INTRODUCING ISLAMIC INSURANCE (TAKAFUL) Concept of Risk Risk or uncertainty is regarded as one of the fundamental facts of life. All human activities, be it financial, industrial or social are subject to risk and uncertainty, which may lead to financial or physical losses arising from unexpected events. Risk and Uncertainty are Two Different Concepts Risk A condition in which there is a possibility of an adverse deviation from a desired outcome that is expected or hoped for. Risk is something that can be quantifiable by using probabilities Uncertainty Being uncertain to varying degrees about everything in the future which one does not have full information. Uncertainty is something that cannot be quantifiable. Since time immemorial human society has adopted various measures and remedies for overcoming or ameliorating the effect of risk or uncertainties. These measures are broadly classified as Risk Avoidance, Risk Mitigation, Risk Retention, Risk Transfer and Risk Sharing. Type Risk Avoidance Approach This is a negative approach to managing risk where the exposure to risks is not permitted to come into existence. A relevant instance would be abstaining from engaging in any action that may give rise to risks. For example, to avoid risk associated with ownership to property, an individual should only rent or lease such property, instead of buying it. This may not be the practical option or the most optimum way of averting possibility of risk, particularly in business, where certain risk taking is required for the opportunities of profit. Risk Retention Generally, certain risks that are negligible and are of little financial value with minute and minimal negative impact can be retained. For the same reason, insurance or takaful cover will not be provided for these types of risk. Risks of loss of a pencil, common cough and 1
cold are simple examples of negligible financial impact of which its losses can be easily absorbed by the individual or organization concerned. Risk Reduction Risk Transfer/ Risk Financing Risk Sharing This may be undertaken by loss prevention and loss control mechanisms such as by way of safety programs and loss prevention measures of which some of its examples are the use of security guards, burglar alarms, sprinkler systems, CCTV, use of better building materials, work safety standards and etc. Additionally, risks may also be reduced in the aggregate by the use of the law of large numbers - by combining a large number of exposure units to reasonably making accurate estimates of future losses. For example; insurance or takaful cover warranted, or in some cases encouraged risk reduction efforts in return for better pricing through discounts. Where risks are transferred to another party who is willing to bear such risk, either for a price or voluntarily. This is a method of providing funds to meet the pre and post cost of loss. Insurance is a form of risk transfer/risk financing from an insured to an insurer. Another method of risk financing is through hedging where a firm transfers defined risks to another party (via standard agreements). Other forms of risk transfer include hold-harmless agreements, leases, and indemnity agreements. A mechanism under which risks are shared among two or more parties who are willing to mutually share the consequences of the risks either for a price or voluntarily. Takaful is a method of risk sharing mechanism between various participants of a takaful scheme managed by a takaful operator. Costs of Risk Costs of Loss Costs of loss may be easily identifiable such as loss or destruction of asset. Costs of Uncertainty Costs of uncertainty are subjective in nature such as fear, anxiety and worry and most importantly, may cause misallocation of resources, poor decisions and unnecessary high cost of capital/expenses. 2
Concept of Risk in Islam Fundamentally, in Islam the concept of risk and uncertainty is in the realms of the unknown (al ghaib). It is absolutely in the knowledge of Allah (SWT) whose affairs of the physical and metaphysical world and the world hereafter are entirely in His command and control, as pronounced in the Holy Quran: and with Him are the keys of the invisible. None but He knoweth them. And He knoweth what is in the land and the sea. Not a leaf falleth but He knoweth it. Not a grain amid the darkness of the earth, naught of wet or dry but (it is noted) in a clear record (the Preserved Tablet or Lohmahfuz)... (Surah al An am: Verse 59). As a religion, Islam also seeks to free man from the shackles of ignorance (jahl) and guides him in his fear and apprehension of the unknown to only rely on the will of Allah (SWT) based on the principle of tawheed (unity) instead of practising polytheism (shirk) through acts such as shamanism, astrology, superstitious beliefs, omens, beliefs in ghosts and spirits, beliefs in oracles and soothsayers as described in the Holy Quran: O you who believe, intoxicants, and gambling and sacrificing stones, and divining arrows are an abomination of Satan s handiwork; eschew this that you may prosper (Surah al Maidah: Verse 90). Attitude towards risks and uncertainties is also closely related to the concept of al- Qada wa al-qadar (Divine Ordainment and Predetermination) which is an article of faith in Islam. However, many Muslims have the negative misconception of divine ordainment and predetermination. Ibnu Qayyim Al Jawziyyah in his book Shifā' al-alīl fīmasā'il al-qadā' wa-al-qadar wa-al-hikma wa-al-talī (Healing the Person with Wrong Concept about Predetermination and Causality) indicates that in upholding the belief in predetermination and divine ordainment, Muslims have the responsibility to exercise his choice (ikhtiar) and will (irada), and then carries out his actions (fa ala) accordingly. This is in line with the concept of tawakkul (means to rely on Allah or to put complete trust in Allah) in man s endeavours towards fulfilling his role as khalifah and abd of Allah (SWT) as declared in the Holy Quran: I put my trust in Allah, my Lord and your Lord! There is not a moving (living) creature but He has grasp of its forelock. Verily, my Lord is on the Straight Path (Truth) (Surah Hud: Verse 56). The concept and practice of ikhtiar, irada, fa ala and tawakkul is evidenced in a Hadeeth that one day the Prophet (pbuh), noticed a bedouin who left his camel untied (which would expose the risk of the camel being stolen or getting strayed), advised the Bedouin: 3
Why don't you tie down your camel? The Bedouin answered, I placed my trust in Allah." At that, the Prophet said, Hobble (tie) your camel and place your trust in Allah (Jame Tirmidhi). Al-Bukhari and Abu Dawud reported that Ibn `Abbas (ra) said, The people of Yemen used to go to Hajj without taking enough supplies with them. They used to say, `We are those who have Tawakkul (reliance on Allah)'. Allah (SWT) revealed in the Holy Quran: and take provisions (with you) for the journey, but the best provision is At-Taqwa (piety, righteousness) (Surah al Baqarah: Verse 197). Abdul Hamid Abu Sulaiman in his book, Crisis in the Muslim Mind provides a lucid distinction between the concepts of tawakkul and tawakul. Tawakkul refers to one s trust in Allah after undertaking all the necessary effort ikhtiar to avert or mitigate future risks whilst tawakul refers to a state of inertia, carelessness, incompetence and refusal to strive accordingly to avert or mitigate future risks and losses. Sheikh El Gari in his definition of risk reaffirms the Shariah position that prohibits the act of being fatalistic without taking precautions to reduce the probability of loss or by being reckless and ignore risks around them. It is a hallmark in Islam that a Muslim is commanded to strive for good management which in essence calls for proper planning. One of the dimensions to be effectively dealt with in order to attain good risk management is through takaful. Concept of Insurance In its earliest form, insurance had been practiced in the various Babylonian, Greek, Chinese, Phoenician, Indian, Egyptian, Arabs and Roman civilizations as tools of risk management. It was primarily used to protect maritime and other trade activities at that time, as well as for the provision of social safety net for the communities. The history of insurance indicates that insurance mechanism germinated from financial arrangements between bankers and merchants. This is a method involving risk transfer, whereby the risks of sea trade are managed through loans with interest made by money lenders to ship owners and merchants with the ship or cargo pledged as collateral. It was further attached with an option (at a higher rate of interest) whereby the loan will be cancelled if the ship or cargo were lost at sea. This mechanism is called bottomry. 4
A classic definition of insurance is provided by Lord Ivamy as: a contract of insurance in the widest sense of the term may be defined as a contract whereby one person called the insurer undertakes in return for the agreed consideration called the premium, to pay to the other person called the assured, a sum of money or its equivalent on the happening of a specified event A pre-roman-dutch definition of an insurance contract was an agreement by one person, having agreed with another on the price of a risk, takes upon himself that other s misfortune Concept of Takaful Islam is a religion that promotes solidarity, cooperation and joint-help among the community with the objective of mitigating the burden of loss in the event of a mishap or catastrophe. As these are universal virtues some forms of joint-help had been practiced before Islam. This manner of joint-help took the structure of mutual help schemes among its members. Scholars and researchers have identified some of the practices as Al-Diyat, Al-Aqilah, Ma qil, Al-Qasamah, Al Tahanud, Al Diwan, Al Muwalah, Dhaman Khatar Al Tariq. These were joint-indemnity or solidarity schemes, of which its virtues are pronounced by Allah in the Holy Quran, help one another in furthering virtue and God-consciousness, and do not help one another in furthering evil and enmity (Surah al Maidah: Verse 2). Al-Aqilah (which literally means slayer's paternal relative who undertakes to pay blood money ) was introduced as a covenant of mutuality formed between the Meccan immigrants (Muhajirin) and the Medinans (Ansars) whereby members paid their annual contributions through a fund called Al Kanz. The fund then was used to pay compensation on behalf of a member who was liable to pay a diyat. Ma qil was provided under the Constitution of the city-state of Medina. By this practice, each member of a tribe had to contribute to a fund for the purpose of funding and settling of ransom money in the event of any member of the tribe was made a prisoner of war by an enemy. Other related or neighbouring tribes provided assistance for the ransom if the fund were to be insufficient. 5
Al-Qasamah was another pooling system under which a common community fund was created. Contributions to the fund were made jointly by members of the community to assist the family of murdered victims where the murderer could not be found. Al-Muwalah was another scheme formed between two parties with the intention that either one of the two will be responsible in the event of a mishap or misfortune inflicted upon his counterpart. Al-Tahanud was basically a food sharing and rationing programme among travelers in view that the journey or time taken to travel from one point to another during those days was ardous and long. All the travelling members agreed to contribute their foods to be pooled so that it can be shared later during the journey. Al-Diwan in essence was a register. Persons named or recorded in the Diwan actually owed one another mutual assistance and in consideration, were obliged to contribute to the payment of compensation including financial aid akin to a retirement or pension benefit, in particular those who had served for the cause of Islam and Allah. As a matter of fact, conceptually the takaful product called Maash (a form of annuity) was guided by the practice of the Diwan. This system was institutionalised during the second Caliph Umar Al Khattab. Dhaman Khatar Al Tariq whereby the merchants of Mecca established a kind of common fund by pooling the resources from all participating members. This form of mutual fund was used to help the victims or survivors of natural hazards during their journey plying their commercial ventures. It was reported that the Prophet (pbuh), who traded with the capital provided by Khadijah (ra), contributed to such fund. Milestones of Takaful Prophet Muhammad (pbuh) validated a system of community self help and financial assistance and later institutionalised by Caliph Umar al Khattab Early Islamic history Seljuk Sultan Ghias al Din Kayhusraw introduced a form of state insurance which reimburse traders if their merchandises were stolen or robbed within the Seljuk state of Anatolia Ibn Abidin, a Hanafite jurist allowed a form of insurance for marine venture 12 th Century 17 th Century 6
Fatwa of Sheikh Muhammad Abduh legalising insurance 18 th Century Fatwa issued by National Fatwa Council of Malaysia. 1972 Resolution by First International Conference on Islamic Economics held in Makkah Incorporation of the first modern Takaful Company in Sudan. 1976 1979 Shariah Background of Takaful Whilst fully appreciating the great service and importance of insurance as a risk management tool to individuals, businesses and society, contemporary Islamic scholars are not in agreement with the contractual nature of buying-and-selling transaction of insurance which is not in line with the precepts of Shariah. They have identified a number of traits of the insurance contract as well as its practices which they have concluded contravening the Shariah principles and requirements namely, the presence of the elements of gambling (maisir and qimar), uncertainty (gharar fahish), interest (riba). As consequent, they further resolved the whole transaction is shrouded with fraud and cheating (ghish wa ghabn), ignorance and uncertainty (al-jahala). From the various fatawas and research works by scholars and jurists, the alternative form of insurance which is permissible under Shariah should be based on the concept of takaful. In this manner its operation will be structured on the contract of donation (uqud tabarruat), instead of the conventional commercial contract of exchange (uqud muawadhah) as the latter contains major elements of riba, maisir and gharar which invalidates the conventional insurance contract. Gharar in Insurance Gharar literally means risk. It is derived from the word tagheer which refers to unknowingly exposing oneself or one s property to jeopardy. Gharar may arise where: (i) The parties are unaware whether such an event will take place or not (ii) The subject matter is not within the knowledge of the parties (iii) There is no certainty over the existence of the subject matter (iv) Its acquisition is in doubt (v) Its quantum is unknown. This principle can be derived by the command of Allah (SWT) that in dealing with one another or muamalah, it must be based on mutual acceptance, fairness and justice: 7
O ye who believe! Eat not up your property among yourselves in vanities: but let there be amongst you traffic and trade by mutual goodwill: nor kill (or destroy) yourselves: for verily God hath been to you Most Merciful... (Al Quran, Surah an-nisa: Verse 29). It is obvious that in an insurance arrangement, there are major elements of uncertainty and lopsidedness in a contract known as gharar fahish. For example, both the insured and insurer do not know: (i) With any degree of certainty of the insured events which is integral to any insurance transaction (ii) Its liability and obligations as they relate to future, unknowable events. (iii) When and how much the claim under the insurance agreement will be paid or whether payable at all? Riba in Insurance Riba (usury) is forbidden in the Quran and the Hadith of the Prophet (pbuh). Riba originally means increase and growth (see Al Quran, Surah Al Hajj verse 5). Increase here means the hike over capital or nominal amount: irrespective of whether the increase is large or small. Therefore, in Islamic jurisprudence the presence of riba in a contract will render the contract invalid and void, those who devour usury cannot arise except as one whom Shaitan has prostrated by (his) touch does rise. That is because they say, trading is only like usury; and Allah has allowed trading and forbidden usury. To whomsoever then the admonition has come from his Lord, then he desists, he shall have what has already passed, and his affair is in the hands of Allah; and whoever repeats (the offense) - these are the inmates of the fire; they shall abide in it (forever). Allah will deprive usury of all blessings and He will give increase for deeds of charity. For He loves not creatures ungrateful and wicked. O ye who believe! Fear Allah, and give up what remains of your demand for usury if ye are indeed believers. If ye do not (give up usury), take notice of a war from Allah, and His Messenger, but if ye turn back ye shall have your capital sums, without increase or diminution (Surah al Baqarah: Verse 275-279). The Prophet (pbuh) said, Gold is to be paid for by gold, silver by silver, wheat by wheat, barley by barley, dates by dates, salt by salt, like for like and equal for equal, payment being made hand to hand. If these classes differ, then sell as you wish if payment is made hand to hand (Sahih Muslim in Kitab al-musaqah, Hadith No.1587). There are basically four kinds of riba: 1) Riba al fadhl - an increase which occurs in exchanging riba goods not due to a postponement 8
2) Riba al nasiah - an increase which occurs in exchanging riba goods because of postponement. 3) Riba al qard - a loan granted on condition that the borrower gives something beneficial or useful to the lender. 4) Riba al yad - a deferment or postponement in the delivery or receipt of goods which to be exchanged. The nature of the insurance contract is such that money is exchanged for money (i.e. insurance premiums for claims). Riba in insurance involves both riba al fadhl and riba al nasiah: (i) Riba al fadhl - since the amounts exchanged are not equal insurance premiums (ii) paid and the claims payout Riba al nasiah - since the exchange is not spot between paying the insurance premium and receiving the insurance claim payout. (iii) Investment - undertaken by insurance companies comprising of elements/portfolios not compliant with Shariah. Maisir in Insurance Qimar and Maisir (Gambling and Wagering) which literally means getting a profit without working for it, or earning something too easily is clearly prohibited in Islam as stipulated in the Holy Quran They ask you about wine and gambling. Say, In them is great sin and (yet, some) benefit for people. But their sin is greater than their benefit. And they ask you what they should spend. Say, The excess (beyond needs). Thus Allah makes clear to you the verses (of revelation) that you might give thought... (Surah al Baqarah: Verse 219) Essentially, Qimar and Maisir are acts involving the acquisition and distribution of property based on a zero sum game whereby the winner takes all and the loser losses all, contingent upon an uncertain event. Jurists also regard gambling as a form of gharar and at the same time a form of qimar because the gambler is ignorant of the result of the gamble he had undertaken. Maisir in insurance contract happens where: (i) as a consequence of excessive gharar upon receipt by the insurer of the insurance premium although no claim is paid no actual exchange took place. (ii) insurer loses if the amount of claims paid to the insured is larger than the premium collected (iii) if the insurance premium collected exceeds the claims - the insurer makes profits. 9
Takaful Takaful is derived from the root word kafala. In Arabic it means responsibility, guarantee, amenability or surety. In practice, takaful takes the meaning of joint guarantee, shared responsibility, solidarity, mutual undertaking among its participants against certain or defined financial loss as a result of being inflicted with specific or defined misfortunes. In line with its meaning takaful participants agree to contribute to a defined fund. Simply put, takaful is the creation of a common defined fund by way of defined contributions from all its participants for the purpose of relieving their financial burden in the event of a defined loss. Insurance in Islam according to Yusuf Al Qaradawi is: in my view insurance against hazards can be modified in a manner which would bring it closer to the Islamic principle by means of a contract of donation with a condition of compensation In that perspective takaful can be visualised as a pact among its participants to remove damage or harm when it occurs on any of them, by way of the payment of compensation from common takaful contributions, described in the Islamic legal maxim as al darar yuzal (damage or harm is removed). Therefore, takaful is a system that manifests a sense of brotherhood and solidarity among participants. The Prophet (pbuh) in the following Hadeeth declared the importance of this virtue: Narrated by Abu Hurairah (r.a) from the Prophet (pbuh) Whosoever removes a worldly hardship from a believer, Allah will remove from him one of the hardships of the hereafter. Whosoever alleviates the needy person, Allah will alleviate him in this world and the next (Sahih Muslim, Kitab al-birr). AAOIFI Shariah Standard 26(2) of 2007 provides a comprehensive definition of takaful business as: Islamic Insurance is an agreement between persons who are exposed to risks to protect themselves against harms arising from the risks by paying contributions on the basis of commitment to donate (iltizam bi altabarru ). Following from that, the insurance fund is established and it is treated as a separate legal entity (shaksiyyah i tibariyyah) which has independent financial liability. The fund will cover the compensation against harms that befall any of the participants due to the occurrence of the insured risks (perils) in accordance with the terms of the policy 10
The practice of takaful can be summarised as follows: 1) A contract of donation between defined takaful participants to share their respective takaful risks and liabilities based on solidarity and mutual assistance (taawun) 2) By voluntarily contributing defined takaful contributions into a defined takaful fund, 3) By jointly agreeing to cover defined takaful risks, 4) In a defined takaful period, 5) Under the trusteeship and management of a defined takaful operator based in accordance with the selected business model al-mudharabah, al-wakalah or hybrid. Differences between Insurance and Takaful Points Insurance Takaful Risk Management mechanism Underlying principles and practices Essence of intention Contract Risk transfer from insured to insurance company Conventional principles and practices Intention to create legal relationship only based on individual needs Commercial (buying and selling) contract or Uqud al-muawadhah 11 Risk sharing among takaful participants Shariah principles and practices Intention to create both spiritual & legal relations and as a form of ibadah (worship to Allah) based on solidarity and cooperation between the takaful participants. Donation contract or Uqud al-tabarruat as well as other Shariah approved contracts such as al-mudharabah, al-wakalah, alwaqf Company Guarantor of insurance fund Trustee and manager of takaful fund based on Shariah approved contracts of al-mudharabah, alwakalah or al-waqf Guarantee Given by insurance company Takaful participants mutually guarantee each other Investment Shariah Advisory Council Source of regulatory framework No restriction as long as sound investment in both riba or Shariah based instruments Not required under the law Man-made laws: statutes, legislation, case laws, based on common Strictly in Shariah compliant instruments as well as sound investment Required under the law Divine justified principles : Quran, Sunnah, juristic opinions, legislation, based on Shariah
Legitimacy of Funds law principles Insurance funds belong to the company though separation of assets is maintained between the shareholders and the policyholders principles Funds belong to the participants and managed by the operator for a legitimate consideration for the services rendered. Shareholders funds are accounted for separately Justified risk Pure risk Defined pure risk Subject matter Common law justified Shariah justified (mal mutaqawwim) Operating expenses Operating/ mortality surplus/deficit Reinsurance Reinsurance contract Reinsurance Commission/Reta kaful Service Fee From insurance fund (premium) Surplus belongs to the insurance company whilst the deficit shall be the responsibility of the insurance company No restriction whether conventional or retakaful companies as long as sound reinsurance basis. Based on risk transfer mechanism from insurer to reinsurer on commercial (buying & selling) terms. Treated as income to the insurance company Damages (claims) The Courts of justice are in some cases empowered to award unlimited damages Payment of premium/contribu tion Intermediary (brokers and agents) Paid premium creates an obligation against the insurer on a sale and purchase relationship. Contract based on principal and agent relationship where commissions are paid from insurance fund 12 Shareholders fund (mudharabah model) / defined from contribution as fixed up-front charges (wakalah model) Principally shared between participants. Takaful operators may share profit based on profit-sharing principles of mudharabah or jualah. Deficit on the other hand shall in principle be the responsibility of the takaful participants Strictly with retakaful operators unless insufficient retakaful capacity as a temporary hajah as well as sound retakaful basis Based on risk sharing mechanism between takaful operator and retakaful operator on Shariah approved contracts of tabarru, almudharabah or al-wakalah. Belongs to the takaful fund. There is no justification to award unlimited or unreasonable damages, but only justified one. Paid contribution is treated as both donation (tabarru ) and investment (mudarabah). Contract based on Shariah approved contract of almudharabah, al-wakalah and aljualah where commissions are paid either from shareholders fund or takaful fund.
Zakat on business Not required Historical Developed from contract of Bottomry in Medieval Europe based on interest/usury Mandatory once the haul and nisb criteria are met. Developed from system of al- Aqilah in traditional Arab custom (approved by the Prophet pbuh), practiced on the basis of mutual cooperation and brotherhood Hukm (religious edict) in Islam Capital Forbidden (Haram) No restriction, except through legal sources Permissible (Halal) and encouraged. Preferably from Shariah compliant sources and legal under the law. Mr. IDRIS JIBRIN ISLAMIC FINANCIAL ADVISORY UNIT, AHMED ZAKARI & Co (Chartered Accountants), 5 th FLOOR, AFRICAN ALLAINCE BUILDING, SANI ABACHA WAY, KANO, NIGERIA. PHONE: +234-64-892449 E-Mail: Web Site: info@ahmedzakari.com www.ahmedzakari.com 13