Introduction to Takaful

This chapter has focused on the concept of insurance to provide a base for the phenomenon of takaful, which is covered in onward chapters. Insurance is a mechanism that enables companies to perform three important functions: to transfer risk, create a common pool and set equitable premiums. These important functions create four main benefits: peace of mind, control of loss, social benefits and economic benefits. Insurance is a well-established business practice, and over time, it has developed its core principles in line with which it operates. These principles include insurable interest, utmost good faith, subrogation, indemnity and proximate cause.

In this chapter, the concept of insurance has been analysed from the perspective of Shariah. Shariah set out Quranic verses and Ahadith that support risk management. Insurance has elements of riba, maysir and gharar, which make it non-permissible from the Shariah perspective. There are two types of riba: riba al Quran and riba al Hadith. Riba al Quran is a conditional or understood increase versus a loan or debt, while riba al Hadith is excess compensation without any consideration resulting from the sale of specific goods. Both types of riba are present in insurance. Gharar has an Arabic root meaning ‘absence’ or ‘insufficient information’, which causes uncertainty. This may exist in a contract, price, subject or transaction outcome. There are degrees of gharar, and excessive gharar is prohibited. Excessive gharar leads to undue loss for one party and unjustified gain for the other, which is prohibited. Maysir also exists in insurance. In maysir, the parties involved put the ownership of their property in danger by linking it with the occurrence of an uncertain event. The outcome is always one party’s gain at the expense of the other.

This chapter has focused on the concept of takaful. Takaful practices existed in the Arab world before the era of Islam, and they were not objected in Islam. The recent practice of takaful emerged in 1979, and there are now more than 300 takaful operators across the globe. Takaful is a contract of tabarru, while conventional insurance is a sale and purchase transaction. The objections to riba al Hadith, maysir and gharar are valid when a contract is commutative, as it is in conventional insurance. However, they are invalid when a contract is non-commutative and is based on tabarru. Therefore, the objections of riba al Hadith, gharar and maysir do not exist in relation to takaful.

This chapter has focused on the concept of risk, which is the probability or threat of damage, injury, liability, loss or any other negative occurrence that is caused by external or internal vulnerabilities and may be avoided through pre-emptive actions. In relation to insurance, three pairs of risk have been discussed: pure and speculative, financial and non-financial, and fundamental and particular. Five risk-management techniques have been explained: avoidance, control, acceptance, transference and sharing. To decide which of these techniques to apply, we first need to identify and analyse the risk. At the end of the chapter, a discussion is provided on the concept of managing risk in Islam. The following examples of risk management in Islam have been mentioned: daman khathar ul tareeq, daman ul darak and aaqila.

This chapter has focused on the different takaful models being practised around the globe. These models can be broadly divided into non-profit and for-profit. The non-profit category includes the tawuni (cooperative) model, in which the takaful operator does not get anything in return for providing its services. In for-profit models, the takaful operator can earn a fee or a profit share (or both) in return for the services it provides. For-profit models are based on mudarabah and wakalah models. In the mudarabah model, the operator takes a share of the profit, while in the wakalah model the operator takes a fixed fee and gets nothing from the surplus. The wakalah–mudarabah waqf model is a refined for-profit model based on wakalah and is mainly practised in Pakistan. In this model, the takaful fund is declared as a waqf fund and the operator becomes the wakeel. The waqf fund compensates participants for their defined losses when an event that is covered occurs.

This chapter has focused on the different services that family takaful companies offer. These services can be divided into unit-linked family takaful and family-term takaful. Unit-linked family takaful pays compensation to beneficiaries if a participant dies or becomes disabled and has a saving element if a participant survives the coverage duration. Family-term takaful provides only death benefit. Basic cover can be expanded by adding appropriate supplementary clauses to the contract. In family takaful, supplementary clauses, such as accidental death and dismemberment (AD&D) or an annuity, can be added to the basic contract.

This chapter has focused on the different services that a general takaful company offers. These services can be divided into motor takaful, fire takaful and engineering takaful. In motor takaful, the waqf fund pays compensation to the participant in case of accidental damage, both partial and total, theft and third-party liability. Fire takaful provides compensation to the participant if their property including building, machinery and physical stock is damaged due to fire, earthquake and atmospheric disturbance (flood, hurricane, snow effect, etc.). Engineering takaful provides compensation to the participant if damage occurs to industrial boilers and construction machinery like bulldozers and cranes.

For better risk mitigation, takaful operators often share their risks with re-takaful companies. Re-takaful companies also use wakalah and mudarabah models for their operations. Takaful companies arrange re-takaful for increasing their underwriting and claim-paying capacities. There are two broad types of re-takaful agreements, namely, facultative and treaty re-takaful, which have further subtypes including proportional and non-proportional.

This chapter has explained the distribution channels that insurance and takaful companies use. To cater to the needs of all segments of the market, companies explore all the available distribution channels for reaching out to potential clients. Traditionally, full-time exclusive agents marketed the products of a single company. Over time, independent agents and brokers entered the market, advising clients on the most suitable products available from a range of providers. These agents and brokers represent their client (either individual or corporate) in their dealings with insurance and takaful companies. Developments in information technology have opened several new channels of distribution. Use of these new channels—also called additional or alternate distribution channels—is increasing day by day. They include the Internet, banks and direct mail. In bancassurance and banca-takaful, companies use the banking platform to distribute their products. This significantly reduces marketing costs and gives banks the opportunity to earn income from fees.

This chapter has focused on analysing the risks that potential participants bring to the takaful fund. This is done through a process called underwriting, in which a professional underwriter assesses each potential participant’s eligibility for cover. Based on the risk analysis, the underwriter selects participants of the takaful fund, classifies them according to the risk they present and decides their contributions. Participants are placed into different classes of risk namely preferred, standard, substandard (rated) and declined. Underwriters follow a risk-analysis process that involves collecting and analysing information. After carrying out the analysis, the underwriter can accept the takaful application, refuse the request for cover or accept the application but attach conditions to the cover. If the underwriter approves the application, it is forwarded to the participant membership department for completion. If the application is refused, a rejection letter will be sent to the takaful agent or consultant and the applicant. If modifications need to be made, the application will be sent back to the takaful agent, who will review it with the potential participant.

A test for any takaful operator is how it handles claims when an event covered occurs. A thorough analysis of the claim is necessary in order to differentiate between genuine and fraudulent claims. The operator is responsible for refusing fraudulent claims and processing genuine claims swiftly. The starting steps in the process of handling claims are intimation by the participant or nominee, recording claims in the operator’s books and issuing claim forms. After receiving claim intimation, the operator issues claim forms in order to establish the following: cause of loss, which should match the events covered, otherwise, the claim is not payable; extent of loss, which usually applies in general takaful claims; and whether an investigation of the claim is needed. General takaful claims are usually processed by licensed surveyors. Surveyors engage experts to assess losses relating to vehicles, buildings and machinery. Surveyors assist the takaful operator to decide whether or not the claim is payable and, if it is, the genuine amount to be paid.

Takaful companies invite participants from public to deposit money into a takaful fund and become participants. For better safe-keeping of this money and more effective delivery of the services promised, proper regulation is a must. The regulator should develop a mechanism in which only sound individuals can establish takaful operators. The regulator should provide a licence only when it is satisfied with the expertise and transparency of the takaful operator’s shareholders and its team. Takaful companies claim Shariah compliance; therefore, this claim should be checked by independent Shariah professionals. The role of Shariah professionals within the takaful operator is very important, as they perform important functions such as vetting products for Shariah compliance, approving investments from a Shariah point of view, refunding any surplus to participants and putting any doubtful profits into a charity fund.