The word ‘Takaful’ originates from the Arabic verb ‘kafalah,’ which means ‘to help one another’ or ‘mutual guarantee’ whereby a group of participants agree among themselves to support one another jointly for the losses arising from specified risks. According to the Takaful model, the participants contribute a sum of money as commitment (Tabarru) into a common fund that will be used mutually to assist the members against a specified type of loss or damage.
Takaful is an insurance product promoted as an Islamic alternative to conventional insurance and is regularly referred to as “Islamic” Insurance. The primary differentiation between Insurance and Takaful is that the earlier is a risk-transfer model whereas the latter is a risk-sharing model. Therefore, Takaful insurance is based on sharia or Islamic religious law, which explains how individuals are responsible to cooperate and protect one another. Takaful offers Muslims a valuable risk management tool and the first true alternative to conventional insurance in both the life and non-life sectors that is acceptable to the Muslim faith. However, for non-Muslims, Takaful products potentially offer an alternative source of insurance protection with different investment objectives, an approach to surplus distribution, and an oversight system with an ethical dimension. The key difference between Islamic insurance and conventional insurance is that in conventional insurance there is a risk transfer mechanism whereby risk is transferred from the policyholder (the insured) to the insurance company (the insurer) in consideration of an ‘insurance premium’ paid by the insured. While Islamic insurance is based on mutuality; hence the risk is not transferred but shared by the participants, who form a common pool. The company (takaful operator) acts only as the manager of the pool. In effect, the policyholders are both the insurer and the insured.
Takaful was established in 1979 in Sudan. It only gained momentum in early 2000 when the Malaysian government promoted it and significant growth was witnessed thereafter. The growth of Takaful has varied significantly from country to country and its success, or otherwise, has been largely dependent on the awareness and affluence of the local population, as well as on the robustness of the local regulatory framework. Hence the highest growth has been observed in places such as Malaysia (with its considerable awareness of Takaful and robust regulatory framework), whereas growth in the Middle East has only recently begun to take off.
Takaful is not a type of insurance but rather an alternative to insurance. It has to operate on cooperative principles and incorporate the concept of Tabarru’ (donation, gift). Instead of paying an insurance premium, Takaful participants (policyholders) donate their Takaful contributions to a common pool to mutually assist the members against a defined loss or damage. It is a one-way transaction which does not expect a definite return on the donation, unlike the more traditional bilateral conventional insurance contract where a premium is paid in return for an insurance benefit.
The most popular products are Motor Takaful, Medical Takaful and Pension.
The main misconceptions regarding Islamic Insurance (Takaful) are as follow: 1. Takaful is only for Muslims: More often than not, many non-Muslims dispel the notion of even exploring Takaful because they think it is religion-exclusive.
2. The objective of Takaful is different from conventional insurance: The characteristic of Takaful that has brought about this misconception is that Takaful does not exist for profit, but rather holds mutual assistance of its participants as its main objective.
3. Takaful contains unethical elements due to its religious nature: Due to the pious undertones of Takaful, many tend to carry the misperception that Takaful does not protect one’s interest as well as conventional insurance policies. Indeed, Takaful operators are limited by the fact that they are not allowed to deal with any investments that contain elements of usury, gambling or uncertainty, and the ultimate objective of the participants is mutual assistance and not profit; however, Takaful funds are by no means fruitless or bear higher risk of being liquidated.
Despite the misconceptions like every business Takaful also faces several challenges including;
Lack of consumer awareness- Despite the introduction of Takaful, the increase in the level of penetration anticipated has yet to be realised. Many consumers are still unaware of Takaful as an alternative, and some view Takaful as commercialisation of conventional insurance into the Islamic world and reject the notion that it is a Shariah-compliant instrument. Scarcity of human resources with both insurance and Shari’ah expertise- Future growth may also be hampered by the currently narrow pool of professionals with sufficient Takaful knowledge in areas such as law, sales, and actuarial services. Most operators would typically employ human resources, such as legal advisors and actuaries, with conventional insurance experience. These resources would typically tend to learn the Shari’ah aspects of Takaful and adapt their previous experience to incorporate Shari’ah compliance rules in their new role. Hence the mindset of most operators tends to be driven by conventional thoughts and solutions and, as a result, there has been limited original thinking in the industry.
Shortage of Shari’ah-compliant assets- The lack of suitable (Shari’ah-compliant) investment vehicles, particularly those with longer term duration. There are a number of hurdles related to the Shari’ah-compliant assets in which companies must invest the contributions made by Takaful participants. The lack of Shari’ah-compliant assets restricts product innovation because of the liquidity and mismatching risk as well as potentially lower returns. Introducing pension-related products and variable annuity types of products would be challenging in the absence of long-term investment vehicles.
Determination and distribution of surplus- As insuring risk by a third party (transfer of risk) is prohibited in Islam, any surplus or profits earned out of the risk element are by default prohibited. There is divergence of opinion with regards to the nature and treatment of the underwriting surplus in Takaful which sometimes finds it difficult to implement certain opinion for the benefit of the participants. However, despite all the challenges the future of Takaful industry is very bright as both Muslims and non-Muslims are embracing the Takaful model. If the industry produces better business strategies and employs skilled personnel with Shari’ah knowledge about Takaful there is no telling how far the industry can go.
By: Leila Adam
