Advanced Diploma in Insurance

Transcription

1 590 Advanced Diploma in Insurance Unit 590 Principles of Takaful October 2018 Examination Guide SPECIAL NOTICES Candidates entered for the April 2019 examination should study this examination guide carefully in order to prepare themselves for the examination. Practice in answering the questions is highly desirable and should be considered a critical part of a properly planned programme of examination preparation.

2 590 Principles of Takaful Contents Important guidance for candidates 3 Examiner comments 7 Question paper 9 Model answers 14 Published February 2019 Telephone: Fax: customer.serv@cii.co.uk Copyright 2019 The Chartered Insurance Institute. All rights reserved. 2

3 IMPORTANT GUIDANCE FOR CANDIDATES Introduction The purpose of this Examination Guide is to help you understand how examiners seek to assess the knowledge and skill of candidates. You can then use this understanding to help you in your preparation for this examination. Before the examination Study the syllabus carefully This is available online at All the questions in the examination are based directly on the syllabus. You will be tested on the syllabus alone, so it is vital that you are familiar with it. There are books specifically produced to support your studies that provide coverage of all the syllabus areas; however, you should be prepared to read around the subject. This is important particularly if you feel that further information is required to fully understand a topic, or an alternative viewpoint is sought. The reading list which can be found with the syllabus provides valuable suggestions. Note the assumed knowledge For the Advanced Diploma in General Insurance, candidates are assumed to have studied the relevant units of the Diploma in General Insurance or the equivalent. This knowledge is set out on the relevant syllabus. Read widely It is vital that your knowledge is widened beyond the scope of one book. It is quite unrealistic to expect that the study of a single textbook will be sufficient to meet all your requirements. While books specifically produced to support your studies will provide coverage of all the syllabus areas, you should be prepared to read around the subject. This is important, particularly if you feel that further information is required to fully understand a topic or an alternative viewpoint is sought. The reading list which can be found with the syllabus provides valuable suggestions. 3

4 Make full use of the Examination Guide This Examination Guide contains a full examination paper and model answers. The model answers show the types of responses the examiners are looking for and which would achieve maximum marks. However, you should note that there are alternative answers to some question parts which would also gain high marks. For the sake of clarity and brevity not all of these alternative answers are shown. This guide and previous Examination Guides can be treated as mock examination papers. Attempting them under examination conditions as far as possible, and then comparing your answers to the model ones, should be seen as an essential part of your exam preparation. The examiner s comments on candidates actual performance in each question provide further valuable guidance. You can obtain copies of the two most recent examination guides free of charge at Know the structure of the examination Assessment is by means of a three hour written paper. Part I consists of 8 compulsory questions, worth a total of 48 marks. Part 2 consists of 1 compulsory question, worth a total of 38 marks. Part 3 consists of 3 questions selected from 5, worth a total of 114 marks. Each question part will clearly show the maximum marks which can be earned. Read the Advanced Diploma in General Insurance information for candidates and important notes for candidates Details of administrative arrangements and the regulations which form the basis of your examination entry are to be found in the current Advanced Diploma in General Insurance information for candidates and important notes for candidates, which is essential reading for all candidates. It is available online at 4

5 In the examination The following will help: Spend your time in accordance with the allocation of marks: The marks allocated to each question part are shown on the paper; if a question has just two marks allocated, there are likely to be only one or two points for which the examiner is looking for, so a long answer is wasting valuable time. Conversely, if a question has 12 marks allocated, a couple of lines will not be an adequate answer. Always remember that if the paper is not completed, your chances of passing will be reduced considerably. Do not spend excessive time on any one question; if the time allocation for that question has been used up, leave some space, go on to the next question and return to the incomplete question after you have completed the rest of the paper, if you have time. Take great care to answer the question that has been set. Many candidates leave the examination room confident that they have written a good paper, only to be surprised when they receive a disappointing result. Often, the explanation for this lies in a failure to think carefully about what the examiner requires before putting pen to paper. Highlighting key words and phrases is a technique many candidates find useful. The model answers provided in this Examination Guide would gain full marks. Alternative answers that cover the same points and therefore answer the question that has been asked would also gain full marks. Tackling questions Tackle the questions in whatever order feels most comfortable. Generally, it is better to leave any questions which you find challenging until you have attempted the questions you are confident about. Candidates should avoid mixing question parts, (for example, 1(a)(i) and (ii) followed by 2(b)(ii) followed by 1(e)(i)) as this often leads to candidates unintentionally failing to fully complete the examination paper. This can make the difference between achieving a pass or a narrow fail. It is vital to label all parts of your answer correctly as many questions have multiple parts to them (for example, question 1(a) may have parts (i), (ii) and (iii)). Failure to fully distinguish between the separate question parts may mean that full credit cannot be awarded. It is also important to note a full answer must be given to each question part and candidates should not include notes such as refer to answer given in 1(b)(i). 5

6 Answer format Unless the question requires you to produce an answer in a particular format, such as a letter or a report, you should use bullet points or short paragraphs, as this allows you to communicate your thoughts in the most effective way in the least time. The model answers indicate what is acceptable for the different types of question. Where you are asked to perform a calculation, it is important to show all the steps in your answer. The majority of the marks will be allocated for demonstrating the correct method of calculation. Provided handwriting is legible, candidates will not lose marks if it is untidy. Similarly, marks are not lost due to poor spelling or grammar. Calculators If you bring a calculator into the examination room, it must be a silent, battery or solar-powered, non-programmable calculator. The use of electronic equipment capable of being programmed to hold alphabetical or numerical data and/or formulae is prohibited. You may use a financial or scientific calculator, provided it meets these requirements. The majority of the marks will be allocated for demonstrating the correct method of calculation. 6

7 Candidates overall performance EXAMINERS COMMENTS In general candidates overall performance was good, particularly with significant improved responses to section one compared to the April 2018 sitting. However, disappointing performance was seen from most candidates attempting section two. More detailed answers and in-depth knowledge of concepts were required from candidates to achieve high marks, in particular in section three. Question 1 This question required candidates to explain briefly the difference(s) between fundamental risks and particular risks and many candidates scored well. Question 2 This question tested candidates ability to explain three challenges associated with the basic co-operative model, which the majority of candidates scored well in. Question 3 Another direct question testing the basic concepts of the differences between bilateral contracts and unilateral contracts and many candidates scored well. Question 4 Candidates were expected to identify three criticism points for Takaful windows. This question was not answered well by some candidates, although candidates who knew this area achieved high marks. Question 5 This question tasked candidates with explaining the difference(s) between operational risk and liquidity risk in a Takaful operational model. Responses to this question from many candidates were quite limited. Question 6 Many candidates did well in this question and received high marks for identifying three main responsibilities of the Shariah Liaison Officer. Question 7 The answers to this question required candidates to explain briefly the difference(s) in respect of the treatment of surplus or deficit in the proprietary and Takaful modes of insurance provision saw some disappointing responses. Question 8 A straightforward question where candidates were expected to outline how Gharar can be mitigated by Tabarru. Most candidates scored well in this question. Question 9 This question aims to test the strategic and operational application of the core concepts. The responses provided by most candidates was not at the required standard. 7

8 Question 10 Most candidates who answered this question could not explain the concepts in sufficient detail required for an essay style question. Question 11 Although this question offered a good opportunity to score marks, many candidates did not attempt this question and those who did could not provide sufficient depth in their answers. Question 12 This was a question which required candidates to apply the application of core concepts under Takaful offered an excellent scoring opportunity for the candidates, many of whom answered this question and received reasonably good marks. Question 13 The candidates who answered this question could not elaborate on the key concepts of Gharar and Maysir and their prohibition in Shariah. Question 14 This question was asking candidates to explain the objectives of Islamic finance. Candidates who attempted this question score fairly well. However, some candidates did not provide the detailed responses expected for a 38 mark essay style question. 8

9 590 Advanced Diploma in Insurance Unit 590 Principles of Takaful October 2018 examination Instructions Three hours are allowed for this paper. Do not begin writing until the invigilator instructs you to. Read the instructions on page 3 carefully before answering any questions. Provide the information requested on the answer book and form B. You are allowed to write on the inside pages of this question paper, but you must NOT write your name, candidate number, PIN or any other identification anywhere on this question paper. The answer book and this question paper must both be handed in personally by you to the invigilator before you leave the examination room. Failure to comply with this regulation will result in your paper not being marked and you may be prevented from entering this examination in the future. 9

10 Unit 590 Principles of Takaful Instructions to candidates Read the instructions below before answering any questions Three hours are allowed for this paper which carries a total of 200 marks as follows. Part I 8 compulsory questions 48 marks Part II 1 compulsory question 38 marks Part III 3 questions selected from marks You should answer all questions in Part I, the compulsory question in Part II and three out of the five questions in Part III. The number of marks allocated to each question part is given next to the question and you should spend your time in accordance with that allocation. You are advised to spend no more than 45 minutes on Part I. Read carefully all questions and information provided before starting to answer. Your answer will be marked strictly in accordance with the question set. You may find it helpful in some places to make rough notes in the answer booklet. If you do this, you should cross through these notes before you hand in the booklet. It is important to show all steps in a calculation, even if you have used a calculator. If you bring a calculator into the examination room, it must be a silent, battery or solar-powered, non-programmable calculator. The use of electronic equipment capable of being programmed to hold alphabetic or numerical data and/or formulae is prohibited. You may use a financial or scientific calculator, provided it meets these requirements. Answer each question on a new page and leave six lines blank after each question part. 10

11 PART I Answer ALL questions in Part I Each question is worth six marks Note form is acceptable where this conveys all the necessary information 1. Explain briefly the difference(s) between fundamental risks and particular risks. (6) 2. Explain briefly three challenges associated with the basic co-operative model. (6) 3. Explain briefly the difference(s) between bilateral contracts and unilateral contracts. (6) 4. Explain briefly three criticism points for Takaful windows. (6) 5. Explain briefly the difference(s) between operational risk and liquidity risk in a Takaful operational model. (6) 6. Identify three main responsibilities of the Shariah Liaison Officer. (6) 7. Explain briefly the difference(s) in respect of the treatment of surplus or deficit in the proprietary and Takaful modes of insurance provision. (6) 8. Explain briefly how Gharar is mitigated by Tabarru. (6) 11

12 Part II Compulsory question This question is worth 38 marks 9. The Board of Directors of ABC Takaful firm has recently conducted a meeting in relation to the strategy and operations of the firm. As a member of the management team, you have received the following brief about the Board s requests in relation to the debate that took place during the meeting. Strategy While reviewing the strategy, the Board of Directors discussed the available expansion opportunities. Much of their debate related to the emerging markets. They have requested the management team to provide them with further details on the emerging market economies. Operations While reviewing the financial statements and the accounting policies of the firm, the Board noted several references to Financial Accounting Standard No. 12 (FAS 12) and Financial Accounting Standard No. 13 (FAS 13) of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) standards. The Board requested the management team to provide them with some details in relation to FAS 12 and FAS 13. Prepare a report to the Board of Directors addressing their requests. (38) 12

13 Part III Answer THREE of the following FIVE questions Each question is worth 38 marks 10. Explain Shariah compliant mechanisms available to address a deficit in the participant risk fund(s). (38) 11. Explain the formation of the Takaful fund from theoretical and practical perspectives. (38) 12. Explain Gharar and Maysir and their prohibition in Shariah. (38) 13. Explain the key features of a Takaful model of insurance provision. (38) 14. Explain the objectives of Islamic finance. (38) 13

14 NOTE ON MODEL ANSWERS The model answers given are those which would achieve maximum marks. However, there are alternative answers to some question parts which would also gain high marks. For the sake of clarity and brevity not all of these alternative answers are shown. An oblique (/) indicates an equally acceptable alternative answer. Model answer for Question 1 Fundamental risks can be defined as those that arise from social, economic, political, or natural causes and are widespread in their effect. The problem with fundamental risks is that it is often a lack of willingness or capacity on the part of insurers that causes such risks to be difficult to insure or even completely uninsurable. Fundamental risk is not an easily defined category and there seem to be, on the face of it, many exceptions to the general rule. In contrast to fundamental risks, risks are localised or even personal in their cause and effect. Sometimes the cause may be more widespread (a storm over a whole region), but the effect is localised or even related to an individual. Model answer for Question 2 Limited incentive for a Takaful operator (TO) to perform well because the model only covers operating costs and the TO is not compensated for their work; responsibility to fund any deficit can be onerous for participants, especially in the absence of reserves; it has been problematic to determine the appropriate management fees because they not linked to a performance matrix apart from the solvency of the pool, leading to the possibility of high fees and little reward for better performance. As a result, it has proven difficult to hold the TO accountable for performance; and the regulatory environment often declines to recognise future potential funding from participants as eligible capital. This in turn implies that any surplus must be retained in the operation rather than returned to the participants. 14

15 Model answer for Question 3 Bilateral Contracts: - Two parties or more involved; - parties make a promise to each other; - actions are obligated to all parties involved; - offer, acceptance and consideration are all available in the contract; - must adhere to principles such as transparency, fairness and no uncertainty in the context of Islamic finance. Unilateral Contracts: - Single party; - only one party makes a promise; - actions are obligated to one party; - offer is made; acceptance does not need to be communicated; and the offeree s performance is regarded as the consideration; and - the terms of the contract are at the offeror s discretion, and no rules such as transparency and uncertainty are attached. Model answer for Question 4 Commitment A conventional insurer s incorporation and statutes do not comply with Shariah. For some jurists this raises a question over the insurer s commitment to comply with the Shariah in their Takaful windows. Supervision Concern that lack of Islamic expertise or commitment could lead to weak supervision of Islamic windows, resulting in potential violations of Shariah. Segregation Division between conventional operations and the Takaful window can be problematic. Concern that the window s funds could be diverted to finance activities of the conventional operation which are not permissible in Shariah. Unfair advantage Concern that conventional financial institutions operating Takaful windows could compete unfairly with newly established Islamic financial institutions due to their wealth of experience, expertise and a strong presence in the market. Risk of conflict of interest Concern that a conventional company may prefer transacting through its conventional operations over its Takaful window operations. Model answer for Question 5 Operational risk Risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. For a Takaful fund, this also includes risk of loss resulting from Shariah non-compliance and failure of the TO in managing the fund. For example, the TO has allowed commingling of the funds, or invested the proceeds of the fund in non-shariah compliant products. Liquidity risk Risk of loss to the Takaful fund arising from its inability to meet its obligations to pay claims. This may arise due to the Takaful fund s inability to dispose of its assets in time to meet the claims, or withdrawals of the participants. 15

16 Model answer for Question 6 The main responsibilities of the Shariah Liaison Officer (SLO) are to: ensure that the day-to-day operations are in line with Shariah standards and guidelines set by the company s Shariah Supervisory Board (SSB) and in accordance with international standards such as the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and the Islamic Financial Services Board (IFSB); act as a liaison officer between the company and the SSB. This involves preparation of any queries to be put to the SSB and periodic reports on the on-going operations for review by the SSB; keep continuous and clear communication between the company and the SSB, and to communicate any problems or queries in a timely manner; and prepare relevant documentation for the SSB s Shariah audit of the Takaful company s operations. Model answer for Question 7 Proprietary: Surplus belongs to company. Surplus likely to be paid as no-claims bonuses to policyholders and dividends to shareholders. No policyholder liability. Deficits met from company s funds. Takaful: Members entitled to share of surplus. Surplus encouraged to be retained in the pool. Member liability. Deficits met from reserves. If reserves are insufficient, deficit funded by an interest-free loan from Takaful operator (to be repaid from future surpluses). Model answer for Question 8 In Shariah the prohibition of Gharar does not strictly apply to charitable and unilateral contracts and generally does not render the arrangement void or voidable. The main reason for the tolerance of Gharar is the charitable and gratuitous nature of the contract where no counter-value is expected in return. However, a risk-pooling arrangement where the participants contribute to a common pool reduces the inherent Gharar in insurance to minor Gharar. Minor Gharar would then not make the insurance arrangement void or voidable in Shariah. The reasoning is that those paying the Tabarru are not aiming to profit from the uncertainty inherent in the provision of any insurance. Instead, they intend to raise a pool of mutual donations that will be used for mutual indemnity to compensate those of the participants who suffer from defined perils. 16

17 Model answer for Question 9 Strategy Emerging Market Economies The demand for insurance is projected to rise at a faster pace in emerging market economies than in the markets of developed countries. There is a well-established connection between Gross Domestic Product (GDP) per person and insurance penetration; a report published by the Islamic Financial Services Board (IFSB) in 2016 shows that insurance demand strongly increases as economies move through a typical transitional phase of development. This phase of development is currently being experienced by major potential Takaful markets, such as Indonesia and South Asia. Insurance penetration levels were previously very low in these counties. Insurance penetration rates are likely to grow at a rapid pace as these countries experience economic growth. This will present the Takaful sector with the following opportunities: Urbanisation of societies Malaysia, for example, has changed from being 70% rural in the 1970s to nearly 70% urban in 2015, and similar trends are evident in other societies. This means that the traditional self-insurance possibilities provided by extended family and tribal groups may no longer be possible, as people in cities often have to make their own risk mitigation arrangements. Increase in GDP Economic growth leads to an increase in personal wealth and creates more need for the insurance of corporate assets, liabilities and interests, such as business interruption. Fewer State-sponsored welfare benefits With the protracted period of historically low oil and commodity prices, such benefits are expected to come under pressure in many countries. This would cause a greater need and scope for the private provision of many services which are traditionally provided by insurance companies. An increase in insurance potential does not necessarily mean growth in Takaful. The key question for the Takaful industry is how much of this potential growth will be captured by them rather than conventional insurers. It has already been noted that the Takaful sector s share of total insurance markets in many countries remains very low. Operations AAOIFI Financial Accounting Standard No. 12 (FAS 12) The preface to FAS 12 mentions that presenting adequate, reliable and relevant information to users of the financial statements of Islamic insurance companies could help to develop and implement accounting standards of Islamic insurance companies. FAS 12 stresses the importance of segregation of funds. Each fund should provide its own statement. There should be separate income statements for participants and shareholders. FAS 12 requires separate disclosures for shareholders equity and the participants surplus. The rationale for separation of statements is that it illustrates the various interests in the company. 17

18 FAS 12 defines the financial statements that are required to be produced by Islamic insurance companies to satisfy the needs of users of financial reports. The financial statements comprise of the following: a. Statement of financial position (balance sheet); b. Statement of comprehensive income; c. Statement of participants revenues and expenses; Statements b) and c) are extremely useful to participants in understanding the structure of the company. It identifies each component of the company and its resulting profit or loss. These statements explain and differentiate between the remuneration of the operator and operating and investing expenses. d. Statement of changes in owners equity (shareholders); e. A statement of policyholders surplus (or deficit); Statements d) and e) inform the participants of the movements of equity and surplus during the relevant year. It indicates how the surplus was distributed or used to pay off any outstanding loans or deficits. f. Statement of cash flows; provides a separate and individual breakdown of total assets and liabilities representing shareholders equity and participants surplus at the end of the year. g. A statement of sources and uses of funds in the Zakah (obligatory contribution/tax) and charity fund; An Islamic insurance company has social responsibilities and accordingly, the company is required to provide details in the statement to show how it discharged its social responsibility through charitable donations. The company must also provide details of any Shariah-prohibited income it has accrued and set aside for distribution to charity. h. Explanatory notes to the financial statements; Explanatory notes should include all necessary material information that would make the financial statements more relevant and reliable for their users. i. Any statements, reports and other data which assist in providing information required by the users of the financial statements if required by their profession, as long as they not contradict the rules and principles of Shariah. AAOIFI Standard Financial Accounting No. 13 (FAS 13) The purpose of FAS 13 is to regulate the disclosure of the bases for determining and allocating surplus or deficit in Islamic insurance companies in order to present reliable and relevant information to assist users of financial statements in their decision-making process. FAS 13 focuses primarily on the relationship between the participants and the shareholders and the resulting transactions that occur due to the relationship. It also provides specific disclosures relating to the surplus: how was it determined and distributed amongst the participants. FAS 13 requires the following disclosures: 1. The basis that governs the relationship between the participants and shareholders in respect of the management of the insurance activities and investment. 2. On what basis was the remuneration determined for the above services and any variations that occurred to the determination during the year. 3. On what basis the investment profit was generated from the funds allocated. 4. The basis for investment of funds in income-producing investments and the priority applied in the event the investor was unable to invest all the available fund for these investments. 18

19 5. The method of distribution of surplus and Shariah principles and rules applied to that particular method. Although AAOIFI has made a conscious effort to improve financial reporting in Islamic insurance by introducing the above standards, it is widely agreed that greater transparency is needed. There is debate as to whether AAOIFI should like the IFSB recognise that standards exist in the wider insurance market and focus on how those should be correctly applied to Takaful to recognise its specificities, rather than setting up a parallel framework which many entities are not permitted to use. Model answer for Question 10 The Takaful fund may fall into deficit due to a catastrophic disaster or through a series of losses higher than anticipated. The Takaful fund would be in a compromised position where it is unable to meet claims. Shariah-compliant Takaful standards and procedures have been adopted to manage such risks. Article 10 of Resolution Number 200 from the International Islamic Fiqh Academy (IIFA) deals with deficit in the Takaful fund as follows: In the event the cooperative insurance fund is unable to pay its accrued liabilities, it is permissible for the operator without any restriction to resort to arranging one or more of the following: a. Borrow money from a third party. b. The operator provides an interest free loan to the fund. c. Raise further contributions, with the approval of the participants. d. Get an agreement from the claimants to reduce the amount of compensation or reduce the instalments. You may consider other options as appropriate with the approval of the Shariah supervisory board". The TO should ensure that these options are properly explored within the constraints of national law and that provision for the preferred option is in place to mitigate the risk of inability to meet claims from within the fund. The above four options provided by the IIFA can be applied in circumstances where there is a deficit in the Takaful fund. The first two relate to third party agreements and the last two relate to the participants. Further contributions from participants In the event of a deficit in the Takaful fund, the TO may subject to the constraints of national law have the option to refer back to the participants and either: ask the participants to donate further contributions to Takaful fund; or request the claiming participants to reduce and waive a percentage of the claim so that other outstanding claims can be met. The IIFA resolution is reciprocated in AAOIFI Standard 26 where it states: the participant donates his contribution and the return thereon to the insurance account (Takaful fund) for payment of indemnity, and may undertake to bear any deficit that may occur The principles of Shariah require the participants to cover the deficit in the fund. After all, the meaning of Takaful is guaranteeing each other or joint guarantee. Each participant is guaranteeing each other that they will be indemnified against loss. In practice, referring back to the participants to make further contributions to cover any deficit in the Takaful fund is likely to be impractical and may be constrained by national regulations. It may 19

20 be achievable where the Takaful relates to small homogenous risks grouped together, similar to mutual. In contrast, when there are several types of risks of different values, profiles and complexity plus hundreds of participants who are not concentrated or restricted to one village, but are scattered around the globe, it is almost impossible to contact every participant to ask them for further contributions. Qardh-al-Hasan facility The remaining two options provided by the IIFA are related to third party agreements: borrow money from a third party, such a bank or a lender; or ask the TO to provide an interest-free loan. Borrowing money from a bank in accordance with Shariah can prove to be an expensive option, regardless of which Islamic financial structure is used. The repayment of outstanding loans would have first call on any surplus. But what will happen if there is no surplus? The other option is to ask the TO to provide a Qardh-al-Hasan. In simple terms this is described as an interest-free, benevolent loan. The obligation of the TO to provide Qardh-al-Hasan (benevolent, interest free loan) in the event of a deficit in the claims fund is a key distinguishing feature of Takaful. In most cases: Shariah scholars have endorsed the idea of the TO injecting Qardh-al-Hasan in the event of a deficit; and it is a mandatory requirement by regulators in most jurisdictions where Takaful insurance is provided. The inevitable volatility of insurance business periodically requires large amounts of capital. The mechanism of Qardh-al-Hasan enables the capital to be provided by an operator who does not, under Shariah, assume the risk which is shared by the participants. Thus, the funds are loaned as needed. If one looks carefully, the obligation to inject Qardh-al-Hasan also acts as a disciplining role on the activities of the TO. The obligation to fund deficits provides the TO with an incentive to manage the contributors fund prudently in order to avoid the need for the loan. The obligation to inject Qardhal-Hasan is also onerous for the TO and can create conflicts of interest. In addition, According to AAOIFI Standard 26, the TO is committed to providing an interest-free loan. The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) argues that: the commitment of the company to furnish qard hasan to the insurance account is based on the Shari a requirement of honouring pledges that are binding to either of the two parties. The Islamic Financial Services Board (IFSB) is an international organisation that deals with supervisory standards. It recommends the use of Qardh-al-Hasan: Qard is frequently identified as a mechanism for providing capital to a PRF of a Takaful operation. Capital of the shareholders fund is made available to the PRF, to provide the capital that the PRF requires to commence or sustain its operations. Such Qard is to be repaid out of future surpluses of the PRF. Supporting evidence is provided from the Quran Fulfil (all) obligations (Quran, 5:1) and Ahadith and many scholars support this viewpoint. 20

21 Contrary to this view, other scholars have stated it is forbidden for the participants to impose a condition on the TO provide an interest-free loan in the event of deficit occurring in the Takaful fund. The underlying purpose of a Qardh-al-Hasan is to demonstrate kindness to others with the intention to do good. It is referred to as a voluntary act and translates as a benevolent loan, which signifies the benevolent nature of the act of lending. Qardh is normally extended on a goodwill basis, mainly for welfare purposes or for fulfilling short-term funding requirements. They argue that compelling or imposing a condition to provide a loan contradicts the purpose of Qardh-al-Hasan. In some countries, such as the UK, the financial regulators have fortuitously provided a solution to the issue of Qardh-al-Hasan. The financial regulatory authorities require financial institutions, including insurance providers, to demonstrate solvency and possess sufficient capital to meet their liabilities. In other words, in the event of a deficit occurring in the Takaful fund, it is the insurance company s responsibility to provide funds to meet the outstanding claims. Model answer for Question 11 In theory and in essence, the Takaful fund is a pool of contributions that the participants create to help each other. But: what is the structure and form of this fund? should the Takaful fund be a company with legal rights? should the fund be the ownership of another legal entity? These are the type of questions Takaful practitioners have debated in relation to the Takaful fund. However, in many jurisdictions some of these questions are irrelevant because local regulators have established requirements for the specification and formation of a Takaful fund or, more generally, an entity that holds client money or that provides insurance services. Therefore, Takaful operators (TOs) are restricted and have limited options on how the Takaful fund is structured. In theory An independent Takaful fund some scholars and insurance practitioners have argued that the Takaful fund should be independent from both the participants and the operators who manage the fund. Article 16 of the International Islamic Fiqh Academy s Resolution Number 200 states that the Takaful fund must be completely independent of participants and others, by either: 1. granting it its own legal status; or 2. establishing a completely segregated account for the fund which has no connection with the operator s account. The first of these is unlikely to be possible, which leaves the second as the main model. Takaful fund owned by the participants Others, such as the international association of regulators IFSB in its Standard IFSB-8, have expressed that the Takaful fund should be attributable to the participants. However, the participants liability as owners should be limited to outstanding claims and deficits in the fund. 21

22 The Institute of Islamic Banking and Insurance (IIBI) explains Takaful as follows: Takaful is founded on the cooperative principle and on the principle of separation between the funds and operations of shareholders, thus passing the ownership of the Takaful (insurance) fund and operations to the policyholders. Professor Simon Archer of Reading University regards ownership of Takaful fund by the participants as one of the essentials of Takaful: The essential elements are that all transactions should be compliant with the Shari ah, and that the ownership of the Takaful funds (whether risk funds or investment funds) should be with the participants (policyholders). In practice In practice, the two theoretical positions described pose challenges and complications. In reality, the participants do not: arrange to have a Takaful arrangement; establish a fund; or appoint an operator. Instead, it is the TO that: creates the Takaful product; makes arrangements for a Takaful fund; markets the product; and invites participants to subscribe. The Takaful fund as an independent legal entity In practice, the structure and form of a Takaful fund depends upon the requirements of national law, which raises questions of how the constraints of national law may be accommodated while observing the principles on which Takaful is based. One of the challenging aspects of Takaful is that company and insurance law generally prevent it from being a trust, so the governance structures are designed to create the effect as though it were one. Establishing a Takaful fund as an independent legal entity in most jurisdictions is almost impossible due to the relevant law and regulations. Takaful fund owned by the participants An alternative option is for the participants to own the Takaful funds. This option will face similar challenges posed by national law and regulation. For example, the Takaful funds that hold the client accounts cannot be held by the participants as they are not authorised to do so by the relevant national regulator. There is a third option that provides practical solutions. The TO markets products to which participants subscribe The authorised TO (insurance company) creates the Takaful funds. It then implements the appropriate segregations and takes legal or, in some cases, constructive ownership of them. The TO can do this because it would have been authorised by the relevant national regulator (in the UK, the Prudential Regulation Authority or PRA). In addition, the TO assigns the beneficial ownership of the relevant Takaful fund to the participants as a collective. In other words, the TO (insurance company) will hold the Takaful funds almost as though they were held on trust for the participants, to meet claims of the participants. 22

23 Model answer for Question 12 Gharar Gharar is defined as: Uncertainty over the existence of the subject matter of sale. The term generally refers to uncertainty, but also includes a range of negative connotations, such as risk, hazard and ignorance. In Islamic law, Gharar can be of two degrees, major or minor: - Gharar fahish (major or excessive): Affects validity of exchange contracts and can generally render the contract as void or voidable; and - Gharar yasir (minor or tolerable): Does not generally affect validity of exchange contract. The distinction between what constitutes major and minor Gharar is not fixed and can vary according to the interpretation of different Islamic jurists and regional authorities. Generally, all contracts of exchange that contain ambiguity or uncertainty in relation to the subject matter of sale are invalid. Prohibition The word uncertainty is not explicitly mentioned in the Quran. However, the activities described in the following verses are believed to be uncertain: - O ye who believe! Eat not up your property among yourselves in vanities: But let there be amongst you Traffic and trade by mutual good-will: Nor kill (or destroy) yourselves: for verily Allah hath been to you Most Merciful! (Quran, 4:29) - And their charging of interest, although indeed they have been forbidden from it, and their devouring of peoples properties falsely, and We have prepared for the disbelieving amongst them, a painful chastisement. (Quran, 4:161). Commentators have agreed that the word falsely, used in the latter verse, implies gross uncertainty. Furthermore, there is a Hadith narrated by Abu Huraira (may Allah be pleased with him, MABPWH) in which he states, Muhammad (PBUH) has forbidden sales that contain uncertainty. (Muslim, 10:3614). Explanation When the contract is being agreed, both parties must be aware of the item or service that is being sold and the consideration moving the opposite direction. The description that is given of the items being exchanged must be certain. If there is Gharar fahish (gross uncertainty) surrounding the item, the transaction becomes void or voidable because it will result in an unfair outcome for the parties involved. This principle also applies to insurance contracts. The consideration passing from the insurer to the insured must not be uncertain. Maysir (speculation) Maysir (speculation) can be described as gambling with the intention of making a profit. This includes transactions that rely on chance or speculation, rather than on the effort of the parties to produce a return. 23

24 Prohibition The Quran refers to gambling in the following quotation: O you who believe! Intoxicants and gambling, (dedication of) stones and arrows are abomination of Satan s handiwork: Abstain from it so that you may prosper. Satan s plan is (but) to excite enmity and hatred between you, with intoxicants and gambling, and prevent you from the remembrance of Allah, and from prayer: Will you not then abstain? (Quran, 5:90 1) In the Bukhari collection of Ahadith, it is mentioned that whoever tells their companion Come let s gamble should give charity as a compensation for merely talking about such an evil deed. (Bukhari, 60:363) Explanation Islam categorically and firmly prohibits all forms of gambling. Maysir is a type of gambling transaction, which involves an effortless gain for one party at the detriment of others. This is distinct from ordinary commercial speculation or risk-taking, which is acceptable under Shariah. The profit and proceeds of gambling are regarded as being impure and of no benefit. Maysir forms the basis of one of the Shariah objections to conventional insurance provision and is most likely to arise in the area of speculative risk. Speculative risk will result in either a profit or loss. It is taken on as a conscious choice and is not the result of uncontrollable circumstances. In addition, a critical element of an insurance arrangement (conventional or Shariah compliant) is insurable interest a legal financial relationship between the insured and the subject-matter of insurance. An insurance contract or arrangement will usually be invalid if there is not a clearly defined insurable interest. In general, speculative risk does not have adequate insurable interest to be insurable. Arrangements involving speculative risk are not amenable to Takaful. However, it is now usual for insurable interest to be a core requirement of proprietary insurance contracts. As a result, most gambling or speculation type insurance arrangements have been phased out and Shariah concerns over Maysir have largely been eliminated. Maysir is not inherent in insurance contracts and overall it is not a significant obstacle to Takaful. Generally, Islam prohibits all forms of gambling in which an individual makes an unfair gain at someone else s detriment. This includes gambling activities facilitated by institutions such as casinos, betting shops and national lotteries. 24

25 Model answer for Question 13 What is Takaful? Takaful is an alternative to the conventional concept of insurance that is based on the Shariah concepts of mutuality and cooperation. Takaful is an Arabic word derived from Arabic terms for guaranteeing each other or sharing. It is variously described as meaning mutual protection, shared responsibility or joint guarantee or responsibility, assurance or surety. Takaful insurance provision involves two important adaptations to the conventional insurance models. The first key change is designed to remove or mitigate identified Shariah objections to conventional modes of insurance provision in: the insurance contract itself; and the mode of operation of the insurance company. The second is to devise a commercially viable and sustainable model of mutual provision for an industry in its infancy. As a result, Takaful has developed methods of segregation between: a contributors (or participants ) risk-sharing pool; and a commercially motivated Takaful operator managing the pool for a fee. The operation of the resulting entity is supervised by the Shariah supervisory board (SSB). The approach may involve segregation into separate legal entities; however, the predominant model involves internal segregation within a single legal entity. Shariah objections to conventional insurance provision For a contract of exchange to be valid in Shariah, it must be free from any element that may compromise the Shariah objectives of fairness and justice. The contract must not include elements such as: Gharar (uncertainty); Maysir (speculation); and Riba (usury). This is in addition to requiring the fulfilment of the more familiar conditions of a contract: offer, acceptance and consideration. The main basis for the Shariah objections to conventional insurance provision is due to the presence of Gharar, Maysir or Riba elements in proprietary and mutual insurance contracts and in the operations of the providers. The conceptual Takaful insurance provision model Takaful has to be sustainable and commercially viable in addition to overcoming the Shariah objections to conventional insurance provision. Mutuals may need longer gestation periods and are vulnerable to failures in early stages if enough reserves have not been accumulated. Similar constraints are faced by a Takaful operation with a largely risk-sharing pool operated on behalf of the participants. A new Takaful operation would also 25

26 face challenges due to the contemporary regulatory and capital adequacy environment, which is significantly more demanding to that in place when most conventional mutual were founded. Another constraint is that similarly to mutual participants can t practicably manage their own fund and are likely to lack the commercial experience and incentive to appoint and supervise management. The solution that has been devised is a hybrid model incorporating a risk-sharing pool and a commercially incentivised Takaful operator which is also responsible for the licensing, capital adequacy and regulatory arrangements. Features of a generic Takaful provision model: A Takaful pool or participants risk fund is created by Tabarru donations made by the contributors also known as participants to the pool. The Takaful operator manages the insurance operations of the pool. The operator is remunerated by means of a Takaful operator contract arrangement, which can be one of several forms. In theory, contributors are entitled to a share of surplus and are liable for any deficit. Regulators in most jurisdictions will require the Takaful operator to provide supplementary capital to underwrite any deficit in the contributors pool by means of a Qardh-al-Hasan (interest-free loan) and recoup it from future surpluses. This means that the participants will not have to make additional contributions in the event of a deficit, as would be the case with a pure risk-sharing arrangement. In practice most mutual and co-operatives also do not require contributors to make up any deficit. Instead it is made up by raising subordinated debt where possible. Takaful contribution projections to 2020 The Takaful market has grown rapidly over the last three decades and growth is projected to increase in the next few years. With using the range of gross Takaful contributions in 2015 of US$23-30 billion, Takaful contributions are projected to grow to US$50 billion by The two key markets are Iran and Saudi Arabia: Malaysia is the largest market in Asia/Pacific and Sudan is the largest market in Africa; Iran in particular is projected to gain traction as it emerges from the long sanctions regime. 26

27 Model answer for Question 14 The three objectives of Islamic finance are: economic and social fairness and justice; equitable distribution of wealth; and the middle path. Economic and social fairness and justice Islam encourages trade and business activities to be carried out for the purpose of creating a healthy and vibrant society in which people can be happy and flourish despite their inherent differences. Some people are stronger, healthier and richer than others. However, Shariah seeks to set a level economic and social playing field, in which those who are at a disadvantage do not get exploited, and the rich and powerful do not impose their supremacy unfairly. Shariah attempts to extinguish any opportunity for abuse of power and position which may cause imbalances in society. Islam forbids the exploitation of unhealthy human instincts and making money through immoral and injurious products. It ensures reward for those who deserve it and that loss is shared by all participants. Islam rejects any dealing that establishes an unwarranted enrichment without a justified effort. Equitable distribution of wealth Shariah disapproves of the concentration of wealth in the hands of the few. A common feature of economic societies that are interest based is that the majority of the capital is possessed by very few wealthy individuals. Their lending and borrowing system are influenced and motivated by interest rates, which result in the rich getting richer and poor getting poorer. The wealthy lender is generally not interested in why the money has been borrowed but focuses instead on collateral possessed by the borrower which can be exercised in the event of the borrower s default. The lender s objective is to make more money through the use of money, without any effort or work on their part. If the loan is not repaid, the lender has the option to repossess the borrower s assets and recover the initial loan, plus any payable interest and charges for defaulting repayments. The borrower, whose business venture did not go as planned, becomes poorer as a result. Shariah forbids making money out of money. If an individual lends money to a friend, then all that is due back is the amount that was loaned and not a penny more. The lender cannot generate a return through a loan but must put their capital at some sort of risk. The capital owner is encouraged to invest their wealth instead. This means they have a vested interest in the business venture, as they are entitled to any profits generated and must also bear the burden of any resulting losses. The business owner, who is less wealthy, shares the profit with the capital provider as agreed and does not have to bear any losses alone. The middle path Shariah strives to achieve a balanced and tolerable society. It restricts human behaviour from becoming too extreme either through application or due to a complete lack of activity. The following verse from the Quran demonstrates how Islam prefers moderation, known as the middle path : (O Allah) Guide us upon the Straight Path, the path of those upon whom you have bestowed your faith. 27