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WHAT IS INSURANCE? It is a risk transfer mechanism in which a person or business is compensated for a defined loss.

Insurance is a system for reducing financial risk by transferring it from a policy owner to an insurer. There are many types of insurance to cover any situation including life, health, fire, motor, marine etc. There are always two parties in an insurance agreement. One is the insurance company and the other one the insured / policyholder. Lets explain it with the help of following two examples. Example 01: Normally, an insurance companys sales person approaches the client for insurance. Suppose, the client agrees for life insurance of Rs. 100,000/- then the client has to pay some money to the insurance company that may be Rs. 8000/- per annum and the insurance company will issue an insurance policy with sum assured Rs. 100,000/- with Rs. 8000/- annual premium. The client is now insured with the insurance company. The amount paid by the client is called premium which Rs. 8000/- in this example and Rs. 100,000/- is called Sum assured or sum covered. It is the amount guaranteed by the insurance company to pay if the client dies provided premiums are paid. Suppose this insurance policy is for the duration of 10 years, so the client has to pay Rs. 8000/- each year and if during this period, the insured dies then the insurance company is bound to pay claim of Rs. 100,000/- to the legal heirs of the deceased. Here, the legal heirs are the claimant (widow/parents or children) and amount of Rs. 100,000/- is death claim amount. Premium = Rs. 8000/Sum covered= Rs. 100,000/Example 02: Similarly if someone insures his/her car of value Rs. 500,000/- and pays Rs. 10,000/-(premium) to the insurance company then Rs. 500,000/- is sum covered and Rs. 10,000/- is the yearly premium. Premium = Rs.10, 000/Sum covered = Rs. 500,000/Premium: It is the amount paid by the insured to the insurance company. Sum Covered: It is the amount agreed by the insurance company with the insured and it is paid by the insurance company when the insured event occurs.

TYPES OF INSURANCE: 1) 2) 3) 4) 5) 6) Life: Health Motor Property Marine Miscellaneous

Majority of people knows what insurance is but very few people know the history and reasons for and behind insurance in general. If we go in the history, we will find that a type of property insurance was present in China about 3000 BC.

HISTORY OF INSURANCE
MARINE INSURANCE: Insurance has often been responsive to some problem faced by society. Same idea became the reason of origination of modern day insurance. Chinese merchants used to insure their goods being transported through ships to other parts of the world. Trade through sea has remained in practice since long time ago. In sea, the ships had to face many dangers and it was quite usual that ships got destroyed leaving the merchant in helpless conditions. In such situation, the merchants joined together and made arrangements wherein all the merchants used to contribute if any such loss would occur. In seventeenth century, insuring of ships and cargoes became very often. In England, Such merchants used to sit at various coffee houses transacting the insurance contracts. One of such coffee shops was owned by Edward Lloyd situated near River Thames. Nearly, in 1688, Edward Lloyd encouraged merchants to sit in his coffee house and to carry out their activities; as such sitting would bring extra business for his coffee house. Insurance underwriters also started sitting in his coffee house underwriting the business. At that time, the underwriters used to write the details of the ship and cargo on a piece of paper and used to sign it under a line. Signing under that line introduced the terminology of underwriter and underwriting. FIRE INSURANCE: Fire insurance started when great fire of London broke out in 1666. In that fire, near 13200 houses, 89 churches and dozen of public buildings got destroyed. That fire forced the people to go for some arrangement of compensation in times of such incidents. Resultantly, The first mutual fire insurance company was established in 1696 which later on absorbed in

Commercial union assurance company Ltd of London in 1905. Due to that fire insurance coverage started. With the passage of time, one by one, coverage for the nine allied perils supplemented with the basic fire coverage. MOTOR AND LIFE INSURANCE: As compared to marine and fire insurance, motor insurance started a bit later. The first mechanically propelled vehicle appeared on British roads in 1894 and by 1898, motor insurance took its start. Life insurance originated from Italy where the people formed burial societies and those societies to collect premium from its members and would bear The burial expense from that premium collected. First life insurance policy was signed on 1583.

FUNCTIONS OF INSURANCE:
Lets first discuss the main functions of insurance and then move on to examine the benefits which can be derived from performing these functions. By knowing these functions, we can then answer the question Why do we have the system of insurance in our financial system? 1) Risk transfer mechanism 2) Creation of common pool 3) Equitable premiums 1) RISK TRANSFER MECHANISM: The primary function of insurance is to act as risk transfer mechanism. Lets explain it with the help of following examples. a) Think about a car owner. He owns a car of value Rs. 500,000/which probably represents one of the largest assets. Now, he is worried about risk of car theft, damage (partial and total) which may result in a big financial loss to him. He wants to deal with these risks. Therefore, he approaches an insurance company and tells them that he is worried about the risks and wants to transfer those risks to the insurance company by arranging insurance of his car. Insurance company agrees and tell him that they are ready to accept the risk but they will charge a fee of Rs. 15000/- for accepting those risks and if he pays that fee to the insurance company, then his car will be covered with them against the risk of theft and accidental damage for twelve months. That fee is called the premium. Once the car owner pays the premium to the insurance company, contract completes and the insurance policy issues insurance policy which contain all the details of the contract.

Insurance contract will not prevent the car from getting stolen or getting damaged in an accident but if anything like this happens to the car, the insurance company will provide him financial compensation. Therefore, we can say that owner of the car transfer the financial consequences to the insurer in return of paying a premium. 2) CREATION OF COMMON POOL: In the early days of marine insurance, the various sea merchants who were having goods carried on a ship would agree to make contributions to those who may have suffered a loss during the voyage, after the loss has taken place. This certainly removed the risk of total loss from any one merchant as each one knew that his loss would be shared. What it did not know was to give the merchant any idea of what their loss would be, they only knew this after a voyage. If there had been no losses then they would have nothing to pay but they have agreed to share in any losses which had taken place and the exact amount of these could only be determined after the event. This was not an entirely satisfactory state of affairs. It would have been far better to know what your share of loss was going to be, before it took place. This may seem a strange thing to say. How can we calculate the amount of loss before it takes place? This is where the common pool comes in. The difficult for any one person is that they can only guess what the future holds in terms of losses. The owner of a Rs. Five million house does not know if he will have loss during one year and if he does know then what it will cost. He could put aside a few thousand rupees but the loss could be in millions. In order to demonstrate this point and the function of the common pool, let us concentrate on the risk of his house being totally destroyed and say that there is a one in a thousand chance that this will happen during the year. We could have obtained this figure from past experience of similar houses or from consulting publicly available statistics. To an individual home owner, this knowledge that one in every thousand houses will be destroyed has no great value but if we consider a large number of houses, it does begin to mean something. For example, if there were one thousand similar houses, then we could say that one of them will probably be destroyed during the year. On average, therefore, the expected total loss would amount to Rs. Five million. Knowing this, the owner of one thousand houses could all contribute at least Rs. 5000/- into a common pool and there would be enough to pay for one loss.

To be realistic, we would have to say that there is no guarantee that there would be only one loss. This is what was expected based on our calculations but there could be of course be more than one loss or even no loss. However, the principle remains the same, the losses of the few are met by the contribution of the many and the mechanism which allowed this to happen was the common pool. An insurance company sets itself up to operate such a pool. It takes contributions in the form of insurance premiums from many people and pays the loss of the few. The contributions need to be enough to cover all the losses in the year along with operating cost of the pool. In operating the common pool, the insurer benefits from law of large numbers which says that the actual number of events occurring will tent towards the expected number, where there are a large number of similar situations. Based on above knowledge, the insurer can fix premium and the person insuring knows, subject to the type of cover purchased that he will not to pay any more at the end of the year. EQUITABLE PREMIUMS: Insurer has to ensure that a fair premium is charged, which reflects the risks and the value which a person or a company brings to the pool. This is a complex process and is calculated very carefully by the insurer. In life and health companies, actuaries calculate the premium. Actuary is a person well versed with calculations of insurance premiums and pension benefits. He or she can be called mathematician of insurance companies. So, we were discussing the premium calculations. The premium should be enough to cover the claims but should also be competitive as there are always multiple insurers in the market. So, if the premium is at higher side then the insurer will lose business while charging too low premiums has its dangers, the contribution to the pool would be less than required and a loss would be made. These three functions of insurance are inter dependant: the creation of the common pool and the calculation of equitable premiums all assist in providing a sound transfer mechanism.

BENEFITS OF INSURANCE:
The existence of a sound insurance market is an essential component of any successful economy and its proof can be seen in many parts of the world. There is a close link between insurance and industrial and

development of any country. Lets discuss few benefits of insurance in detail: 1) PEACE OF MIND: The knowledge that insurance exists to meet the financial consequences of certain risks, provides a form of peace of mind. This is important for private individuals when they insure their car, house, life and other possessions but it is also of vital importance in industry and commerce. Why should a person put money into a business venture when there are so many risks which could result in the loss of their money? Yet if people didnt invest in business then there will be fewer jobs, in less goods and general reduction in wealth. But businessman invests in business as he transfers some of the vital risks to the insurer and attains peace of mind for carrying out his business. Example: Since 2005, people are enjoying the services of Daewoo at Peshawar. Most of us regards it a good facility. Few years back, during a demonstration, some people attacked the Daewoo buses parked at the bus stand and burn several buses. Daewoo had to bear a big loss. It was expected that after bearing such a loss, the company would close their operations from Peshawar but the buses were insured and insurance company paid the insurance claims and we can see that Daewoo buses are still at the roads of Peshawar. We can say that the mechanism of insurance made it possible that Daewoo bus service is still available to the people of Peshawar. Few years back, some demonstrators burn down the Daewoo buses in Peshawar at the bus stand. Insurance also acts as a stimulus for the activities of business. This is done by release of funds for investment in the productive side of the business. Medium and larger sized firms can create reserves for emergencies like fire, theft and other accidents and that money would be lying idle for any of the mentioned emergencies. Instead of creating reserves and putting money into it, the business can purchase insurance at a premium which is less than the fund required for the firm for keeping it in reserves for any emergencies and the firm is free to do business with that money resulting in business expansion.

LOSS CONTROL: Insurance is primarily concerned with the financial consequences of losses but it would be fair to say that insurers are doing much more than only compensating the insured in case of a loss. Insurers do have an interest in deducing the frequency and severity of losses by promoting and encouraging the loss prevention and loss reduction techniques, with which insurers not only enhances their own profitability but also contribute in reduction of general waste which results from losses. In 18th century, in UK, insurers used to maintain their own fire brigade departments equipped with fire-fighting equipment. Insurers also used to make their marks on the doors of houses insured with them so that if fire broke out in the house then it used to be easy for their fire brigade to locate and put off the fire. Now a days, when a person asks for insurance of his factory or house, insurers always advise him for arranging fire extinguishers, water pipes and water tanks etc so that if fire breaks out, it can be put off and thus reducing the loss. Insurers gives discounts if fire fighting arrangements are there in the factory or house etc for which the insurance is requested. Now a days in Pakistan, in motor insurance, insurers advice for satellite based tracking device in the vehicles which reduces the theft risks. Sometime, the tracking device is offered by the insurance companies while in other cases, insurers gives premium discounts if client has arranged tracker in his vehicle. SOCIAL BENEFITS: By providing financial compensation if a loss occurs to a business results in continuation of that business which means no loss of jobs, goods and services which could have been resulted if system of insurance was not in place. Example: 100 workers are working in a pharmaceutical manufacturing unit. Fire occurs in the factory resulting in a major damage to machinery and building o the factory. Loss is very big and is not bearable for the business owner. Now, as the owner has no money to rebuild his factory, therefore, he has to close it down resulting in loss of jobs of 100 workers, loss of production of medicine.

But if the factory building and machinery is insured against fire then there is no need of business closure as the insurer will pay the claim to the owner and he will rebuild his factory with that money resulting in continuation of the business avoiding loss of jobs and medicine production. Also to mention that insurance alone cannot keep people employed but it does play a significant role in to ensure reduced problems when any mishap occurs. The three benefits we discussed INVESTMENT OF FUNDS: Insurers receive money in the form of premiums from their policyholders. There is always a time gap between receiving of premium and occurrence of claim. The premium may be received in January and the claim may occur in November. The insurer has all this money at their disposal which they can invest. Insurers invest in a wide range of investments. They provide loans to the banks and leasing companies which onward provide financing to the entrepreneurs and businesses which make the economy running. Such investments are the result of savings of thousands of people in the form of premiums paid to the insurers which brings an element of savings in the people. Example: If we consider a middle class person insuring his car and house, such a person may not be able to invest in a stock exchange or buy shares of a big company or lend his savings to a bank but when the premium of that person is added to the premiums from several thousand other people, then a reasonable amount of investment money is available.
HOSPITALIZATION:

Under this coverage, if a covered member gets ill and is hospitalized, the insurer covers medical expenses incurred up to the specified limit. Eligible medical expenses normally include:
1. Daily room and board charges 2. Operation theatre charges 3. Surgeons fee

4. Anesthetist fee 5. Consultants fee 6. Medicines and drugs 7. Diagnostic tests 8. Blood and Oxygen supplies 9. MRI, CT Scans 10. Miscellaneous charges (patients meals, local road ambulance

charges, etc.) For female covered members, maternity coverage can also be included in the coverage. OUT PATIENT COVERAGE: It covers the consultant fee, cost of prescribed medicines and medical tests. MECHANISM AND PROCEDURES OF INSURANCE: Life entails risk, which is the possibility of loss. People generally seek security and avoid uncertainty. The risk of death is unavoidable, and is especially an economic threat if premature, when an individual may be exposed to heavy financial responsibilities, yet has not had the time to accumulate wealth to offset the financial needs of survivors. Life insurance provides a tool for risk management, a process for dealing with the risk of loss of life. Insurance substitutes certainty for uncertainty, through the pooling of groups of people who share the risks to which they are exposed. Uncertain risks of individuals are combined, making the possible loss more certain, and providing a financial solution to the problems created by the loss. Small, certain periodic contributions (premiums) by the individuals in the group provide a fund from which those who suffer a loss are compensated. The certainty of losing the premium replaces the uncertainty of a larger loss. Life insurance thus manages the uncertainty of one party through the transfer of a particular risk (death) to another party (the insurer) who offers a restoration, at least in part, of relatively large economic losses suffered by the insured individual. The essence of insurance is the principle of indemnity, that the person who suffers a financial loss is placed in the same financial position after the loss as before the loss occurred. He neither profits nor is disadvantaged by the loss. In practice, this is much more difficult to achieve in life insurance than in property insurance. No life insurance company would provide insurance in an amount clearly exceeding the estimated economic value of the covered life. Limiting the amount of life insurance sold to reflect economic value gives

recognition to the rule of indemnity. Additionally, only persons exposed to the potential loss may legitimately own the insurance covering the insureds life.

a) b) c) d)

Creation of common pool Pricing of insurance premiums Marketing of insurance Claims handling CREATION OF COMMON POOL: Life insurance is based on a mechanism called risk pooling, or a group sharing of losses. People exposed to a risk agree to share losses on an equitable basis. They transfer the economic risk of loss to an insurance company. Insurance collects and pools the premiums of thousands of people, spreading the risk of losses across the entire pool. By carefully calculating the probability of losses that will be sustained by the members of the pool, insurance companies can equitably (fairly) spread the cost of the losses to all the members. The risk of loss is transferred from one to many and shared by all insureds in the pool. Each person pays a premium that is measured to be fair to them and to all based on the risk they impose on the company and the pool (each class of policies should pay its own costs). If all insureds contribute a fair amount to the mortality fund held by the insurance company, there will be sufficient dollars in the fund to pay the death benefits of those insureds that die in the coming year. Individually, we do not know when we will die, but statistically, the insurer can predict with great accuracy the number of individuals that will die in a large group of individuals. The insurance company has taken an uncertainty on any individuals part, and turned it into a certainty on their part. ILLUSTRATION OF THE RISK-POOLING CONCEPT: The simplest illustration of risk pooling involves providing life insurance for one year, with all members of the group the same age and possessing similar prospects for longevity. The members of this group agree that a specified sum, such as Rs.100, 000 will be paid to the beneficiaries of those members who die during the year, the cost of the payments being shared equally by the members of the group. In its simplest form, this arrangement might involve an assessment upon each member in the appropriate amount as each death occurs. In a group of 1,000 persons, each death would produce an assessment of Rs.100 per member. Among a group of 10,000 males aged 35, 21 of them could be expected to die within a year, according

to the Standard Ordinary Mortality Table. If expenses of operation are ignored, cumulative assessments of Rs.210 per person would provide the funds for payment of Rs.100, 000 to the beneficiary of each of the 21 deceased persons. Larger death payments would produce proportionately larger assessments based on the rate of Rs.2.10 per Rs.1, 000 of benefit.

Examples of Risk Pooling


Homeowners Insurance Of 1,000 houses, each worth Rs.200, 000, assume only one house per year is destroyed by fire. Each homeowner could contribute Rs.200 per year into a pooled fund that could pay out the full Rs.200, 000 values to the homeowner of a destroyed home. Such pooling transfers the risk of bearing the full impact of a potential Rs. 200, 000 losses by an owner. Life Insurance Ten thousand males aged 35 contribute to a life insurance pool. Twenty-one of them are expected to die this year (based on Mortality Table). The mortality charge is Rs.2.10 per Rs, 1, 000 of benefit. If each of the 10,000 contributes Rs.210 to fund death benefits (ignoring costs of operation), a death benefit of Rs.100, 000 could be paid for each of the 21 expected deaths.

The Law of Large Numbers: For a plan of insurance to function, the pricing method needs to measure the risk of loss and determine the amount to be contributed to the pool by each participant. The theory of probability provides such a scientific measurement. Probabilities for life insurance are represented in a mortality table. The mortality table is very versatile, developing probabilities of dying over the entire life span. Life expectancy at any age is the average number of years of life remaining once a person has attained a specific age. It is the average future lifetime for a representative group of people at any given age. The probable future lifetime of any individual, of course, will depend on his or her state of health, among other things, and may be much longer or shorter than the average. The statistical group that is observed for purposes of measuring probability must have massthat is, the sample must be large enough to allow the true underlying probability to emerge. The law of large numbers states that as the size of the sample (insured population) increases, the actual loss experience will more and more closely approximate the true underlying probability. This means that the insurers statistical group must be large enough to produce reliable results, and that the group actually insured must be large enough to produce results that are consistent with what probability predicts. Insurance relies on the law of large numbers to minimize the speculative element and reduce volatile fluctuations in year-to-year losses. The greater the number of exposures (lives insured) to a peril (cause of loss/death), the less the

observed loss experience (actual results) will deviate from expected loss experience (probabilities). Uncertainty diminishes and predictability increases as the number of exposure units increases. It would be a gamble to insure one life, but insuring 500,000 similar persons will result in death rates that will vary little from the expected. A peril is a cause of a loss. In life insurance, the event against which protection is granted, death is uncertain for any one year, but the probability of death increases with age until it becomes a certainty. If a life insurance policy is to protect an insured during his or her entire life, an adequate fund must be accumulated to meet a claim that is certain to occur. Some people claim that insurance is a gamble. Insurance is actually the opposite of gambling. Gambling creates risk where none existed. Insurance transfers an already existing risk exposure and, through the pooling of similar loss exposures, reduces financial risk. PRICING OF INSURANCE PREMIUMS: All life insurance products are actuarially created by calculating the relationships of mortality, interest, and expense, and the financial values resulting from each based on time. The assumptions made concerning these three factors will determine the premium at which a policy is sold, the structure of the policy, and over time the performance of the policy and the profitability and solvency of the life insurance company. All life insurance policies, regardless of type, are based on these same elements. Mortality rates project the cost of covering death claims as they occur. Interest earnings reflect the income the company expects from the investment of premiums over time that will be added to the reserves, held aside to pay future claims. Expenses include the cost of creating, offering, and maintaining the product to pay all promised benefits. These factors must also provide profit to the insurer. MORTALITY: To price insurance products, and ensure the adequacy of reserves to pay claims, actuaries use mortality tables to project the number and timing of future insured deaths. They study the incidence of deaths in the recent past, and develop expectations about how these events will change over time and develop an expectation for what the timing and amount of such events will be into the future. A safety margin is built in that increases the mortality rates above what is expected. In participating policies, savings created by these conservative assumptions can be returned as dividends. In nonparticipating policies, the safety margins must be smaller in order for the premium rates to be competitive.

A mortality table shows mortality experience used to estimate longevity and the probability of living or dying at each age, and is used to determine the premium rate. Mortality tables may include the probability of surviving any particular year of age, remaining life expectancy for people at different ages, the proportion of the original birth cohort still alive, and estimates of a groups longevity characteristics. Life mortality tables today are constructed separately for men and women, and are created to distinguish individual characteristics such as smoking status, occupation, health histories, and others. INVESTMENT: Insurers invest the premiums they receive and accumulate them for future claims and other obligations, such as policy loans and surrenders. Life insurance company portfolios are traditionally long-term and emphasize safety of principal and predictable rates of return, to accommodate their long-term obligations. Typically, two-thirds or more of this capital is invested in bonds and mortgages, which meet the above criteria. A smaller percentage is invested in common stocks, due to their volatility, and these represent less than 10 percent of an insurers general portfolio. EXPENSE: Life insurance companies incur acquisition and administrative expenses in the course of doing business. Acquisition expenses include the costs incurred in obtaining business and placing it in force, such as advertising and promotion fees; commissions; underwriting expenses; costs associated with medical exams and attending physicians statements, inspection report and credit history fees; home office processing costs; and an addition to the insurers reserve, surplus, and profits. Administrative expenses include the costs associated with collecting premiums and distributing dividends, continuing producer compensation, investment expenses, and home office overhead. Any costs the insurer incurs must be recovered through mortality savings, expense charges, or reduced interest crediting. EXAMPLE: For a group of 100,000 women aged 25 The average mortality rate, according to the Mortality Table, is 1.16 per 1,000. Expected deaths for the group for the year are 116. Rs.1, 000 death benefit per deceased results in Rs.116, 000 in claims. Each woman would contribute Rs. 1.16 to cover the costs of death benefits (ignoring costs of operation). MARKETING OF INSURANCE:

INTRODUCTION TO TAKAFUL

OBJECTIONS ON INSURANCE AND REMEDIES PROVIDED BY WAY OF TAKAFUL SHARIAH REFERNCES

Definition Examples TYPES OF TAKAFUL General Takaful including motor, marine, property, cash and health etc Family Takaful (Life takaful) Risk transfer mechanism V/S Risk sharing mechanism Uncertainty (Gharrar) Interest (Maisir) Gambling (Qimar) Quran, Hadith and Islamic scholar references, Shariah compliance certificates How it started

HISTORY OF TAKAFUL

TAKAFUL: We eat, drink, and exercise to keep ourselves fit and healthy, because we know that health is important. We know that with a good body and a good mind we can work better and enjoy our lives with our families even more. On realizing this, we become more responsible and look after ourselves and our assets diligently. We even stop smoking. We keep our doors locked. We start to drive carefully. We do all this because we care. We dont want to see our loved ones be exposed to any kind of danger. But what if, despite all our efforts, something goes wrong? What if there is a robbery? What if there is an accident? The possibilities are endless and real. Then what? Can you imagine the kind of mental and financial torture a person has to go through to deal with it? They lose their sleep. They lose their peace of mind. They lose their strength and the will to go on. Worst of all is that this could happen to anyone of us at anytime and anywhere. There is really not much we can do about it on the individual level. But if we would do it collectively; if we mutually guarantee to help each other in times of need, like we used to do in the early days of Islam then we could significantly reduce the level of financial loss. This is exactly where Takaful comes into play. This mutual guarantee is what Takaful is really all about. Takaful is an arrangement between members of communities where each member mutually guarantees to help the other in times of need. A family could be troubled by the loss of the breadwinners salary either due to death, severe illness or a bad accident. Imagine the financial distress they would be going through. Isnt it our moral duty to help such families? Takaful is one way of fulfilling this responsibility. Remember, in the future it could be us who would need the same help. Therefore it is important that we help those in distress while we can and know at same time that the others will do the same for you. This is the basic foundation of Takaful. When you decide to become a member/participant, you regularly contribute a small amount called

Contribution from your savings as Taburru or donation which is pooled into a Waqf Fund. Just imagine, if thousands and millions of people make contributions in the Waqf, how much money would there be! This is like the Waqf of a Masjid that provides a place of worship and education to thousands of people and children. Like Waqf Masjid, Waqf Takaful is also a social welfare service. Whenever a members family is in financial trouble, the Waqf Takaful comes to the rescue by compensating for their loss. This way it helps them to get over their immediate trouble and move on with their lives. Please dont forget, it is us, you and I, as members of Takaful, who make all this happen. Obviously, as more and more people join Takaful, and the Waqf Fund gets bigger and bigger, we would need professionals to look after it. We need to trust these professionals with making the best decisions for the continuity and the sustainability of the Takaful system. It is important to know that Waqf Takaful is not only about protection. Yes, while Takaful protects members/participants from financial losses incurring from untoward exigencies, it also provides them with opportunities of earning money at the same time. This is done through investments. The Takaful Operator prudently invests in halal businesses with the objective to increase the value of the Waqf Fund and also to give returns to its members/participants for their contributions. This system works best if the members/participants pay their contributions regularly and continue their membership for the complete term. On top of this, each year, the members/participants share the surplus of the Waqf Pool. The surplus is the amount remaining in the Waqf after meeting all the expenses and the claims. Takaful is based on the golden principles of brotherhood, cooperation, mutuality and solidarity. While insurance companies claim that they provide a similar service, it is not so. Conventional insurance companies contain socioeconomic ills such as Riba, Gharrar, and Maysir which are harmful to society. In Takaful, however, a Shariah Supervisory Board monitors and regulates every function and process of the operations to keep in line with the principles of Islamic Shariah. Takaful, therefore, is a much-needed addition for the welfare of a society and its members and quite simply, a necessity no person should do without. It is a perfect loss-mitigation tool that can be used both by individuals and businesses alike, to meet their specific needs and requirements. Family Takaful deals directly with protecting a person from life-related financial losses whereas General Takaful deals with the non-life financial losses like theft of a car, fire or mishaps at home etc. Takaful Definition: Takaful comes from the Arabic root-word kafala which means guarantee. Takaful means mutual protection and joint guarantee. Operationally, Takaful refers to participants mutually contributing to a common fund with the purpose of having mutual indemnity in the case of peril or loss.

Takaful is a Shariah compliant arrangement whereby individuals in the community jointly guarantee themselves against future losses or damages. The key elements of any Takaful arrangement are the participants, the Takaful Pool, and the Takaful Operator (Company). The Takaful Pool is managed in the shape of Waqf (Endowment) by the Takaful Operator which is actually just an operator and carries out its role in the form of a Wakeel (agent). Participants pool their contribution, which are given in the form of donations, into the Waqf from which they may benefit in the event that they suffer a loss. All claims are paid out by the Waqf and not the Takaful Operator. Youre probably thinking that this is insurance but in reality its not. Insurance is a tool for risk mitigation and financial protection; Takaful is also a tool for risk mitigation and financial protection. They serve a similar purpose but that does not mean that they are the same. A good way to exemplify this is the relationship between frozen yogurt and ice cream. When eaten frozen yogurt looks and tastes just like ice cream, yet it is definitely not ice cream. It generally serves as an alternative to ice cream, one which is usually lower in fat and calories. Its price may be the same, or a little higher or lower. What is most important is that although it is a perfect alternative it is one which is healthier. Risk mitigation and financial protection are things which everybody needs to be concerned about. In order to effectively carry this out they need a tool which is not only effective in mitigating risk but also immaculately serviced, competitively priced, is in compliance with our ethical and religious beliefs and, most importantly, better for the individual and the community. That tool is Takaful. Why Takaful: We have read the benefits of insurance which effectively convey us that the mechanism of insurance is benefiting society in many ways. If a system is beneficial then why there are objections about the system. Majority of Islamic scholars raised objections about insurance. These objections have been effectively addressed in system Takaful. Lets discuss these objections and their remedies in takaful in detail: 1) 2) 3) 4) Risk transfer mechanism V/S Risk sharing mechanism Gharrar (Uncertainty) Riba direct and indirect Gambling

Risk transfer mechanism V/S Risk sharing mechanism: As we discussed in our earlier classes that insurance is a risk transfer mechanism in which financial risk of a loss is transferred to insurer. Islamic scholars object the risk transfer process that it is against our religion to transfer, sell the risk to any person or any other entity against the premium

paid. Instead of risk transfer mechanism, they suggest for risk sharing mechanism. Lets explain it with the help of an example: Example: I own a car worth Rs. 400, 000/- I face the financial risk of my car being damaged in accident or being stolen by someone. Therefore, I have the option of approaching a general insurance company and ask them to insure my car against the risks of damage and the theft. They may accept it and ask me to pay them premium of Rs. 10, 000/- in consideration. I can pay them and transfer my financial risk regarding my car to the insurance company. I work in a company with nearly 100 employees. All of them own a car worth Rs. 400, 000/- They also fear the same risks as I did regarding the car and they can also approach a general insurance company and can arrange insurance for their cars by paying premium of Rs. 10, 000 each. Now, all of us can have our peace of mind by transferring the financial risk to the insurer. But at the same time, we all feel that although we can get our peace of mind by insuring our car but by arranging it by participating in a risk transfer process which is considered objectionable by most of our Islamic scholars. So, we think about another option. We are 100 employees in our work area and each owns a car. For simplicity, we consider the value of every car to be Rs. 400, 000/- Now, we are ready to forego Rs. 10, 000/- for management of damage and theft risks posed to our cars. Total amount ready to forego by 100 employees = 10, 000 x 100 = 1,000,000/Therefore, instead of paying Rs. 1,000, 000/- to the insurance company, we all make a pool fund and place the amount of Rs. 1, 000, 000/- and decide among each other that if car of anyone of us gets damaged accidently or get stolen, that person will be compensated from that pool fund. Here, you can note that risk has not been transferred to any person or any legal entity like an insurance company but the risk has been shared by those individuals who have contributed Rs. 10, 000/- each in the pool fund. Now if the members of the pool increase from 100 to 1000 or 10, 000 then the tasks of collecting contribution for the fund, processing their compensation from the pool fund if loss occurs, requires some individuals to perform them. So, the members of the pool fund decide to hire four professionals well versed in collecting the contributions for the pool fund and arranging their compensations. Members decides pay those individuals for their duties and ask them to pay the compensations from the pool fund and if the amount exhausts in the fund, ask the members to make further contributions. Now, members own the pool fund while the individuals only take care of the fund. There are always three parties in Takaful: 1) Pool fund

2) Members of the pool fund 3) Takaful operator In the above example, the individuals performed the function of a takaful operator. With this arrangement, the 100 employees can have a real peace of mind as they have arranged a mechanism in which the pool fund is there to compensate them if the defined losses of damage and theft occurs to their car and such arrangements is not objected by our Islamic scholars but instead support them because it serves the real spirit of our religion for helping those who need it.

GHARRAR: It literally means uncertainty. It can be defined as the sale of probable items whose existence or characteristics are not certain, due to the risky nature. Many classical examples of Gharrar were provided explicitly in the Hadith. They include the sale of fish in the sea, birds in the sky, un- ripened fruits on the tree, etc. Here, it is important to mention that insurance is sale and purchase agreement. Gharrar also exists in insurance but how. With the help of an example, lets explain Gharrar first and then existence of Gharrar in insurance: EXAMPLE: I hold something small in my hand and my fist is closed. None can see what I am holding. In front of people, I announce that whatever I hold in my hand, I sell it for Rs. 100/- Now, nobody knows what is in my hand. If someone purchases it, the chance is there it wont be of any use for him. So if he purchases it while later on found that it was only a match box and its worth was much less than Rs. 100/- That person would feel himself at loss once he found out the match box. Not knowing about the purchasing item, left an uncertainty in the transaction and resulted in a dispute or displeasure for the buyer. To avoid such kinds of disputes and displeasures, our religion always strives to bring more and more transparencies especially in sale and purchase agreements. Uncertainty is not allowed at all in sale and purchase agreements. Uncertainty also exists in insurance. When a person purchases insurance coverage for his car worth Rs. 400, 000/- and pays premium of Rs. 10, 000/to the insurance company. When the premium is paid to the insurance company, the company becomes an asset for the insurance company and if loss occurs, insurance company has to pay it from its own accounts. Now, it is not known to both, the insured and the insurer that whether the loss will occur or not or if it occurs, how much will be the loss amount and when will it occur. If loss doesnt occur, the client will lose the money and insurer will make profit.

If the car gets stolen, the insured will receive claim Rs. 400, 000/- and will be at profit while insurer will be at loss. Due to presence of such uncertainties (Gharrar) and insurance agreement being a sale and purchase agreement between insured and insurer, Islamic scholars declare insurance agreement as prohibited. In takaful, the agreement is that of Taburru in which the members contribute into the pool fund with the intention that if any defined loss occurs, the members will be compensated from that fund. Here, no sale and purchase agreement occurs. Takaful operators only take care of pool fund. They collect contributions on behalf of the pool fund and pay losses from the pool fund i.e. not from the own account of the takaful operators. Now the question arises, same kind of uncertainty also exists in takaful also. If anyone becomes member of the pool fund by contributing in the pool fund, he doesnt know whether loss will occur and if occur then when and what will be the amount of loss. Answer to this question is simple. Nature of agreement in takaful is different. It is agreement of Taburru instead of sale and purchase agreement and so such uncertainty is allowed in takaful. Let me explain the change in nature of agreement by extending the above mentioned example: Example: Lets go back to the example where an item was offered for sale while it was kept secret in a close fisted hand. In that example, the item was offered for sale. Now lets suppose, if someone is holding the same item in a close fisted hand and declares that he wants to make it a gift to the person who raises his hand first and so a person raises hand quickly before others and get that item which finds out to be a match box. Here, in this transaction, uncertainty existed that nobody knew what was lying in the close fisted hand but as it was not offered for a price and was a gift so the agreement didnt become prohibited as it was not a sale and purchase agreement. In the same way, in takaful, the agreement is that of Taburru instead of sale and purchase, therefore, uncertainty to an extent doesnt make it prohibited. GAMBLING: (Maysir): Making profits at the cost of loss of other party without giving him any product r service is gambling. For gambling following conditions are required: 1) There must be two parties who gamble with each other 2) Outcome of the events should be beyond their control 3) None of them give any service or product to each other.

For example if two people compete in a race with the following conditions, that if you surpass me, then I will give you a thousand pounds and if I surpass you then you will have to give me a thousand pounds. Or if someone says, 'If it rains today you will have to give me a thousand pounds and if it does not rain then I will give you a thousand pounds. When you insure your house, the money you pay is called a premium. The event which neither you nor the insurance company controls is that a fire will damage your home during the next year. If there's no fire, the insurance company keeps your premium. If there is a fire, the insurance company pays you the amount of the damage. This fits the gambling scenario exactly. Buying insurance is a form of gambling. Insurance companies have worked long and hard and very successfully to convince us of the opposite. They say that if you don't have insurance, you're gambling. They talk about protecting us against fire. But fire is beyond their control; they cannot protect against fire. Perhaps they talk about protecting us from loss due to fire. But they can't stop the fire from burning your photos, nor can they limit the damage caused by the fire in any way. The only thing they can do is pay you money when a fire occurs. You have made a bet with them; you bet that fire will occur and they bet that it will not. If it does not occur, you lose the bet, and the premium is your loss; if it does occur, you win the bet, and they pay you. Perhaps the amount they pay you is the amount you lost in the fire; that way it feels like they are paying you back. But the amount they pay you doesn't have to be the same as the amount you lost in the fire (and if you read the fine print, you see that it often isn't); you get whatever you and the insurance company have agreed to. Of course, an insurance company would never call it making a bet. They would say that they want to insure you against loss, but as you will see, they do a good job of ensuring that you lose. Riba: Conventional endowment insurance policies promising a contractuallyguaranteed payment, hence offends the riba prohibition. The element of riba also exists in the profit of investments used for the payment of policyholders claims by the conventional insurance companies. This is because most of the insurance funds are invested by them in financial instruments such as bonds and stacks which may contain elements of Riba.

SHARIAH BOARD ROLE AND RESPONSIBILITY:


MODELS OF TAKAFUL Wakala Waqf model, Wakala model, Modarabah model

RETAKAFUL

Takaful facility offered by large size companies for direct Takaful companies

REINSURANCE:
Reinsurance is insurance that is purchased by an insurance company (insurer) from another insurance company (reinsurer) as a means of risk management, to transfer some risk from the insurer to the reinsurer. The reinsurer and the insurer enter into a reinsurance agreement which details the conditions upon which the reinsurer would pay the insurer's losses. The reinsurer is paid a reinsurance premium by the insurer, and the insurer issues thousands of policies. In this process, the insurer is called ceding company while reinsurer is called reinsurance company. Insurance plays a role of financial shock absorbers in the economy and helps by way of compensations when anything goes wrong. Reinsurance plays the same role of shock absorbers for the insurers. Reinsurance companies provide their services to almost all the continents and helps in geographical spreading of risks. For example, Swiss Re, a Swiss based life reinsurance company provides its reinsurance facilities to majority of life insurance working in different countries. The ceding companies collect premiums from their clients and transfer some of their premium and risks to reinsurance companies. Lets explain the reinsurance process with the help of an example: Example: A factory wants to insure his factory. Value of the factory including building, machinery, and stock is Rs. 100 million. The owner approaches an insurance company and asks for insuring his factory against the risks of fire, earthquake fire and shock, floods (atmospheric disturbance) etc. The insurance company has funds with which, it can only provides insurance coverage of Rs. 25 million therefore, the insurance company has two options then: 1) To offer insurance upto an amount of Rs. 25 million and rests will remain uninsured. 2) To arrange additional coverage of Rs. 75 million from a reinsurance company The insurance company goes for the second option and arranges reinsurance coverage of Rs. 75 million from a reinsurance company and thus offer insurance of 100 million to the factory owner. We can note that insurance company has covered 25% of the total assets of the

factory while 75% has been covered by the reinsurance company. At the face, the 100 million coverage will be provided by the insurance company and will receive the premium in full from the factory owner. The premium fixed by the insurance company can be Rs. 05 million. Now the insurance company will retain25% of the premium while the 75% of the premium will be transferred by the insurance company to the reinsurance company. So, if any loss occurs at the factory due to any above mentioned risks, insurance company will pay the claim in full and will request the reinsurance company to bear 75% of the claim amount and reinsurance company will pay 75% of claim amount to the insurance company.

THE HISTORY OF REINSURANCE: The concept of reinsurance started in the seventeenth century B.C. in commercial insurance, which appeared in the same century. The first document known as reinsurance goes back to 1370 A.D. However, it was not based on true technical bases but was similar to a mortgage. Reinsurance was prohibited in England in 1746 A.D. until 1864 A.D. Real reinsurance started at the beginning of the nineteenth century after insurance had been spreading steadily for a long time. There were no companies specialized in reinsurance at that time. Instead, direct insurance companies used to open branches for reinsurance. There are two basic methods of reinsurance: 1. FACULTATIVE REINSURANCE: This is the oldest method of reinsurance. It requires the direct insurance company to present to the reinsurers each risk that requires reinsurance one by one. A summary of all the basic information related to the risk should be attached to the application. This will enable the reinsurer to judge whether or not to accept each risk presented to it. 2. TREATY REINSURANCE: A contract is made between the direct insurance company and the reinsurer in which both the companies agree to reinsure all works within the limits. These limits include financial, geographical, and time limits. According to this agreement, the reinsurer accepts all the risks on which the conditions of the agreement apply. In return, the direct insurance company is committed to reinsure all the risks according to these

conditions. In this way, the direct insurance company will be able to provide insurance coverage for any risk which it has to insure, as long as it is within the limits of the reinsurance agreement. The reinsurer does not have the right to refuse reinsuring any risk mentioned in the reinsurance agreement. The reinsurer is obligated to accept all the risks presented to it, whether good or bad. The most important criteria for the reinsurer to accept the reinsurance agreements are the efficiency of the direct insurance company's administration, its methods of practicing insurance, its experiences in evaluating the risk materially and morally, and its reputation in the field of insurance. AIMS AND MOTIVES OF REINSURANCE: There are two motives for reinsurance. The first is the inability of direct insurance companies to insure property whose financial value is very high such as huge airplanes, large factories, luxurious buildings, very big stores and so on. The compensation, when the risk occurs, is beyond the financial ability of the insurance company. Therefore, these insurance companies reinsure this type of high value property at the reinsurance companies in order to overcome the serious risks which threaten them. The reinsurance companies offer protection to the direct insurance companies in the case of losses of insured risks. Compensating the insured risk financially is beyond the direct insurance company's ability and capacity. The second motive is to increase the capacity of direct insurance companies in the area of accepting risks in order to increase their gains. When direct insurance companies reinsure, the relationship is limited to only the direct insurance company and the reinsurance companies. The insured party does not have any rights with the reinsurance company; his relationship is confined to the company which insured his risks regarding restoring the damage when the insured risk occurs.
According to the reinsurance agreements, the direct insurance company pays to the reinsurance company an amount of money in the form of premiums, called reinsurance premiums, which is determined according to the size of the insured risk. The reinsurance company acts as insurer and covers a portion of the risks which the direct insurance company is committed to. This is done in return for what it receives as premiums.