Takaful – Islamic insurance
Human beings have long recognised the need to protect themselves
against the impact of risks they face, such as natural disasters, travel
accidents, unemployment, sickness or dying at a young age and leaving a
vulnerable young family behind.
Islam teaches its followers to put their trust in God; at the
same time, it also encourages them to use the resources, skills and abilities
bestowed on them by God to act responsibly and protect their wealth and
In this chapter we will look at the reasons why conventional
proprietary insurance is not regarded as sharia-compliant and
explore the Islamic alternative called takaful.
SHARIA PERSPECTIVE ON CONVENTIONAL
In conventional proprietary insurance schemes, a commercial
entity seeks to provide insurance cover for a particular risk by charging an
insurance premium and make a profit net of any claims and other costs. This
model is at odds with the sharia in three key respects:
Insurance aims to provide protection against an event that could
happen but is uncertain in terms of if or when it might happen. Actuaries model
the probability of events occurring and seek to set insurance premiums at a
level that both compete effectively in the market and maximise profit for the
insurance company. These attempts to model the future will invariably be
imperfect. Some unreliability will exist in almost all commercial dealings (for
example, when a consumer buys fruit, there is a chance that it will not be
fully grown). This level of uncertainty is seen as natural and accepted in the
market. However, the sharia does not tolerate ‘excessive’
levels of uncertainty (gharar) and most scholars are of the opinion that
the uncertainty found in commercial insurance contracts falls into this
Related to the fact that the occurrence of certain events is
uncertain, sharia scholars are generally of the opinion that
the premium charged by commercial insurance companies is similar to placing a
bet (maysir) on whether a particular event will happen. So this is
another sharia objection to conventional proprietary
In conventional insurance schemes, either the policy holder will
receive more than they pay as a premium (if a successful claim is made) or the
insurance company will receive more in premiums than it pays out in claims.
Given that the ultimate outcome is a money-for-money exchange, i.e. a premium
paid in money is exchanged for a potential payout in money later, and that
these two values will invariably be different, in a commercial context this
would amount to riba. Riba can also arise if the
insurance company invests in interest-bearing instruments such as gilts.
TAKAFUL – THE ISLAMIC ALTERNATIVE
Takaful means mutual cooperation or joint
guarantee. It refers to a not-for-profit set-up in which individuals club
together by contributing into a common pool. The monies in this fund are used
to pay out to members of the pool who have been afflicted by certain events
that the members have mutually agreed to cover each other for – travel accidents,
for example. The monies left in the pool after paying claims belong to the
The Takaful Act enacted by Malaysia in 1984 defines takaful as
A scheme based on brotherhood, solidarity and mutual assistance,
which provides for mutual financial aid and assistance to the participants in
case of need whereby the participants mutually agree to contribute for the
The sharia violations of riba, gharar and maysir that
are prevalent in conventional commercial insurance contracts do not occur in
such a system. Instead of a premium payable in a commercial insurance contract,
pool members donate (tabarru means donation) a sum of money to the
pool. If a member is paid compensation from the pool, this payment is regarded
as a form of mutual assistance rather than as a countervalue paid under a
contract of exchange. Hence the issue of riba does not arise
in such a system.
Similarly, the non-commercial nature of the arrangement means
that the prohibitions of gharar and maysir do
not apply. It is in a commercial context that the sharia demands
as much certainty as possible in the exchange between the two parties to a
transaction (i.e. absence of gharar) and forbids gambling/betting (maysir)
by either party.
Takaful is different from commercial proprietary
insurance with regard to who bears the risk. In commercial proprietary
insurance the risk is transferred to the insurance company, which takes on the
risk(s) covered in the insurance policy in exchange for the insurance premium.
Under the takaful system, risk is not directly transferred to any
third party but is borne by and distributed among the members of the pool.
The relationship between the pool members and the pool is framed
in terms of two binding promises: the members promise to contribute to the
fund, and the pool promises to pay out in the event of a claim.
The takaful system is virtually similar to the concept
of mutual insurance, which is still alive today and has a deep heritage in the
United Kingdom, rooted in local communities putting money into a common pool to
protect members from certain mishaps.
It is worth noting at this point that in markets such as the
United Kingdom, the provision of takaful products is limited. Where
the law demands protection (for example, car insurance is required to drive a
car in the United Kingdom) and there is no sharia-compliant
alternative available, scholars have permitted the use of conventional
insurance products. This is based on the fact that it is a legal requirement of
the country and Islamically it is of paramount importance to be law abiding and
maintain social order and harmony in society. Where there is no legal
imperative but there is no sharia-compliant alternative available,
scholars are reluctant to grant the use of conventional insurance products, but
it depends on the circumstances of a particular case, may endorse it if it is
deemed that the potential loss to the person/entity will be very hard to
takaful could in theory be embed by
administratives or by privately organised groups. In real, given the range of
risks that requires covering and the fact that different risks apply to
different groups of people, it is difficult for system to provide the
compulsory range and depth of coverage. Therefore takaful solutions
have tended to be set by private organisations.
A single non-profit body can be set up on a mutual or communal
basis. This is almost similar to a mutual organisation in the United Kingdom,
in which the entity is owned by members and there are no external shareholders
seeking to make a profit from its activities. Members appoint a board or
management to run the operation. The cost of management and other expenses are
funded through member contributions and other activities such as profits earned
from investments. Any excess, net of claims paid and expenses, belongs to
members. Any shortfall needs to be covered by increased contributions from associates.
structure of takaful operation is:
Entity 1: a takaful mutual
fund/pool operating on a non-profit basis to collate members’ funds and pay out
to them on the incidence of certain events covered by the fund. The monies in
the pool, including any surplus, belong to the members.
Entity 2: a commercial entity,
usually referred to as the takaful operator , engaged by
the takaful fund to manage activities such as claims handling
and investments in accordance with sharia principles. The
commercial entity is motivated by the revenues it can earn for shareholders
from services provided to the takaful non-profit-making
entity. The TO has no direct liability in respect of any takaful policies
issued by the fund – it is merely entrusted to manage the takafulentity
and its investments.
A common feature of the relationship between the TO and
the takaful fund is that the operator agrees to provide an
interest-free loan to the fund in the event of a shortfall in the fund
due to claims exceeding member contributions.
Possible pitfalls of the double entity structure
Most takaful operations around the world have
been set up based on the double entity structure, and have usually been
initiated by takaful operators who have identified a commercial
opportunity in providing sharia-compliant protection.
There are some potential pitfalls with this structure:
1. takaful is
in essence a non-profit-making activity, set up for the mutual protection and
benefit of its members. The takaful fund must ensure that its
original purpose and values are not undermined by the involvement of a
commercial entity focused on maximising profit. Close attention needs to be
paid to how the commercial entity is remunerated, so that its interests are
fully aligned to those of the takaful fund. We will look at
this more closely when discussing how the relationship between the TO and
the takaful fund can be structured.
commentators have argued that the agreement by the TO to provide an
interest-free loan to the takaful fund in the event of a
shortfall is tantamount to transferring risk from the takaful fund
to the TO. Such a transfer would be fundamentally at odds with the concept
of takaful – that risk needs to be shared and distributed
among members of the takaful fund and not transferred to a
between the takaful pool and the takaful operator
As described above, the operator provides services to the pool.
These services fall into two broad categories:
1. Underwriting –
this includes issuing new takaful policies and claims
handling. These services are typically provided by the operator to the pool
through a wakala contract (principal–agent relationship). The
operator acts as the agent (wakil) of the pool members (the principal)
and receives a fee for its underwriting services on this basis. This can be
structured as a fixed fee or as a percentage of the contributions paid into the
management – this refers to investing the monies of the takaful pool
on behalf of the pool members. A mudarabah contract for the
investment management services is typically provided by the operator. The
operator acts as the mudarib, providing investment management
services to the pool members, who collectively form the rabb-ul-maal (providers
of capital). Under such a contract, the operator does not receive any fixed
remuneration, instead sharing in any profit generated through the investment
activity, while any losses are borne solely by pool members.
The wakala contract for underwriting services
and the mudarabah contract for investment management services
is the most common model used to define the relationship between the TO and
the takaful pool and its members. There are a number of
reasons for this:
The wakala contract lends itself well to the
provision of underwriting services as a management fee is charged to the pool
by the TO. This is usually either a fixed fee or a percentage of the value of
contributions received by the pool (this can be justified on the basis that the
greater the value of contributions, the more work the operator needs to do).
Applying a mudarabah (profit-sharing) contract
to underwriting would not work as well for the following reasons:
The essence of takaful is that any underwriting
surplus should belong to the pool members, as they are and should be the ‘risk
takers’. If the operator shares in the surplus, its role as a ‘risk manager’
starts to merge wrongly into ‘risk taking’.
An underwriting surplus is not the aim of the takaful pool
and is not the same as a profit – it is in fact an undistributed surplus from
the tabarru. Hence to apply a contract of profit sharing is
something of a mis-fit.
Similarly, if the operator is remunerated according to the value
of the underwriting surplus, the operator will be motivated to maximise the
surplus. This is not aligned to the interests of the pool members, nor is it
compatible with the aims and values of takaful.
Yet the mudarabah contract is well suited to
the investment management activities of the TO. The operator receives a share of
any profits from the investments and hence the operator’s interests are
generally aligned to those of the pool members – to make the best possible
return. However, there is the potential misalignment of interests if the
operator wants to take more risk than is suitable for the pool members. Such
issues need to be addressed in the governance applied to takaful operations.
Nevertheless, it is also possible to use a wakala contract
for investment management services, instead of the mudarabah contract.
The fee payable to the operator (wakil) can be structured to contain a
performance-related component. The mudarabah contract is
generally more risky from the operator’s point of view as no remuneration will
be received unless a profit is made on the investments. Hence either wakala or mudarabah contracts
could be used for investment management services: the contract chosen depends
on the preferences of, and agreements between, the TO and the pool members.
Use of the waqf (endowment)
concept in takaful
A waqf is
an inheritance created by a person who donates an asset that they own to an
endowment vehicle, with the intention of benefiting specified beneficiaries.
The benefactor can still manage the holding or may pass management
responsibility to other specified members. In the United Kingdom and other
jurisdictions, where specific waqf prescription
does not exist, trusts can work well similar to endowment vehicle.
In the takaful arena,
the use of the waqf concept has been increasingly applied. In
Pakistan, for example, a waqf takaful model
has been used. The waqf founder initiates a takaful operation by dowering a sum of money to
the waqf. Contributors then participates to the waqf with
the objective of giving out and helping participants who are affected by
specified events, risks or disasters.
In this type of scheme, all dowry returns and any
underwriting surplus remain within the waqf and
are not shared with the donators. The participants at the outset agree that any
surplus should be kept and used by the charitable waqf.
A waqf may appoint external providers to supply
services such as investment management.
A more common model is to combine a waqf with
a wakala contract, and in some circumstances with mudarabah as well. For example:
A takaful manager provides underwriting services on
a wakala basis.
The operator also provides speculation management
services on a mudarabah basis.
Any spare generated by the takaful pool
is donated to a waqf, instead of being redistributed back to contributors.
Using a waqf in
this way can help to reduce a practical issue of redistributing surpluses back
to contributors. Insurance is a dynamic activity with a continuous stream of beginners
and leavers and new claims. Moreover, claims can sometimes be made some
considerable time after the incident giving rise to the claim has occurred. As
a result, accurately ascertaining what proportion of the surplus a member is
entitled to can be difficult. This issue is resolved if all contributors agree
that any excessive should be paid to a charitable waqf.
TYPES OF TAKAFUL POLICY
Conventional insurance is broadly divided into life
insurance and general insurance. In a similar way, takaful can be broadly categorised into general and
like general insurance, seeks to provide accidental coverage suffered by replacing value equivalent to that
prior to the damage or loss. The risks covered are generally short-term in
nature, such as protection against car accidents, travel problems, fire, damage
to property and so on. Within this space, protection for businesses such as
professional indemnity, employer liability and public liability cover are all
possible. General takaful policies usually last one year and focus almost
entirely on protection as opposed to investment return and growth. Hence the
activities of the TO or the mutual takaful pool
are centred around underwriting.
Takaful can cater for all risks, including death – to
provide intervention to the family of the deceased is very much in line with
Islamic values. Family/life takaful plans
are generally schemes that provide coverage to a person wishes to save a sum of
money for dependants, should the participant die prematurely. This cover is
effectively a long-term savings plan, typically of 10–30 years duration. Given
the long-term savings nature of these policies, contributions by participants
are usually split into an underwriting pool and an investment pool. If the
participant dies during this period, the policy provides some financial
protection for the family and dependants left behind; otherwise the policy
matures at the end of the contracted period.
Such policies can also usually be redeemed at any time
up to maturity. Family/life takaful therefore
goes beyond simply insuring against the event of death; it also enables the
participant to save a capital sum on survival.
There are three typical scenarios:
before plan matures: heirs to the affected’s estate receive
all of the monies accumulated in the investment pool based on the deceased’s
contributions into the pool and the returns earned on those contributions. In
addition, the heirs will receive from the underwriting pool an amount of money
equivalent to all remaining or outstanding total donations that would have been
made if the participant had survived until maturity of the takaful plan.
at maturity: if the participant survives until
maturity of the plan, he or she will typically receive the monies accumulated
in the investment pool (as above) plus a proportion of the excess, if any,
arising in the underwriting pool.
benefit: this arises when a participant decides
to end his policy before maturity. Typically he or she receives monies
accumulated in the investment pool on his behalf, but does not receive any
monies from the underwriting pool.
It is possible to provide takaful such that a person’s family receives a payout on
death, whenever that occurs. This is rare because life cover is invariably a
long-term policy; in takaful, the hard cash in the pool belong to the members and
hence this is suited to a plan in which the member benefits from investment and
Malaysia is a leading takaful provider in Malaysia. It
provides both family and general takaful products. On the
family side it provides protection for health problems (paying for medical
fees, etc.), protection against the risk of not being able to pay for home
finance payments, and protection against death before a certain age.
On the general takaful side
it offers protection against fire, damage to property, motor accidents and
personal injury, and a multitude of protection products for
As with conventional insurance, the takaful pool needs to be able to redistribute some of
the risk outside the pool if it is to remain viable and sustainable. Otherwise,
very large claims resulting from catastrophic events (such as heavy storms or
flooding) could cause the pool to become insolvent. Consequently, retakaful has developed in a similar way to reinsurance.
The takaful pool
redistributes some of the risk in the pool by passing a portion of the
contributions in the takaful pool to the retakaful pool. The retakaful pool
works on the same principles as takaful:
the members of the retakaful pool (other takaful pools/funds) make contributions into the pool to
mutually guarantee each other. The participants in a retakaful contract are the takafuloperators, acting on behalf of the respective takaful pools they represent.
THE FUTURE OF THE TAKAFUL INDUSTRY
A report by Ernst & Young in 20131 commented
that ‘there is a dearth of takaful operators
who are capable of providing leadership to the growing internationalisation of
the industry. There is a need for large, regional champions to lead growth in
regional markets and to participate in international markets’.
There are signs of change. In this 2013 publication,
Ernst & Young reported that global gross takafulcontributions are estimated to be around $15 billion
in 2014, growing at more than 15 per cent per annum.
Momentum seems to be building in takaful’s three key markets – Saudi Arabia, Malaysia and UAE.
Saudi Arabia accounts for approximately half of the Islamic insurance industry,
partly due to the fact that conventional proprietary insurance is not permitted
in the country. The growth lever for strong growth in Saudi Arabia and UAE
(specifically Abu Dhabi) was the implementation of the compulsory national health
insurance policy. Qatar is also legislating to make it mandatory to hold a
national health insurance policy, which will drive demand of its takaful industry. Malaysia, with a relatively developed
Islamic finance industry, has actively supported the growth of its takaful sector. In fact, Malaysia has emerged as the
world’s largest family takaful market. With a proven model and regulatory
clarity, the country is set to further build on this leadership position.
Family and medical takaful are the major business lines across all markets.
Scale in the protection space is very important and
this has been a challenge outside of Saudi Arabia and Malaysia. Regulatory
enhancements are also presenting new opportunities in rapid growth markets such
as Turkey and Indonesia. The challenge is to build on the lessons learned from
core Islamic finance markets to address rising demand expeditiously.
Takaful is in many ways the ‘sleeping giant’ of the
Islamic finance industry. As highlighted at the beginning of this chapter,
protection against the risks we face as human beings is a basic need. With the
significant and growing Muslim demographic across the world, a tremendous
opportunity exists to provide sharia-compliant
protection solutions. Conventional insurance still dominates across the Muslim
world (in a report by Swiss Re in 2011, 83.1 per cent of premiums went to
conventional insurance providers in Muslim countries2)
and in most of the non-Muslim world there is very little provision of takaful.
For the takaful industry
to compete with conventional proprietary insurance, it needs to achieve scale,
a more accessible regulatory framework, have suitable long-term investments for
the family/life takaful market and attain operational efficiency. Scale
is important to overcome significant start-up costs, provide competitive
pricing and mitigate the risk of insolvency. Regulation in individual
jurisdictions and the regulatory framework across borders need to be simplified
to allow larger, regional players to develop. A lack of relatively stable,
long-term sharia-compliant investments has been an issue – these are
needed to match the long-term nature of family/life takaful plans and the fact that these plans have a
strong investment focus. Instruments such as longer-term sukuk are
required to support the growth of the takaful industry.
World-class standards of operational efficiency are required to compete
effectively with the well-established conventional insurance market.