“Takaful and Insurance”
A comparative study

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Comparative study of Takaful and insurance
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CONVENTIONAL INSURANCE AND TAKAFUL: CONCEPTUAL AND
OPERATIONAL DIFFERENCES
M.Arsalan Tahir & Hatim jabbar

Abstract:
This study attempts to differentiate concepts and operations to execute the conventional insurance and Takaful. Management, financing, ownership and accounting system creates difference between both apparatus.

Conventional insurance based on Riba (interest), Gharrar (uncertainty) and Maisir (Gambling), which are prohibited in Islam. Unlike Insurance, Tabbarro (voluntarily) and Ta’wan (mutual assistance) are cornerstone of Takaful fund. Rich literature in study, collected from secondary source, describe the differences discussed above.

INTRODUCTION:
Miss haps, disasters, damages and risks are inevitable in Human life, but manageable. To manage risks, damages through fire, floods, accidents, and Business, Man has find out ways to protect him from these challenges. Conventional insurance and Takaful are the ways to protect lose, but both have major differences in concepts and operations.

Insurance definition According to Pfeiffer (1956) defines as “insurance is a device for the reduction of risk of one party, called the insured, through the transfer of particular risks to another party, called the insurer, who offers a restoration, at least in part, of economic losses suffered by the insured.

Takaful, is drive from Arabic word “Khlafa” mean mutual guarantee, Islamic alternative to insurance promotes the concept of social solidarity, cooperation and mutual indemnification of losses of members. It is a pact among a group of members who agree to jointly indemnify the loss or damage that may inflict upon any of them out of the funds they donate collectively.

Takaful is now nourishing in Islamic finance, and people now prefer Takaful over insurance to get along with Islam in this world. However, some school of thoughts still does not accept the concept of Takaful, due to lack of knowledge about concepts and operations of Takaful. This study aims to create awareness in public to differentiate Between Takaful and Conventional Insurance.
Literature review:
Many researchers have written on this topic, some of them are

Essential Guide to Takaful (Islamic Insurance) by Engku Rabiah Adawiah and Hassan Scott
Islamic and Modern Insurance – Principles and Practices by Mohd. Ma’sum Billah.
Takaful and Retakaful – Advanced Principles & Practices by Tobias Frenz and Younes Soualhi.
Takaful (Islamic Insurance): Concept, Challenges, and Opportunities by Safdar JafferFarzana Ismail, Jabran Noor and Lindsay Unwin.
Al Ta’min wa ahkamuh by Sulaiman bin Ibrahim.

Our study attempts to describe the concepts of Takaful and insurance, models of operation, differences and references and objection on Takaful.

Methodology:
This study is based on qualitative data, collected from secondary source. This Secondary data has been collected from several sources. Relevant literature has been gathered from a number of books. Extensive data has been collected through websites, and database articles. To receive objective of the study information work by different authors and organization have been used. We have used secondary data most of which is in English. Comparison between the conventional insurance and Islamic insurance (Takaful) has been done based on the collected data.

What is Takaful?

Takaful:
Takaful is originated from an Arabic word “khafala” mean guarantee. Ta;awm(mutual assessment) and Tabarru (voluntary contribution) are the cornerstone of the Takaful, where the risk is shared collectively by the group. It is derived on the basis of shared responsibility, brotherhood, solidarity and mutual cooperation or assistance, which provides for mutual financial security and assistance to uphold participants against a definite risk.
Principal of Takaful: * Rabbul Mall (capital providers) makes Ra’sul mal (contribution of money) to help those who need that money in their hard time. * Losses are liabilities speared among all participants according to proportion of their money in Takaful fund. * Uncertainty is eliminated in accordance to shariya laws. * Takaful is not derived to gain profits but to uphold the defined and certain risk.

Models of Takaful: There are several Models to execute Takaful, to build a society with an atmosphere of brotherhood, solidarity and Mutual Corporation. The following two models are
Mudharabah Model:

Under the Mudharabah contract, the takaful operator acts as a Mudharib (entrepreneur) and the participants as Rabbul mal (capital providers). The contract specifies how the surplus from the takaful operations is to be shared between the takaful operator and the participants. Losses are borne by the participants as the capital providers; However, to protect the interest of the participants, the takaful operator is required to observe prudential rules including provision of financing rate-free loans ( Qard e hasana) by the operator to the takaful risk funds in the event that there is a deficiency in the takaful risk funds.

Profits attributable to Shareholders
Company’s Admin. & Mangt. Expenses
Takaful Contribution paid by Participant
General
Takaful
Fund
General
Takaful
Fund Operational
Cost of
Takaful
Surplus
(Profit)
Participant’s
Share
from Surplus
Company’s
Share from Surplus
Investment
By Company
Profit
From Investments
Company

Participant

Mudaraba Model

Wakalah Model:
The second model is Wakalah Model. This model portray that the surplus of policyholders’ funds investments – net of the management fee or expenses go to the policyholders. The participant pays the Wakalah fee from contributions that cover the total operator expenses of the business and operator salaries. The Wakalah fee is underwritten by the Sarah Advisory Board of the company one year advance basis. To give incentive to operator for good governance, management fee is paid as per the level of performance.

General
Takaful
Fund
Operational
Cost of
Takaful/
ReTakaful
Surplus
(Profit)
Surplus
Distribution to Participants

Participants’
Takaful Fund

Wakala Model
Takaful
Contribution paid by Participant

Company
(Capital)

Mudarib's’
Share
of PTF’s Investment
Income

Management
Expense
of the Company
Profit/Loss
attributable to
Shareholders

Wakala
Fee
(30% to 35%)
Profit
From
Investments

Investment
Income

Reserves

Investment by the Company

Investment Income Sharing on Mudaraba Basis

Insurance:
“An agreement whereby one party, the insurer, in return for a consideration, the premium, undertakes to pay to the other party, the insured, a sum of money or its corresponding in kind on the happening of a particular event, which is contrary to the insured’s financial interest”
Products of Insurance:
There are many products of insurance, which can meet needs of individuals and industry. some of them are as following:
General insurance:
General insurance is basically an insurance policy that protects against losses and damages other than those covered by life insurance. For more comprehensive coverage, it is vital for to know about the risks covered to ensure that insurance holder and his family are protected from unforeseen losses.

The coverage period for most general insurance policies and plans is usually one year, whereby premiums are normally paid on a one-time basis.
General insurance bears following risks: * Accidental death * Liability by damage * Property loss ,etc |
Life insurance:
Life insurance is an insurance coverage that pays out a certain amount of money to the insured or their specified beneficiaries upon a certain event such as death of the individual who is insured. The coverage period for life insurance is usually more than a year. So this requires periodic premium payments, either monthly, quarterly or annually.
Life insurance covers: * Illness * Premature death * Income during retirement

Comparison between Takaful and insurance:
Takaful and insurance are compared in our study in following perspective:
Policy:
In Takaful models, operation, rules and regulation are derived from Shari’ah. The outlook and interpretations of Al-Qur’an and Al – Sunnah from suitable, prominent Islamic Shari’ah scholars also considered in this regard.
Conventional insurance is based on policy made by human. Most of the rules are based on philosophy of west, which leads to materialism and secularism.
Objective
In charter of Takaful the objective is not to earn effort less interest, but to uphold the defined risks. Takaful promotes the air of brotherhood, solidity and mutual assistance.
On the other hand, insurance aims to maximize profit for its shareholders. This leads society to greed, dissatisfaction and self-indulgence, and the well being of society left behind.
Risk Transfer/Sharing
Conventional Insurance is a apparatus whereby individual or business enterprises by paying out contribution (termed ‘premium’ in insurance) transfer some of the uncertainty of risks to the insurer. Insurer in the event of loss from insured peril compensates the victim (insured) out of the contribution so gathered from large numbers of insured. The contribution is usually a very small amount compared to the amount of protection available.
Unlike conventional insurance, which risk is not transferred from the insured to the insurer, the Takaful Insurance mutual risk is shared among the participants. Takaful operations are based upon the principles of mutuality, whereby each participant makes a donation to a Takaful fund. In the event of its loss, the participant will receive the amount of its claim.
Custody:
Participants are owner of Takaful fund, and operator’s role is of manager. They have a complete right of contribution and benefits. On the contrary, in conventional insurance the relationship of issuer of insurance and policy holder is relationship of seller and purchaser.
Monitoring board:
Conventional insurance company doesn’t have any monitoring board, which could monitor compliance of operation of company with sh’ariya laws. While in Takaful fund, The Shari’ah Supervisory Board is to be formed by the operators and their role is to review the operations, supervise its development of Shari’ah insurance products, and determine the Shari’ah compliance of these products and the investments
Operations:
In Takaful, participants make contribution and operator divide amount in two heads; the policyholders would co-operate (ta’awun) among themselves for their common good; it falls under the donation contract (al-tabarru’) which is intended to divide losses and spread liability according to the community pooling system.
Conventional insurance operates in such a way that premium is paid by policy holders to insurance company and that amount is invested in interest bearing investment which are noncompliance to Islamic law.
Investments:
According to Billah (2001) “The distinction between the conventional insurance and Takaful business is more visible with respect to investment of funds”. Insurance companies invest their funds in interest-based avenues and without any gaze at the concept of Halal-o-Haram. These investments could be prize bonds, interest bearing bonds etc.Unlike insurance companies, Takaful companies undertake only Shari’ah compliant business and the profits are distributed in accordance with the initially agreed ratios in the Takaful contract.

Forfeit:
Under this rule the insurance company deduct the premium which has been paid been policyholders when policy holders cancel their contract. On the other hand Islam does not allow deduction of contribution as forfeit in Takaful.
Virtues:
Takaful helps people to mount up their saving for goodness of whole community, to practice Islam. Insurance is a tool to accumulate money to rationalize their needs, which leads to selfishness. Takaful is more suitable than conventional insurance to whole mankind especially to the vast Muslim community of the world.

Profit distribution:
Under Takaful contract every policyholder has the right to know how profits from different investments are divided among the participants but under conventional system there is no hard and fast rule for profit distribution, it is totally depends on company management.

References:
Reference — Al Quran:
Takaful is a form of mutual help (ta’awun) in furthering good/virtue by helping others who are in need / in hardship. Help (ta’awan) one another in furthering virtue (birr) and Allah consciousness (taqwa) and do not help one another in furthering evil and enmity”. Al Maidah: verse 2 (5:2).
Reference – Hadith:
The hadith implied a strategy to mitigate/reduce risk.Takaful provides a strategy of risk mitigation/reduction by virtue of collective risk taking that distributes risks and losses to a large number of participants. This mitigates the otherwise very damaging losses, if borne individually. * “tie the camel first, then submit (tawakkal) to the will of Allah”
OBJECTIONS:
There are conflicts among several rules of Takaful and operation, which leads its frame work against sh’ariah. These issues are

The common practice of contribution made by policyholders as ‘tabarru,which means donation. The Shari’ah ruling on donation, similar to those concerning gifts and charity, is that once made, the maker loses any right to it and may not recall it or receive back any portion of it (Mohd, 2011; Bekkin, 2007). Therefore, if paid contributions are referred to as tabarru, the policyholder would legally be unable to make a claim and receive compensation in cases of loss.

The models used in takaful also raise some questions. The mudarabah model creates conflict because tabarru is not meant to be a profit making and sharing relationship (Imran, 2011). Therefore, tabarru fund cannot be mudarabah capital at the same time. The sharing of underwriting surplus between the takaful participants and the operator turns the mutual insurance into a commercial venture not an agreement for mutual cooperation and assistance. Imran (2011) and Jaffer, Ismail, Noor & Unwin, (2010) express misgivings about the practice of the takaful operator advancing a non-profit loan to the fund in the case of deficit. This technically converts the operator, as mudarib, to a guarantor which is not a feature of the mudarabah contract.

The common practice among takaful operators is of mixing financing models so as to maximize profits of operators. Muhammad (2011) raises the important issue of whether the takaful scheme is really a mutual co operation or proprietorship. One has the feeling that Islamic ideals have been sacrificed to ensure the economic viability of the takaful company. Also, in takaful, the question to which there is no unanimous answer is whether the amount on the policy should be regarded as a gift to the beneficiary, or that he holds it in trust for the heirs of the deceases which may or may not include him (Ismail, 2009)
A number of takaful company purchase reinsurance from conventional reinsurers due to the lack of adequate retakaful providers (Arbouna, 2000) or the retakaful operator may not be subjected to the same rigor of scrutiny concerning Islamic principles as is done for the takaful company(Mohammad, 2009). Finally, a crucial issue is created by the conflict of laws regulating takaful. In most cases, the company may be bound to follow regulations and implement practices which are not Shari’ah compliant. In addition, each takaful operator usually has a Shari’ah Advisory Board whose function is to ensure that the takaful company operates within and remains Shari’ah compliant. The problem here is that there is no central Shari’ah board which would ensure the uniformity of practices amongst the companies.

The absence of uniformity of laws regulating takaful, is also a deterrent to ensuring that the same service is obtained worldwide. While certain jurisdiction may have achieved a significant degree towards ensuring the system conforms to every Islamic ideal, others are still far behind.

Under Takaful contract every policyholder has the right to know how profits from different investments are divided among the participants but under conventional system there is no hard and fast rule for profit distribution, it is totally depends on company management.
To make people familiar Government and Scholars must develop and refine Takaful which is contrary to conventional insurance, based on Riba,Gharar and Maisir.

Conclusion:

In our study we discussed Concepts of Takaful and conventional insurance; model; operations; accounting systems; and did comparison of Takaful and insurance. takaful can provide products and services to corporate clients despite insufficient financial capacity to provide amount of coverage and Islamic financing products offered by Islamic banking still being at the development stage whereby most corporate customers use conventional loans to finance their assets. It shows that takaful business can be expanded and developed through the harmonization of operational and shariah issues through the application of the principles of fiqh with specific justifications.

The assessment of conventional insurance indicates that an Islamic alternative is the preferred choice for Muslims thus the introduction of mutual insurance referred to as takaful. However, this system though striving to encapsulate Islamic principles still faces challenges. One must, however, agree that monumental bridges have been crossed towards the islamization of financial services. Thus, despite the presence of certain practices and principles which should be subjected to closer scrutiny, takaful insurance is still the better alternative for Muslims.

References:
Dorfman, M.S., (1978). Introduction to insurance, Englewood Cliffs, USA:Prentice-hall.

Essential Guide to Takaful (Islamic Insurance) by Engku Rabiah Adawiah and Hassan Scott

Islamic and Modern Insurance – Principles and Practices by Mohd. Ma’sum Billah

Takaful and Retakaful – Advanced Principles & Practices by Tobias Frenz and Younes Soualhi

Al Ta’min wa ahkamuh by Sulaiman bin Ibrahim

Takaful (Islamic Insurance): Concept,Challenges, and Opportunities by Safdar Jaffer Farzana
Ismail, Jabran Noor and Lindsay
Unwin
Bekkin, J.(2007). Islamic Insurance: National Features and Legal Rgulation, Arab Law Quarterly, Vol. 21, pp. 109-134
Jaffer, S., Ismail, F., Noor, J., Unwin, L. (2010). Takaful (Islamic Insurance): Concept, Challenges, and Opportunities, Millman Research Report, November, 2010.

Mohamed Ma’sum Billah, (2003b). Islamic Insurance (Takaful), Selangor, Malaysia: Ilmiah Publisher