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Takaful
An Islamic Alternative to Conventional
Insurance Sees Phenomenal Growth

rowing up in a Muslim country, I never really had an idea of


what insurance was. I was familiar with the word and yes,
there were occasional advertisements in the media about
protecting the family, but I never really questioned the fact that my
family never carried any insurance of any kind. In high school, as
time came to decide on a career, I found out about something called
actuarial science; the curriculum for which fitted pretty well with
what I considered to be my strengths.
As I discussed this potential career with my family and friends, after
the initial question of what is it? came the barrage of accusations:
You want to work in insurance? You do realise its not allowed in
Islam, right? It is forbidden! Is there nothing else you like?
That is not an attitude unique to my friends and family, but one
that is fostered across the Muslim world. The consequence of this
can be seen in the following chart, which displays the insurance
penetration rates (premiums as a percentage of GDP) across various
Muslim-majority countries and compares them with certain more
established insurance markets, like Australia and the UK. Apart from
Malaysia (which has a significant non-Muslim population), no other
Muslim-majority country in the chart crosses the two percent mark;
some dont even make it to one percent.

The issues with insurance


This averseness to insurance, as I found out in my subsequent
research into the topic, is not entirely unjustified. Since the first
formal insurance contracts started surfacing, Muslim scholars
have been taking a stance that it does not comply with Islam for
various reasons (outlined in the following comments). However, the
important thing to note is that there is no objection to the concept
of risk-pooling. The simple act of many people coming together to
help the few in times of need is something that is not only allowed,
but also encouraged in Islam. However, there are objections to the
way modern insurance companies operate, and brief descriptions
of these objections follow:
Photographs courtesy of Heywood-Hall Images

ACTUARY A U S T R A L I A August 2009

Riba loosely translated as interest, this is the biggest

difference between Islamic finance and conventional finance.


Islam completely forbids Riba in all forms, and while most
commentaries you will see on Islamic finance talk of not being
able to invest in interest-bearing securities, there is an added
complication for insurance. Riba in its broader sense also means
exchange of money for money, so the simple act of premiums in
exchange for possible benefits is not allowed!
Gharar or uncertainty is another issue cited by scholars as

a problem with insurance. This doesnt refer to uncertainty of


outcome, as that is inherently present in all business ventures.
Uncertainty in contract terms is what the scholars object to;
limited amount of disclosure, complex contracting terms, lots of
exclusions and small print.
Maisir or gambling is also strictly forbidden in Islam. And

despite what practitioners say about insurable interest making


insurance different from gambling, Muslim scholars dont seem
to agree. Frankly speaking, traditional insurance doesnt always
adhere to the principle of insurable interest entirely; different
benefits on the same risk for different perils, is something very
common within the industry, for example death benefits on an
accidental death versus a naturally occurring one.
An added problem comes in when dealing with life insurance how
do you value a life? Can you put a value on it at all?

Takaful as an alternative to conventional


insurance
Thus came about the need for an alternative to conventional
insurance. Keeping in mind that pooling of money to help those in
need is desirable, the building blocks of traditional insurance needed
to be changed so that they would comply with Islamic law. This led
to the advent of takaful, whereby life insurance was converted into
family takaful, and non-life insurance became general takaful.

takaful provider (akin to an insurance company). In case there


are more claims expected than the money in the tabarru funds,
the takaful provider agrees to provide an interest-free loan that
can be reclaimed from future underwriting surpluses.
Shariah-compliant investments are investments that comply

with the Shariah (Islamic law). That means there can be no


investments in interest bearing securities (e.g. conventional
bonds) or in equity of companies that are either highly leveraged
(e.g. conventional investment banks) or indulge in businesses
not allowed in Islam, for example, manufacture or distribution of
alcoholic beverages, among other things. Other asset classes,
like most equities, real estate, commodities and any physical
assets are completely acceptable.
The role of the takaful provider is to manage the pool of money
in the tabarru funds, to make sure the participants contribute
appropriately and those who suffer losses are paid accordingly.
They provide qard-hasan, if needed, and manage (and invest) the
money in the pool in a manner compliant with the Shariah. The
takaful provider gets compensated for providing these services by
way of either:
Wakalah fees that is, a fee earned by the takaful provider

Takaful, in Arabic language, means mutual guarantee. There are


various models, using different building blocks, that can be used
to achieve mutual guarantee, but all have at least three things in
common:

for rendering services prescribed at the time of signing of the


contract with the participant. This can be a fixed amount or a
percentage of the participants contributions.
Mudharabah profits that is, a percentage of profits from any

Tabarru the financial transaction related to the act of

donation is the most basic of building blocks underlying takaful.


Participants in a risk-pooling fund (akin to policyholders),
donate their contributions (akin to premiums) into the pool
which has the purpose of helping those who suffer from
specified losses. The concept of donation actually eliminates the
elements of money-for-money exchange, as well as gambling.
Qard-hasan loosely translated as interest-free loan. This is

the way any shortfall in the tabarru account is made up by the

surplus left in the tabarru funds, also prescribed at the time of


the signing of the contract. While it is perfectly acceptable for
the takaful provider to share in any investment gains, there is
a debate about whether or not they can share in underwriting
surplus; or
a mix of the two above.

For the interested reader, further details can be found on the website
of the Islamic Financial Standards Board (www.ifsb.org), document

A C T U A RY A U S T R A L I A August 2009

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report

ED8, the exposure draft on Guiding Principles on Governance for


Islamic Insurance (Takaful) Operations. The document provides
additional descriptions of the models in use, as well as illustrative
examples of the possible flow of funds under each model, both for
family and general takaful.
Some might be thinking here that this whole thing looks a little too
much like normal insurance with a few added terms and maybe a
twist or two. While the structure is intentionally kept similar in order
to be able to integrate takaful companies into a marketplace that
is largely conventional, the structure does add some complications
unique to takaful.
For starters, the definition of surplus is different from a conventional
insurer; while a conventional insurer can accumulate the surplus
from all lines of business and declare it as profit, the takaful provider
can only take from the tabarru funds that which is prescribed
by the Wakalah and/or Mudharabah contracts. Generally, each
individual line of business has its own tabarru fund and mixing
of the funds is not allowed either, effectively restricting any
cross subsidies.
There are other issues too, such as what can or cannot be covered
(for example, bars cannot be covered), and the bigger issue of
being competitive in a conventional marketplace while dealing with
the added complexity in operational structure and when investment
options are limited. The latter issue also gives rise to potential asset
and liability mismatches, among other problems.

The opportunity
Despite these, and other added complications, the takaful industry
has been thriving as of late. While the modern takaful structure
was conceived in the late 1970s and Malaysia became the first
country to adopt independent takaful legislation in 1984, the real
growth on a global scale has come in the last five years or so,
where global contributions have shown an annual increase of over
20%. The current estimate of global annual contributions is over

US$2 billion (this can vary depending on the source of information;


US$1.7 billion in 2007, per Swiss Re Sigma No. 05/2008). While
starting from a small base, the expected rates of growth over the
next five years are even higher than the last five years.
Globally, given the low insurance penetration rates among the Muslim
populace, takaful presents an opportunity with great potential. While
direct comparison of penetration rates with countries like the USA,
UK and Australia may be misleading due to overall difference in
disposable incomes, propensities to save, and liability systems,
nobody can deny that, given the global Muslim population of over
1.2 billion, there is room for phenomenal growth.
Another opportunity, albeit less talked about, is to target the Muslim
populations of the countries that have higher insurance penetration
rates. A number of European countries have significant Muslim
populations, many of whom would likely seriously consider takaful
as an alternative to their conventional insurance policies. A takaful
provider was recently set up in London, offering motor takaful to the
local Muslim population.
In Australia, according to the Department of Foreign Affairs and
Trade, the total number of Muslims per the 2006 census is estimated
at over 340,000; mostly living in either Melbourne or Sydney. This is
an easy to target market which may represent an opportunity for a
number of companies that decide to take the first steps in providing
the needed services to this market segment.
Of course, a takaful company can underwrite non-Muslims as well,
who may be attracted to takaful for various reasons:
the requirement for lack of complexity, and clarity in contracts

may be appealing;
due to the restrictions on investments, takaful companies

cannot invest in any companies involved in practices that may


be considered unethical (e.g. alcohol, gambling and weapons,
among others). Socially conscious investors may prefer this over
conventional insurance companies; and
the excess surplus in tabarru funds, if any, is typically distributed

back to the participants who did not incur losses, by surplus


sharing agreements defined at the time the policy is underwritten.
This is an attractive feature for Muslims and non-Muslims.
Thus, while the Muslim population will always be the main impetus
for providing takaful, the target market is not necessarily limited to
Muslims alone. For companies that can enter now,
establish a name and educate the masses about
takaful, the future looks extremely bright.
Hussain Ahmad
hussain.ahmad@towersperrin.com

ACTUARY A U S T R A L I A August 2009

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