The term Takaful itself is derived from an Arabic word meaning guarantee or responsibility. The word Takaful is characterized by Musharakah, which means sharing. Hence, Takaful literally means shared responsibility, shared guarantee, collective assurance and mutual undertakings. Technically, Takaful means mutual guarantee or assurance based on the principles of al-aqd or contract provided by a group of people living in the same society against a defined risk.
The concept of Takaful is based on the following verse:
“and help ye one another in righteousness and piety, but help ye not one another in sin and rancour” (Al Maidah: 2)
There are generally four parties involved in Takaful – participants, operator, insured and beneficiary. Participants contribute the premium to the fund. The operator is a registered or licensed body or corporation who manages the fund according to Shariah principles. The insured are the participants who face the risk and are assisted by the fund. The beneficiaries are those who benefit from the fund. Takaful funds are divided into two schemes – general Takaful and family Takaful – which will be discussed below.
Takaful schemes are free from elements involving gharar (uncertainty) in respect of premium and coverage, maisir (gambling) and riba (interest). They are based on Shariah principles according to the verse: “And Allah permitted to you sales and prohibited interest.”
The general Takaful contract is a short-term policy where participants pay contributions and operators undertake to manage risk. The premiums paid by the participants are credited into the general Takaful fund, which is then invested and the profits generated are paid back to the fund.
The contributors’ payments are divided into management cost, risk management, surplus and Special Security Fund (SSF). Management cost is divided into commission, management cost and establishment cost, which covers bills and other miscellaneous expenses. The commission pays the staff salaries and is determined by the operator, which is deducted from the management cost. Commission can also be paid by the participant through mutual consent and agreement. The management cost is the cost of the establishment of the company.
A percentage of the participants’ contribution also goes to the SSF account, which backs up the Takaful company and handles the risk of insolvency. A certain percentage of a predicted amount is contributed to the SSF as a reserve for bankruptcy. For example, a company estimates the probability of bankruptcy for the next 10 years and calculates that it will reserve RM10 million (US$2.69 million) for back up. The participants then contribute 2% each to fulfil the reserve requirement of RM10 million (US$2.69 million), which will be held by the Central Bank. This money cannot be touched by the Central Bank and will not earn or lose any interest. If the company becomes insolvent before the predicted 10 years, say in five years, the Central Bank will return RM5 million (US$1.35 million) from the reserve to the company. If the company does not become insolvent after 10 years, the reserve remains untouchable. The purpose of this is to protect the benefits of the participants. A hadith stated that:
“Narrated by Abu Huraira (R) the Holy Prophet SAW said: Whosoever removes a worldly grief from a mu’min, Allah will take away from him one of the grieves of the hereafter. Whosoever alleviate a needy person, Allah will alleviate from him both the world and the hereafter”
A proposal has been mooted to use the Qardh Hasan concept in the SSF mechanism. From the RM10 million (US$2.69 million) the company reserved in the Central Bank, it will get back RM1 million (US$269,025) for every year it earns profit. So if the company earns RM1.5 million (US$403,509) profit in the first year, the Central Bank will return RM1 million (US$269,025) to the company. However, if this occurs every year, and the money that is returned is then used or invested, if the company becomes insolvent in the ninth year, there will be insufficient reserved funds left to cover the loss.
To avoid these consequences, the returned reserved money could be credited to another account of the company where it could not be touched, specifically for back up purposes. The Central Bank would no longer hold the reserve.
Meanwhile, the risk management contribution is divided into four different accounts in specified percentages. The fund works according to the Tabarru’ concept – re-Takaful, Incurred But Not Recorded (IBNR), claims reserve and unearned contributions.
Tabarru’ means a donation, charity or gift, which cannot be taken back. In general Takaful, a percentage of the participants’ contribution will be considered as Tabarru’ and thus cannot be taken back, as it is the principle of the joint guarantee to help other participants. Once a participant joins the Takaful policy, a portion of his contribution is allocated through the Tabarru’ principle to help all participants from unexpected but defined risks.
A Hadith stated that:
Re-Takaful is where a Takaful company is backed or reassured from any insufficiency in paying the claims or insolvency by another Takaful company. The re-Takaful company is sharing the risk and responsibility with the Takaful company. The percentage borne by the companies is determined through mutual agreement. This mechanism can be illustrated as follows:
In re-Takaful there are two coverage systems available: the facultative and the treaty systems. Facultative is a product-by-product coverage, meaning that it only covers a particular specified policy, such as fire.
The treaty system, however, covers the whole range of claims and is divided into two conditions, compulsory or optional. The treaty system is compulsory when the government requires the Takaful company to reassure its policies in a specified percentage. It would be optional whether to have a re-Takaful company or not.
Incurred But Not Recorded
IBNR is when a participant makes his claim after the policy period, as illustrated by the diagram below.
The payment of all claims within the policy period is made out of the claim reserve account. For example, A had an accident at X and made his claim within the stipulated policy period. The claim payment is made out of the claim reserve account.
Unearned contribution is an account to back up any accrued accounts. For example, if there is an accrual in the claim reserves account, the unearned contribution account will cover the accrued amount. After the claim has been paid and costs deducted, any surplus will be put in the surplus account. There are three differing opinions of ulama regarding the contribution of surplus.
1. Some ulama believe the surplus is from the Tabarru’ fund and whatever is left should be returned to the risk management fund.
2. Some ulama believe it should be returned to the participants in the surplus account according to their contributions, because management costs have been deducted.
3. Some ulama believe the surplus should be shared between the two parties – the operator and the participants. After the management costs are deducted, the surplus should be divided – a small portion to the operator and a bigger portion to the participants on a no claims basis.
According to an officer of Takaful Malaysia, surplus is spread as a bonus to the staff, with the manager receiving a portion according to performance. The participants receive their benefits yearly, based
Family Takaful, or life insurance, does not mean insuring one’s life, rather it is a financial protection for the heirs or beneficiaries of the deceased or insured against future unexpected financial risk. Family Takaful is based on the principle of Mudarabah, which relies on the principles of mutual cooperation.
Life Takaful consists of two types of accounts: Participant’s Account (PA) and Participant’s Special Account (PSA). PA is treated in line with the principle of Mudarabah, while the PSA is treated on the basis of Tabarru’ or donation. If the risk occurs, beneficiaries have the right to claim policy value from the PSA, as well as the accumulated amount from the PA.
Profit is distributed to participants according to their contribution or investment in the family Takaful fund, based on the terms and conditions applied by the company. The contribution paid by the participants in family Takaful is divided into four parts. As with general Takaful, a certain percentage of the premium paid will be allocated for management costs, which comprises commission, management costs and the SSF account. The majority of the contribution paid for family Takaful is invested in PA and PSA.
Thus if A contributes RM1,000 (US$269) to the life policy, this will be divided into the two accounts according to the percentage determined: PA 70% and PSA 30%.
If a participant makes a claim within the policy period, the beneficiaries are entitled to benefits from the PSA fund, as its purpose is to provide financial security for the participants.
However, if there is no claim made during the policy period, the participant can claim from the PA fund only. The reason for this is that the participant is a donor to the Tabarru’ fund, which cannot be taken back, as outlined earlier in this article.
The Tabarru’ rate, as determined by actuaries, is affected by:
• the expected claim rate;
• the incidence of claim;
• the basic cover;
• the reserving basis;
• the profit-sharing expectation between the operator and participant; and
• any expenses or commission loading.
If the participant’s PSA fund has a large surplus, the operator can donate some of this to charity or use it to develop the social infrastructure, in contributing for the sake of Ummah.
Additional benefits of Family Takaful
For example, if a participant who paid his premiums for 25 years met with an accident and died, or was permanently paralyzed, within his policy period, his beneficiaries could claim all of the benefits from both the PA and PSA accounts. If an accident befell a participant during the policy period which did not lead to any serious harm or death, compensation would be awarded according to his condition. A participant who made no claims during the policy period can only claim from the PA.
(b) Family benefits
If a participant paid life Takaful premiums for a 10-year policy period and died within the policy period, the benefits would be distributed among his beneficiaries according to the principles of Faraid.
(c) Permanent disabilities.
(d) Hospital benefits.
• Bank order;
• Cash or cheque;
• Credit card or charge.
Advantages of family Takaful
(1) The participants can select the maturity date.
(2) Profit sharing is according to the agreed ratio.
(3) The policy can be terminated at any time.
(a) if less than two years, the participant will be charged RM30 (US$8.07);
(b) if more than two years, 50% of the PA can be withdrawn without charge;
(c) if more than five years, 70% of the PA can be withdrawn without charge.
(5) There is flexibility to change the premium paid, the period and the instalments in one year.
(6) Income tax exemption.
(7) As a mortgage in bank.
Takaful could be an example of the union of the Ummah, as the principles are primarily based on co-operation and helping one another out against a defined risk. The Takaful policy is meant to financially protect the participants via the premium paid by them through the policies provided, based on Islamic principles of Mudarabah and Tabarru’. The development of Takaful as an alternative to conventional insurance should be upheld by the Ummah in order to avoid the elements of maisir, gharar and gambling, which are contrary to the Shariah.
The author is Islamic Corporate Advisor on Shariah Compliance of Banking, Finance, Investment, Takaful, re-Takaful, Business, Wealth, Asset and Property Management, Capital Market, Bond (Sukuk) Market, Money Market and e-Commerce. He is a Professor of Islamic Finance at the Faculty of Islamic Finance, University of Camden, USA (Malaysian Center). He can be contacted by email on:
; website: http//.www.applied-islamicfinance.com.