Islamic Banking and Finance Research Paper of 13 pages

Everybody values own properties and life. This value inspires protection from loss and to avoid risks by all ways and measures. The examples of events which people are vulnerable to are theft, accidents, deaths, hurricanes, and fire. Insurance was therefore, invented to indemnify a member from a loss. Insurance is a not a new concept per se. The ancient Arabic trade caravans would contribute funds to help a member from loss due to robberies or any disaster on their way to Asia. The Chinese are also great insurance icons. 5000 years ago, Chinese families tied together houses to prevent drowning and to share risks as their houses were on floating water. In ancient Rome, the survivors of a military member who died were compensated by being offered some money as assistance. The other pioneers of insurance are Rhodes who formed the first law on loss in relation to cargo transportation via sea, the Phoenicians, and Lombardians. Insurance is therefore, a tool that helps to control such risks. Modern insurance is traced to 1977 when academicians from Saudi Arabia tried to resolve takaful as cooperative insurance, leading to the formation of the first insurance company in 1979. Generally, Islam allows risk management concept. However, it enhances risk management under certain conditions such as not making profit at others expenses. The initiatives to solve risk problem in ways that comply with sharia have led to Takaful emergence. In this perceptive, the purpose of this research paper is to tackle the concept of Takaful insurance. It is an interesting topic worth studying in that its formation reflects Islam religion. Islamic banking and finance will first be looked into before narrowing down to takaful insurance. Islamic banking sets the foundation for Takaful insurance.

Table of Contents Abstract 2 Introduction 4 Islamic banking and finance overview 4 Takaful definition 5 Takaful principles 7 Takaful insurance model 8 Takaful features 9 Takaful and conventional insurance 9 Variations between Takaful and conventional insurance 10 Takaful development 11 Takaful milestones 12 Takaful models 12 Mudarabah model 12 Wakalah model 13 Wakalah / Mudarabah hybrid 15 wakalah with Waqf 17 Takaful products 18 Family Takaful 18 Family takaful types 19 General Takaful 19 Retakaful and reinsurance 20 Conclusion and recommendations 21 References 23

It is obvious that human activities are prone to loss risk from unexpected circumstances. Insurance has been there for several years back to indemnify the individuals from losses. Insurance concept has been exercised in different places for several years. During those days, trade caravans who encountered risks were the same as those faced presently in trading activities were there. The Muslim academicians recognize that shared reasonability basis in Al aagilah system as exercised between Madinah and Makkah Muslims laid mutual insurance foundation. It encompassed contributions from the members to share responsibility to indemnify victims against finance liability from events. Prophet Muhammad accepted that system under mutual protection principle and cooperation in good deeds and virtue. Shared responsibility in “Aquila” system as exercised between the Muslims of Medina and Mecca therefore, laid mutual insurance foundation. Islamic insurance was formed in the early Islamic century second era when the Muslim Arab traders who expanded into Asia agreed to make contributions to a fund to cover any colleague who was robbed along the way or was befell by a disaster referred to as marine insurance. In this perspective, this research paper aims to analyze takaful insurance in-depth (Cheikh, 2013). The first section will define takaful insurance, origin of the concept, takaful principles, features, models, takaful development, difference between takaful and conventional insurance, takaful products, Retakaful and reinsurance, and lastly conclusion and recommendations.

Islamic banking has been making stellar improvements to become a competitive and feasible option to conventional systems globally. Islamic banking inclusive of finance institutions have garnered footholds in south East Asia and Middle East. These hubs have been playing a great role about raising the awareness of Islamic banking in Western finance markets and businesses. The elements which have contributed to Islamic banking and finance success are spiraling oil prices globally, long boom in middle east economics, innovation of products and complexity, receptive convention regulators attitude and advancements in information technology which have been pushing Islamic finance and banking to expand globally (Khan & Bhatti, 2008). Provided the growth trends, there is high probability of Islamic banking winning over a large percentage of customers from Muslim nations in the future. The growth in Islamic banking as well as finance is attributed to “Islamic revival”.

While “mainstream economics” is still dominating the world, there has been “Islamic revival” in several Islamic nations since 1970s resulting in “Islamic economics” appearance. Implementation of Islamic economics was viewed as a shift from colonial rule toward Islam and has established key transformations in various economic sectors. In the nations where, Islamic economics ideologies have become famous, finance services have been offered to comply with Islamic principles. As a result, new banks have been formed according to Sharia requirements and there has been a remarked Islamic banking and finance growth. Islamic banking generally refers to a banking system which is based on Islamic principles or sharia and depends on Islamic economics for guidance (Egresi & Belge, 2017). The key Islamic banking principles are profit and loss sharing and not collecting and paying interest by investors and lenders. Islamic banks must shun away from transactions which attract excess risks for example, gambling or transacting products and services which Islam prohibits. Takaful insurance also shares ideas with Islamic banking as its foundation is based on Sharia principles.

Takaful is Arabic terminology which stems from “Kafalah” meaning guaranteeing one another. Takaful generally implies mutual assistance. It is focused on ta’awun (mutual assistance and tabarru’ (donate) whereby the associated is shred among people in a voluntary manner. Takaful legitimacy is gotten from the Sunnah and Quran (Maarifa Academy, 2014). This terminology shares similarity with compensation principles and shared responsibilities. Takaful or Islamic insurance implies an agreement process among a group of people to deal with injuries which emanate from certain risks to everybody is vulnerable. A process is introduced which involves contributions payment as donations, and resulting in an insurance fund formation which enjoys legal entity status and has independent finance liability. This funds resources are meant to indemnify a participant who is struck by a disaster (Cheikh, 2013). The management of the funds is by a chosen policy holders or joint stock company which manages insurance functions and invests fund assets, against a certain fee.

Takaful is traceable to ancient Arabs as a unified liability which made offenders to compensate the victim. It later expanded to varied dimensions inclusive of sea trade to cover any colleague who was robbed along the way or was befell by a disaster referred to as marine insurance (Cheikh, 2013). Other traditions also form takaful origins examples being Kafalah, Diya, mulawat, Al-Tariq, Hilf, and Ju’hala. Tabarru’ (donation or contribution) is core of Takaful freeing it from gambling and uncertainty.

Takaful industry is experiencing quick growth. Takaful contributions increased by nineteen percent (19%) in 2010 and were expected to reach twenty-three percent (23%) by 2012. Takaful is not restricted to the Muslim fraternity only. Its values are one and accepted by all religions (Cheikh, 2013). In addition, it has in it a profit sharing element which may be good to growing an investment segment that is ethical. Takaful goal is to pay a loss that is defined from a fund that is defined.

Takaful refers to the way of bringing economic and social benefits of contemporary insurance coverage, in a manner consistent with their religious beliefs, to Muslims, and to merging economics of several Muslims nations. Therefore, Takaful development is important, both to social inclusion in non-Muslim nations, and to economic development in various nations with emerging economies. Surprisingly, Takaful industry is experiencing quick growth (Cheikh, 2013). However, Takaful development encounters barriers because of difficult structure of understanding Takaful and pending problems related with it. These problems add to making a proper regulatory and legal infrastructure development besides finance reporting, rating, corporate governance among others.

Takaful concept is based on cooperative principle and on separation principle between shareholders’ funds and operations therefore passing Takaful fund ownership and operations to policy holders. The investment poll’s profits and losses are shared by policy holders. The policy holders are joint investors with insurance vendor who acts as the manager (Cheikh, 2013). Health and family plans now exist for Muslim communities. Islamic insurance necessitates each participant to make contribution into a fund which is used for supporting each other with a participant contributing adequate amounts to cover anticipated claims.

The basic Takaful principles are mutual indemnity and mutual contribution and has been exercised for centuries. Takaful has greatly helped in risk management and risk mitigation basing on shariah rules. Takaful ideology is to distribute loss among policy holders or participants instead of transferring to an insurance company as is exercised in conventional insurance (Cheikh, 2013). The key principles of Takaful are Ta’awun, Tabarru’, and riba, maysir, or gharar prohibition.

Takaful principles as explained by(Cheikh, 2013) are one must have a legitimate finance interest in subject matter to take part in takaful plan, takaful contract is focused on trust principle whereby all the required material information must be disclosed, finance loss can only be recovered and not gain in profit due to quantifiable loss, there is cooperation among policyholders for common good, takaful operator will find out the real significant cause which led to the loss in establishing compensation, each policyholder pays own subscription to assist those who require help, after compensation for loss the operator has right to claim from third party who caused the loss, losses are sub-divided and the liabilities spread as per pooling system, uncertainty is eradicated with regard to compensation and subscription, and does not obtain merit at others cost.

Takaful insurance model features mutual concepts of mutual protection, mutual help, and mutual responsibility as shown by the below diagram.

Takaful exhibits cooperative risk sharing, sharia compliant strategies and policies, and clear finance segregation. Cooperative risk sharing via donation use was meant to cancel gharar and riba elements in takaful and solve social responsibility issues, solidarity and need to care for others (Maarifa Academy, 2014). The premiums paid by the policy holders are seen as donations to help the members who suffer loss.

Under strategies and policies, insurance funds investment must be made on ethical businesses without harming the environment or people. Ethic considerations cover investments in products or businesses which do not contradict sharia (Maarifa Academy, 2014). Both end product and process must comply with sharia. The operators must have a standardized sharia governance system to see to it compliance with sharia.

Under finance segregation, there must be clear segregation between operators and participants in Islamic law. In addition, the insurance company role is limited to an operator managing portfolio and investing the contribution on policyholders’ behalf. In conventional insurance, the insurance companies’ objective is to make profit and agree to bear policy holders finance burden and losses (Maarifa Academy, 2014). The shareholders are eligible for profit and bear any deficit burden at finance year close.

Takaful is an Islamic option to conventional insurance where the funds are contributed by members into a pool based on ta’awun or mutual help and tabarru’ or donation to share mutual risks. Conventional insurance approach is based on uncertainty or gharar, indemnity contract, gambling or maysir, and interest-based investments involvement or riba (Maarifa Academy, 2014).

Conventional insurance is traced to tenth century10th before Christ when the first law in relation to public loss was issued in Rhodes, especially losses from cargo transportation via sea. Same types of cooperative insurance were evident in china around 5,000 years back when some families dwelled in houses that were floating on water. To save a house from drowning, the families decided to tie together the houses to share risk. Some communities assisted military members’ family when one of them died in ancient Rome (Maarifa Academy, 2014). The community offered vital salaries and money to survivors in exchange of subscription that each member paid. Insurance concept spread to Phoenicians then, Lombardians. The pools were formed and funded by merchants who possessed goods to minimize losses prone to any merchant.

The variation between the two insurance are parties to contract, premiums payments, and insurance funds investment. Takaful insurance combines tabarru’ contract as well as profit or profit sharing contract (Maarifa Academy, 2014). Conventional insurance is exchange contract between insured and insurer.

In Takaful, the participant is obliged to contribute to the scheme and must mutually share the surplus. In conventional insurance, the participant is obliged to pay premium to insurer (Maarifa Academy, 2014).

The Takaful operator receives a fee for managing the fund and from profit-sharing scheme. In conventional, the company makes profit when there is underwriting surplus. On the other hand, the counter value is effort and or risk undertaking while in conventional insurance, there no clear valid counter value (Maarifa Academy, 2014). Profit source is hoping that uncertain future will be in insurer’s favor.

Takaful operator poses as fund administrator and attracts benefits. If fund is inadequate, operator must offer a loan that is interest free to correct the deficiency (Maarifa Academy, 2014). Insurer is liable to pay benefits as promised from insurance funds or shareholders’ funds in conventional insurance.

Indemnification part is focused on mutual contribution while the indemnification in conventional insurance is a commercial relation between insured and insurance company (Maarifa Academy, 2014).

The insured-insurer relationship between participants and takaful operator is not there in takaful. The participants pose as insurer and insured at the same time (Maarifa Academy, 2014). In conventional, there is a clear insured-insurer relationship.

The Takaful funds must be invested in sharia compliant instruments while there is no restriction in funds investment in conventional insurance (Maarifa Academy, 2014).

Takaful development in contemporary times was introduced by Abidin Ibn, an Islamic judge and lawyer who attracted by insurance concept, with an emphasis on marine insurance as it common during that period (Maarifa Academy, 2014). In a similar vein, Muhammed Abduh another great jurist viewed insurance transaction as same as Mudaraba financing and that transaction which is same as life insurance or endowment is legal.

The efforts towards the institutionalization of takaful were set by Sudan in the year 1979 and Malaysia in the year 1984 (Maarifa Academy, 2014). The key role in Takaful development was by Islamic scholar council declaration in Saudi Arabia and Majma in 1985 when conventional insurance was declared forbidden and only the insurance based on sharia was permissible.

Takaful development is in a span of six years.

· The resolution on takaful as cooperative insurance by Saudi scholars took place in 1977.

· A breakthrough was in 1979 when an Islamic insurance company in Sudan.

· In 1980, an Islamic Arab company was formed in the United Arab Emirates and in Saudi Arabia.

· The fist law in takaful was formed in 1984 in Malaysia.

· OIC academy approved takaful system in 1985 but left the work to the scholars (Maarifa Academy, 2014).

The contributions in the takaful industry were expected to hit twenty-five billion dollars in 2015. The growth is approximately ten to twenty percent annually (Maarifa Academy, 2014). The takaful market attained nineteen billion dollars in 2017 and the market is forecasted to exceed forty billion dollars by 2023.

The key parties of takaful system are takaful operator and participants. The models examples consist of Mudarabah, Wakalah, Wakalah / Mudarabah hybrid, and wakalah with Waqf.

This model is based on the trust partnership between takaful operator appointed by participants to manage takaful business. The funds contributed are participants risk fund and participants’ investment fund. The participants provide capital and own takaful undertaking. The operator is regarded participants’ business partner in investor to entrepreneur relationship under mudarabah contract (Maarifa Academy, 2014). The profit distributing ratios are predetermined. The participants bear finance loss while operator may lose managerial efforts.

Wakalah model is based on agency contract between takaful participants and operators where the participants own the fund while the operators pose as agent. The operator qualifies for agency fee for rendering the services. The fee must be clearly stated and specified in the contract. Agency fee must cover management expenses, distribution costs inclusive of intermediaries’ remuneration. Any surplus from investing the funds is diverted to participants (Maarifa Academy, 2014). Operator only receives agency fee focused on takaful model nature. The operator does not share risk in fund investment or management.

The model is a mixture of wakalah and mudarabah. The wakalah is used for underwriting while mudarabah is used for investments. The multi-tasking of the operator makes this model distinct. Takaful operator qualifies for agency fee for agent role. Moreover, the operator is qualified to a share in profits realized for the management of investment activities as entrepreneur (Maarifa Academy, 2014). The income sources of the operator are agency fee, profit share from funds investment, and incentive fee. A significant element of this model is clear segregation between participants’ funds and shareholders’ funds.

In this model, the shareholder donates to common pool, forming waqf fund. The company becomes shareholders’ agent and is responsible for waqf funds management, paying mandatory claims. The company receives an agreed fee for posing as shareholders’ agents (Maarifa Academy, 2014). The company further manages such waqf funds’ investments as an entrepreneur, thus eligible to share in profit investment.

The two common Takaful businesses are general and family Takaful.

A family Takaful refers to savings and investment program which are long-term and have a fixed period of maturity. The plan enjoys investment profit and offers mutual finance help among participants. This Takaful is a finance program which unites efforts to assist one in times of need because of sudden death among other events which lead to disablement or injury (Cheikh, 2013). Takaful plans would allow participation in a Takaful scheme with the objectives of saving regular, invest with a desire of making profit, and avail cover in terms of benefits to the successors in case a participant pass on before maturity.

The examples of Takaful plans which can be invested in are family Takaful mortgage plan, family Takaful plan for education, group hospitalization and medical benefit, and group family Takaful plan. family takaful is the same as life insurance (Cheikh, 2013). Other examples are accidental death, retirement plans, savings and education plans, Waaqf plans, and disability (Maarifa Academy, 2014).

Family takaful consists of ordinary collaboration, collaboration focused on certain groups, and collaboration with savings. In ordinary collaboration, the participants agree to contribute funds via donations. The premiums are used for the underwriting activities in case of a disaster for a member (Maarifa Academy, 2014). The payment is made directly to participant or beneficiaries according to takaful contract.

Collaboration focused on certain groups reflects ethnic, organization, or community needs. The participants from similar community assemble to form a common funds pool for a certain objective. The membership is restricted to who stem from similar group (Maarifa Academy, 2014). Contributions may be made jointly by participants and the organization. The benefits can be enjoyed by beneficiaries or participants.

General Takaful schemes refer to joint guarantee contracts on short-term among participants to offer mutual compensation in case of loss (Cheikh, 2013). The schemes are meant to fulfill needs for individuals and organizations protection with respect to material loss or damage as a result of a catastrophe. This scheme is renewable annually.

General Takaful means Islamic concept where the participant contributes money to a fund in terms of participative contribution. The person enters into contract to become among the participants by agreeing to mutually assist one another in case a participant suffers a misfortune due to death, loss, damage, or permanent disability (Maarifa Academy, 2014). This product is the same as general insurance.

Contributions gathered from policyholders are seen as donations and form Takaful fund from which all the claims are reimbursed (Cheikh, 2013). At year close, after deducting the expenses, any cash surplus that remains will not be retained but will be released to policy holders under cash dividends.

Examples of disasters covered by general takaful are motor, fire, employer liability, fire consequential loss, theft, workmen compensation, machinery breakdown, and health (Maarifa Academy, 2014).

Retakaful is an option to reinsurance. It refers to takaful business reinsurance on Islamic rules. It is an insurance where an insurance company has the ability to transfer to another insurer part or all of its liabilities against agreed portion from insurance contribution, this allows insurance company to safeguard itself against insolvency risk. Retakaful bases on direct insurance companies’ inability to insure the properties whose finance value is high for example, large factories’ and big stores (Maarifa Academy, 2014). Second, to increase direct insurance companies’ capacity in the section of accepting risk to improve their gains.

In conventional insurance, the insurance operators share risks collectively. The large insurance companies underwrite small insurance companies’ risks. Reinsurance is a way of mitigating such high risks by transferring risks to a reinsurer. Retakaful is based on Sharia. Risk aversion is structured in a manner where the takaful operators are participants in undertaking with a large company. An amount that is agreed is paid periodically from operators’ fund as premiums to Retakaful company (Maarifa Academy, 2014). All underwriting risks of takaful operators are insured by Retakaful company.

Takaful generally implies mutual assistance. It is based on mutual responsibility, mutual help, and mutual protection. The concept encourages participants to contribute funds to a takaful system the funds, which are then, used to help a member in case of a loss. The participant choose a takaful operator to oversee the funds. The operator is paid an agency fee for the service rendered. Takaful concept originated from Kafalah among other traditions such as Diya, mulawat, Al-Tariq, Hilf, and Ju’hala. Takaful legitimacy is gotten from the Sunnah and Quran. Takaful exhibits cooperative risk sharing, sharia compliant strategies and policies, and clear finance segregation. From the discussion, it is evident that takaful is different from conventional insurance. Conventional insurance is based on uncertainty or gharar, indemnity contract, gambling or maysir, and interest-based investments involvement or riba which are not accepted by Takaful. The model’s examples consist of Mudarabah, Wakalah, Wakalah / Mudarabah hybrid, and wakalah with Waqf. The types of takaful insurance that a person can join are geeral and family takaful. The recommendations are to choose Takaful over conventional insurance. Takaful is based on Sharia with regards to Sunnah and Quran and prohibits gharar, indemnity contract, maysir, and riba. Moreover, Takaful industry is experiencing quick growth. The takaful market attained nineteen billion dollars in 2017 and the market is forecasted to exceed forty billion dollars by 2023. Takaful is also not restricted to the Muslim fraternity only. Its values are one and accepted by all religions. In addition, it has in it a profit sharing element which may be good to growing an investment segment that is ethical.

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