Takaful: Islamic Insurance Lecture Notes PDF

Takaful : Islamic Insurance Toseef Azid Lecture 5, 6 and 7 Fundamentals of Islamic Finance Overview of Presentation Brief overview of Takaful Ta’awuni (TT) Takaful in early Islam Takaful in Modern day Islam Takaful Models Sharia Approval Takaful, Commercial or Mutual Examples of Product Offerings Br...

Takaful : Islamic Insurance Toseef Azid Lecture 5, 6 and 7 Fundamentals of Islamic Finance Overview of Presentation Brief overview of Takaful Ta’awuni (TT) Takaful in early Islam Takaful in Modern day Islam Takaful Models Sharia Approval Takaful, Commercial or Mutual Examples of Product Offerings Brief Overview of Takaful Ta’awuni What Is Takaful Ta’awuni? “An Islamic alternative to a conventional mutual life insurance and savings/investment program, based on a Sharia compliant, approved concept.” Definition of Takaful Ta’awuni Takaful Mutual guarantee or indemnification among the group members Ta’awun The act of mutual help and assistance between the participants within the group Takaful in Islam Hadith of the Prophet “Tie the camel and then submit to the will of Allah” This hadith implied a need to mitigate risk Historical Examples of “Takaful” Dawania-Mutual indemnification amongst officers working in the same department during the rule of Umar Ibn Al Khattab (the 2nd Caliph) Diyyah and Aquilah-Blood money and the concept of removing hardship inflicted on the family of the victim by payment of Diyyah, on a mutual basis, by the relatives of the offender Takaful in Modern Day Islam Key Features of a Takaful Model Cooperative Risk-sharing for Protection. (Cooperative alone is not sufficient to be a Takaful operation) Clear segregation between Participant and Operator. Sharia (Islamic) Compliant Investment strategies. Avoids al Riba (interest) and al Maisir (gambling). Al Gharar (uncertainty) is forgiven, using Tabar’ru (charitable donation). Sharia Advisory Oversight. Fatwa – judicial opinion. Fiqh Academy Resolution 1985 Islamic Fiqh (science of Sharia) Academy, emanating from the Organization of Islamic Conference, meeting in its Second Session in Jeddah, KSA, from 10 to 16 Rabul Thani, 1406 H (Dec 1985) issued a Resolution which in summary stated the following: The commercial Insurance contract… is prohibited (Haram) according to the Sharia. The alternative contract which conforms to the principles of Islamic dealings is the contract of cooperative insurance, which is founded on the basis of charitable donation and Sharia compliant dealings. Points to Consider on the Fiqh Academy Ruling The Fiqh Academy Takaful resolution did not specify the contract of choice for Takaful operations. Pluralism of Fatwas has been an integral element of Islamic law, resulting in the variations of Takaful models throughout the industry i.e. Wakala and Mudarabah, Mudarabah models charging expenses to the participants pool. There is no mention of an operator or surplus distribution There is no mention of a savings element, only mutual risk protection Takaful Models Takaful Islamic Models Wakala-A fee driven Islamic contract Mudarabah-A Profit Sharing Islamic contract Mudarabah Model- Non-Surplus Sharing Family (individual) Takaful- Long Term Plans Mudarab/ Operator Participant Risk A/C Risk A/C 70% (Example) Claims/ Direct Exps. Contribution Savings A/C Savings A/C Surplus 100% to Participant In the single example of this model in Malaysia, no expenses are charged to the participants pool. There could be use of this model in Sudan with charging of expenses to the pool for both Family and General Takaful Points to consider with Non-Surplus Sharing Mudarabah Model Excellent and laudable model In many ways exceeds a Mutual insurance model as no expenses are charged to the participants funds Operator does not share in surplus therefore no Mudarabah issue to debate Very difficult business model as a stand-alone Family/Individual Life Takaful operation (especially where no charging of expenses to participants fund envisaged) Possibly only potentially viable where a composite Takaful operation is being considered. Could take many years to realize a commercial profit from such a business model as it relies on the build up of reserves and savings funds As a stand-alone model, would lend itself to a philanthropic, state sponsored or participants providing capital, business operation. Mudarabah Model- Operator Sharing in Surplus General/Group Takaful- One Year Plans Mudarab/ Operator Investment Profits Investment Profits 50% profit share Participant General/Group Takaful Less Claims/ Direct Expenses Surplus, Underwriting and investment results To Participant Different models treat expenses differently. Some charge the participants funds, others charge the shareholders funds. Example 50% profit share Points to consider with a Mudarabah Surplus Sharing Model First and foremost, this is a Sharia issue, not an issue between operators Surplus is what remains of capital/contributions after the deduction of claims and direct expenses. Profit is the creation of a value in excess of the capital provided. As no profit (only surplus) is generated in the Takaful underwriting operations , the application of a Mudarabah contract is being debated by Sharia scholars Applying a Mudarabah contract to the investment profits however, is accepted Surplus Differs from Profit, when applying the principles of a Mudarabah contract Investment Dealings Tabar’ru Contributions Takaful Underwriting Surplus Profits ? $5 Gross Income Capital-$10 Million $2 Mil SURPLUS* $1 Mil DIRECT EXPENSES $7 Mil CLAIMS $2 Mil PROFITS $3 Mil EXPENSES * Under Mudarabah principles, only the Sahib al Mal (Capital Provider) may share in the original capital provided Bank al-Jazira Model Family Takaful- Long Term Plans/Group Takaful-One Year Plans Fees Full Operational Expenses Wakeel/ Operator Fees Participant Contribution Specified As: Tabar’ru Savings Fees Risk A/C Tabar’ru Individual Savings A/C IIA IRIA Risk A/C Tabar’ru Claims/ Direct Exps. Individual Savings A/C Surplus IIA Jordan Islamic Insurance charges a fixed expense fee for one year contracts and reimburses the participants if expenses amount to less than this fixed fee. IRIA Points to consider with the Bank al Jazira Wakala Model Fees only taken if a product is sold No charging of expenses to the participants fund Operator alone totally responsible for all start up expenses and operational costs No issue of agency or commission sales Clear separation between participant and operator Wakala Fee on Surplus accepted by Sharia advisors Total transparency on all aspects of the operation and fee structure. Takaful, Commercial or Mutual? Comparing Takaful to Insurance Examples only-list is not comprehensive Issue Commercial Mutual Takaful Organization Principle Profit for shareholders/ Risk transfer Mutual for policy holders Mutual for participants Value Proposition Profits for Shareholders Affordability to Policyholders Affordability and spiritual satisfaction Laws Secular/Regulations Secular/Regulations Sharia plus regulations Capital Shareholders Initial Premiums Operator provides set-Up capital. No paid up capital for TT fund Ownership Shareholders Policyholders Participants Management Company Management Appointed Management Operator Contract Form Commercial Exchange/contract of compensationadhesion Mutual risk sharing with aspects of commercial contractual principles Cooperative, Islamic contracts of Wakala or Mudarabah with Tabar’ru donations Investments Equity/debt-no restrictions Equity/debt-no restrictions Sharia compliant equities/no interest Surplus Shareholders account Policyholders account Participants accountperformance fee for operator Motives of Takaful Company The motives of takaful company can be underlying as: Company has to earn profit but other objectives are also important, i.e., looking after the interest of others, improvement in the material, moral and aesthetic terms of the society, production of the essential goods and services (duty), and provision of employment and as a trustee motive of profit maximization is not so much important “Riches and sons are the adornment of he life of the world, and the righteous works that last are excellent with your Lord in respect of reward and excellent in respect of hope” (18:46) Objective? If only objective is to maximize the profit then market may be monopolized by the conventional firms, there should be Islamic rationality instead of Economic rationality It is point of thinking that why Non-Islamic firms are opening Islamic windows (commercial Banks or Insurance companies) So dire need to establish the norms related to the stakeholders under the umbrella of Shrai’ah What is Corporate Social Responsibility Standard of behaviour to which a firm must subscribe to impact society in a positive and a productive manner at the same time as abiding by values which exclude profit seeking at any cost Companies have two kinds of responsibilities – commercial (running their business successfully) and social (their role in society and the community – activities beyond profit making) Dimension of CSR (Carroll; 1979, 1991) Economic Responsibilities Maximum profit Control cost efficiency Plan for long-term success Improve economic performance Offering viable products and service quality Ethical Responsibilities Promoting human rights Promoting good environment practice Treating employees fairly Friendly and maintain Islamic reputation and image Legal Responsibilities Employee health and safety Refrain from violating contractual obligations Refrain from bending the laws Abide to Shari’ah principles Philanthropic responsibilities Help solve social problems Supporting charities and community projects Participate in management of public affairs Play a role on society goes beyond profit maximization Human Right Dimensions “I have made oppression unlawful for Me and for you, so do not commit oppression against one another” (Sahih Muslim) “help thy brother whether he is in the oppressor or the oppressed, i.e., If he is an oppressor he should prevent him from doing it, for that is his help and if he is oppressed he should be helped (against oppressor)” (Sahih Muslim) Environmental Dimensions “And when he goes away, he strives throughout the land to cause destruction therein and destroy crops and animals> And Allah does not like mischievous act” (2:205) “And do not mischief on the earth, after it has been set in order, but call on him with fear and aspiration> Indeed the mercy of Allah is near to the does of good” (7:56) Philanthropic Dimensions And fear Allah as much as you can, listen and obey; and spend in charity for the benefit of your own souls. And those saved from the covetousness of their own souls; they are the ones who achieve prosperity” (64:16) “ Human resource dimensions Experts have the consensus that the goals of the organization is not only to maximize the profit or sale as we mentioned elsewhere is also to create the environment of social justice and especially a good relations in between entrepreneur and workers. Literature of sociological economics emphasized more on the sense of identity of the worker within an organization and his attachment to an organization is critical to well-functioning enterprises (Akerlof and Kramtoz 2005, Granovetter 2005). Human resource dimensions Corruption has a high economic cost where as honesty, fairness, reliability and loyalty enhanced the efficiency of the economic agents, the by product of the social behavior. “Any servant who observes Allah’s right and his master’s right will get a double reward.” (Bukhari) “A servant is a guardian of his master’s property and is responsible for it.” (Bukhari) Woe to those who are dishonest in weighing and measuring - those who exact a full measure they receive their due from others, but give less than due when they measure or weight for them.” (83:1) Human resource dimensions It is very much significant in the Islamic environment that entrepreneur/producer is not the owner, he is the trustee and according the spirit of Islam he is brother of the workers. “For a rich man to crave pretexts to avoid the fulfillment of his commitment towards the basic rights of worker is oppression.” (Bukhari) and “ Take head of (daily) prayers and of (the rights of) those are subordinate to you.” (Ibn Majah) Human resource dimensions “Your brethren are your servants whom Allah has made your subordinate. So, the man who has his brother as his subordinate, should give him to eat what he himself eats, and to wear he himself. And do not put on them the burden of any labor that may exhaust them. And if you have to put any such burden on them, then help them yourselves (in his work).” (Bukhari) Human resource dimensions Islam promotes a universal approach that considers all human beings as single brotherhood, and encourages peace, tranquility and the welfare of all……. Islam enjoins justice and fairness in all human dealings. It places a high value on individual freedom and human dignity. In addition, Islam grants certain inalienable rights to individuals. These fundamental human rights include: the right to life, the right to equality before law, the right to privacy, the right to protest, the right to justice and the right to participate (Ahmad 2000). Human resource dimensions The Prophet (PBUH) said: ‘All people are the dependent of Allah, and the most beloved among them are those who are most benevolent to his dependents including those who put his resources to proper use (Ibn Kathir, 1980:287). CSR relevant to Takaful firms Yes: Why? Takaful company is based on Shari’ah principles which require them to operate in morally, ethically and socially responsible manner, i.e., conforming to the Islamic norms of business and economic activities Principles of Taqwa (public interest) Principles of Maslahah (public interest).1 Daf’ al darar (prevention of harm) Raf’ al-haraj (removal of hardship) Laa Dharara wa la Dhirar (neither harming or reciprocating harm).2.3 Stakeholder coverage shareholders Distributors Suppliers management Community & consumers Employees Providers of complementary services and products Responsibilities of the management Improve the business without environmental destruction The poor are more victim and agents of environmental damage Islam rejected the conventional conception of business activities because it is linked with the realization of only material benefits Concept of brotherhood between generations also prevailing Should have a conception about social profit versus private profit, priority should be given to the former Responsibilities of the management It is expected that a balanced relation between private and social interest is attainable in the Islamic system Reasonable profit/just profit instead of maximization of profit According to some scholars maximize the revenuers instead of profit Abstain completely from conducting any transactions that are prohibited by the Shari’ah (fraud, misappropriation, riba, hoarding and usurpation of the rights of workers) Resources are given by Allah (SWT) to Muslims as a trust The motivation for poverty alleviation and human development in Islam is linked with Shari’ah and aqidah Protection of all internal and external stakeholders’ rights Shareholders model Shareholders ought to have control.1 Managers have a fiduciary duty to.2 serve shareholder interests alone The objective of the firm ought to be.3 the maximization of the shareholders’ wealth Stakeholders model All stakeholders have a right to participate in.1 corporate decisions that affect them Managers have a fiduciary duty to serve the.2 interests of all stakeholder groups The objective of the firm ought to be the.3 promotion of the interests of all and not only those of shareholders (implicit contract, ethics, moral and social order, e.g., honesty and trust) Takaful company in Islamic economic system A Takaful Company in the Islamic economic system can be viewed as a nexus-of-contracts type and objective is to minimize transaction cost in order to maximize profits and returns to investors subject to constraints that these objectives do not violate the property rights of any party, whether it interacts with the firm directly or indirectly. In pursuit of these goals, a firm honours its obligations to explicit and implicit contracts without impinging on the social order Property rights and Governance: in Islamic Framework Rights are not limited to human beings only but encompasses all forms of life as well as the environment Each element of Allah (SWT)’s creation has been endowed with certain rights and each is obligated to respect and honour the rights of others These rights are bundled with the responsibilities for which human are held accountable Say of Prophet (PBUH) “So give to every one who possesses a right, his right” Rights are also property (al-mal ); rights have beneficial uses and are regarded as capable of being possessed Rules defining the property rights in Islam deal with the rights of ownership, acquisition, usage and disposition of property Property rights and Governance: in Islamic Framework (ownership) A) It can be real and absolute [belongs to only Allah (SWT)] b) It can be delegated and restricted through time-bound possession (is reserved for man in order that he becomes materially able to perform his duties and obligations, a temporary possession of a man, vicegerent of Allah, trustee and custodian) Right of possession is a collective right, and individuals can only earn priority in the use of these resources 9requiring preservation of society’s well-being and interests) The individual, the society and the state each has a claim on property rights in respect of the roles assigned to them, rights of these three agents should not come into conflict with one another in chaos, it is justified for the legitimate authority to take corrective measures.1.2 Property rights and Governance: in Islamic Framework While rights are protected and sanctioned by Shari’ah, this is only as long as it does not come into conflict with society’s interest and wellbeing No one has a right to force appropriation (expropriation) of any person’s property (which is allowed by Shari’ah) to anyone else Say of Prophet (PBUH) “Muslims’ blodd, property and dignity are protected against each other” Degree of rights are different (Ibn Taimiyah), i.e., can sell, lend, make a gift, etc and sometimes right is incomplete – proprietor’s rights are limited and restricted Lawful rights to property Property should not have been acquired by unlawful means (means repugnant to the Shari’ah).1 The acquisition and its continuity should not result in any damage or harm to others.2 The acquisition of property should not invalidate any valid claim or establish a non-valid one.3 Property rights and Governance: in Islamic Framework No limit is imposed on the acquisition of property and wealth Individual can obtain rights to property Through its own creative labour Through transfer Property acquired through non-permissible and unjustifiable means such as gambling (maysir), bribing, stealing, cheating, forgery, coercion, or illegal trading does not qualify as al-mal is proscribed and for bidden so ownership is not legitimate (a (b Property rights and Governance: in Islamic Framework Responsibility: not to waste, destroy, squander, or use the property for purposes not permitted by the Shari’ah May not alter his property which harm even his neighbour Inability to use the property properly, forfeit the ownership rights Al-adl and al-ihsan Property rights and Governance: in Islamic Framework ( Takaful Company) A balance between the rights of individuals, society and the state It is not the firm which accrues property rights, but it is the property acquired in course of the firm’s economic activity that has property rights and claims Once property earned or acquired by the firm, it is subject to the same rules of sharing and prohibition on wasting which apply to the property of individuals A firm’s property rights also come with similar claims and responsibilities as individuals’ Expected to preserve the property rights not only of the local community or society but also of those who have participated in the process of earning the firm’s property Contracts and Governance Islam forcefully places all economic relations on the firm footing of contracts It recognize only one status, moral consciousness and virtue; all other status on any basis is obliterated Contracts are considered binding and their terms are protected by the Shari’ah, no less securely than the institution of property Reward and punishment are linked with the fulfilment of obligations incurred under the stipulation of the contract Intention is also very important with which some one enters into every contract Contracts and Governance When the Prophet (PBUH) was asked “Who is believer? He replied that ‘a believer is a person in whom people can trust their person and possessions’. The Quran exorts ‘O you who believe, fulfil contracts’ Fulfil, whether verbal or written, explicit or implicit Explicit: This contract is to be free of information asymmetry; parties intend to comply with the terms of the contract and are fully aware of rights and obligations Implicit: not formal contract with clearly defined terms but are claims and obligations that come with the right to be part of the society Contracts and Governance Contractual obligations with community and society- honouring this obligation is considered as sacred duty This sacred duty to preserve the property rights of others is a moral, social and legal foundation for recognizing and enforcing obligations in implicit contract Corporate Governance Structure Behaviour of the manger becomes the behaviour of the firms their actins are subject to the same high standards of moral and ethical commitment expected from a Muslim A firm’s economic and moral behaviour is shaped by its mangers acting on behalf of the owners and it becomes their fiddciary duty to manage the firm as a trust for all the stakeholders and not for the owners alone Corporate Governance Structure Elimination of the problem of asymmetric information, moral hazards and adverse selection A shari’ah board must be there to look after the interest of all the stake holders, not only to look the interest of the shareholders Contexuality verbal and non-verbal credible commitments, supporting a balanced governance mechanism between exchange partners Current empirical work shows that relational governance is associated with trust and that it improves the performance of interorganizational exchange Actually it is the basic norm of the business sector that the language of managers should be relatively simple, straightforward statements and based on truth. Contexuality If greed, cheat and steal are the part of the language of the managers then these firms will not get the success and have not any credibility in the market. So Islam is strictly ordered to its followers that whenever you say something say in a straight way. Contexuality As it is observed from the following verses of Quran: “O you who believer! Fear Allah, and speak a straight speech” (33:70) and “O Believers! Why do you say whay you do not act? Most odious it is to Allah that you should say what you do not act” (61:2-3) Contexuality Language reflect the bond with each other, abusing language weaken the liar’s behaviour and this will create the other sorts of unethical behaviour in the market. Allah (SWT) says about the liars in Quran as: “Allah does not approve of the uttering of harsh words, except by one who has been wronged; and Allah is ever, Hearing, and knowing” (4:148) and Quarn also warns those are not behaving in a good manner with others: “nor revile one another by odious appellations” (49:11) Fulfilment of the obligations In this system to fulfil the promise is an obligatory condition.: “O you who believe! Fulfil your obligations”. (5:1) Saying of Prophet (PBUH) describing in this way: “There are distinguishing features of a munafiq, when he speaks, he lies, when he promise he backs out, and when he given something in trust, he breaches the trust” (Bukhari) Dealing of management It is observed even in the conventional system that behaviour which shows mere the self interest, suspicion, greediness, immoral and cutthroat is not promoting the image of the firm. If the dealing of the management is fair and that is based on ethical and moral norms, then the greatest number of the member of society will get the benefit which will ultimately enhance the efficiency in of the economy and society in the long run. Thank you