Islamic Finance Ch 8 PDF

Introduction to Islamic Banking and Finance: Principles and Practice M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni Chapter 8 Islamic Insurance (Takaful) Learning Objectives Upon the completion of this chapter, the reader should be able to: 1. Understand the me...

Introduction to Islamic Banking and Finance: Principles and Practice M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni Chapter 8 Islamic Insurance (Takaful) Learning Objectives Upon the completion of this chapter, the reader should be able to: 1. Understand the meaning and basic concepts of takaful as an alternative to conventional insurance with an insight into its historical development 2. Describe the innovative Sharī‘ah-approved models and structures of takaful 3. Describe the main takaful products and their expansion into the global insurance market 4. Analyze the process of determining and allocating surplus or deficit as proposed by AAOIFI 5. Explain the relevance of reinsurance and retakaful in the modern practice of takaful business  Learning Objective 1.1 Understand the meaning Basic Concepts of Takaful and basic concepts of takaful as an alternative to conventional insurance with an insight into its historical development Takaful - Arabic word originating from the root verb kafalah –to guarantee, to secure or to be responsible for others Literally, takaful means joint responsibility or guarantee based on mutual agreement Three basic concepts of mutuality are embodied in the takaful model of insurance: - Mutual help - Mutual responsibility - Mutual protection  Learning Objective 1.1 Basic Concepts of Takaful Understand the meaning and basic concepts of takaful as an alternative to conventional insurance with an insight into its historical development Figure 8.1: Triangular Relationship of the Major Aspects of Takaful  Learning Objective 1.1 Understand the meaning Basic Concepts of Takaful and basic concepts of takaful as an alternative to conventional insurance with an insight into its historical development Takaful: Islamic alternative to conventional insurance where members contribute financial resources into a pool based on principles of: - ta’awun (mutual assistance) - tabarru’ (donation) where the group undertakes to share the mutual risk together An appropriate Sharī‘ah-compliant framework effectively manages risks in commercial activities as well as other civil engagements - following the hadith ‘Tie your camel first’ All prohibitive elements in Islamic commercial transactions are prohibited in the design of takaful models  Learning Objective 1.1 Understand the meaning Basic Concepts of Takaful and basic concepts of takaful as an alternative to conventional insurance with an insight into its historical development Main Features of Takaful 1. Cooperative Risk Sharin 2. Clear Financial Segregation 3. Sharī‘ah-compliant Policies and Strategies  Learning Objective 1.1 Understand the meaning Basic Concepts of Takaful and basic concepts of takaful as an alternative to conventional insurance with an insight into its historical development Main Features of Takaful 1. Cooperative Risk Sharing Cooperative risk sharing through the use of donation was designed to: - eliminate riba and ghrar elements in takaful - address issues of social responsibility, solidarity and the innate need to care for others Donations adopted/merged with other frameworks of Islamic commercial transactions to replace premiums Premiums paid by policyholders are considered donations to assist members who suffer any loss  Learning Objective 1.1 Understand the meaning Basic Concepts of Takaful and basic concepts of takaful as an alternative to conventional insurance Main Features of Takaful with an insight into its historical development 2. Clear Financial Segregation In Islamic law: - Clear segregation between participants and operators - The role of the insurance company is restricted to an operator managing the portfolio and investing insurance contribution on behalf of participants In the conventional practice of insurance business: - - The insurance company is a profit-making entity which agrees to bear the financial burden and losses of its policyholders The shareholders are entitled to receive profit and bear the burden of any deficit at the end of the financial year  Learning Objective 1.1 Understand the meaning Basic Concepts of Takaful and basic concepts of takaful as an alternative to conventional insurance with an insight into its Main Features of Takaful historical development 3. Sharī‘ah-compliant Policies and Strategies Investment of insurance funds should be made on ethical businesses that cause no harm to people or the environment Ethical considerations in takaful extends to investment in businesses or products that do not contradict Sharī‘ah. Both the process and the end-product must be Sharī‘ah-compliant Takaful operators are required to put in place a standard Sharī‘ah governance system to ensure absolute compliance with the Sharī‘ah  Learning Objective 1.1 Understand the meaning Basic Concepts of Takaful and basic concepts of takaful as an alternative to conventional insurance with an insight into its historical development Takaful Core Principles Ta’awun (mutual assistance) Tabarru’ (donation) prohibition of riba, gharar and maysir  Learning Objective 1.1 Understand the meaning Basic Concepts of Takaful and basic concepts of takaful as an alternative to conventional insurance with an insight into its historical development Major Differences Between Takaful and Conventional Insurance The major differences between the two frameworks are: ○ Parties to the contract ○ Payment of premiums ○ Investment of insurance funds  Learning Objective 1.1 Understand the meaning Basic Concepts of Takaful and basic concepts of takaful as an alternative to conventional insurance with an insight into its historical development Specific Differences between Takaful and Conventional Insurance Refer to Table 8.1 of your text book for a summary of specific differences between takaful and conventional Insurance  Learning Objective 1.1 Understand the meaning and basic concepts of takaful as an alternative to Basic Concepts of Takaful conventional insurance with an insight into its historical development Historical Development of Takaful The Prophet (PBUH) upheld and preserved insurance protection practices carried out by ancient Arab traders. A classical precedent of takaful among the Muslims was displayed during the incidence of migration of the Prophet (PBUH) from Mecca to Medina The companions of the Prophet promoted mutual assistance and shared responsibility under the close supervision of the Prophet (PBUH)  Learning Objective 1.1 Understand the meaning Basic Concepts of Takaful and basic concepts of takaful as an alternative to conventional insurance with an insight into its historical development Figure 8.2: Timeline of the Development of Takaful  Learning Objective 1.1 Understand the meaning Basic Concepts of Takaful and basic concepts of takaful as an alternative to conventional insurance with an insight into its historical development The modern history of takaful - Islamic Insurance Company established in Sudan in 1979 - The establishment of Islamic-Arab Insurance Company in Saudi Arabia and later in UAE in 1980 - The Malaysian Takaful Act of 1984 Contemporary Islamic Scholars have issued many resolutions on the permissibility of takaful - The resolutions of the Council of Saudi Scholars in 1977 - The resolutions of the Fiqh Council of the Muslim World League in 1978  Learning Objective 1.1 Understand the meaning Basic Concepts of Takaful and basic concepts of takaful as an alternative to conventional insurance with an insight into its historical development The OIC Fiqh Academy approved the takaful system in 1985 The growth in the takaful industry is estimated at 10-20 percent a year The global takaful premium surpassed US$8.9 billion in 2010 and is expected to reach US$25 billion in 2015 For more recent data, visit: World Takaful Report - Ernst & Young www.ey.com/.../World_Takaful_report...2011/.../WTR2011EYFINA  Learning Objective 1.2 Describe the innovative Models of Takaful Sharī‘ah-approved models and structures of takaful The main two parties involved in the implementation of the takaful system regardless of the takaful model being used are: Takaful operator: the party who manages and administer the takaful fund Participants: the owners of the takaful fund, participants and policyholders  Learning Objective 1.2 Describe the innovative Models of Takaful Sharī‘ah-approved models and structures of takaful The Mudarabah Model The Wakalah Model Hybrid Wakalah-cum-Mudarabah Model Wakalah with Waqf Model  Learning Objective 1.2 Describe the innovative Models of Takaful Sharī‘ah-approved models and structures of takaful The Mudarabah Model Islamic insurance model based on trust partnership between the takaful operator (mudarib) appointed to manage the takaful business by the participants who act as the financiers, investors or fund contributors (rabb al-mal) The funds contributed by the participants are divided into: - Participants’ Risk Fund (PRF) and - Participants’ Investment Fund (PIF) The Takaful Participants are the capital providers and the owners of the takaful undertaking  Learning Objective 1.2 Describe the innovative Models of Takaful Sharī‘ah-approved models and structures of takaful The Mudarabah model The Takaful Operator is considered a business partner of the participants in the investor-entrepreneur relationship under the mudarabah contract The ratios of profit distribution are predetermined Financial loss is borne by capital providers (Takaful Participants), while the entrepreneur (Takaful Operator) may lose his/her managerial efforts Takaful Operator remunerated from the underwriting surplus as agreed upon in the underlying takaful contract  Learning Objective 1.2 Describe the innovative Sharī‘ah-approved models and structures of takaful Models of Takaful Surplus The amount that remains after all expenses and management fees for the administration of the takaful fund have been deducted and the contributions are more than the claims made by the participants  Learning Objective 1.2 Describe the innovative Models of Takaful Sharī‘ah-approved models and structures of takaful The Wakalah Model Islamic insurance model based on the contract of agency between takaful participants and takaful operator where the former are the real owners of the fund while the latter acts as an agent Wakalah takaful is based on the contract of agency between the takaful participants and the takaful operator where: - the takaful participants are the real owners of the fund - the takaful operator acts as an agent The takaful operator is entitled to agency fee or commission for its service. The agency fee must be specified and clearly stated in the contract  Learning Objective 1.2 Describe the innovative Models of Takaful Sharī‘ah-approved models and structures of takaful Figure 8.4: Example of the Wakalah Model of Takaful  Learning Objective 1.2 Describe the innovative Main Takaful Products Sharī‘ah-approved models and structures of takaful Hybrid Wakalah-Mudarabah Model The hybrid takaful model (also called the mixed model ) is a combination of the wakalah model and the mudarabah model where: - the wakalah model is employed for the underwriting purposes - the mudarabah model is utilised for the investment activities  Learning Objective 1.2 Describe the innovative Models of Takaful Sharī‘ah-approved models and structures of takaful Hybrid Wakalah-Mudarabah Model The twin role of the takaful operator makes the model unique with its hybrid structure: - the takaful operator is entitled to agency fee or mutually predetermined commission for the role it plays as a wakil or agent who manages the takaful funds - the takaful operator is also entitled to a share in the profits realised for managing the investment activities of the fund as an entrepreneur (mudarib)  Learning Objective 1.2 Describe the innovative Models of Takaful Sharī‘ah-approved models and structures of takaful Hybrid Wakalah-Mudarabah Model The sources of income of the takaful operator consist of: - agency fee - incentive fee - the profit share from the investment of the funds One important element of the hybrid model is the clear segregation between the shareholders’ funds and the participants’ funds  Learning Objective 1.2 Describe the innovative Models of Takaful Sharī‘ah-approved models and structures of takaful Waqf-Wakalah-Mudarabah Model The Waqf Component The shareholders of a takaful company make donations to a common pool of funds which is established as a waqf. Waqf funds are invested in Sharī‘ah- compliant activities. Returns from such investments in addition to tabarru’ funds in Participants’ Special Account ( PSA) are used for the benefit of the participants. The original capital amount contributed into the common pool of f unds must be reinvestment to ensure continuity of waqf funds  Learning Objective 1.2 Describe the innovative Models of Takaful Sharī‘ah-approved models and structures of takaful Waqf-Wakalah-Mudarabah Model The Wakalah Component The shareholders of the Takaful company donate to it, establishing a waqf fund The company becomes the agent of the shareholders and assumes responsibilities of proper management of the waqf funds, paying necessary claims Company stands to receive a pre-agreed fee for acting as an agent of the shareholders The company also manages the investment of such waqf funds as an entrepreneur, therefore entitled to share in the profit from investment  Learning Objective 1.2 Describe the innovative Models of Takaful Sharī‘ah-approved models and structures of takaful Figure 8.6: Model (Ultra- hybrid Model)  Learning Objective 1.3 Describe the main takaful Main Takaful Products products and their expansion into the global insurance market Main Takaful Products Available products in the takaful industry: - General Takaful: is a Sharī‘ah-compliant alternative to the general insurance - Family Takaful: is a Sharī‘ah-compliant alternatives to the life insurance  Learning Objective 1.3 Describe the main takaful Main Takaful Products products and their expansion into the global insurance market Main Takaful Products General Takaful General takaful: a short-term policy renewable periodically; covers assets and other proprietary belongings of participants from foreseeable material loss or any form of damage General takaful fund established through participants’ contributions. Funds invested in Sharī‘ah-compliant investments Proceeds accrue from such investment will be returned to the fund for indemnifying the takaful participants Underwriting surpluses of the takaful funds are distributed to the participants annually  Learning Objective 1.3 Describe the main takaful Main Takaful Products products and their expansion into the global insurance market General Takaful Covers (list is not exhaustive) - Motor Takaful - Fire Takaful - Employer Liability Takaful - Fire consequential Loss Takaful - Burglary Takaful - Workmen Compensation Takaful - Machinery Breakdown Takaful - Health Takaful Available takaful covers are categorised into motor takaful and non- motor takaful  Learning Objective 1.3 Main Takaful Products Describe the main takaful products and their expansion into the global insurance market Family Takaful Family takaful is a long-term policy (may span between 10 to 30 years) where people come together to mutually indemnify one another against disasters that may occur such as sudden death or permanent disability Examples of family takaful include - accidental death - savings and education plans for one’s dependants - retirement plans - disability plans - waaqf plans  Learning Objective 1.3 Describe the main takaful Main Takaful Products products and their expansion into the global insurance market Types of Family Takaful Ordinary collaboration Collaboration with savings Collaboration based on specific groups  Learning Objective 1.3 Describe the main takaful Main Takaful Products products and their expansion into the global insurance market Three Types of Family Takaful First: Ordinary Collaboration The participants mutually agree to contribute to a common pool of funds through donations (concept of tabarru’) Premiums used for underwriting activities in case of calamity or disaster for any of the members of the group Payment made directly to participant or his/her beneficiaries in accordance with the underlying takaful contract  Learning Objective 1.3 Describe the main takaful Main Takaful Products products and their expansion into the global insurance market Second: Collaboration with Savings The parties contribute through donations into a common pool of funds from which the underwriting activities are carried out The second pool of funds constitutes savings of individual participants which may be demanded by respective owners at maturity of certain period of time The two pools of funds are strategically segregated The participants benefit individually as well as collectively form the collaboration with savings  Learning Objective 1.5 Explain the relevance of Reinsurance and Retakaful reinsurance and retakaful in the modern practice of takaful business. The Islamic alternative to reinsurance is retakaful, which has been structured in a Sharī‘ah-compliant model, i.e. reinsurance of takaful business on the basis of Islamic principles is known as retakaful Within the conventional framework of insurance: - Insurance operators collectively share the risks they have undertaken to underwrite - Large insurance companies underwrite the risks of smaller insurance companies - Reinsurance is a mechanism of the mitigation of such great risks by transferring the risks to a large insurer known as reinsurer  Learning Objective 1.5 Explain the relevance of Reinsurance and Retakaful reinsurance and retakaful in the modern practice of takaful business. Retakaful Structured in a Sharī‘ah-compliant model; the Islamic alternative to conventional reinsurance The risk aversion method of Retakaful is structured in a way where: - Takaful operators are participants in a takaful undertaking with a large takaful company - An agreed amount is paid periodically from the takaful fund of the operators as premiums to the Retakaful company - All the underwriting risks of the takaful operators are insured by the Retakaful company  Learning Objective 1.5 Explain the relevance of Reinsurance and Retakaful reinsurance and retakaful in the modern practice of takaful business. The Retakaful companies play a significant role when the takaful operators record deficits or losses Capital of many Retakaful companies not so large to attain an “A” rating which is mostly required for reinsurance purposes Sharī‘ah scholars allow takfaul operators to reinsure with conventional insurance companies under certain conditions Key Terms and Concepts Aqilah Participants’ Investment Fund (PIF) Contribution Participants’ Risk Fund Fiqh al-muamalat (PRF) Hybrid takaful model Qard hasan Insurable interest Retakaful Mudarabah model of takaful Surplus Mutual indemnification Tabarru’ Operator or wakil Takaful Participants Takaful policy