Chapter 8 Takaful Chapter Objectives Students must be able to: Understand the Sources of Islamic Law Understand the Concept of Takaful Define and Relate to the 3 Principles of Syariah Relating to a Contract Understand the Concept of Tabarru Understand the Principles of Family and General Takaful. Malaysian Financial Planning Council (MFPC) 8-
Chapter 8 Takaful Sources of Islamic Law Takaful is an alternative insurance plan, specially designed to address the needs of a Muslim who prefer Syariah-compliant insurance products. Islam as a religion can be divided into 3 main branches, as follows: - 1. Faith and Belief (Aqidah) 2. Laws (Syariah) 3. Moral and Ethics (Akhlaq) Syariah is an Arabic term and it is one of the main branches in Islam. Laws (Syariah) can be subdivided into two areas; namely submission to God (Ibadah) which deals with religious practice or rituals like prayers, performance of the Hajj, fasting and many others as specified in the religion. Another area covers daily activities (Muamalat) which deals with issues like criminal laws, politics, economy, state administration and family laws. Takaful is under the purview of Muamalat. At this point, it is prudent to understand the basis of Islamic laws. Where do the rules come from and in what manner it is deduced. In Islam, there are two main sources of laws; namely Al-Quran (Word of Allah) and Al-Sunnah (word or conduct of Prophet Muhammad, peace be upon him). Some rules are clearly stated in the two sources but some are not. An example of a clear ruling from Al-Quran is prohibition of drinking liquor and gambling. There are many others that cover the various scope of life. In matters which are not clearly stated in the Al-Quran, apart from his affirmation, the Prophet will interpret and explain through his words or conduct. Prophet Muhammad (peace be upon him) is considered the last prophet. After his demise, the Muslim deals with contemporary issues using both sources as the main reference. In the event where the Muslim faces issues or problems that are not clearly elaborated in Al-Quran and Al-Sunnah, they can refer the issues to consensus agreement by the Muslim Scholars or the Mujtahidin who are highly regarded as experts in Islamic rules and teachings. Again, this method of legal deduction is only allowed after the demise of the Prophet. This method is known in Arabic as Ijma. One of the requirements of making binding rules out of Ijma is that the agreement has to be unanimous. All scholars must agree on a particular ruling. In the event of disagreement, Ijma will not be able to form an absolute ruling alongside with Al-Quran and Al-Sunnah. Personally, an Islamic scholar has the right to have his own opinion within the principles spelt out in the main sources but cannot impose his own stand on others. 8- Malaysian Financial Planning Council (MFPC)
Concept of Takaful There is no specific provision in both Al-Quran and Al-Sunnah relating to insurance. However, if we look at the principles that govern insurance, there exist values that are propagated in the abovementioned sources. Values like creating strong bond in the community, helping each other and safeguarding the rights of the orphans can be found in both sources. Insurance is a tool in risk management and it is an economic institution. As Islam is acknowledged as a religion that provides guidance in all aspects of life, insurance is not an exception. It falls under the purview of Muamalat. Islam promotes justice and fairness in dealings and business transactions. Islam forbids transaction that involves uncertainty. The origin of word Takaful is kafala, which means to safeguard, guarantee or preserve. In the context of insurance practice, Takaful means mutual guarantee, mutual help or mutual preservation. According to Syariah interpretation, Takaful is agreement or consent of a group of individuals who agree to mutually guarantee and help each other. It is in line with the Prophet s saying that, No one will enter paradise if they do not help or protect their neighbors who are in difficulties. The term Takaful is also mentioned in few verses of Al-Quran, but in a different context. In reality, insurance cannot prevent a house from being burnt down or keep us away from death or accident but insurance helps in indemnifying the loss or reducing the risk of loss. Thus, like insurance, Takaful refers to an agreement entered into by a group of people with a Company to indemnify the loss that may be suffered after a disaster in return for specific premiums payable to the Company. The issue now is how does Takaful differ from the conventional insurance? If both objectives are common, why is there a need for an alternative form of insurance which generally appeals to the Muslim? Shariah Scholars View on Conventional Insurance Resolutions about conventional insurance: 1. The Fatwa Committee in Malaysia declared in 1972 that the life insurance as practiced in the country was unlawful as it had the element of riba, gharar and maisir. 2.The First International Conference (1976) on Islamic Economics (Mecca) resolved that: "Commercial insurance as presently practiced does not satisfy the Islamic conditions for it to become acceptable." 3. Resolution No 9 Concerning Insurance and Reinsurance of the Islamic Fiqh Academy (Jeddah, 1985): First: The Commercial Insurance Contract, with a fixed periodical premium, which is commonly used by commercial insurance companies, is a contract, which contains major element of risk, which voids the contract and, therefore, is prohibited (Haram) according to the Sharia. Malaysian Financial Planning Council (MFPC) 8-
Elements that Exist in Conventional Insurance but are Forbidden in Islam 1. Al-Gharar (Uncertainty) In Islam, intention is an important element in determining the validity of a transaction. Indeed, our intention which is reflected in our thoughts influences our actions and response. In Islam, it is vital for those involved in business to be transparent in their dealings to enable the prospect or customer to make an informed decision. This helps to manage the expectation of the client. According to Muslim scholars, the basis of an insurance contract is a contract of buying and selling. As Muslims, they are generally obliged to follow the principles and guidelines provided by Syariah. Do the Muslims have specific guidelines in determining a valid buy-sell contract? The answer is a clear yes. For a buy-sell contract to be valid in the eyes of Syariah, the following must exist: - a. Seller and Buyer b. Consent (Sighah Ijab and Qabul) c. Subject matter According to the Committee for the establishment of Islamic Insurance in Malaysia, conventional insurance is not Syariah-compliant because the subject matter of the insurance contract is not certain. As it uses buy-sell as a basis of the contract, the real test in determining the validity of the contract from the Syariah perspective is whether it fulfills the conditions above. For a subject matter to be permissible in a buy-sell transaction, generally it must fulfill the following conditions: - a. The subject matter can be delivered in the transaction b. The delivery date has been determined c. The subject has been identified its type and quantity d. Place to deliver the subject is determined e. The subject matter is not something forbidden by Syariah The outcome of not fulfilling the above conditions is a void contract, and is thus not permissible. In the context of conventional insurance, the subject matter of a life policy is the benefit of the policy, which is the assurance to pay the sum insured upon occurrence of certain specified events in the policy. The issue of al-gharar turns up in conventional policies due to the uncertainty of the subject matter of the contract or ma qud alaih. For instance, in life insurance, the payment of the death benefit is the subject matter of the contract. From the Syariah point of view, the subject matter here is not valid because the benefit cannot be delivered at a specified time (uncertain in terms of timing). As the sum assured payment is dependant on the duration of 8- Malaysian Financial Planning Council (MFPC)
human life, it is impossible to predict that is when will death occur? and consequently when will the claim be paid? Furthermore, how much sum assured or bonuses ( uncertainty as to the amount) that will be payable upon death cannot be determined in absolute terms and quantity at the onset of the contract thus introducing an element of uncertainty. This gives rise to the first forbidden element in conventional insurance which is known in Arabic as Al-Gharar or uncertainty (unknown or uncertain factors in the operation of a contract). 2. Al-Maisir (Gambling) According to Muslim scholars, element of gambling or Al-Maisir in Arabic, exist in conventional insurance contract. Whenever there is uncertainty in a transaction, an element of gambling is present. The element of al-maisir (or gambling) arises as a consequence of the presence of al-gharar (uncertainty). Gambling deals with uncertainty as to the outcome although the aim of the person who gambles is to reap big gains out of small bet or contribution. According to the scholars, the element of gambling is present as the insured makes a bet on the occurrence of the loss. Furthermore in an insurance contract there are situations where the insured will lose the premiums paid if the insured event did not happen during the term of the contract, and, the contract subsequently expires (e.g. in a term policy) without any benefit being paid. When policy owner dies within the insured period after paying only a portion of the premium, his dependants will receive the sum assured a value far greater than the premiums paid. 3. Al-Riba (Imposing Interest) In a normal commercial loan contract, Al-Riba takes place when the lender charges interest on the loan to the borrower. Often the charges are subject to changes depending on the policy of the lender and the interest rates available in the market place. A person who needs money may resort to borrowing from lenders. From the Islamic perspective, the person is in dire need and should not be burdened further by the imposition of an interest. This is the rationale for Al-Riba being prohibited in a conventional loan contract. However, Allah stated in the Al-Quran that though God forbids Al-Riba, God permits buying and selling. For a seller who wishes to make a reasonable profit from the sale of his property, he is allowed to do so as long as there is consent from the buyer and all other essentials of a valid contract exist. In conventional insurance apart from other sources of revenue, the company generates profits from interest earned from conventional banks, investments in bonds etc which have an element of interest payments, and on the liability side, it earns interest on loans. Malaysian Financial Planning Council (MFPC) 8-5
al-gharar al-maisir al-riba Un-Islamic Elements in Conventional Insurance Alternative Insurance: Concept of Tabarru How can the 3 elements mentioned above be eliminated from the conventional insurance practice? This can be done by changing the basis of the contract from a buy-sell contract to a charitable donation contract which is also known in Arabic as Tabarru. Tabarru is a contribution made by individual group members who wish to get Takaful protection. Here, the policy holder or participant has to understand that Tabarru is a practice where the participant is willing to relinquish the contribution and treat it as a donation. This is a unilateral contract. In the Tabarru type of contract, buy-sell conditions do not apply. Thus, it eliminates the 3 elements that are forbidden in conventional insurance contract. The term takaful means joint guarantee in the Arabic language. The takaful concept can thus be described as a covenant among a group of members or participants who agree to jointly protect themselves against financial related losses. A fund is created through the contributions made by the participants, and is used for compensating members who suffered losses due to occurrence of disastrous or catastrophic events. The suffering member will receive a certain sum of money or financial benefit from the fund as a form of relief as earlier agreed upon by the group of contributors. From the above description, we can get the notion that the fundamental objective of Takaful is to compensate predefined losses of members from a predefined fund. It can be observed that this practice differs from conventional insurance of which the compensation payment and the fund are not predetermined. Takaful is based on mutual risk sharing, whereas, conventional insurance is 8-6 Malaysian Financial Planning Council (MFPC)
based on risk transfer. The Muslims consider takaful as a conduit through which members of the group pool effort to support each other in times of trouble. Predefined Fund Fundamental Objective of Takaful To Compensate Predefined Losses of Members In the family takaful business, policies similar to the conventional policies whole life, endowment, investment-linked, disability etc are sold to individuals in compliance with the Syariah. Terms Used in Takaful Contract As the concept of Takaful in principle differs from conventional insurance, the terms used in the contract are also different. As stated earlier, the basis of Takaful contract is a charitable donation as opposed to buying and selling in conventional insurance. In a takaful scheme, the individual who contributes to the fund is called a participant and the and premium is termed a contribution. Tabarru charges or rates can be associated with risk charges. Coverage Generally, the benefits under the takaful plans will mirror those that are available under the conventional plans. However, there are instances where coverage is not provided. It should be noted that Takaful operators do not pay death benefits where death is the result of suicide as the act of committing suicide is against the Syariah principles. In conventional insurance, death benefit Malaysian Financial Planning Council (MFPC) 8-7
will still be payable provided that suicide is committed after 12 or 13 months from the inception of the policy (or as stated in the policy document). Takaful Operating Model In Malaysia, there are two models operating in the Takaful business i.e. Al-Mudharabah (Profit sharing model) and Wakalah model (Agency model). Al-Mudharabah was the first Takaful operating model in Malaysia and it is still used by some Takaful operators. Al-Mudharabah is based on profit sharing whereby the policyholders will get a profit on their part of fund, if the Company makes a profit. The operator acts as a Mudarib (entrepeneur) and the participants as capital providers. A contract details how profits are shared and liability for losses is fully borne by the participants (borne by the capital providers). Under the Wakalah model, the takaful operator, who acts as an agent (Wakeel), earns a fee (Wakalah fee) for services rendered in administering the fund, while the liability for losses is borne by the participants. The Company charges fees from contributions that cover most of the expenses of the business. Generally, the fees will vary based on the performance of the operator. Principles and Operations of Family Takaful A family takaful plan is a long-term savings and investment programme with a fixed maturity period. Apart from enjoying investment profit, the plan provides mutual financial assistance among its participants The family takaful plan is a financial programme that pools efforts to help the needy in times of need due to untimely death and other mishaps resulting in personal injury or disablement The takaful plans designed by the takaful company would enable participants to participate in a takaful scheme with the following aims: (a) To save regularly; (b) To invest with a view of earning profits which are syariah-compliant; and (c) To avail of cover in the form of payment of takaful benefits to heir(s) should a participant die before the maturity date of his takaful plan The Operations of Family Takaful A person who participates in any family takaful plan is called a participant. A participant may choose any one of the plans offered by the company. The family takaful plans have a defined period of participation 8-8 Malaysian Financial Planning Council (MFPC)
The takaful company and the participant will enter into a long-term takaful contract, which is based on the principle of Al-mudharabah (profit-sharing) The takaful contract spells out clearly the rights and obligations of the parties to the contract. The participant is required to pay regularly the takaful instalments in consideration for his participation in the takaful plan The participant will decide the amount of takaful instalments that he wishes to pay, but such an amount shall be subject to the minimum sum as determined by the company Each takaful instalment paid by the participant shall be divided and credited by the takaful company into two separate accounts, namely the participant s account and the participant s special account. A substantial proportion, for example, such as 93% of this installment is credited into his participant s account solely for the purpose of his savings and investment The balance is credited into his participant s special account as tabarru for the purpose of mutual help Mutual financial assistance such as takaful death benefits to fellow participants is paid from the participant s special account. What proportion of the takaful installment to be relinquished as tabarru and credited into the participant s special account is determined based on sound actuarial principles The takaful installment credited into these two accounts will be pooled as a single fund for the purpose of investment activities undertaken by the takaful company in a manner permitted by the Syariah Any profits generated from the investment shall be shared between the participant and the company in a ratio to be mutually agreed between the participant and the company in accordance with the contract of Al-Mudharabah. For instance, if the ratio agreed is 7:3 then the participant shall be entitled to 70% of the profits whilst the company shall be entitled to 30% The participant s share of the profits shall be credited into his participant s account. With the accumulation of such profits, the balance in the participant s account will increase over a period of time Family Takaful Benefits In the event that a participant should die before the maturity of his family takaful plan, the following takaful benefits shall be paid to him: (i) The total amount of the takaful instalments paid by the participant from the date of inception of his takaful plan to the due date of the instalment payment prior to his death and his share of profits from the investment of the instalments which have been credited into his participant s account; Malaysian Financial Planning Council (MFPC) 8-9
(ii) The outstanding takaful instalments which would have been paid by the deceased participant should he survive. This outstanding amount is calculated from the date of his death to the date of maturity of his takaful plan which shall be paid from the participant s special account as agreed upon by all the participants in accordance with the takaful contract If a participant survives until the date of maturity of his takaful plan, the following takaful benefits shall be paid to him: The total amount of takaful instalments paid by the participant during the period of his participation plus his share of profits from the investment of the takaful instalments credited into his participant s accounts The net surplus allocated to his participant s special account as shown in the last valuation of the participant s special accounts In the event that a participant is compelled to surrender or withdraw from the takaful plan before the maturity of his takaful plan, he shall be entitled to the surrender benefits The participant is entitled to receive the proportion of his takaful instalments that have been credited into the participant s account including his share of investment profits. However, the amount that has been relinquished as tabarru will not be refunded to him The various types of family takaful plans available in the market are: 1. Individual family takaful plans 2. Family takaful plan for education 3. Family takaful mortgage plan 4. Group family takaful plan 5. Group hospitalisation and medical benefit Principle and Operations of General Takaful General takaful schemes are basically contracts of joint-guarantee, on a short-term basis (normally one year), between groups of participants to provide mutual compensation in the event of a defined loss The schemes are designed to meet the needs for protection of individuals and corporate bodies in relation to material loss or damage resulting from a catastrophe or disaster inflicted upon properties, assets or belongings of participants In the event of a catastrophe or disaster resulting in a loss or damage to a property or bodily injuries or other physical disability to a person, the owner of the property or the person concerned may suffer substantial financial losses 8-10 Malaysian Financial Planning Council (MFPC)
For instance, if a house is destroyed or damaged by fire, the owner would certainly require a sufficient sum of money to repair the house, or rebuild a new one as well as enough money to replace the damaged furniture, fixtures and fitting Similarly, a person being injured in an accident would require an adequate sum of money to pay for the medical treatment With the various general takaful schemes offered in the market, that person would be assured of takaful benefits in case of misfortune resulting from such loss or damage Participants of a general takaful scheme shall also enter into a contract with the company on the basis of the contract of Mudharabah. The contract stipulates the right and obligations of the participants as well as the company In consideration for participating in the various schemes, the participants agree to pay the takaful contributions as tabarru. The company manages the general takaful business including managing the investment of the general takaful fund assets As the al-mudharib, the takaful company will invest the general takaful fund in line with Syariah principles and all returns on the investment will be pooled back to the fund In line with the virtues of cooperation, shared responsibilities and mutual help as embodied in the concepts of takaful, the participants agree that the company shall pay from the general takaful fund, compensation or indemnity to fellow participants who have suffered a defined loss upon the occurrence of a catastrophe or disaster The fund shall also pay for other operational costs of general takaful business such as for the retakaful arrangements and the setting up of technical reserves. Should there be a surplus (profits) in the general takaful fund after deducting all the operational costs of general takaful, that surplus will be shared between the participants and the company provided the participants have not incurred any claims, and that no takaful benefits have been paid to them This sharing of the surplus will be in a ratio agreed in accordance with the contract of Al-Mudharabah. If the ratio agreed is 6:4, then 60% of the surplus will be shared among such participants whilst the balance 40% is the share of the company General Takaful would include all takaful business that is not family takaful business. Types of General Takaful Scheme 1. Fire Takaful Basic fire Houseowners and householders Industrial all risks Malaysian Financial Planning Council (MFPC) 8-11
2. Motor Takaful Schemes 3. Accident/Miscellaneous Takaful Scheme Personal accident (normal and for pilgrims) All risks Workmen s compensation Public liability Money Equipment all risks, and Employers liability 4. Marine Takaful Scheme Cargo 5. Engineering Takaful Scheme Machinery breakdown Erection all risks Boiler and pressure vessel Contractors all risk, and Bonds 8-12 Malaysian Financial Planning Council (MFPC)
Self Assessment 1. The element of uncertainty under the Syariah is called? A. Al-Gharar B. Al-Maisir C. Al-Ijara D. Al- Riba 2. The element of gambling under the Syariah is called? A. Al-Gharar B. Al-Maisir C. Al-Ijara D. Al- Riba 3. The element of interest under the Syariah is called? A. Al-Gharar B. Al-Maisir C. Al-Ijara D. Al- Riba 4. General takaful schemes are short-duration contracts that give cover to individuals or businesses against loss or damages due to a catastrophe or disaster. A. Al-jazera B. Al-ijara C. Tabaruk D. Al-wadiah Malaysian Financial Planning Council (MFPC) 8-13
5. Under the Syariah principles, for a subject matter to be permissible in a buy-sell transaction, it must fulfill the following conditions. Select the correct combination I. The subject matter can be delivered in the transaction II. The delivery date has been determined III. The subject has been identified its type and quantity A. I only B. II only. C. I and II only. D. All of the above 6. The origin of word Takaful is, which means to safeguard, guarantee or preserve. A. Aqidah B. Akhlak C. Kafala D. Ijma 7. In Malaysia, there are two models operating in the Takaful business. These are the A. Al-Mudharabah and Wakalah models. B. Al-Mudharabah and Al-Ijma models. C. Al-Akhlak and Wakalah models. d. Al- Muamalat and Al-Ijma models. 8. The Al-Mudharabah operating model in Malaysia is based on A. profit sharing whereby the policyholders will get a profit on their part of fund, if the Company makes a profit. B. profit sharing whereby the Company will get a profit on their part of fund and the policyowner is covered for the sum assured only. C. the policyowner is given a guaranteed profit D. profit sharing whereby all the policyholders will get an equal profit, if the Company makes a profit 8-14 Malaysian Financial Planning Council (MFPC)
9. The operator in the Al-Mudharabah operating model acts as an entrepeneur and the participants A. as policyowners and will suffer no loss. B. as capital providers but with a guaranteed profit margin. C. as capital providers who will share in the profits or losses as the case may be. D. none of the above statements is true. 10. Under the Wakalah model, the takaful operator, who acts as an agent is called a A. Wakeel B. Mudarib C. Qabul D. Ijab Answers: 1-A, 2-B, 3-D, 4-C, 5-D, 6-C, 7-A, 8-B, 9-C, 10-A Malaysian Financial Planning Council (MFPC) 8-15