Shari'ah Principles Governing Takaful Models
Takaful is an Arabic word that means mutual protection and indemnity: one party, while providing help to others, is also indemnified by them. This idea of mutual protection is in clear contrast to the profit motive which underlies conventional proprietary insurance. The concept of takaful is fundamentally different from conventional proprietary insurance, although it has affinities with conventional mutual insurance. To put it simply, conventional proprietary insurance is the business of selling protection or indemnity for a certain amount of money. The insured will benefit from the protection and indemnity to be provided by the insurer, while the insurer will benefit from the premium paid by the insured. The element of mutuality is absent because the insurer views the insurance contract as a purely commercial contract with its own risk and reward profile. Takaful, on the other hand, is centered on the principle of mutuality and avoids any commercial contract between the insurer (the insurance company) and the insured (the policyholders). The concept of providing indemnity under takaful does not involve any commercial relationship between the insurer and the insured. In fact, the takaful operator is not an insurer as understood in conventional insurance markets, but merely an operator who manages the takaful operations (underwriting, risk calculation, investments, claim processing, and so on).
Being different in concept and practice, takaful is based on a set of principles that are both Shari'ah compliant and economically viable. Also, it is equally important that takaful practice is of a high standard of corporate governance and risk management, as well as embracing best practices in the industry. This chapter aims to explain the important Shari'ah principles that govern and regulate the practice of takaful as a new way of providing protection and indemnity to members of society. While some of these principles relate directly to the very structure of takaful, others incorporate a basis for some regulatory and best practice requirements in order to add value to this new instrument.
3.2 TAKAFUL: NOMENCLATURE AND CONCEPTUAL MEANING
Takaful, from the standpoint of pure semantic and Arabic morphology, indicates two parties or more providing an indemnity to one another. As much as one party intends to indemnify his fellow participant, he also expects to be indemnified by the other parties. Everyone must contribute some amount of money to a common fund, but not all of those who contribute to this fund necessarily receive any consideration in return, as the actual payment of any indemnity will depend on the occurrence of a certain specified type of event against which the takaful fund is established to provide indemnity. The scheme provides an opportunity for each participant to be indemnified only in the case that he is entitled to the indemnity. Any compensation must be provided from within the takaful fund and not from outside. This feature makes Islamic insurance or takaful distinct from conventional proprietory insurance. Takaful emerged as a new concept in the mid-1980s, when Shari'ah scholars approved a takaful product for the first time in modern history.1
As a necessary background, it is appropriate to reiterate that conventional insurance—with the exception of mutual insurance schemes—is based on the principle that the insurer provides indemnity in return for a premium paid by the insured—that is, the policyholder. Put simply, the insurer, by law and practice, sells an indemnity for a premium; thus, the risk of loss is transferred to the insurer entirely. This, in a nutshell, makes insurance a sale or transfer of the risk for a price. The seller of indemnity against risk, namely the insurer, has accepted, for a price, the transfer of the risk exposure of the insured to his account, and he will be liable to indemnify (that is, pay a claim from) the insured if the insured risk actually results in a loss, and hence, gives rise to a claim. Otherwise, the insurer will earn a profit from this contract because the premium received is not offset by any claim. All premiums received are for the sole benefit of the insurance company, and for this, the company is solely liable to provide indemnity. The commercial gain to this company is derived from the underwriting surplus and the investment yield on the funds provided by the premiums. The transfer of risk is the essence of the conventional insurance business for which proprietory insurance companies are set up. To make the insurer a responsible and viable corporate entity which can honor its obligation to provide indemnity at all times, a great many regulations have been drawn up.
A takaful operator (TO), on the other hand, is not an indemnity provider. The obligation to pay the claims lies with the takaful fund, alternatively known as a risk fund. According to the Shari'ah Standard on Takaful, this fund is the result of donations (tabarru') contributed by all participants or policyholders. All participants agree to join a scheme of mutuality of contribution (premium) and protection (indemnity). Each and every participant agrees to contribute a donation to this fund, on the understanding that, based on the deed of the takaful fund, any claim for indemnity by any participant will be paid from this fund. The TO is not, technically and legally speaking, under any obligation to pay all the claims as is the case for a conventional insurance company. Participants, who are donors when they contribute to the fund, are not necessarily also recipients or beneficiaries unless they have a valid reason to claim from the risk fund. The donation act has transferred the donated amount to the risk fund; thus, the donors have given up their individual ownership over the amount of money they donated. When they receive compensation, this is not from their own donation. Rather, the indemnity amount is paid out of the risk pool, which is collectively owned by all the participants. Technically speaking, the compensation has no relationship with the original individual contribution made by the indemnified participant.
From both an economic and a TO's perspective, takaful offers an entirely new business model. It differs from conventional business in that it involves risk sharing instead of risk transfer, and more specifically in the following respects:
(a) The obligation to pay the claims, if any, is vested with the takaful or risk fund. However, the TO as the initiator and manager of the risk pool may be legally obliged2 to ensure the solvency of the takaful fund by providing an interest-free loan (qard hasan) in cases where claims exceed contributions (and reserves). The loan has to be paid back by the participants out of future contributions.
(b) While the underwriting surplus is the main source of profit for conventional insurance companies, TOs may receive income from wakalah fees, which are normally paid upfront out of contributions, profit sharing from the investment yield, and in some exceptional cases, surplus sharing from the underwriting surplus.3 The second source of income is of particular relevance for family takaful with a substantial savings component, while the third source is accepted only in a few jurisdictions (in particular, Malaysia). The structure of fees and ratios depends on the modes of takaful management being adopted by respective TOs, which will be explained in the next section.
3.3 SHARI'AH PRINCIPLES GOVERNING TAKAFUL CONTRACTS
This chapter will examine a few Shari'ah principles which are deemed significant in shaping the takaful contract, as well as in making takaful a viable economic product in modern times. This section will deal with general Shari'ah principles only, while specific rules that are peculiar to a particular model of takaful management will be dealt with in the subsequent section. The issues to be discussed in this section include, inter alia, the rationale for using the contract of donation to render takaful Shari'ah compliant, the principle of risk sharing instead of risk transfer, the ownership of the takaful fund, and the obligation of a takaful undertaking to pay all the claims in the case of a deficit of the takaful fund.
3.3.1 The Basis of a Contract for Takaful
The first and fundamental question to be posed is whether or not takaful involves a contract. This question is significant from a Shari'ah perspective, as any financial dealing between people must be based on a particular contract to achieve the approval of the Shari'ah scholars. The contract must be compliant with Shari'ah principles. A contract of lending or borrowing money for a premium is not a valid contract because it is tantamount to riba. Likewise, a contract between two parties who agree to sell and purchase an asset the existence or specification of which is uncertain is prohibited, because the subject matter of the sale must be identified to avoid uncertainty or gharar. Takaful must be based on a valid contract to legitimate its operations, which include the contributions of the participants to the takaful fund, the investment of these monies, and the payment of the claims to those who are entitled to them. These are all financial transactions which require a contractual basis to be valid and legitimate.
Relatively speaking, the modern or conventional concept of insurance is easier to understand and appreciate, particularly from a commercial perspective. It is simply a contract that imposes on the insurance company as insurer an obligation to provide either the sum insured or the payment of a claim. The policyholders have to pay a premium to benefit from this contract. Being a company which has an established duty under the contract, the company must be seen, from a regulatory perspective, to be financially solvent to meet this obligation. This justifies the requirement of sufficient capital when setting up an insurance company, as well as the observance of a solvency margin to ensure the financial ability to pay the claimants or beneficiaries what is due to them under the contract.
Takaful cannot adopt the same concept because Islamic law requires that the contract of exchange—that is, exchanging protection for a premium—has to be free from uncertainties in the countervalues. Being free from uncertainties is never possible in the insurance industry, because uncertainties are peculiar and integral to both premium/contribution and claim/compensation. In response to this, the first global fatwa issued for Islamic insurance required the takaful contract to be based on a different type of contract—namely, a tabarru' or donation contract. The legal argument for this fatwa was very logical, though not necessarily commercially coherent and appealing. Having accepted the fact that uncertainties or gharar cannot be removed from the real world, a type of contract was considered which can tolerate the presence of uncertainties. Based on a fiqhi maxim which says, “uncertainties are tolerable in the gratuitous contract,” the concept of tabarru' was adopted for takaful. This is seen as the best principle to facilitate modern takaful schemes.
Technically speaking, tabarru' is the generic name, not for a bilateral contract, but for a unilateral declaration of intent, which is a contract with a particular nature in Islamic commercial law.4 The purpose of this type of contract5 is to give a favor for the recipient without any specific consideration in return. In its original form, it was gratuitous in character. In takaful, it implies that a person who participates in this scheme gives away some money to benefit the other participants according to agreed terms and conditions. The donor does not receive any predetermined consideration for this act. This contract is valid and enforceable in Islamic commercial law even for no consideration.
Tabarru' was originally not intended to satisfy any commercial purpose but rather to benefit the recipient alone. For this type of contract, the requirement of certainty of both the subject and the consideration is not relevant as the action is based on the goodwill or favor of the “donor.” The issues of uncertainty, mistake, fraud, or misrepresentation are not relevant because the donor voluntarily gives away his property or right to another party, and the recipient, in turn, receives this for no consideration paid. The issue of “non-satisfaction” of the contract cannot be raised, as the recipient never paid any consideration. The issues of uncertainty, mistake, fraud, or misrepresentation are only relevant in commercially driven contracts such as sale, lease, and so on, because one party to the contract may be put at a disadvantage due to elements of uncertainty in the contract, be it in the goods or services or the payment.
Having argued for the validity and relevance of tabarru' contracts, one may pose the question of whether a simple tabarru' contract is an effective instrument to make takaful practice economically and legally feasible. It is perhaps against this background that the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) approach to defining a takaful contract has developed a more technical view of tabarru'. It defines takaful as a collective undertaking (by the participants) to donate, and not simply as an individual donation contract. The element of undertaking has turned takaful into a more legalistic structure. According to this view, a participant who fails to contribute may subject himself to losing benefits which are an integral part of this undertaking. The benefits are usually related to the payment of compensation or indemnity in the case of death or any other risks specified in the policy.
Though this aspect, may make the takaful contract more structured and legalistic, it implies the challenging issue of whether an undertaking to donate can be made conditional upon the potential ability to benefit from this undertaking. Put simply, can a potential participant (donor) who undertakes to contribute (donate) a sum of money impose on the takaful fund that he will only do so on the condition that he could benefit from the risk fund should he suffer a particular loss or damage? This is known in Islamic commercial law as a conditional gift for a consideration, or “hibah mashrutah bi ’iwad.”
In the practice of takaful the gift or donation contract is not a pure or simple contract, as the participant will only donate to the takaful fund if he can potentially benefit from the fund in the form of claim and surplus sharing.6 The question that is posed is whether or not a conditional gift is permissible in Islamic commercial law. Some fiqhi texts are available to indicate that a gift with a condition of consideration is compliant with Shari'ah principles. In other words, there is no objection to someone donating something with a view that he may benefit from his donation in the future.7 The likelihood of receiving the claim from the participants/donors will not render the initial donation null and void as the claim may or may not happen. Even when the claim is paid, the amount is sourced from the common fund which is mixed and inseparable.
3.3.2 Principle of Risk Sharing Vis-à-Vis Risk Transfer
It is obvious by now that the reason Islamic insurance has resorted to the principle of donation—or, to be more precise, mutual donation among the participants—is Islamic jurisprudence would not allow any risk transfer in return for a premium. A risk can be transferred from one party to another as in the case of kafalah—that is, suretyship. However, the majority of the scholars have not allowed this transfer if it is for a fee to be paid by the guaranteed person, arguing that the contract of kafalah should be gratuitous in character. The provider of the protection, while assuming the risk from the guaranteed person in favor of the principal creditor, for example, shall not impose any fee for this service. This has been the view of many Shari'ah boards and is reflected in the AAOIFI Shari'ah Standards.
In the practice of insurance, the risk must be assumed by another party to alleviate the financial burden of the policyholder who happens to be inflicted with an accident. This is the cardinal principle and objective of insurance. As Islamic jurisprudence does not allow the transfer of risk for a fee, the principle of risk sharing has been advocated instead. Islamic jurisprudence does not prohibit the sharing and distribution of risk among a group of people if each and every one in the group has agreed to absorb parts of the risk of the group and of the financial burden according to an agreed formula. Therefore, the principle of risk distribution finds no objection from any texts of the Shari'ah as well as the views of the jurists. In fact, Umar al-Khattab, the second rightly guided Caliph, introduced this concept through his institution of Dawawin. Each section of the government agencies he created had to contribute money for the benefit of mutual help within the section. This practice endorses not only the principle of risk distribution, but also that of classification of risk, whereby the risk is assessed differently to ascertain the level of risk of each section. This works well in modern insurance and takaful, as the premium or contribution, must suit the profile of the risk being insured or distributed, as the case may be.
3.3.3 Ownership of Takaful Fund
It may be obvious that the takaful fund is a separate fund that does not belong to the TO or its shareholders. Generally speaking, the fund is owned by all the participants who have donated financial contributions to the fund. Depending on the management contract between the takaful participants and the TO, the fund will be managed by the TO either as the agent (wakeel) for the takaful participants or as a manager or entrepreneur (mudarib), or as both agent and entrepreneur. In all scenarios, the TO will not have any ownership right in the fund. The TO will only have the right to claim either fees or profit shares or both, as the case may be, from the fund.
Are the participants the owners of the takaful fund? To answer this question, it is appropriate to relate the question to the market practice to underpin the real issues. As for general takaful, the policy of takaful seems to view all the “premium” or contribution made by the participants as a donation. Each individual donation is an outright gift to another party who is the recipient for no consideration. Literally speaking, each participant has lost his individual ownership over the contributions he has made. However, owing to the concept of conditional gift which was discussed in the previous section, and also to the scheme of takaful, the participants collectively own the takaful fund and have individual rights to the fund according to the terms and conditions of their takaful policy (covering, inter alia, the amount of the donation, the claims to be paid from the takaful fund, and the rights in the underwriting surplus). One may conclude by simply saying that, although the participants do not have any individual ownership right over the takaful fund, they have a right to claim from the fund in certain cases which are prescribed in the deed of donation (or, rather, the takaful Policy Scheme).
The issue is somewhat more complex in family takaful where a savings element complements the risk protection. The practice of this scheme of takaful seems to view the contributions by the participants more as an investment than a donation. The reason is that only a (usually much smaller) portion of the contribution will be earmarked for risk protection and thus has the same qualities as takaful donations as discussed so far. The remaining (usually larger) amounts of the contribution will be managed as an investment to generate returns for the participants. They constitute a separate fund with specific allocations to the individual participants in the so-called participants' investment accounts. For all intents and purposes, the ownership of these funds is not collective but remains with the individual participants and is not transferred to a third party.
In both general and family takaful schemes, the ownership right over the takaful fund has never been transferred to the TO. Therefore, in the case of liquidation of the TO, it should be upheld that the creditors of the TO have no right of recourse to the assets of the takaful fund since these are not part of the TO's assets. The same principle applies in the case of underwriting surplus, whereby all the surpluses (if not retained in reserves for solvency purposes) should be distributed exclusively among all the participants proportionately. The participants may, however, agree in the takaful policy on another arrangement that binds all participants to award some of the underwriting surplus to the TO as a performance fee. They may also agree to create a reserve out of the underwriting surplus, or they may agree to give away the underwriting surplus to a charitable organization either during the lifetime of the takaful scheme or in the event of liquidation.
Having established this principle of law pertaining to ownership rights, one could raise an important issue regarding the extent to which the takaful fund is protected in the case of the liquidation of the TO. Is there any legal provision in the existing legal framework to affect the complete separation between shareholders' funds and the takaful fund? This could be addressed through either guidelines issued by the regulator or a Takaful Act. Alternatively, it may be proposed that the takaful fund is registered as a trust fund with a legal personality of its own, managed by the TO as trustee, and with the participants (in the case of claims and surplus distribution) as the sole beneficiaries. A trust fund is not affected by the bankruptcy of the trustee who is legal owner of the fund, as the fund is created solely for the benefit of beneficial owners or the beneficiaries, or simply the participants of the takaful scheme. This will surely give more legal protection for the takaful fund.
3.3.4 The Obligation of the Takaful Operator in the Case of Deficit of a Takaful Fund
A takaful fund can run into a deficit if the claims of a given period exceed the contributions and the reserves (which may be non-existent in the early years of takaful schemes). Since the participants are the risk bearers, their (future) contributions should cover all claims, but future contributions will not deal with the problem if an immediate insolvency of the takaful cannot be averted. For this purpose, the TO may provide a qard hasan, or benevolent (interest-free) loan, which will be recovered from future contributions. Existing Takaful Acts in many countries have not specifically prescribed an obligation of the takaful operator to provide a qard hasan to a takaful fund in deficit. However, some regulators have issued a guideline imposing on licensed TOs a requirement to provide this loan if the need arises. In some other jurisdictions, this obligation is well incorporated in the Articles of Association of the TO. Both approaches could satisfy the requirement to meet the prudential needs of the Islamic insurance industry, as the risk of insolvency (that is, non-payment of claims from the takaful fund) is mitigated by a third party undertaking to meet all the outstanding payments on a temporary basis (that is, pending repayment out of future contributions).
Recently, an increasing number of regulators are requiring takaful or retakaful operators to provide a qard hasan facility in favor of the takaful fund. The provision of this facility from the outset serves to secure the payment of all claims if the takaful fund runs into deficit. The facility is very visible to rating agencies and signals that the interests of the participants will be protected in case of an underwriting deficit, due to the availability of dedicated funds. However, there are a number of interrelated issues which require due consideration. These issues include the following:
(a) The provision of a qard hasan facility by the TO, and the drawing down of this facility, must not reduce the TO's capitalization. The funds still belong to the TO, since the loan provided is an asset of the TO and a liability of the takaful fund to which it has been provided. Hence, the provision of this loan will not entail any decrease in the regulatory capital of the licensed TO or reduce its ability to meet the regulatory capital requirement.
(b) From the TO's perspective, the investment returns from the assets backing the qard hasan facility must be for the benefit of the shareholders alone. However, to the extent that the facility has been drawn down in the form of liquid assets to meet claims, any such returns will accrue to the takaful fund, as explained below. Most important of all, the provision of this qard hasan facility must be compliant with Shari'ah principles with regard not only to the very purpose of providing this facility as standby capital for a takaful fund, but also to all relevant issues arising from a qard hasan contract, such as the benefit accruing to the shareholders/lenders, and the contractual relationship between the TO and the participants.
It is to be noted that the disclosure of capital for a qard hasan facility from the very beginning of the operation could be significant for rating purposes. These resources are earmarked for the support of the takaful fund in case of need. Subsequent to that principle of Shari'ah, once the qard facility has been drawn down, all the investment returns from the funds drawn down, if any, are the sole entitlement of the borrower—that is, the takaful fund—since the fund (as a representation of all participants) is under the liability to repay. This feature may not be beneficial, however, to the TO who provides the loan as the lender from the very beginning.
Once the qard facility had been utilized and is due to be repaid out of future contributions, the Shari'ah principles of qard prohibit any additional advantage for the lender either in cash or in kind. This implies, for example, that a wakalah fee for the TO which is based on that part of the participants' contributions that is set aside for the repayment of the previous qard might not be permissible. This is because, from the Shari'ah perspective, a loan contract cannot be combined with another contract that may be beneficial or advantageous to the lender. This is based on a Prophetic tradition which prescribes that any loan that generates extra benefit to the lender is tantamount to riba, or interest, which is prohibited. Pursuant to that argument, the wakalah management contract for a fee that is based on contributions, including amounts to be used to repay a qard loan, may be deemed by some scholars as giving an advantage to the lender in case of a deficit of the takaful fund, and thus is prohibited. Notwithstanding the Shari'ah objections to any benefit accruing to the lender under a qard hasan contract, as previously highlighted, the provision of a qard hasan facility is likely to serve the rating and capitalization purposes of a takaful scheme well. Therefore, we need to seek some solutions to render this practice compliant with Shari'ah principles, as well as fulfilling the requirements of rating and capitalization of a licensed takaful or retakaful operator.
It is against this backdrop that it is proposed that the provision of a reserve account under a trust concept could be a more holistic solution. Under this proposal, the TO can create a trust account with a certain amount of money (which is equivalent to an anticipated qard hasan amount). This account can be managed by the TO as the trustee. To meet the requirements of the rating exercise, the trust deed must clearly mention that the beneficiary for this trust account shall be the takaful fund, but that the account is to be invoked only in the case of the deficit of the fund. To reinforce the rating requirements, the trust deed shall mention clearly that it is irrevocable. The TO may continue to invest the trust assets for its own benefit. The investment income may be ploughed back into the reserve account. On the issue of capitalization, it is to be noted that this requires some legal argument that the trust account is as good as capital for the TO as the money will only be used for a specific purpose—that is, in the case of the deficit of the takaful fund. In normal circumstances, the funds in the trust account remain intact and stand to be returned to the settlor, who is also the TO if the trust expires.
The previous section has examined the Shari'ah principles that are common to all takaful practices irrespective of the management models being adopted by the TO. We shall now look at additional Shari'ah principles governing different takaful models. The three currently adopted models are wakalah, mudarabah, and a combination of wakalah and mudarabah. For the sake of clarity, these contracts do not concern the contractual relationship among the participants that effectively form the takaful fund, as previously explained under the principle of mutual donation and mutual help. These contracts of the different takaful models deal with the contractual relationship between the participants and the operator that manages the contributions paid by the participants. For all intents and purposes, these contracts refer generally to management and/or investment activities of the TO. Ironically, however, these contracts may have some implications for the very objective of the takaful scheme—that is, the provision of protection and indemnity for participants in case of need.
In a nutshell, the participants may engage the TO in three possible modes of arrangement.
1. The first option is a straightforward management contract known in Islamic jurisprudence as a wakalah contract. The participants as the principals may appoint the TO as their agent or manager to manage all the activities of the takaful fund according to established guidelines agreed by all the participants. A fee for this service has to be determined upfront (out of contributions) if the wakalah management service is to be rendered for a fee. All the profits and risks arising from managing the takaful fund will accrue to or be borne by the participants who are the principals.
2. Alternatively, the participants may appoint the TO as the investment manager under a mudarabah contract, under which the TO may share in the returns from the investment of the takaful fund (in a family takaful including the savings component) according to a certain agreed profit-sharing ratio. The TO will only benefit if there is some return generated from the investments of the takaful fund. Otherwise, there is no remuneration for the TO in return for its efforts and services.
3. Given the latter scenario, some takaful companies have adopted an approach that combines both wakalah and mudarabah contracts. While the wakalah contract is devoted to providing services related to day-to-day takaful operations, the mudarabah contract is meant for investing the takaful fund and for sharing in the returns generated from this investment. Under this model, practically speaking, the TO will get the fees under a wakalah management contract and will also get a share of the returns provided the investment of the takaful fund is profitable.
The practical features of the respective management models are:
- The wakalah model—the TO will impose an upfront fee based on the amount of gross contributions, and may also receive a performance-related fee to be deducted from any surplus.
- The mudarabah model—the TO will only share in the investment returns, if any. No fee shall be charged on gross contributions or the surplus. While this works well in family takaful, it is difficult to implement in general takaful. TOs who apply this model in general takaful have to share in the underwriting surplus, which is not acceptable under Shari'ah rules because the surplus cannot be considered as a profit under the arrangement of mudarabah.
- The wakalah/mudarabah model distinguishes between the underwriting fees, which are based on wakalah, charged on gross contributions, and profit sharing in investment returns, which is based on mudarabah. There is no sharing of underwriting surplus, as the surplus is not considered as profit.
The key features of each model are illustrated in Table 3.1.
Table 3.1 Key Features of the Main Models
| Wakalah | Mudarabah | Wakalah for management and mudarabah for investment |
| Fixed amount of fees paid to the takaful operator. | No fee is paid. The takaful operator will share in the profit (investment profit for family takaful and both investment profit and surplus for general takaful). | Fixed amount of fees paid to takaful operator for underwriting services. Takaful operator will also share in investment profit (excluding surplus). |
| Profitability of the takaful operator is derived solely from fees income (with or without incentive fee in the form of surplus sharing) minus all costs and expenses. | Level of profitability of the takaful operator depends on actual investment profit minus management cost of the takaful operator in family takaful, or the actual surplus plus investment amount in general takaful. | Level of profitability of the takaful operator depends on fee income plus profit sharing less investment cost and expenses. |
| Suitable for both family and general takaful—that is, both long- and short-term policy. | Suitable only for family takaful—that is, long-term policy—because profit is not common in general takaful. Surplus is not a profit to be shared. | Suitable for both family and general takaful—that is, both long- and short-term policy. |
| Surplus may be “shared” as an incentive fee. | Surplus must be returned to participants/capital providers in the case of family takaful. Some general takaful companies operating on this model have allowed the surplus to be shared as an incentive fee. | Surplus may be “shared” as an incentive fee in general takaful. Surplus in family takaful goes to participants. |
In conclusion, various models of managing the takaful business are subject to Shari'ah principles which suit the selection of that model. The TO is not in the position to select a model without observing the legal effects arising from the contract(s) underlying that model. For example, a general takaful operator who adopts the mudarabah model is not supposed to share in the underwriting surplus (even if some scholars allow the share of surplus as an incentive fee) because surplus is technically not a profit to be distributed under a mudarabah contract. This TO may either change the model to a pure wakalah model or a combined model to earn some income for the operator, because general takaful is essentially a surplus business (that is, investment returns are modest, except possibly when the risks covered are “long-tailed” so that contributions remain invested for substantial periods).
Notes
1 This prevailing view is based on the earliest global fatwa issued by the International Islamic Academy of Fiqh on Takaful in 1985 which upheld that takaful through a tabarru' contract is compliant, as uncertainties that are common in the insurance business are tolerable in a tabarru' contract. See Fatwa of International Islamic Academy of Fiqh 9 (9/2).
2 This requirement is made either through guidelines and directives issued by the regulator or through incorporating this clause in the Articles of Association of the respective licensed takaful operator.
3 The AAOIFI Shari'ah Standard on Takaful has not allowed the takaful operator to share in the surplus. Some takaful companies, based on the view of their respective Shari'ah board members, have allowed the takaful companies to “share” the “surplus” on the basis of incentive for a good performance.
4 Islamic commercial law has recognized a number of contracts that belong to this type of contract. This includes a will (wasiyyat), endowment (waqf), donation (sadaqah), gift (hibah/hadiah), waiver (I'fa), discount (ibra'), and so on. Each of these contracts has its own salient features which are distinct from each other. However, all of them can be generally categorized as a tabarru' contract—that is, an action that leads to a transfer of ownership to another party (recipient) without the need for the latter to pay a consideration.
5 Initally, tabarru' was just a generic name and not a technical and specific contract. It appears that “sadaqah” (simply translated as “donation”) would be more apt to describe the action of the participants when they contribute some money to a takaful fund. Perhaps along this line of argument, some scholars have proposed the contract of waqf to be the underlying contract of contributions by the participants. For all intents and purposes, waqf is also a gratuity contract, and therefore, must behave in a manner that is consistent with other contracts subscribing to this class of contract. It seems that there is no obvious reason why the term “tabarru” became predominantly used in the contemporary takaful industry for the wording of policy and the relevant guidelines and governing Acts. The usage of this term may be relatively convenient for both the regulators as well as the industry. Although the term “tabarru” may also include waqf and wasiat, these two terms may not be as conveniently appealing. While waqf may relate to the issue of jurisdiction of Islamic law administration pertaining to waqf in many Islamic countries, the wasiat modus operandi does not really tally with the very structure of takaful operations. This is because a waqf, if established or founded, has to be managed by the relevant Islamic ministry or agency in many Muslim countries. A TO shall not be authorized to manage this fund as per the law of the respective country. A will, unlike a donation contract, will be valid and enforceable only upon the death of the testator. Also, the will is not valid to be given to beneficiaries of inheritance under Islamic law.
6 Al-Quradaghi, p. 24.
7 Al-Mirghirani, al-Hidayah, vol. 9, p. 40, as cited from Al-Quradaghi, p. 242.