Takaful (Islamic Insurance)

HISTORY OF INSURANCE
Insurance has a long history. There is evidence of many practices resembling insurance in
the ancient world. As early as 3000 B.C. Chinese merchants utilized the technique of
sharing risk. These merchants shipped their goods by boat downriver, and because of
treacherous rapids, not all boats made it safely. To reduce the impact of losses on any one
individual, i) they devised the plan of distributing their goods on each other's boat. If a
boat was hit the rocks and sank, the loss was shared by all rather than falling upon a
single individual. About 500 years later the famous Code of Hammurabi provided for
the transfer of the risk of loss from merchants to moneylenders. Under the provision of
the code, a trader whose goods were lost to bandits was relieved of his debt to the money
lender from whom he had borrowed the money to buy the goods. ii) Babylonian
moneylenders undoubtedly loaded their interest charges to compensate for this transfer of
risk. The borrower was offered an option whereby, for a somewhat higher interest
charge, the lender agreed to cancel the loan if the ship or cargo was lost at sea. The
additional interest on such loans was called a "premium", and the term has become a
part of insurance terminology. The practices similar to insurance were in vogue in pre-
Islamic Arab society. iii) Some of the known practices were A'qila (payment of blood
money by the tribe of the murderer), iv) Qasama (payment of blood money by the people
of the town where dead body was found) and v) Wila' (support of a tribe to freed slave of
one of its members). These institutions were allowed to work in Islam due to their
usefulness and some other institutions of the similar nature were established under
Islamic state. These all institutions will be explained in the coming chapter.
Although these were insurance of sort, the modern insurance business did not begin until
the commercial revolution in Europe. Marine insurance appears to have started in
Italy sometime during the thirteenth century. From there it spread to the other
countries of the continent and then to England through the Lombard merchants. This
early marine insurance was issued by individuals rather than by insurance
companies as we know them. A ship owner or merchant who desired protection on his
ship or cargo prepared a sheet with information describing the ship, its cargo, its
destination, and other pertinent information. Those who agreed to accept a portion of the
risk wrote their names under the description of the risk and the terms of agreement. This
practice of writing under the agreement gave rise to the term underwriter. Finding it
difficult to manage at individual level, individual underwriters gradually gave way to
corporate insurers, and the term underwriter retained its meaning as one who selects and
rejects risks.8
Ship owners seeking insurance and the underwriters found the coffee houses of London
convenient meeting place. One of the coffee houses, owned by Edward Lloyd, soon
became the leading meeting place because its proprietor made available papers and pens
and information regarding shipping. This coffee house is known to have been in existence
early in 1688. In 1771 the underwriters who were using Lloyd's facilities entered into a
formal agreement, and the Lloyd's exchange was formally created.
From the beginning of insurance in the Europe and The United States the insurance
companies chose to specialize in one field or another. As more and more states began to
regulate insurance, state limitations on the companies' underwriting powers became
common.

 Practice of Al-Nihd
Ibn Hajar al-Asqalani in his book, Fat’hul Bari indicated that Al-Nihd was an ancient
practice of Muslim travelers who used to contribute equally for provision of the stock
of food they needed during journey, and allow every body to consume freely
according to his needs. At the end of the journey, they used to distribute the food
leftover among participants, unless they decide to keep it for another journey.18
Narrated by Wahab bin Kaisan: Jabir bib Abdullah reported that, Allah’s Apostle
sent troops to the sea coast and appointed Abu ‘Ubaida bin al-Jarrah as their
commander. We were three hundred (soldiers). We set out, and we had covered some
distance on the way, when our journey-food (Zad) runs short. Abu ‘Ubaida ordered
that all the food available with the troops be collected at one place. Our journey-food
was dates, and Abu ‘Ubaida kept on giving us our daily ration from it bit by bit
(piecemeal) till it decreased to such an extent that we did not receive except one date
each”. I asked (Jabir), how could one date benefit you? “He said “We came to know
its value when even that finished.” Jabir added, “Then we reached the sea (coast)
where we found a fish like a small mountain. The troops ate of it for eighteen (18)
nights (i.e. days). Then Abu ‘Ubaida ordered that two of its ribs be fixed on the
ground (in the form of an arch) and that a she-camel be ridden and passed under
them. So it passed under them without touching them.20
Models of Takaful
Presently three basic models of Takaful are operational in different regions. These
models are;
i. Mudarabah model which is common in Malaysia and other countries of
South-East Asian region, therefore it is generally referred to as Malaysian
model.
ii. Wakalah model which is being practiced in Gulf region. It is referred to in
the literature as Bahrain model, since it was first launched in Bahrain.
iii. Waqf-Wakalah model which is initiated in Pakistan and South Africa. It is
known as Pakistan’s model of Takaful.

The Working Model

Mudarabah Model
Mudarabah is defined as a profit-and-loss sharing principle applied normally to a
business or commercial contract between the party that provides the fund or capital
(called Rab-ul-Maal) and the party that manages the business (called Mudarib). For
Takaful business, this would mean the contract of profit sharing taking place between the
participants and the operator from the profit, if any, of the takaful business. Under this
arrangement, a profit sharing contract is signed between the operator, as the entrepreneur
or termed Mudarib who is entrusted with managing the Takaful business and the
participant(s) as the provider of capital, called Rab-ual-mal who is obliged to pay the
Takaful contribution as the capital. The contract will define the profit of the Takaful
business and the ratio to be shared between the two parties such as 50:50, 60:40 or 70:30
for the participant and operator respectively. In essence, profit in Takaful is defined as
returns on the investment and surplus from the underwriting in respect of the Takaful
funds only. As such, this does not include profit posted by the Shareholders Fund. For the
family Takaful business it includes the mortality surplus to be allocated to the eligible
participant as declared by the actuarial valuation at the end of every financial year.
However, unlike the Mudarabah contract for Islamic banking product, profit sharing in
Takaful will be undertaken only after all the obligations of Takaful have been accounted
for the biggest factor is the claims. In the event of a loss or deficit of Takaful fund, the
loss will be borne wholly by the participant(s) as provider of capital.
Notwithstanding the above, it is the responsibility of the operator to safeguard the
interests of the participants in order to ensure the business will not be seriously affected
by the loss that might jeopardize the and credibility confidence of Takaful business as a
whole. For this reason proper governance, prudence and professionalism in managing the
business on the part of the operator is imperative. In the event of such loss, it is
incumbent upon the operator to make good the loss by qard-e-hasan or interest free
loan from the shareholders fund. An important feature to note is that under the
Mudarabah model, management expenditure is not charged on the Takaful fund
instead it is borne by the shareholders fund. Revenue of the latter comprise a portion
from the profit sharing of the Takaful funds with the participants, and all returns on the
investment of the shareholders fund itself.
Therefore, under the above business model, the participant and the operator enter into a
contract of Mudarabah from inception, for indemnification and share of the underwriting
profit. The fact that management expenses are not charged to the takaful fund provides
better opportunity for the positive underwriting performance. Although the actual profit
payable to each entitled participant would vary according to the profit sharing ratio and
period of participation as well as the time of payment of the contribution, in general the
above business model has been paying attractive profits to its participants. Similarly, as
there is no upfront leakage of the installment contribution to cover management expenses
or agency cost, a participant of a long-term family product would be refunded all the
installments meant for his savings inclusive of its returns on investment should he chose
to cancel or surrender the participation in the first year. In this regard, the unique
difference of Takaful from the conventional insurance is very clear. The difference is not
only in the underlying basis of contract (aqad) that is founded on Shariah, but also in the
business operation, which is advantageous to the consumers.

Working of the Takaful Business under Mudarabah Model

Takaful Business is based on the concepts of Mudarabah and Tabarru (donation).
Involvement of these two Islamic elements eliminate the element of Riba from the
insurance contract and convert Gharar into tolerable form. Under Takaful arrangements,
as the relationship between the participants and the Takaful fund is based on the concept
of unconditional donation from both the sides, any discrepancy in the amount of
contribution and the compensation is not amounts to Riba al-Fadl. The operator is bound
to invest Takaful fund in Shariah compliant investments only with the approval of their
respective Shariah Supervisory Board, so the element of Riba al-Nasiyyah disappears
from the contract. As already has been discussed that Gharar in donation contracts (Aqd-
e-Tabarruat) is tolerable. Similarly issue of Gambling and other objections resolved due
to contractual form and structure of Takaful.
The operational details of different Takaful businesses under Mudarabah model are as
follows:

Family Takaful
The Family Takaful Fund consists of two sectors. All the takaful plans with the maturity
period of ten, fifteen, twenty, up to forty years. Takaful Mortgage plan and Takaful plan
for Education which may be participated by the individual only are grouped and managed
under the individual sector. The Group Takaful plan, the Group Hospitalization plan and
Surgical Takaful plan which may be participated by corporate bodies only as well as all
the supplementary contracts which may be attached to the Family plans are part of the
Group Sector.

Working of Individual Sector:

Any individual between the ages of 18 to 55 years can participate in the Family Takaful
business. Participants are required to pay regularly the Takaful installments which are
credited to a defined fund known as the Family Takaful Fund. Each Takaful installment
is divided and credited to two separate accounts namely, the Participants' Account (PA)
and the Participants Special Account (PSA). A substantial proportion of the installment
is credited to the PA solely for the purpose of savings and investment. The balance of the
installments is credited to the PSA as `tabarru' (donation) for Sharikah Takaful Malaysia
to enable it pay the Takaful benefits to the heir(s) of any participant who may die before
the maturity of his Family Takaful Plan. Takaful operator only manages these two
accounts but owns none of them. PA solely belongs to the participant and he receives
back whatever is available in this account in case of maturity or discontinuation of
Takaful policy. Takaful pool or PSA belongs to the participants collectively. The amount
accumulated in the PA is invested in various businesses according to Islamic financing
techniques, and the resultant profits are divided between the Shirakat and the participants
according to the agreed upon ratio, e.g., 30-70. The participant's share is calculated
according to their individual contribution to the PA, and credited into their respective
accounts, the PA and the PSA.
Suppose a participant has purchased a 10 years Family Takaful policy and paying RM
1000 to Takaful company as his annual contribution. The allocation of contribution
between PA and PSA is 97.8% and 2.2% respectively. The investment profit is shared
between Takaful operator and the participant at the rate of 30% and 70%. Out of 70% of
profit each participant’s share is calculated according to his individual contribution in PA
and the resultant amount is added into PA and PSA with the ratio of allocation of
installment. Next year the participant again provides RM1000 as his contribution which
is again added into PSA and PA. In this manner both the accounts swell over time. The
management of both accounts can be explained with the help of the following chart:
Sahariah Concerns Regarding Mudarabah Model
Despite the success and popularity of Mudarabah model, some scholars and Islamic
jurists expressed concern on the suitability of applying the Mudarabah contract for
takaful operation. According to them, it is not appropriate to link a contract of tabarru
between participants to profit sharing contract of Mudarabah. Their important concerns
are mentioned as follows;
 A major objection against commercial insurance was the presence of gharar
which considered being intolerable in a commutative contract. As the presence
of uncertainty about future is the basic cause of existence of insurance contract, its
eradication is not possible from the contract. To solve this problem, it was
proposed to arrange insurance scheme as a donation based contract (Aqd-e-
Tabarru) instead of commutative contract (Aqd-e-Muawadah). Mudarabah being
a commutative contract does not sound appropriate to be used in a donation based
scheme.
 The capital of Mudarabah remains in the ownership of Rab-ul Mal, whereas
the donor loses the ownership rights over the donated amount. Being opposite in
nature, two status may not be possible for an amount at the same time. It will
either be capital for Mudarabah or a donation. In case of Family Takaful
product, where installment is distributed into two components, it may be
possible to apply Mudarabah contract for investment component (PA) and
donation for the risk component (PSA), but in case of General Takaful where
whole the amount is given as donation, it is not appropriate to treat it like
capital for Mudarabah.
 Intention of the participant should be clear whether the amount is being given as
donation or for a business purpose on Mudarabah basis because the two are very
different in their impacts.
 In a Mudarabah business, the Rab-ul-Mal share the profit, if any, according to
predefined ratio. But in case of Takaful it is not necessary to get a share out of
profit or surplus. It is on the discretion of the operator whether to distribute
surplus or keep it as reserve.
 The Takaful operator receives a share out of surplus instead of profit against the
requirements of Mudarabah. Surplus is defined after subtracting operational costs
of Takaful, including direct business costs, claims and cost of re-Takaful, from
the profit.
 Participants’ collective ownership of Takaful fund creates the issue of payment
of Zakat and inheritance in case of death of any participant during the policy
period.
 Accepting the responsibility of arranging Qarz-e-Hasan from the shareholders
fund in case of any deficit in Takaful fund is also not correct as Mudarib is not a
guarantor.
 Provision of Qarz-e-Hasan to PTF, which is owned by a group of participants,
and recovering that loan some time in future from the donations given by other
 participants is also questionable.
However, the view of scholars and Islamic jurists, in particular those who have been
serving on the Shariah bodies of various takaful operators in Malaysia, supporting the
permissibility of the above model is based on the legal maxim where a ruling is decided
on the understanding of the issue at hand. In this regard, one of the approaches used is
the principle of ‘urf as one of the secondary sources of Shariah.

Figure 5.1
Mudarabah Model Profit Attributed
To Shareholders
Family Takaful

Share of Share of Company’s Admin

Company Profit on Profit for
S.H. capital Mudarib & Manag. Expenses

Takaful Contract Share

Holders Fund
based on Mudarabah
Investment Profit

C
O
N
T
PA PA Payment to
The Family from
R
Participant I FTF PA & PSA
B
U
T
I PSA PSA Cost of Re-takaful
And Other Direct Surplus
O
Business Expenses
N
 Figure 5.2 Mudarabah Model
General Takaful

Share of profit Share of Surplus Administration

Takaful & Management Profit for
Operator On S.H. Capital For the Operator Expanses
Shareholders

Share
Holders Fund
Takaful Contract
Based On Invest Profit
Mudaraba ment
40%

con G G Payment of
Claims 60%
tri T T Cost of re- Sur
Participant Share of Surplus for
but F F
Takaful
Business Exp
The Participants
ion plus