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Tuesday, January 5, 2010



Takaful or Islamic Insurance is a growing and fast developing industry. Islamic jurists resolved that the system of insurance, which falls within the confines of Islamic framework, should be founded on the concept of al-Takaful. Thus, the main reason behind the introduction and development of takaful is to offer an Islamic and Shariah compliant alternative to conventional insurance. An Islamic insurance transacting is a policy of mutual co-operation, solidarity and brotherhood against unpredicted risk or catastrophes, in which the parties involved are expected to contribute genuinely. It is designed to provide protection and indemnity to both individuals and corporate bodies against loss or hazards to their selves or properties. The nature of the principles of takaful is fundamentally different from the principles of conventional insurance in many ways. It has been observed that takaful is still in the development stage but in some countries it has made significant progress. Despite the developments in the field of takaful, there is still room for improvement and also necessary changes need to be made in order to make takaful more beneficial to the Islamic world and not only for the present century but also for the centuries ahead. This project paper endeavours to explore the opportunities and challenges lies ahead in the progress and development of takaful in the years ahead.

1.0              Introduction

According to the teachings of Islam, all that happens in this world is by the will of Allah, and although Muslims are taught to accept any misfortune that befalls them as the will of Allah, Islam provides that one must find ways and means to avoid such catastrophes and disasters wherever possible, and to minimise his or his family’s financial losses should such events occur. One possible way out is to buy an insurance cover as in the conventional system. However, the conventional insurance is unlawful for Muslims because it is dealing with gharar[1]( uncertainty), maisir[2]( gambling) and  riba[3] (usury). The alternatives would be to participate in Islamic insurance or takaful.

Takaful, the Islamic alternative to insurance is based on the concept of social solidarity, brotherhood, cooperation and mutual assistance (or mutual indemnification) which provides for mutual financial aid and assistance to the participants in case of need whereby the participants mutually agree to contribute for that purpose. It is a pact of group of persons who agree to jointly indemnify the loss or damage that may inflict upon any of them, out of the fund they donate collectively. The main reason behind the introduction and development of takaful is to offer an Islamic and Shariah[4] compliant alternative to conventional insurance. Many Islamic scholars agree that takaful, which is based on the concept of ta’awun or mutual assistance, is fully consistent with Shariah law. A fatwa by the prominent Shariah scholar, Dr. Yusuf Al-Qardhawi, states that Islamic insurance may exist in a condition where each participant contributes into a fund used to support one another. According to him in his book “The Lawful and the Prohibited in Islam”[5];

“In my view insurance against hazards can be modified in a manner which would bring it closer to the Islamic principles by means of contract of donation with a condition of compensation….” and “A further requirement is that the company must be free from usurious business”

Conventional insurance is operated by buying and selling of insurance contracts. Despite having the same intention with takful of providing protection and coverage to the participants or policy holder, it is clear that in conventional insurance, the main contract between the parties is an exchange contract, specifically, ‘Sale Contract’. This is because the insurance company sells the policy holder in return for the payment of the premium. The subject matter here which is the policy and premium are not certain because the actual value or amounts of both are tied or conditional to the occurrence of uncertain events, which is the perils or hazards. Until the actual occurrence of the event happened, the total amount payable under the policy or the amount of premium payable vice versa, cannot be determined.

Impliedly, the conventional insurance is operated on the basis of risk transfer with guarantee given by the insurance operator whilst takaful operated on the basis of risk sharing and participants mutually guarantee each other. Thus, it is clear that the most essential modification that needs to be undertaken in order to make it lawful on the purview of Shariah is to substitute the contract of sale and purchase of insurance policy with a contract of donation with a condition of compensation.

Shariah scholars are generally agreed of the opinion that to be Shariah compliant for insurance, the premium must be paid on the basis of tabarru’[6] and in fact, tabarru’ contract is the main element that differentiates takaful from conventional insurance is the feature tabarru’. Tabarru’, in general, is a contract of donation with a condition of compensation. Thus, tabarru’ contract is the pillar in the takaful scheme that allows the gharar element to be tolerated under the arrangement, without affecting the validity of the contract. The logic being, those paying the tabarru’ contributions are not aiming to profit from the uncertainty. Instead, they intend to raise a pool of mutual donations that will be used for mutual indemnity to compensate the participants who suffer from perils. In this sense, the tabarru’ element removes the objectionable feature of gharar (embedded element in conventional insurance in an exchange transaction) and makes it Shariah compliant. By agreeing to tabarru’ or donate part of their contribution, participants in various takaful schemes agree to cooperate and be mutually responsible to help one another should a member suffer a defined loss.

According to the definition of the ‘underwriting surplus’ by Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), ‘underwriting surplus’ is the excess of the total premium contributions paid by policyholders during the financial period over the total indemnities paid in respect of claims incurred during the period, net of reinsurance and after deducting expenses and changes in technical provisions. Thus, another feature that differentiates takaful from conventional insurance would be that, in takaful, all underwriting surplus or losses are for the account of the participants while in conventional insurance, it belongs to the shareholders.

This paper endeavours to analyse the potentials, opportunities and challenges faced by this rapid-growing industry. Critical to this discussion is the origin of takaful and mechanism models of takaful practices which are the key to appreciating the opportunities and challenges face to takaful operators. All of the salient features are discussed in this section, which are as follows: (i) Origination of takaful, (ii) The Shariah basis of takaful, (iii) The myths and facts of takaful, (iv) Categories of takaful products, and (v) Mechanism models of takaful.

The second section of this paper will analyse the opportunities lying in front of takaful industry and ways to realise the takaful potential to the fullest. Subsequently, the third section will highlight the challenges that are currently faced by takaful operators. Only by understanding the challenges, takaful industry’s potential can be tapped.

1.1              Origination of Takaful

Takaful has its origins laid down in the Holy Quran and Sunnah. The name takaful originates from the Arabic verb ‘kafala’, meaning guarantee. For many, the term takaful is relatively new, however the concept can be traced back many years and it was known to be practised by the Muhajirin of Mecca and the Ansar of Medina following the Hijra of the Prophet Muhammad (pbuh) for over 1,400 years. Takaful is derived from the Arab customary practice of ‘asabiyaa’ (tribal solidarity) and diyah (compensation or blood money) under the doctrine of al-aqilah. It was a common practice among the tribes that, if any member of a particular tribe would have been killed unintentionally by a member of a different tribe, the heirs of the deceased would have to be paid by the paternal relatives of the accused with an amount of blood money (diyah) as a pecuniary remedy.

The central idea of the doctrine of al-aqilah; the members of the accused’s tribe used to be mutually agreed to a financial contribution for the purpose of protecting him (the accused) from financial liability arising out of causing a culpable homicide. This form of contribution has the resemblance with the contribution paid under the doctrine al-aqilah has also the resemblance with today’s takaful indemnity (benefit) paid to the victim or heirs.

1.2       The Shariah basis of Takaful

The Shariah basis of takaful can be deduced from al Quran, Sunnah and Islamic legal maxim. This section attempts to highlight the sources of takaful based on the sources of Shariah law;

Surah al-Maidah, verse 2, reads to the effect:

“Help (ta’awun) ye one another in righteousness (birr) and piety, but help ye not one another in sin and rancour, fear Allah, for Allah is strict in punishment”.
(al-Maidah: 5:2)

“Yusuf said: “For seven consecutive years, you shall sow as usual and that (the harvest) which you reap shall leave it in the ears, (all) except a little of it you may eat”. “ Then will come after that, seven hard (years) which will devour what you have laid by in advance for them, (all) except a little of that which you have guarded (stored)”.
(Yusof: 12:47-48)

The following hadith, the Holy Prophet (pbuh) also urges people to help each other especially to those that facing hardship:

“The attitude of believer and feeling of brotherhood to one another is like that of the single body. When one member of the body is hurt, it will have an effect to the whole body”

                                        (Narrated by Bukhari and Muslim)

“Whosoever removes a worldly hardship from a believer, Allah will remove from him one of the hardships of the hereafter. Whosoever alleviates the needy person, Allah will alleviate from him in this world and the next”
(Narrated by Muslim)

In addition to the Quranic verse and hadith above, there are a few legal maxims which imply a recommendation for people to undertake certain precautions to mitigate or reduce risk. The following are five fundamental legal maxims acted as the statement of principles for any Shariah compliant contracts;

  • “Acts are judged by the intention behind them” (Al-umuru bi-maqasidiha);
  • “Certainty is not overruled by doubt” (Al-yaqinu la yuzallu bish-shakk);
  • “Custom is the basis of judgement” (Al-’aadatu muhakkamatun);
  • “Hardship beget facility” (Al-mashaqqatu tujlab at-taysir);
  • “Harm must be eliminated” (Ad-dararu yuzal);

In addition, the corollary legal maxims that have been used in the discussion of takaful are the followings;

  • The original legal position of any matter is permissible until there is evidence prohibiting it.
  • Whatever leads to haram (forbidden), is in itself haram.
  • In contracts effect is given to intention and meaning and not to words and phrases.
  • The ends do not justify the means.

Based on the Quranic verses, hadith and Islamic legal maxim above, it is understood that the concept of takaful is generally encouraged in the Shariah.

            1.3       The Myths and Facts of Takaful.

Unfortunately, there are still embedded myths on the concepts and practices in the mind of publics.

The followings are the common misconceptions on takaful;

  • By having takaful policies, we are against the belief in pre-destination, qada’ and qadar.
  • Takaful is similar to insurance. It is a zero-sum game or game of chance.
  • There are still elements of excessive uncertainties or gharar in the takaful contract and there is still element of ‘buying’ and selling of takaful policy or plan.

The followings are the main arguments to counter-back the said presumptions and misconceptions. First, by having takaful policy, it does not mean to deny the divine pre-destination (qada’ and qadar). This is because no one can deny divine destiny. Yet, takaful only attempts to reduce or remove harms and hardship when the pre-destined events happen. This is in line with the famous Sunnah of the Prophet (pbuh) whereby he has said to tie camel and leave it to the will of Allah[7]. This is the basic concept of tawakkul[8].

Secondly, takaful is not a form of gambling or game of chance because it is a mutual cooperation, not a zero-sum game. The participants, both donor and donee benefit from the mutual indemnity scheme together.

Thirdly, on the issue of gharar, the uncertainties will still remains because nobody knows when the peril or hazard will happen, or the extent to which the peril will occur. However, in a takaful contract, such uncertainties are tolerated because it involves charitable or gratuitous contracts.

            1.4       Categories of Takaful Products
Takaful schemes can be broadly divided into two categories;

*      Family takaful (Islamic life insurance)
Family takaful basically a long term contract takaful . The schemes can be for individual or group and cover hospitalisation and surgical, mortgage, education and investment-linked.

*      General takaful (Islamic general insurance)
General takaful schemes are usually on a yearly basis. Example of the schemes; (i) fire takaful, (ii) motor takaful, (iii) accident/ miscellaneous takaful (iv) marine takaful, and (v) engineering takaful.

1.5              Mechanism model of takaful

Based on the nature of relationship between the company and the participants, there are various models like mudarabah[9] model, wakalah[10] model and the combination of mudarabah and wakalah models. The operation of takaful is generally based on the governing principles of mudarabah (as in Malaysia), profits and loss sharing technique, which is an alternative to the riba (interest), based financing technique. Generally, these risk-sharing arrangements allow the takaful operator to share in the favourable investment performance of both the participant’s takaful fund and the participant’s investment account. However, if there are losses in the participant’s special account, the takaful operator provides an interest-free loan (qadrul hassan) that has to be repaid when the participant’s special account returns to profitability and before any future surplus is distributed.

Under wakalah model (as in the Middle East region), the policyholder (participant) places their contribution into a pool as a donation (tabarru’) and not a premium. The takaful operator which acts as an agent or wakeel of the policyholders is entitled to levy a fee (in the form of management fee, business expense or fund performance incentive fee) from the surplus (profit) of policyholder’s funds investments in the participant’s special account. The fee is fixed annually in advance in consultation with Shariah committee of the company. In order to give incentive for good governance, management fee is related to the level of performance.

In the Sudanese Takaful Model that is preferable to majority of the contemporary Shariah experts whereby every policyholder is also the shareholder of the Takaful Company. There is a Board that runs the business on behalf of all the participants and there is no separate entity managing the business. However, the legal framework in other Islamic countries normally does not allow this arrangement and Takaful companies work as separate entities on the basis of Mudarabah (as in Malaysia) and on the basis of Wakalah (as in the Middle East region). 

Some takaful operators use both wakalah and mudharabah contracts in their operational model, with wakalah being the dominant contract. In this model, the participants will still contribute fund in the form of tabarru’ but then, the participants as a group appoints the takaful operator to be their agent (wakeel0 to manage the takaful fund for the purpose of underwriting activities, risk assessments and claim management. For this agency (wakalah) arrangement, the takaful operator charges a specified and agreed management fee. At the same time, for the purpose of investment of the takaful fund (while waiting for any claims), the participants as a group appoints the takaful operator to be the investment manager (mudarib) under the mudharabah contract. Any profits from the investment will be shared between the takaful operator and participants according to a pre-agreed ratio of profit sharing.

2.0       Opportunities for takaful operator

The Middle East, especially the countries of the Gulf Cooperation Council (GCC), has one of the lowest insurance penetration rates in the world. This may be due to the absence of insurance ‘shopping’ in certain locations especially in the countries which might otherwise be seen as a natural catchment area given the high GDP in countries such as Kuwait, Saudi Arabia and United Arab Emirates (UAE). In fact, expenditure on life insurance in Saudi Arabia in 2000 was USD$1 per head and USD$68 per head in UAE, whereas life premiums per capita in the UK were USD$2,503, USA USD$1,447 and Switzerland USD$2,914. Egypt, as many other Islamic countries, suffers from the common attitude that insurance is unnecessary, only accounts for 1 per cent of the country’s gross domestic product. The same goes for general insurance which follows the similar pattern. Some possible reasons for the low insurance density and penetration in some of these countries include a greater reliance on social welfare, the extended family system and attitude to risk.

However, since 2001, there has been a steady increase in the number of takaful players across the GCC (family takaful is only introduced in Qatar in 2001 and 2002 in Bahrain) but their numbers are dwarfed by the number of conventional providers. What is interesting is that even though there are many conventional insurance providers, the penetration rates in the region are still low, possibly suggesting that the majority of the population is unwilling to buy non-Islamic products and conventional insurance providers are unable to target these market segments. Thus, this is the main reason for the low penetration and underdevelopment of insurance in all forms in these countries. Conventional insurance does not relate to the values and beliefs of customers in these countries. But takaful does. This would suggest that takaful providers could rapidly increase market share by targeting specific market segments with relevant Shariah compliant products. Logically, an increase in the number of providers will result in better product offerings to customers and force existing players to improve. Given the economic boom for oil-producing GCC countries, the future for takaful looks very promising.

Recently, Salama Islamic Arab Insurance Company in Dubai has reported that takaful will be the leading financial segment across the Asian, Arab and African regions with growth rates of 10 to 30 per cent over the last couple of years with around 60 takaful operators in 30 countries worldwide. Salama Islamic Arab Insurance Company also states that the global takaful market is expected to grow at between 15 to 20 per cent per annum. According to the report by Moody’s in August 2006, total takaful written premiums exceeded USD$2 billion in 2005 and it is expected to reach USD$7.4 billion by 2015. Salama Islamic Arab Insurance Company also reported that GCC will see a dramatic increase in takaful in the coming years; the introduction of compulsory health insurance for expatriates from 1 January 2006 and motor third party liability will be the catalysts. In addition in UAE, health insurance will also be made compulsory for foreigners, providing considerable sources of revenue to takaful companies. In October 2006, the Council of Ministers in the Kingdom of Saudi Arabia licensed 13 new insurance companies most of which are joint ventures with foreign partners and several more applicants are in the line.

Takaful operators in collaboration with Islamic banks have implemented a concept called bancassurance or banctakaful. It is termed as a means of promotion and marketing of takaful products by the banking institutions. Islamic bancassurance or banctakaful is interpreted as the distribution of takaful products through Islamic banking channels. For the banks, bancatakaful will result in increased product range and earning of incomes in terms of fees whilst for takaful operators, bancatakaful broadens their distribution and market coverage. The considerable success of bancassurance or banctakaful; which is one of the distribution channels for selling takaful through retail banks, contributes to the progress and growth of takaful worldwide. Thus, there is a good prospect for bancatakaful to increase its market share in the insurance industry and such prospect can be turned into reality if enough efforts are spent on key focus areas and one of the most important area is creation of more awareness of takaful products to the publics.

3.0       Challenges

Even at the thriving rate of growth as discussed above, but the takaful’s rate of penetration is still low, given after 30 years, takaful is still alien to some and vague to many people. Why such things happened to takaful industry has raised a lot of questions. Is takaful strategically positioned and robust enough to face the ever challenging financial environment? Are the marketing strategies presently adopted open enough to the general public? Are there constraints for non-Muslims to participate? Is the government commitment and political will together with legal framework effective enough for takaful industry to grow even more? Is takaful industry lack of calibre human capital and technical expertise so that they can compete effectively with conventional insurance? In this section we will examine some of the challenges that have to be faced by takaful operators.

3.1       Shariah acceptability

A related factor is the poor reputation of insurance among many Muslims. For generations, Muslims around the world have grown up with the suspicion that insurance (life insurance especially) contravenes basic Islamic tenets. Objections have been raised on the ground that taking out a family takaful policy is against tawakkul[11]. The Shariah Control Board of the Faisal Islamic Bank in Sudan for example, thinks that insurance should be prohibited due to its inherent elements: a wagering contract of which the consequences are unknown. Such a contract would possess the prohibited elements of uncertainty of outcome (gharar) and gambling (maisir), and is frowned upon by the Shariah law. However, as jurists have pointed out, they may seem to forget the Prophet Muhammad (pbuh)’s famous hadith: “tie your camel, then depend on Allah”. Taking precautions in future planning for one’s life is not against tawakkul but, on the contrary, is a perquisite, because it is a financial transaction for protecting widows, orphans and other dependants, rather than leaving them needy and having to ask others for help.

3.2       Supporting structures

A number of conditions need to be put in place to facilitate the development of takaful business. These include a cohesive regulatory and legal framework that emphasizes transparency and consumer protection, uniform accounting standards and a higher degree of consensus on the interpretation of Shariah principles in the context of takaful operations. A few countries have special laws governing takaful, for example Malaysia has enacted Takaful Act 1984 to provide procedure for the registration of takaful providers and to establish the conditions under which they operate. Although having a special takaful law seems appealing and appropriate, other Muslim countries have not followed Malaysia’s lead. On the other hand, Bahrain does not have a specific takaful law, but the Bahrain Central Bank (formerly The Bahrain Monetary Agency) has introduced special regulations for takaful regulation. Bahrain can be regarded as an example of a light regulatory environment; the rules are specific where it matters, especially with regard to the disclosure of information to the policyholders. In some respects, the regulations in Bahrain are more developed than those in Malaysia, despite the latter having a long-established takaful law.

For the mudarabah based takaful operator, their Shariah Supervisory Board should insist on a high level of transparency and accountability in the interests of policyholders because the policyholders certainly want to know where is the takaful fund is invested and the extent of financial reporting on this. The takaful management company will need to have its own accounts audited, as this is a regulatory requirement in all jurisdictions. However, the primary purpose of the financial statements is to report to the shareholders, not the policyholders. Therefore takaful operators should have good corporate governance in order to instill confidence of public to them and to manage conflict of interest issues effectively.

3.3       Reward structure

A related factor is the reward structure to either mudarabah based or wakalah based takaful operators. This needs to be structured carefully to ensure appropriate incentives and risk-sharing from the Shariah viewpoint. Most operators adopt mudarabah approach, but at present there are some issues in regard to the approach: whether the mudarib or entrepreneur can deduct operational expenses prior to the distribution of the surplus. Greater hamonisation on the reward structure may aid to the industry development.

3.4       Retakaful

Retakaful is the reinsurance on Islamic principles. One of the main problems is the lack of retakaful operators in the market. Since the launch of the first Islamic takaful operator, retakaful has been the missing link in takaful operations. The insurance operator needs reinsurance operator to spread the risks as a technical requirement such as to reduce the claims volatility. The same need goes for takaful operator. By having retakaful operator in the industry, the takaful operator can share the takaful risk by reducing the impact or the amounts of claims made. It is an insurance for insurance companies or takaful for takaful companies.

Takaful operators are obliged to make their operations Shariah compliant. By having a few numbers of retakaful operators in the market, this has left takaful operators with the dilemma of having to reinsure on a conventional basis. Shariah scholars provided fatwa for allowing dispensation to takaful operators to reinsure on a conventional basis when no retakaful alternative is available. Only if Shariah compliant capacities were not available was it permissible to use conventional reinsurer. Existing capacities are still not sufficient to meet the demand for Shariah compliant capacities. The lack of this capacity within the takaful industry worldwide has led up to 80 per cent of the takaful operator in the Middle East reinsure on a conventional basis.

3.5       Flexibility

There are similarities between family takaful and unit-linked policies in conventional insurance basis, and that takaful companies operate on the basis of ‘non-interference’ in terms of portfolio selection. This non-interference feature differs from conventional unit-linked policies, under which provision for switching between funds is feature. An office issuing unit-linked policies may provide a policyholder with a choice of, say two different funds. These can be equity funds and unit trust funds. Frequently, one switch per year is allowed free of charge. These feature may well be adopted without departing from mudarabah principle in takaful companies, since each separate fund’s investments would remain at the takaful operator (mudarib)’s discretion.

3.6       Investment avenues

One of the other difficulties facing takaful operators is finding riba-free investments. For conventional insurance companies, they hold significant proportion of their assets in bonds or floating rate notes, which in many respects are well suited to their needs, as the maturity value is known, the only risk being of default. They also have the availability to match the length to maturity of their assets with their anticipated payments obligations. The problem for takaful companies is that they cannot hold conventional bonds or notes due to riba elements. Avenues of investment must be in accordance with Shariah principles and these can be limited. Widening the range of investment instruments and products that are Shariah acceptable remains a high priority, particularly in the area of Islamic project finance and infrastructure financing so important for Muslim countries. In Malaysia, the substitution of sukuk[12] for bonds and notes is not a problem. The position in the Gulf is very different, with relatively few sukuk available until recently.

3.7       Competition

Another challenge for takaful operator is that they compete on a global basis with conventional international insurance companies. The advantage they (conventional insurance) have would be the huge resources that they have and their brand strength that provides assurance to potential clients. The fact that they have been developed around the world for over 500 years, gives them the capacity to influence millions of customers worldwide with variety of products to sell. On the contrary, takaful players’ lack of competence can be seen in the area of underwriting skills, quantitative analysis and also in developing the products. The same difficulties face by the retakaful players. In order for takaful and retakaful operators to optimize their capability and to be more competitive than its conventional counterparts, they must make a change through scientific approach. They also must emphasize on the qualitative factors apart from quantitative factors. One of the ways to achieve this is through learning from conventional insurers and reinsurers about its methods and operations.

The systems and processes used in the process of takaful and retakaful also need to be developed to ensure the smooth running of the operation. This includes processes and procedures that are in accordance with Shariah principles, integration of the IT system and the operator turnaround. Again, the smooth running of systems and operations can be benchmarked to the conventional counterparts. As mentioned above, the insurance companies have been here for over 500 years proved that they have achieved operational consistencies. Thus, takaful and retakaful operators may put some studies on these operational issues. As a conclusion, the takaful and retakaful operators’ challenges in system and process challenges can be met with greater knowledge of its procedure and process from its conventional counterparts. Besides that, the operators must prepare themselves to achieve higher financial strength, intense political will and greater cooperation with others. In fact, takaful and retakaful operators may develop strategic alliances with conventional insurance counterparts in order to be at par, if not better than them.

3.8       Mutuality

Islamic insurance is based on the principle of mutuality, in that members are both the insured and insurers themselves. The members themselves share all the losses and thus no transfer of risk involved. Unfortunately, some of the jurists have opined that most of the takaful companies established in Muslim countries are in fact similar in ownership structure to stock or proprietary insurance companies. This perception may limit the acceptability of the concept of takaful in the Islamic community. Certainly, a mutual insurance company that invested its funds in Islamically acceptable ways would satisfy all of the conditions laid down by jurists as a valid alternative to conventional insurance. With such organizations like the first takaful company in Sudan where there were no shareholders but rather the policyholders are the owners and they have an undivided interest in the capital subscribed as long as they continue paying their premiums. The major limitation of mutual societies is that they can only obtain resources from their members and cannot raise equity capital. One of the problems in formation of such company is that the respective countries do not have specific rules and legislation to support formation of such company.

3.9       Reserving and Solvency Margin issues.

The goal of actuarial reserving in takaful is to match the receipt of each contribution in the accounts to the equivalent risks taken. The level and types of reserves are dependent on the takaful model being used. Say that the mortality risk is accounted for by dripping charges monthly from the participant account (PA) into participant special account (PSA), for the PSA, reserves of say ½ month contribution should be reserved for. On the contrary, for a product that put the entire contribution into the PSA such as general takaful products, full reserves of future benefits to be paid or future expenses should be made. This sometimes leads to reserving strains. Thus, the establishment and existence of these reserves has an integral effect on the risk management of the operator.

One issue to note with regards to reserving is in the area of conservatism or the prudence concept. What level of conservatism the reserves should be set at? On the risk management issue, conservative reserves are usually favored. The new international accounting conventions under the International Accounting Standard 39: Financial Instruments: Recognition and Measurement (IAS 39), has call for the fair value of liabilities as well as assets. The development of international insurance conventions has also posed the same requirement. This development, called Risk Based Capital (RBC). The setting of reserves at fair market value also cuts to the essence of takaful not only to the issue of reserves, but also to the fair value of surplus for which can be distributed fairly. The requirement fair value computation do pose significant problems not only to takaful and retakaful operator, but also for insurance companies. Thus, the RBC and IAS 39 requirements have led to the fair value of reserves are so complex especially when it has direct effect on the risk management.

The solvency margin is an additional prudent margin added together into the reserves as an additional buffer in the light of proper risk management. Again, the RBC and IAS 39 pose similar difficulties in valuing such margin.

The setting of fair value of reserves and solvency margin is still at a very early stage in the takaful world. Due to significant diversity of takaful companies plus takaful model worldwide, this should prove to be more challenging exercise for takaful operators and will keep them busy on the foreseeable future.

3.10     Harmonisation of practices

Harmonisation of practices can be the cornerstone for the progress of takaful in the world. This is more toward the stardardisation of practices of adopting mudarabah model and wakalah model and the expected characteristics of the former and the latter respectively. In Bahrain, the current practice of takaful operator is to use the wakalah model for underwriting activities and the mudarabah model for the investment activities. Some commentators are critical of this so-called mixed model and would like to see a unified set of principles. However the Bahrain Central Bank, like Central Bank of Malaysia, does not specify the rules as to what constitutes a takaful product, this being a matter for each firms’ Shariah Supervisory Board.

3.11     Human capital and technical expertise

The lack of human resources dedicated to takaful is one of the major weaknesses of the industry. This is visible especially in the Middle East and North African (MENA) region because of the recent development of takaful. The backgrounds of underwriting, accounting and marketing staff are in conventional insurance. Apart from lack of technical competence, shortage in Shariah competence also causes setbacks to the takaful industry. This tends to negatively affect their ability to develop an appropriate takaful profile needed for better service to the clients. The takaful industry must develop proper educational tools to ensure professionals within the industry are able to fully develop and market takaful products and the concept of takaful. Only then can differentiation develop within the industry. In addition, most Shariah advisors lack of operational knowledge and this results in the inability to develop the takaful and retakaful industry to its full potentials. One of temporary solution would be to hire staff with experience and skills in takaful for retakaful operators. The skills required are in the area of underwriting and qualitative skills. In addition, more qualified staff with insurance background is still necessary. For investment department, there should be continuous training program to existing and new staff. Continuous training programs can upgrade their skills and update them with the current knowledge on the Shariah compliant investment avenues. In this connection, Malaysia has taken initiative to establish the International Centre for Education in Islamic Finance (INCEIF) to nurture Islamic finance professionals and experts in order to address the human capital needs either in banking or takaful industry.

4.0              Conclusion

There are ample opportunities for developing the takaful industry worldwide. However, the opportunities for takaful lie in the strength of the takaful operators themselves. Despite the thriving growth of the industry, it just captures a small portion of market share of the insurance industry. Currently, the global takaful industry is relatively small compared to its conventional counterpart with current market size is estimated between USD$2.5 billion to USD$3.5 billion of annual premium. It needs to gain critical mass, build worldwide brand recognition and exceed performance standards set by the conventional insurance industry. Thus, takaful operators should strive to increase the market share. With well over one billion Muslims in the world accounting for approximately 22% of the world’s population, the potential for Shariah compliant insurance products is enormous. However, only genuine efforts to develop a business in keeping with Shariah principles will bring success. Any attempt to enter the market for the sake of soaking up business without genuine effort to provide a fair system will be of limited value.

Effective promotional and awareness programs that shows good experiences of takaful participants are needed to attract both Muslim and non-Muslim alike to support takaful industry. The unique features of takaful products that promote transparency, fairness and profit sharing should appealed to all.


Sohail Jaffer. 2007. Islamic Insurance - Trend, Opportunities and the Future of Takaful. United Kingdom. Euromoney Books.
Mohd. Ma’sum Billah. 2003. Islamic and Modern Insurance - Principles and Practices. Kuala lumpur. Ilmiah Publishers Sdn Bhd.
Munawar Iqbal and Rodney Wilson. 2005. Islamic Perspectives on Wealth Creation. United Kingdom. Edinburgh University Press.
Rosly, Saiful Azhar. 2005. Critical Issues on Islamic Banking and Financial Markets: Islamic Economics, Banking and Finance, Takaful and Financial Planning. Kuala Lumpur: Dinamas Publishing.
Dr. M. Muslehuddin. 2004. Insurance and Islamic Law. New Delhi. Adam Publishers & Distributors.
Mohd. Ma’sum Billah. 2003. Islamic Insurance  - Takaful. Kuala lumpur. Ilmiah Publishers Sdn Bhd.
Mohd. Ma’sum Billah. 2007. Applied Takaful and Modern Insurance  - Law and Practice. Petaling Jaya, Selangor. Sweet & Maxwell Asia.
Dr. Engku Rabiah Adawiah Engku Ali & Hassan Scott P. Odierno. 2008. Essential Guide to Takaful (Islamic Insurance). Kuala Lumpur. CERT Publications Sdn. Bhd.

[1] Gharar : Literally means deception, danger, risk and uncertainty. Technically, means exposing oneself to excessive risk and danger in a business transaction as a result of uncertainty about the price, quality, quantity of the counter-value, date of delivery, and the ability of either the buyer or the seller to fulfill his commitment or ambiguity in the terms of deal.
[2] Maysir : An ancient Arabian game of chance played with arrows without heads and feathering, for stakes of slaughtered and quartered camels. However, the term is now used to refer to all types of hazard and gambling – acquisition of wealth by chance/ easily (without paying an equivalent compensation (counter value or ‘iwad) for it or without working for it, or without undertaking any liability against it).
[3] Riba : Literally, an excess or increase. Technically, it means an increase over the principal in a loan transaction, over a debt or in exchange transactions, accrued to the lender/ creditor or a party to exchange without giving an equivalent counter value or recompense (‘iwad) in return to the other party.
[4] Shariah : The Shariah is the body of revealed injunctions found both in the Quran and Sunnah and it includes the following three main components: Al-ahkam al-I’tiqadiyyah or aqidah (the sanctions relating to beliefs), Al-ahkam al-akhlaqiyyah (the sanctions relating to moral and ethics), and Al-ahkam al-‘amaliyyah (sanctions relating to the sayings and doings of the individuals and his relations with others) which is also called Fiqh.
[5] Quoted from the book “The Lawful and the Prohibited in Islam” by Sheikh Dr Yusuf al Qardawi, page 26.
[6] Tabarru’ : An Arabic word meaning donation, gift or contribution. It is a contract of gratuity/ charity, i.e. to relinquish a portion from the contribution as a donation for fulfilling obligation of mutual help, used to pay claims submitted by eligible claimants.
[7] When an Arab Bedouin asked the Holy Prophet (pbuh), ‘Shall I leave my camel untied and seek Allah’s protection on it, or should I tie it?’, the Holy Prophet (pbuh) replied to him, ‘Tie your camel and then depend on Allah’ – a Hadith, narrated by Al-Tarmizi and Ibn Majah, Book 60, No. 2517. This hadith clearly indicates that a person should always take appropriate measures to safeguard himself or his property against risk of loss.
[8] Tawakkul : Relying and depending totally on the will of Allah.
[9] Mudarabah : A profit and loss sharing contract in which one party provides the financial capital or known as Mudarib and the other party or known as Rab al-Mal manages the enterprise. While profit is shared, loss is borne by the financier.
[10] Wakalah : Representation or agency. Entrusting a person or legal entity (wakeel) to act on one’s behalf or as one’s representative.
[11] Tawakkul : Relying and depending totally on the will of Allah.
[12] Sukuk : Refers to a financial paper showing entitlement of the holder to the amount of money shown on it. It is a form of financial note.


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