Takaful

“the Islamic Insurance”

 Coursepack
 Chapter 5
 Pages 79-94
Islamic Terminologies:
 Maisir
- Gambling
 Gharar
- Uncertainty (extreme?). A transaction under Islamic law
should be held invalid, if it involves the element of Gharar
 Riba
- Fixed Interest, usury(?)
 Tabarru
- Donation, charity
 Wakalah
- Agency
Islamic Terminologies (…cont’d)
 Mudharabah
- Co-partnership where at least two parties are involved in a
commercial transaction, in which one party provides capital, while
the other offers skill in carrying out the business successfully in view of
sharing the subsequent profits or loss accordingly.
 Qard al-Hasanah
- A gracious loan.
 Takaful
- Mutual responsibility, an alternative term to Islamic insurance.
Why Takaful?
Conventional Insurance contracts are considered un-
Islamic because of:
 Maisir: it is argued that insurer effectively bets that the
contingencies insured against will not occur, indulging in
gambling

 Gharar: the insurer does not know whether he will ever be

called upon to pay claims under policy, nor the size of such
claims, and the insured does not know if he is going to receive
any financial benefit in the future, nor the size of such claims.
Why Takaful? (… cont’d)

 Riba: the policyholder expects to receive a pre-

determined amount greater than that invested,
provided that the contract has fixed interest rates
rather than profit shares.
Why Takaful? (…cont’d)
Takaful or Islamic Insurance works on the
following principles:
 solidarity,
 responsibility, and
 brotherhood

among participants who have agreed to share

defined losses to be paid out of defined assets.
Concept of Takaful
 Insurer (Takaful operator) disassociates itself
from profit/loss “risk” activity (to avoid Maisir
or Gharar)
 Insurer largely manages the “risk” activity and
meets expenses (& profit) from specified
proportion of revenue
 Claims are paid directly from the risk pool
belonging to the participants (co-operative
principle)
 Profit or loss from risk activities is credited to
or borne by the policyholders
Working of Takaful
 Takaful operator creates “2” funds from the
premium
i. Participants (Takaful) Fund
ii. Shareholders Fund
 Participants / Takaful Fund
i. Receives a portion of premium
ii. Pays claims
iii. Distributes surplus to participants
iv. Receives and repays loan (Qard-e-Hasana) to
shareholders in case of deficit
Working of Takaful
 Shareholders Fund
i. Receives remaining portion of premium (Wakala
Fee)
ii. Pays Management Expenses
iii. Manages Islamic Investments
iv. Gives Qard to Takaful Fund (if required)
v. Generates profit for Shareholders
Conventional Term (Risk) Product (Non
Takaful)
Policyholder
Premium

Investment Profit Shareholder Policy Benefits

Fund

Surplus / (Deficit) Management Expenses

Shareholder’s
Surplus
Conventional Example
Conventional

Premium (BOY) 100,000

Investment Income (10%) 10,000
Claims (EOY) (70,000)
Expenses (EOY) (25,000)
Surplus Total (EOY) 15,000
Shareholder's Surplus (100%) 15,000
Policyholder Surplus -
Wakalah Model
 Operator (insurer) fully disassociates itself from
profit of risk activities (acts as a “Wakil”)
 Operator, however, provides interest free loan to
participants fund in case of deficit
 Operator does not share any portion of
participants’ surplus
 Operator’s revenue is only a specified portion of
premium (Wakalah fee) apart from investment
income in shareholders fund.
Wakalah Model
 Participants/policyholders are entitled to 100% of
underwriting surplus and Investment Income on
participants/Takaful Fund

 Note : Underwriting surplus excludes associated

investment income
Takaful Models
Pure Wakalah Model
Shareholders Shareholders Surplus
Investment
Participants Management Expenses

Contribution
Wakala Fee

Shareholders
Islamic Takaful Fund Policy Benefits Fund
Investments

Underwriting Profit
Investment Profit +
Investment Profit Qard-e-Hasna

Surplus / (Deficit)

100% of Surplus
Wakalah Example
Takaful Wakala Takaful Wakala
Wakala Fee = 30% Wakala Fee = 40%

Participant Portion Participant Portion

Contribution (BOY) 70,000 Contribution (BOY) 60,000
Investment Income 7,000 Investment Income 6,000
Claims (EOY) (70,000) Claims (EOY) (70,000) Qard – e
Surplus (EOY) 7,000 Surplus (EOY) (4,000) – Hasna
Induction
Shareholder Portion Shareholder Portion
Wakala Fee (BOY) 30,000 Wakala Fee (BOY) 40,000
Investment Income 3,000 Investment Income 4,000
Expenses (EOY) (25,000) Expenses (EOY) (25,000)
Surplus (EOY) 8,000 Surplus (EOY) 19,000

Total Surplus (EOY) 15,000 Total Surplus (EOY) 15,000

Participant Surplus 7,000 Participant Surplus (4,000)
Shareholder Surplus 8,000 Shareholder Surplus 19,000
Issues with PureWakalah Model
 Takaful operator has little incentive to
underwrite good business (no incentive to
maximize policyholder surplus)
 Takaful operator has little incentive to
maintain good investment practices.
 Potentially higher profit for insurer with
reduced risk.
Mudharbah Model
 To address the “lack of incentive” issue in
Wakalah model, Mudharbah model entitles
Takaful operator to a portion of “Participants”
surplus.
 Operator “partly” disassociates itself from
profit/loss of “risk” activity.
 “Operates” like a conventional model except
shareholders surplus is partly shared with the
policyholders
 Saudi Arabia shareholder surplus share of 90%
Mudharbah Model
 At least 2 versions
 Version I has sharing percentage after meeting
claims but before meeting expenses
 Version II has sharing percentage after both
claims and expenses (policyholder bears a
portion of “expense” risk as well)
Takaful Models
Mudharabah Model (Version 1)
Shareholders Surplus

Participants Management Expenses

Contribution

Shareholders
Islamic Takaful Fund Policy Benefits Fund
Investments

Underwriting Profit
Investment Profit +
Qard-e-Hasna
Investment Profit

Surplus / (Deficit)

y% of Surplus (100 – y)% of Surplus

Takaful Models
Mudharabah Model (Version 2)
Participants
Contribution

Shareholders
Islamic Takaful Fund Policy Benefits Fund
Investments
Management Expenses
Underwriting Profit
Investment Profit +
Investment Profit
Qard-e-Hasna

Surplus / (Deficit)

y% of Surplus (100 – y)% of Surplus

Mudharabah Example (Version 1)
Shareholders Share 80%
Participants Share 20%

Premium (BOY) 100,000

Investment Income 10% 10,000
Claims (EOY) (70,000)
Surplus after claims (EOY) 40,000
Policyholder Share (20%) 8,000
Shareholders portion (80%) 32,000
Expenses (EOY) 25,000
Shareholders share (EOY) 7,000
Mudharabah Example (Version 2)
Mudharaba

Shareholder Share = 70%

Participant Share = 30%

Same as conventional

Surplus Sharing (70%, 30%)

Aggregate Surplus (EOY) 15,000

Shareholder Surplus (EOY) 10,500

Participant Surplus (EOY) 4,500

Mixed Model
 Takaful Operator does not participate in “pure risk” (also
called underwriting surplus)
 However, operator participates in “Investment Income”
(only) of Risk Fund/Participants Fund
 Shareholder is entitled to
i. Wakala fee
ii. Specified share of investment income of Risk /
Participants / Takaful Fund
Takaful Models
Mixed Model
Shareholders Shareholders Surplus
Investment
Participants Management Expenses

Contribution
Wakala Fee
Shareholder
Islamic Takaful Fund Policy Benefits s Fund
Investments

y% of Underwriting Profit
Investment +
Profit Investment Profit

(100-y)% of Investment Profit

Investment Profit

Surplus / (Deficit) Qard-e-Hasna

100% of Surplus
Mixed Model Example
Mixed Model
Wakala Fee = 30%
Shareholder Share in Investment Income = 20%

Participant Portion
Contribution (BOY) 70,000
Investment Income Participant Share (80%) 5,600
Claims (EOY) (70,000)
Surplus (EOY) 5,600

Shareholder Portion
Wakala Fee (BOY) 30,000
Own Investment Income 3,000
Investment Income Shareholder Share (20%) 1,400
Expenses (EOY) (25,000)
Surplus (EOY) 9,400

Total Surplus (EOY) 15,000

Participant Surplus 5,600
Shareholder Surplus 9,400
Waqf (Wakala) Model
The distinct feature of the model is:

 The shareholder makes an initial donation to

establish the Takaful Fund (Waqf Fund)
 Waqf – separate legal entity
 All other features similar to Wakalah Model
 Surplus in Takaful/Participants Fund is NOT the
right of policyholders
 Takaful Models
Waqf (Wakala) Model
Charitable Causes Shareholders Shareholders Surplus
Surplus may or may not
be given to participants Investment
(not their right)
Participants Management Expenses

Contribution
Wakala Fee

Shareholders
Islamic Waqf Fund Initial Donation Fund
Investments Policy Benefits

Underwriting Profit
Investment Profit +
Investment Profit Qard-e-Hasna

Surplus / (Deficit)

100% of Surplus
Key Features
Features Wakala Mudharabah Mixed Model Waqf Wakala

Wakala Fee Yes No Yes Yes

Investment Income Sharing No Yes Yes No

Underwriting Surplus Sharing No Yes No No

Takaful Fund is a separate legal entity No No No Yes

Models in Operation
Country Wakalah Mudharabah Waqf Wakala
Pakistan No No Yes
Malaysia Yes Yes No
UAE Yes No No
KSA No Yes No
Example
You are given the following information :

1. Contribution / Premium (BoY) X

2. Wakala fee as percentage of contribution 30%
3. Claims 700
4. Expenses 200
5. Investment Income in Takaful (Participants) Fund 150
6. Investment Income in Shareholders Fund 100
7. Surplus in participants (Takaful) Fund 500
Example (Contd…)

Find (i). find X, assuming Pure Wakala model

(ii). find shareholders surplus assuming Pure Wakala model

and the calculated value of X in (i).

(iii). find policyholders surplus assuming :

a). X calculated in (i). above; and
b). Mixed Wakala model with 40% of participants
investment income shared by shareholders.
Example Solution

(i) .7X + 150 – 700 = 500

X = 1,500
(ii) 1,500 x .3 + 100 – 200 = 350

(iii) Surplus in Participants Fund under Pure Wakala model –

Participants Investment Income ceded to shareholders
500 – 150 x .4 = 440
All in all…
 Has not achieved targeted success
 More people of integrity
 Marketing on better product value and service
rather than religious emotions (Malaysian
example)
 Takaful requires more transparency.
 Takaful models must ensure uniqueness of
Takaful system
 Should be easily understood by customers
All in all…
 Indulge in “apparently unIslamic” ways to
achieve fairness??
 All models make compromises
 Mutuals resemble Takaful
 Don’t take things at face value – accepting
interpretation by others(?)
Term (Risk) Product difference
between Takaful and Conventional
 Generally no visible difference
 Commitment to pay risk surplus (full or
portion) to policyholders
 Sometimes specify Wakala fee
Insurance Companies Gambling & Gharar
 Do insurance companies create additional
uncertainty (like gambling) or simply manage
existing one.
 Gambling can be disallowed without any
repercussion – what about insurance
 Do insurance companies shift money between
individuals without any economic or social
justification (like gambling)
 Does Takaful arrangement reduce gharar or
gambling in any way (shifts to participants)
Insurance Companies Gambling & Gharar

 Uncertainty (gharar) & management

 Industry has one of the most rigorous risk
management frameworks to reduce and manage
risk
 Actions against excessive risk taking
o Reinsurance
o Avoid unnecessary risky lines
o Take risks as per appetite
o Have capital as per risk taken (RBC)
 Regulatory oversight
Insurance Companies Gambling & Gharar

 Gambling
 Treat customers fairly
 Statistical studies to estimate expected value of
losses
 Customers charged as per study results
 Regulatory approval
 Justification for charging
 Shareholders returns
 Comparable to other industries
 Stability also comparable
Food for Thought

 Why is fixed interest (even if fixed at a

reasonable level) considered “haram”
 Why is interest on interest considered
“haram”
 Why are other betting “like” activities not
considered “haram” such as
i. Speculation in stocks
ii. Speculation in real estate
 Compromises on Interpretation of “Un-Islamic”
Food for Thought
 Same activity considered acceptable if done
by policyholders
 Sharing in apparently illegal income is
acceptable
 Some lines of business are allowed even if
they have higher risk
 Such as having business use (marine, fire, motor)
etc.
 Life insurance not allowed but insurance on death
due to accident is okay.