TAKAFUL AN ALTERNATIVE TO INSURANCE

It is worth noting that among D-8 countries it is only Pakistan where Takaful business has not yet been introduced.

MUHAMMAD AYUB
Mar 12 - 18, 2007

Islamic finance has developed mainly in two directions, namely Islamic banking and Islamic insurance (Takaful). While information about Islamic banking is being increasingly disseminated, features, models and structures of Takaful are little known particularly in Pakistan. This brief article describes main features and models of Takaful system operating in various parts of the world.

All human beings are invariably exposed to the possibility of meeting catastrophes and disasters giving rise to misfortunes and sufferings such as death, loss of limbs, accident, destruction of business or wealth, etc. Notwithstanding the belief of all Muslims in Qadha-o-Qadr, Islam provides that one must find ways and means to avoid such catastrophes and disasters wherever possible, and to minimize his or his family's financial losses should such events occur. One possible way out is to buy an insurance cover as in the conventional system.

Different views have been expressed about the status of conventional insurance from Islam's point of view. An overwhelming majority of the Shariah scholars believe that it is unlawful due to involvement of Riba (interest), Maisir (gambling) and Gharar (uncertainty). Takaful, the Islamic alternative to insurance is based on the concept of social solidarity, cooperation and mutual indemnification of losses of members. It is a pact among a group of persons who agree to jointly indemnify the loss or damage that may inflict upon any of them; out of the fund they donate collectively.

The Takaful contract so agreed usually involves the concepts of Mudarabah, Tabarru (to donate for the benefit of others) and mutual sharing of losses with the overall objective of eliminating the element of uncertainty.

Takaful is not a new concept in Islamic commercial law. The contemporary jurists acknowledge that the foundation of shared responsibility or Takaful was laid down in the system of 'Aaqilah', which was an arrangement of mutual help or indemnification customary in some tribes at the time of the Holy Prophet (Peace Be Upon Him). In case of any natural calamity, everybody used to contribute something until the loss was indemnified. Similarly, the idea of Aaqilah in respect of blood money or any disaster was based on the concept of Takaful wherein payments by the whole tribe distributed the financial burden among the entire tribe. Islam accepted this principle of reciprocal compensation and joint responsibility.

The contract of Takaful provides solidarity in respect of any tragedy in human life and loss to the business or property. The policyholders (Takaful partners) pay subscription to assist and indemnify each other and share the profits earned from business conducted by the company with the subscribed funds. Takaful companies normally divide the contributions into two parts, i.e. donations for meeting mortality liability or losses of the fellow policyholders and the other part for investment. Accordingly, the clause of Tabarru is incorporated in the contract - how much of the contribution is meant for mortality liability and how much for investment account is based on a sound technical basis of mortality tables and other actuarial requirements. Both the accounts are invested and returns thereof distributed on Mudarabah principle between the participants and the Takaful operators. The profit attributable to the participants is credited into the two accounts separately. To describe from another angle, a Takaful contract may comprise clauses for either protection or savings/investments or both the benefits of protection as well as savings and investment. The protection part of Takaful works on the donation principle according to which individual rights are given up to indemnify the losses reciprocally. In the savings part, individual rights remain intact under Mudarabah principle and the contributions along with profit (net of expenses) are paid to the policyholders at the end of policy term or before, if required by him.

The distinction between the conventional insurance and Takaful business is more visible with respect to investment of funds. While insurance companies invest their funds in interest-based avenues and without any regard for the concept of Halal-o-Haram, Takaful companies undertake only Shariah-compliant business and the profits are distributed in accordance with the pre-agreed ratios in the Takaful agreement. Likewise, they share in any surplus or loss from the pool collectively. Takaful system has a built-in mechanism to counter any over-pricing policies of the insurance companies because whatever may be the premium charged, the surplus would normally go back to the participants in proportion to their contributions.

The terms 'Family Takaful', 'Takaful Ta'awani' or just 'Takaful' are generally used for family solidarity in place of conventional life insurances. Other products available in various countries are General Takaful, Education/Medical Takaful, etc. Based on the nature of relationship between the company and the participants, there are various models like Wakalah (agency) model, Mudarabah model and the combination of agency and Mudarabah models. In the Sudanese Takaful model that is preferable to majority of the contemporary Shariah experts, every policyholder is also the shareholder of the Takaful company. There is a board that runs the business on behalf of all the participants and there is no separate entity managing the business. The legal framework in other Islamic countries normally does not allow this arrangement and Takaful companies work as separate entities on the basis of Mudarabah (as in Malaysia) and on the basis of Wakalah (as in the Middle East region). In Mudarabah model that is practiced mainly in the Asia Pacific region, the policyholders get profit on their part of funds only if the Takaful company earns profit. The sharing basis is determined in advance and is a function of the developmental stage and earnings of the company. The Shariah committee approves the sharing ratio for each year in advance. Most of the expenses are charged to the shareholders.

In Wakalah model, the surplus of policyholders' funds investments net of the management fee or expenses - goes to the policyholders. The shareholders charge

Wakalah fee from contributions that covers most of the expenses of business. The fee rate is fixed annually in advance in consultation with Shariah committee of the company. In order to give incentive for good governance, management fee is related to the level of performance.

The Takaful business has proved its viability in a period of only two decades. It has been growing at the rate of 10-20% per annum compared to the global average growth of insurance of 5% per annum. A large number of Takaful companies exist in the Middle East, Far East, Iran, Turkey, and Sudan and even in some non-Islamic countries. There are over 60 companies offering Takaful services (including Windows- 5%) in 23 countries around the world. Malaysia has developed Re-Takaful business as well. Takaful products are available to meet the needs of all sectors of the economy, both at individual as well as corporate levels to cater to short and long term financial needs of various groups of society.

A convention of D-8 countries was held in Kuala Lumpur in November, 2002 on "The Emergence of Takaful in the Wake of Globalization". It is worth noting that among D-8 countries it is only Pakistan where Takaful business has not been introduced so far. Islamic banks and financial institutions require Takaful services for their operations. Although, the insurance business in Pakistan falls in the jurisdiction of the Securities & Exchange Commission of Pakistan, institutions operating Islamic banking would have to deal with insurance. As such, the Central Bank should desire that Takaful business be introduced in the country at the earliest. In the revised Insurance Act, the Pakistan government has added the provisions for Takaful companies in the country. As reported in the press, Pak-Kuwait Investment Corporation has recently been allowed by the SECP to establish a Takaful company in Pakistan under the name of First Takaful Insurance Company Limited" with authorized capital of Rs 100 million.

ISLAMIC BANKING SECTOR- CONSOLIDATED BALANCE SHEET FOR 3RD & 4TH QUARTER

Rs. In "000"

DESCRIPTION

SEP-06

DEC-06

% CHANGE

ASSETS

Cash and balances with treasury banks

12,164,803

15,266,243

25%

Balances with other banks

15,191,421

16,383,041

8%

Due from financial institutions

300,000

5,602,000

1767%

Investments

6,642,160

7,053,163

6%

Financings

52,620,814

65,137,207

24%

Operating fixed assets

2,151,084

2,517,543

17%

Deferred tax assets

123,189

192,259

56%

Other assets

5,826,290

6,031,374

4%

Total Assets

95,019,761

118,182,830

24%

LIABILITIES

Bills payable

1,127,126

1,259,513

12%

Due to financial institutions

5,052,380

6,547,021

30%

Borrowings from Head office

2,858,400

4,193,833

47%

Deposits and other accounts

66,010,905

83,741,910

27%

Sub-ordinate Loans

-

-

-

Liabilities against assets subject to finance lease

-

-

-

Deferred tax liabilities

431,746

491,450

14%

Other liabilities

6,762,028

6,101,835

-10%

Total Liabilities

82,242,585

102,335,562

24%

NET ASSETS

12,777,176

15,847,268

24%

REPRESENTED BY

Paid-up capital/Head office capital account

11,087,161

14,465,290

30%

Reserves

735,463

528,851

-28%

Inappropriate /Unmerited profit

829,239

756,148

-9%

Sub Total

12,651,863

15,750,289

24%

Surplus /(Deficit) on revaluation of assets

125,313

96,979

-23%

Equity

12,777,176

15,847,268

24%

- The writer is retired Senior Joint Director, Islamic Banking Department, State Bank of Pakistan, Karachi.