 1.1
Understand the meaning
Basic Concepts of Takaful and basic concepts of
takaful as an alternative to
conventional insurance
with an insight into its
historical development

• The modern history of takaful

- Islamic Insurance Company established in Sudan in 1979
- The establishment of Islamic-Arab Insurance Company
in Saudi Arabia and later in UAE in 1980
- The Malaysian Takaful Act of 1984
• Contemporary Islamic Scholars have issued many
resolutions on the permissibility of takaful
- The resolutions of the Council of Saudi Scholars in 1977
- The resolutions of the Fiqh Council of the Muslim World
League in 1978
 Learning Objective 1.1
Understand the meaning
Basic Concepts of Takaful and basic concepts of
takaful as an alternative to
conventional insurance
with an insight into its
historical development

• The OIC Fiqh Academy approved the takaful system in 1985

• The growth in the takaful industry is estimated at 10-20 percent a
year

• The global takaful premium surpassed US$8.9 billion in 2010 and is

expected to reach US$25 billion in 2015

For more recent data, visit: World Takaful Report - Ernst & Young
www.ey.com/.../World_Takaful_report...2011/.../WTR2011EYFINA

 
 
 
 Learning Objective 1.2
Describe the innovative
Models of Takaful Sharī‘ah-approved models
and structures of takaful

The main two parties involved in the implementation of the

takaful system regardless of the takaful model being used
are:
• Takaful operator: the party who manages and administer
the takaful fund

• Participants: the owners of the takaful fund, participants

and policyholders
 Learning Objective 1.2
Describe the innovative
Models of Takaful Sharī‘ah-approved models
and structures of takaful

• The Mudarabah Model

• The Wakalah Model

• Hybrid Wakalah-cum-Mudarabah Model

• Wakalah with Waqf Model

 Learning Objective 1.2
Describe the innovative
Models of Takaful Sharī‘ah-approved models
and structures of takaful

The Mudarabah Model

• Islamic insurance model based on trust partnership between
the takaful operator (mudarib) appointed to manage the
takaful business by the participants who act as the
financiers, investors or fund contributors (rabb al-mal)

• The funds contributed by the participants are divided into:

- Participants’ Risk Fund (PRF) and
-Participants’ Investment Fund (PIF)

• The Takaful Participants are the capital providers and the

owners of the takaful undertaking
 Learning Objective 1.2
Describe the innovative
Models of Takaful Sharī‘ah-approved models
and structures of takaful

The Mudarabah model

• The Takaful Operator is considered a business partner of the
participants in the investor-entrepreneur relationship under
the mudarabah contract
• The ratios of profit distribution are predetermined
• Financial loss is borne by capital providers (Takaful
Participants), while the entrepreneur (Takaful Operator)
may lose his/her managerial efforts
• Takaful Operator remunerated from the underwriting
surplus as agreed upon in the underlying takaful contract
 Learning Objective 1.2
Describe the innovative
Sharī‘ah-approved models
and structures of takaful
Models of Takaful

Surplus

The amount that remains after all expenses and

management fees for the administration of the takaful fund
have been deducted and the contributions are more than
the claims made by the participants
 Learning Objective 1.2
Describe the innovative
Models of Takaful Sharī‘ah-approved models
and structures of takaful

Figure 8.3 An Example of the Mudarabah Model of Takaful

 Learning Objective 1.2
Describe the innovative
Models of Takaful Sharī‘ah-approved models
and structures of takaful

The Wakalah Model

Islamic insurance model based on the contract of agency
between takaful participants and takaful operator where the
former are the real owners of the fund while the latter acts
as an agent
• Wakalah takaful is based on the contract of agency between
the takaful participants and the takaful operator where:
- the takaful participants are the real owners of the fund
-
the takaful operator acts as an agent
The takaful operator is entitled to agency fee or commission
for its service. The agency fee must be specified and clearly
stated in the contract
 Learning Objective 1.2
Describe the innovative
Models of Takaful Sharī‘ah-approved models
and structures of takaful

• IFSB-8 suggests that the agency fee should cover the total
sum of the following costs:
- management expenses;
- distribution costs, including intermediaries’
remuneration; - a margin of operational profit to the
Takaful Operator
• Any surplus realised from the investment of the participants’
funds will go to the participants. The operator only receives
its agency fee based on the nature of the takfaul model.

• The Takaful Operator does not share in any risk borne in the
investment or management of the takaful fund.
 Learning Objective 1.2
Describe the innovative
Models of Takaful Sharī‘ah-approved models
and structures of takaful

Figure 8.4: Example

of the Wakalah
Model of Takaful
 Learning Objective 1.2
Describe the innovative
Main Takaful Products Sharī‘ah-approved models
and structures of takaful

Hybrid Wakalah-Mudarabah Model

• The hybrid takaful model (also called the mixed model ) is a

combination of the wakalah model and the mudarabah
model where:
- the wakalah model is employed for the underwriting
purposes
- the mudarabah model is utilised for the investment
activities
 Learning Objective 1.2
Describe the innovative
Models of Takaful Sharī‘ah-approved models
and structures of takaful

Hybrid Wakalah-Mudarabah Model

• The twin role of the takaful operator makes the model

unique with its hybrid structure:

- the takaful operator is entitled to agency fee or

mutually predetermined commission for the role it
plays as a wakil or agent who manages the takaful
funds

- the takaful operator is also entitled to a share in the

profits realised for managing the investment activities
of the fund as an entrepreneur (mudarib)
 Learning Objective 1.2
Describe the innovative
Models of Takaful Sharī‘ah-approved models
and structures of takaful

Hybrid Wakalah-Mudarabah Model

• The sources of income of the takaful operator consist of:
- agency fee
- incentive fee
- the profit share from the investment of the funds

• One important element of the hybrid model is the clear

segregation between the shareholders’ funds and the
participants’ funds
 
 Learning Objective 1.2
Describe the innovative
Models of Takaful Sharī‘ah-approved models
and structures of takaful

Figure 8.5:
Hybrid
Takaful
Model
 Learning Objective 1.2
Describe the innovative
Models of Takaful Sharī‘ah-approved models
and structures of takaful

Waqf-Wakalah-Mudarabah Model
The Waqf Component
• The shareholders of a takaful company
make donations to a common pool of
funds which is established as a waqf.
• Waqf funds are invested in Sharī‘ah-
compliant activities.
• Returns from such investments
in addition to tabarru’ funds in
Participants’ Special Account ( PSA) are
used for the benefit of the participants.
• The original capital amount contributed
into the common pool of f
unds must be reinvestment to ensure
continuity of waqf funds
 Learning Objective 1.2
Describe the innovative
Models of Takaful Sharī‘ah-approved models
and structures of takaful

Waqf-Wakalah-Mudarabah Model
The Wakalah Component
• The shareholders of the Takaful company donate to it,
establishing a waqf fund
• The company becomes the agent of the shareholders and
assumes responsibilities of proper management of the waqf
funds, paying necessary claims
• Company stands to receive a pre-agreed fee for acting as an
agent of the shareholders
• The company also manages the investment of such waqf
funds as an entrepreneur, therefore entitled to share in the
profit from investment
 Learning Objective 1.2
Describe the innovative
Models of Takaful Sharī‘ah-approved models
and structures of takaful

Figure 8.6:
Model (Ultra-
hybrid Model)
 Learning Objective 1.3
Describe the main takaful
Main Takaful Products products and their
expansion into the global
insurance market

Main Takaful Products

Available products in the takaful industry:

- General Takaful: is a Sharī‘ah-compliant alternative to
the general insurance
- Family Takaful: is a Sharī‘ah-compliant alternatives to
the life insurance
 
 Learning Objective 1.3
Describe the main takaful
Main Takaful Products products and their
expansion into the global
insurance market

Main Takaful Products

General Takaful
• General takaful: a short-term policy renewable periodically;
covers assets and other proprietary belongings of participants
from foreseeable material loss or any form of damage
• General takaful fund established through participants’
contributions. Funds invested in Sharī‘ah-compliant
investments
• Proceeds accrue from such investment will be returned to the
fund for indemnifying the takaful participants
• Underwriting surpluses of the takaful funds are distributed to
the participants annually
 Learning Objective 1.3
Describe the main takaful
Main Takaful Products products and their
expansion into the global
insurance market

General Takaful Covers (list is not exhaustive)

- Motor Takaful
- Fire Takaful
- Employer Liability Takaful
- Fire consequential Loss Takaful -
Burglary Takaful -
Workmen Compensation Takaful
- Machinery Breakdown Takaful

- Health Takaful
• Available takaful covers are categorised into motor takaful and non-
motor takaful
 Learning Objective 1.3

Main Takaful Products Describe the main takaful

products and their
expansion into the global
insurance market
Family Takaful
• Family takaful is a long-term policy (may span between 10
to 30 years) where people come together to mutually
indemnify one another against disasters that may occur
such as sudden death or permanent disability

• Examples of family
takaful include
- accidental death
- savings and
education plans
for one’s dependants
- retirement plans
- disability plans
- waaqf plans
 Learning Objective 1.3
Describe the main takaful
Main Takaful Products products and their
expansion into the global
insurance market

Types of Family Takaful

• Ordinary collaboration

• Collaboration with savings

• Collaboration based on specific groups

 Learning Objective 1.3
Describe the main takaful
Main Takaful Products products and their
expansion into the global
insurance market

Three Types of Family Takaful

First: Ordinary Collaboration
• The participants mutually agree to contribute to a common
pool of funds through donations (concept of tabarru’)

• Premiums used for underwriting activities in case of

calamity or disaster for any of the members of the group

• Payment made directly to participant or his/her beneficiaries

in accordance with the underlying takaful contract
 Learning Objective 1.3
Describe the main takaful
Main Takaful Products products and their
expansion into the global
insurance market

Second: Collaboration with Savings

• The parties contribute through donations into a common
pool of funds from which the underwriting activities are
carried out

• The second pool of funds constitutes savings of individual

participants which may be demanded by respective owners
at maturity of certain period of time

• The two pools of funds are strategically segregated

• The participants benefit individually as well as collectively
form the collaboration with savings
 Learning Objective 1.3
Describe the main takaful
Main Takaful Products products and their
expansion into the global
insurance market

Third: Collaboration Based on Specific Groups

• Type of family plan usually structured reflecting communal,
ethnic, or organisational needs
• Participants from the same community, district or social
group come together to establish a common pool of funds
for a specific purpose
• Membership to collaboration is limited to those who come
from the same group
• Contributions to the fund may be made jointly or severally
by the organisation and the participants
• Benefits from the common pool of funds can only be
enjoyed by the participants or their beneficiaries
 Learning Objective 1.4
Analyze the process of
Underwriting Surplus and Technical determining and allocating
surplus or deficit as
Provisions proposed by AAOIFI

Underwriting Surplus
Insurance or underwriting surplus is the excess of the total
premium contributions paid by policyholders during the
financial period over the total indemnities paid in respect of
claims incurred during the period, net of reinsurance and
after deducting expenses and changes in technical
provisions”
(AAOIFI, 2010, p. 409)
 Learning Objective 1.4
Analyze the process of
Underwriting Surplus and Technical determining and allocating
surplus or deficit as
Provisions proposed by AAOIFI

Regulating the Underwriting Surplus Process

• The underwriting surplus calculated for specific financial
year
• Indemnities paid for deserving claims, the retakaful policy
and changes in technical provisions must be deducted from
the total premium contributions of the participants
• Net of reinsurance implies that all retakaful operations must
be considered while computing the underwriting surplus
• All changes in technical provisions (mainly relate to the
method of accounting and balancing the financial
statement) including unpaid claims and unearned premiums
must be adjusted to reflect actual financial position of
takaful fund
 Learning Objective 1.4
Analyze the process of
Underwriting Surplus and Technical determining and allocating
surplus or deficit as
Provisions proposed by AAOIFI

Right of Policyholders to Surplus

• Policyholders or takaful participants collectively have right
to surplus originated from policyholders who made the
financial contributions
• Should be a clear segregation between assets, obligations
and results of operations of policyholders and shareholders
• Shareholders are not entitled to the takaful surplus but will
get reimbursed from the profit realised from the investment
activities of the takaful undertaking
• Some rulings by Sharī‘ah boards permit the shareholders to
share the surplus with the policyholders
 Learning Objective 1.4
Analyze the process of
Underwriting Surplus and Technical determining and allocating
surplus or deficit as
Provisions proposed by AAOIFI

Allocating the Takaful Surplus

AAOFI identifies the following methods (alternatives) of
allocating takaful surplus
(a) Allocation of surplus to policyholders, regardless of whether
they have made claims on policy during the financial period

(b) Allocation of surplus only among policyholders who have not

made any claims during the financial period  
(c) Allocation of surplus among those why (conditions apply)
(d) Allocation of surplus between policyholders and shareholders
(e) Allocation of surplus by using other methods
 Learning Objective 1.4
Analyze the process of
Underwriting Surplus and Technical determining and allocating
surplus or deficit as
Provisions proposed by AAOIFI

Covering the Takaful Deficit

AAOIFI proposes the following methods for covering the takaful
deficit:
• To settle the deficit from the reserves of policyholders, if any
• To borrow from the shareholders’ funds or from others the
amount of deficit that should be paid back from future
surpluses.
• To ask the policyholders to meet the deficit pro rata.
• To increase the future premium contribution of policyholders
on a pro-rata basis.
 Learning Objective 1.4
Analyze the process of
Underwriting Surplus and Technical determining and allocating
surplus or deficit as
Provisions proposed by AAOIFI

Deficit in Participants’ Risk Funds (PRF)

• Deficit occurs when assets of PRF are insufficient to meet
liabilities
• Duty of the takaful operator to rectify deficiency and loss in
PRF initially through qard hasan
• Must be a sound repayment mechanism managed by takaful
operator ensuring loan will be repaid through future
surpluses of the PRF
 Learning Objective 1.4
Analyze the process of
Underwriting Surplus and Technical determining and allocating
surplus or deficit as
Provisions proposed by AAOIFI

Deficit in Participants’ Investment Fund (PIF)

• Recorded losses in Participants’ Investment Fund (PIF) shall

be absorbed by the capital providers (the participants)
• The takaful operator as the entrepreneur cannot rectify
deficit through qard hasan
• When it is proved that the deficit occurred as a result of the
professional negligence or mismanagement of takaful
operator, deficiency shall be rectified through necessary
transfer from the shareholders’ fund
 Learning Objective 1.5
Explain the relevance of
Reinsurance and Retakaful reinsurance and retakaful
in the modern practice of
takaful business.

• The Islamic alternative to reinsurance is retakaful, which

has been structured in a Sharī‘ah-compliant model, i.e.
reinsurance of takaful business on the basis of Islamic
principles is known as retakaful

• Within the conventional framework of insurance:

- Insurance operators collectively share the risks they
have undertaken to underwrite
- Large insurance companies underwrite the risks of
smaller insurance companies
- Reinsurance is a mechanism of the mitigation of such
great risks by transferring the risks to a large insurer
known as reinsurer
 Learning Objective 1.5
Explain the relevance of
Reinsurance and Retakaful reinsurance and retakaful
in the modern practice of
takaful business.

Retakaful
• Structured in a Sharī‘ah-compliant model; the Islamic
alternative to conventional reinsurance
• The risk aversion method of Retakaful is structured in a
way where:
- Takaful operators are participants in a takaful undertaking
with a large takaful company
- An agreed amount is paid periodically from the takaful
fund of the operators as premiums to the Retakaful
company
- All the underwriting risks of the takaful operators are
insured by the Retakaful company
 Learning Objective 1.5
Explain the relevance of
Reinsurance and Retakaful reinsurance and retakaful
in the modern practice of
takaful business.

• The Retakaful companies play a significant role when the

takaful operators record deficits or losses

• Capital of many Retakaful companies not so large to attain

an “A” rating which is mostly required for reinsurance
purposes

• Sharī‘ah scholars allow takfaul operators to reinsure with

conventional insurance companies under certain conditions
Key Terms and Concepts

• Aqilah • Participants’ Investment

Fund (PIF)
• Contribution
• Participants’ Risk Fund
• Fiqh al-muamalat
(PRF)
• Hybrid takaful model • Qard hasan
• Insurable interest • Retakaful
• Mudarabah model of takaful • Surplus
• Mutual indemnification • Tabarru’
• Operator or wakil • Takaful
• Participants • Takaful policy
Key Terms and Concepts

• Takaful ta’awuni
• Underwriting policies
• Waqf-wakalah-mudarabah
model
• Wakalah model of takaful