Legal Issues in Takaful
It is interesting to note that takaful (Islamic insurance) historically has been a well-established practice in the pre-Islamic era among Arab tribes and continued to expand especially among Muslim merchants in shipping and trading throughout the glorious period of Islamic civilisation.1 This is unlike the practice of “banking,” which is relatively unknown within Islamic civilization—forcing Islamic economists, product engineers, and other proponents of modern Islamic banking to grapple with various Shari'ah-compliant financial contracts which can be used to meet the banking needs of Muslims, and thus, basically developing the entire sector from scratch. Ironically, the development of takaful as a segment within the Islamic financial services industry itself has been much slower than the building up of the banking and capital market sectors. In addition to the general prohibition against receiving or paying riba (usury), as well as elements of gharar (dubious ambiguity) and maisir (excessive speculation replicating gambling), takaful also places considerable emphasis on the spirit of ta'awun (solidarity and mutual assistance) as well as tabarru' (donation or contribution). It is not by coincidence that takaful entities during the glorious period of Islamic civilization were set up as mutuals rather than proprietorship businesses.
Hence, while other types of Shari'ah-compliant financial contracts may have been based on clear profit-driven objectives, in the classical context, takaful is fundamentally different; it has been applied mainly as a risk management and risk distribution tool based on ta'awun and tabarru'. This means that the modern application of a takaful undertaking would raise some typical legal issues (such as conflict of laws and adequacy of the legal framework) when we analyze the interactions and interfaces between the Shari'ah and the existing laws in relation to insurance contracts within the respective jurisdictions, as per any other Shari'ah-compliant financial contracts in modern times. Indeed, some jurisprudential questions or issues of judicial thoughts may also remain to be answered.
It is upon this premise that this chapter aims to highlight the intricacies of some legal issues in takaful. We want to go beyond the insights provided by a number of existing studies by other authors.2 We humbly offer to share some additional perspectives, both theoretical and pragmatic, on the legal issues arising from typical takaful operations and what ought to be the appropriate legal framework to address these issues. In this respect, the chapter presents the authors' personal observations and interpretations on questions such as whether existing contracts constituting a takaful undertaking satisfactorily cover the interests of all contracting parties; what are the delicate issues that may eventually test the effectiveness of a takaful undertaking and the enforceability of its contracts; and what are the infrastructural supports that may be required by a takaful system to spur its growth. It will also try to identify the key considerations in contemplating the need for separate legislation for takaful operators rather than relying on existing laws governing (conventional) insurance practices. The concluding remarks comment on the need to intensify legal discourse and technical understanding of takaful, and propose some recommendations for moving forward.
5.2 TAKAFUL MODELS AND THEIR IMPACTS
As deliberated in much of the literature on takaful,3 including other chapters in this book, several models with different underlying Shari'ah contracts have been adopted in takaful practices. These include the mudarabah (partnership between entrepreneur and capital owner), wakalah (agency), and waqf (endowment) models. Each model comprises different sets of rights and obligations between the insurers and the insured parties; nevertheless, they all share common economic objectives—namely, to collectively share the individual risks of the takaful participants (that is, policyholders) in order to reduce the individual participant's exposure against a defined loss. It is submitted that there is no apparent legal advantage of one takaful model over another. In fact, the decision of a takaful operator to adopt a specific model is mainly based on the broader consideration of the model's economic viability, rather than its legal factors. It may also be argued that if the clarity and lucidity of the applications of mudarabah, wakalah, and waqf as underlying principles that govern Shari'ah-compliant financial contracts are taken into consideration, this would leave very little room for disputing any contractual rights and obligations between the parties.
The real issue, then, lies in the structure through which the takaful undertaking is offered and operated. Due to the role of takaful operators as players within the broader financial system, and the possibility of the failure of a takaful undertaking triggering systemic risk in the system, financial regulatory authorities require takaful operators—without exception—to comply with a set of rules similar, if not identical, to those applying to conventional insurance operations. While it can be argued that due to its underlying principles and very close resemblance to conventional mutuals, a takaful scheme should best be formed as a mutual or cooperative entity. In reality, in some countries where takaful operators are present, there is no appropriate legal framework that accommodates the establishment of mutuals or cooperatives and their recognition as legal entities. Even if there is such a legal framework, mutuals and cooperatives per se in most countries may not fall under the jurisdiction of the financial regulatory authority.
As a result, we see most, if not all, modern takaful undertakings set up by operators as proprietorships, rather than as mutuals.4 It is easy to understand the pragmatism and convenience in the “hybrid” approach, which attempts to combine the proprietorship and mutual approaches within the same entity. For the regulators, a proprietorship can be regulated and supervised in a more “direct” manner, in the sense that they can categorically monitor and hold accountable the “regulated parties”—namely, the management, board of directors, and shareholders—for any action that may harm the “protected party”—namely, the consumers (that is, policyholders or participants). Since in mutuals and cooperatives the policyholders themselves are the owners of the entity, regulators may face the inconvenient dilemma that the regulated parties generally are also the supposedly protected party because they wear the hats both of clients and owners.
The approach of having a proprietorship licensed as a takaful operator is also convenient for the business owners who look at offering takaful products as a commercial initiative, motivated by the potential profits.5 The owners—that is, the shareholders of the takaful operator—see themselves as better positioned to control the management and carry out activities in a manner that mutuals or cooperatives could be restricted from doing, such as raising funds through the issuance of shares.
5.2.1 “Firm within a Firm” Dichotomy: A Mutual within a Proprietorship?
On close examination, the current pragmatic approach adopted in takaful operations would result in the unintended creation of “a firm within a firm”: a mutual operating within the set-up of a proprietorship body corporate. Here, what is supposedly a mutual—that is, the takaful participants coming together to make contributions (replacing the premiums in conventional insurance) and thus, rightfully owning whatever is in the takaful fund, including any assets and liabilities—is actually operated and managed, almost with absolute discretion, by a proprietorship corporation—that is, a takaful operator—acting as the managing agent on behalf of the takaful participants.
The impact of this structure is fundamental; it raises the question of the true identity of the takaful scheme. What, actually, is the takaful scheme—is it a mutual or a proprietorship? Obviously, from a strictly legal perspective, it cannot be treated as a mutual when the law of the country does not cater for or accommodate the setting up of such forms of company with no shareholders. Moreover, the regulators issue the takaful license specifically to the takaful operator on the basis of its form as a proprietorship with properly identified share capital and shareholders; thus, at least as far as the regulators are concerned, the takaful scheme is not a mutual. Beyond the legal form, it has to be highlighted that it is not purely a proprietorship either, as we cannot simply erase the actual ownership of the takaful fund in which the takaful participants pool their money—these funds are certainly not the shareholders'. In other words, to treat the takaful scheme as a pure proprietorship would directly jeopardize the whole takaful concept and contracts. It is hard to argue that it is both—first, because in principle, a mutual is a totally different type of legal entity than a proprietorship; and second, because the regulators would not accept it anyway.
The reality check on this legal quagmire would truly be put to the test in the event that a takaful fund is found to be insolvent. On the one hand, the regulators may argue that in the event of such a situation, they can instruct the takaful operator to grant a qard (loan) to enable the takaful fund to meet its obligations in order to preserve systemic stability. On the other hand, there is nothing that can restrict the takaful operator from challenging the regulator's instructions in court by arguing that, based on the contractual arrangements, it is the duty and obligation of the takaful participants themselves to make up for any deficit in the takaful fund, since the takaful operator is nothing more than a managing agent and the takaful participants remain as the principal. At this point, although the regulators may have all the statutory powers to revoke the license of the takaful operator for defying an explicit instruction, it may not necessarily be a satisfactory option, considering that the court may hold the view that (i) the regulators are not being fair to the takaful operator, as contractually, it is not obliged to meet any of the takaful funds' obligations; and (ii) the regulators should not intervene, as it should really be left to the takaful participants as to whether they want to continue maintaining the scheme as a going concern or let the fund be dissolved and liquidated.
Even if we set aside the insolvency scenario, it can still be argued that since the takaful participants own the takaful fund and all the assets and liabilities that come with it, they should be in a position to appoint another manager/takaful operator to manage the whole scheme on their behalf if they are not satisfied with the performance of the current manager.6 It may be in the best interests of the takaful participants as well as the general public for such an arrangement to be permitted, as it forms a kind of market discipline for takaful operators, and thus, would increase efficiency. By and large, the takaful participants, especially those in contracts with long durations, are not in a position to exercise any governance controls and do not attend general meetings, as policyholders in conventional mutuals may. Hence, in reality, the participants may find that organizing themselves is a big challenge. Takaful participants would also need to carve out the takaful fund, as well as its assets and liabilities, separately from those of the shareholders, which items may or may not be clearly identifiable and divisible. Would the takaful participants be able to recover any loss incurred by the takaful fund due to misconduct or negligence of the takaful operator, given that under the Shari'ah (whether the scheme adopts a mudarabah, wakalah, or waqf model) the takaful operator would always be liable to compensate the takaful participants for any loss owing to its own misconduct or negligence? These questions raise another fundamental aspect that requires serious examination by regulators and market players alike: what should be the appropriate governance structure for this “firm within a firm”?
Inevitably, the legal framework for takaful in most countries is still in its infancy and has not been tailored to address the above issues, though they are fundamental. It is argued that we have yet to fully understand the repercussions of the “firm within a firm” dichotomy whereby a mutual operates within a proprietorship set-up (or vice versa, whichever way we may wish to look at it). We may need more research in order to be able to gain a more coherent and comprehensive understanding of the complications triggered by the current pragmatic approach to takaful operations. Nevertheless, we should strive to continue looking into the finer details of the takaful concepts and contracts in order to move forward.
In addition to the “firm within a firm” dichotomy which fundamentally underlies the specificities of takaful operators and raises several questions, the following issues, which perhaps have been quite commonly highlighted, are worthy of examination.
5.3.1 Conflict of Laws and their Interpretation
In order to be duly effective and enforceable, takaful contracts, just like any other Islamic financial contracts, are expected to comply with both sets of laws that govern them—namely, Shari'ah rules and principles, as well as the laws of the jurisdictions in which the contracts are to be enforced. While lawyers who draft the contracts surely would take all the necessary precautions to meet this expectation, there are no hard-and-fast rules to prevent parties to a contract from disputing the construction and interpretation of its clauses. Furthermore, Shari'ah rules and principles are largely uncodified and subject to various interpretations by Shari'ah scholars. As a result, the potential for disputes arising from conflicts of laws and their interpretation would continue to be present.
What has by now become a classic example of such a situation is the case of Shamil Bank of Bahrain EC v. Beximco Pharmaceuticals Ltd.7 whereby an English court had to decide on the construction and interpretation of the “Governing Law” clause in a Shari'ah-compliant financial contract which reads, “Subject to the principles of the Glorious Shari'ah, this agreement shall be governed by and construed in accordance with the laws of England.” The Court of Appeal held that the Islamic financial contracts in this case were governed by English law alone, while the reference to the principles of Shari'ah was simply intended to reflect the Islamic banking principles according to which Shamil Bank held itself out as doing business, rather than incorporating a system of law intended to override the application of English law as the law to be applied in ascertaining the liability of the parties under the terms of the agreement.
In Malaysia, where the Shari'ah court system and the civil court system exist as parallel jurisdictions, it was established since the cases of Bank Islam Malaysia Berhad v. Adnan bin Omar8 and Dato' Nik Mahmud bin Daud v. Bank Islam Malaysia Berhad9 that banking matters fall under mercantile laws which, according to the Federal Constitution, shall be under the civil court's jurisdiction.
It could be argued that the legal frameworks in the U.K. and in Malaysia, to this extent, have proven themselves to be equipped with the relevant structure and experience in dealing with the issue of conflict of laws and their interpretation. In Malaysia, the Chief Justice of the Federal Court, the Right Honourable Tun Dato' Seri Abdul Hamid bin Haji Mohamad, noted that knowledge of Islamic law, civil law, conventional banking, finance, and insurance is necessary for understanding the technicalities of Islamic financial products and identifying the parts that may attract Shari'ah issues before arriving at the conclusion, which, very often, requires the exercise of ijtihad (deductive reasoning) by the experts. He urged all judges who are facing issues relating to Islamic banking, finance, and takaful to refer them to the National Shari'ah Advisory Council (NSAC) at Bank Negara Malaysia for a ruling, as this has already been provided for in the law.10
How far the same could be true in respect of other jurisdictions where Islamic institutions such as takaful undertakings are present remains to be seen. This is especially the case, bearing in mind the lack of specific laws for takaful undertakings in most jurisdictions. So far, besides Malaysia, which introduced a Takaful Act in 1984, the only other jurisdictions known to have come out with specific takaful legislation are Brunei11 and Pakistan.12
5.3.2 Effect of Nomination Clause on Mirath (Succession or Inheritance) and Wasiyah (Will or Bequest)
Under the Shari'ah, there is already a developed set of laws regarding mirath (succession or inheritance) and wasiyah (will or bequest). There are explicit Qu'ranic injunctions requiring Muslims to abide by it,13 and among other things, the categories of heirs and their entitlement to the estate of a deceased person are clearly set out by these rules. The Shari'ah also imposes certain restrictions on how a person can make a wasiyyah, including to whom he may make the bequest and the permissible amount of the bequest.
A nomination clause in a typical conventional life-insurance policy may enable a Muslim to violate rules of mirath and wasiyah,14 as the person nominated may be an heir and/or may end up getting more than one-third of the assured's estate. This is so because a nomination is made by the assured during his lifetime but takes effect on his death. On the other hand, some scholars argue that a takaful benefit should not be considered as part of the deceased's estate, because it does not form part of the deceased's assets during his lifetime. In fact, the takaful benefit comes from a pool of funds derived from donations of other takaful participants as well, in part even after the deceased has died.
In Pakistan, in the case of Karim v. Hanifa15 it was held by the Karachi High Court that the status of the nominee in life insurance is nothing more than an agent (or executor) who receives the benefit on behalf of all the heirs.
In Malaysia, this is a settled issue especially after the NSAC resolved in 2003 that whether a nomination clause in a takaful contract results in the takaful benefit being a hibah (gift) or part of the deceased's estate, which is subject to inheritance, depends on how the clause is constructed.16 According to the NSAC, a takaful benefit can be given to a nominee as hibah if the clause is constructed as such, which indicates the participant's intention to make a gift to the nominee. It is interesting to note that in the Malaysian Insurance Act 1996, a nominee of a Muslim policy owner receives the money from an insurance policy benefit as executor.17
5.3.3 Framework for Waqf
It is worth noting that a fatwa (religious edict) may not automatically have any legal effect in the sense that it would not bind any party, especially the court, unless it is incorporated into the law. In Malaysia, this is done by way of gazetting such fatawa. This might bring us to another potentially disputable issue with regard to waqf. As recently proposed by some scholars, instead of using the principles of mudarabah or wakalah, takaful schemes should appropriately adopt the principle of waqf, which would make it clearer that a takaful undertaking is strictly non-commercial, being based rather on mutual assistance. Considering that some countries may have an explicit legal framework in respect of waqf, takaful operators adopting the waqf model may need to be aware of additional compliance beyond what is normally identified under general regulations for takaful.
For example, in countries that adopt a common law system—such as Malaysia, Pakistan, and the U.K.—a waqf would very likely be governed by trust laws, namely in the form of a Trustee Act. While the Trustee Act might lay out specific provisions relating to the creation of trusts, including those based on waqf, a key question is whether in a waqf-based takaful the parties can contract out of the statute by creating sets of roles and responsibilities for the trustee under the waqf deed which are different from those already specified under the Trustee Act. This is especially of interest, considering that the relevant Trustee Act may only provide for a general set of roles and responsibilities for trustees without taking into consideration the specific needs of waqf-based takaful undertakings. A takaful operator may also need to register each takaful fund as a waqf in order to enjoy tax benefits normally granted to a waqf as a charitable entity; otherwise, a different tax treatment may be applied to those waqf.
Therefore, unless careful thought is given to these issues to ensure that they can be properly addressed within the existing legal framework, a waqf structure for takaful may raise more issues than just those of complying with the Shari'ah rules and principles governing waqf.
5.3.4 Mandate (and Breaches of it) by a Takaful Agent
In Malaysia, the powers of an agent are provided for under the Contracts Act 1950, which among other things provides under section 181 that the principal will not be liable for any dealings or transactions carried out by an agent beyond his or her authorized powers. These powers could be categorized as follows:
(i) Express authorities—these must be mandated verbally or in writing, and in the event of ambiguity which raises questions of interpreting the authorizations, the agent can be protected as long as he or she interprets them reasonably, even if not according to the intention of the principal in the first place.
(ii) Implied authorities—while these authorities may not be expressed verbally or in writing, generally they refer to the powers whereby the agent should be able to act according to general guidance given, and which are reasonably relevant to or connected with his or her express authorities. Section 140 defines implied authorities as something that can be derived from the circumstances of the case—that is, what reasonably could be understood from an expression verbal or in writing or in the ordinary course of business.
(iii) Common authorities—the authorities that naturally would come with the function or role of a job, something that is commonly practiced within the industry or the profession.
Conduct of a takaful agent is also governed by sections 25, 28, and 66 of the Takaful Act 1984. The Malaysia Takaful Association issues a code of ethics for its members, which also covers agents.18
While these laws, in general, are consistent with the Shari'ah rules and principles on agency (wakalah), disputes and ambiguity may still arise, particularly with regard to: (a) the almost absolute discretion of the takaful operators themselves as agents for the takaful participants in the management of the takaful fund investments and the utilization or distribution of underwriting surplus; and (b) any misconduct or negligence on the part of the takaful operators.
In addition, it is not uncommon for takaful operators to appoint agents (or brokers) particularly as distribution channels for their products. Again referring to the position in Malaysia, a takaful agent is a legal agent of a takaful operator as the principal, licensed under the Takaful Act 1984 and authorized to execute the marketing of takaful products and to deal with the participants on behalf of the takaful operator.
These additional layers of principals and agents add complications, particularly in relation to the fiduciary duties of takaful operators, the conduct of their agents/brokers, and how takaful participants seek remedies for any loss attributable to misconduct and negligence of the takaful operators.
5.3.5 Retakaful
For risk-sharing and pricing purposes, reinsurance transfers are commonly classified into proportional and non-proportional arrangements. In takaful reinsurance (also known as retakaful), some scholars have argued that non-proportional arrangements such as excess of loss or stop-loss arrangements may not be Shari'ah compliant because there exists uncertainty with respect to the assessment of losses in those arrangements. Hence, retakaful is likely to be arranged on a proportioned or pro-rata basis—for example, quota share or surplus reinsurance, where the reinsurer becomes technically a coinsurer of the original risks. If, however, a non-proportional reinsurance arrangement is selected, it could be based on a strict profit commission plan or on a reciprocal basis. In this regard, it matters little whether the reinsurance transfer is on a facultative or treaty basis.19
In the past, the lack of retakaful operators has often forced takaful operators to use the services of conventional reinsurers, and Shari'ah scholars have generally allowed a moratorium for them to continue doing so until there exist suitable retakaful operators that can meet their requirements. However, in terms of their contractual relationship with the takaful participants, takaful operators are nevertheless obliged to ensure that their operations are fully Shari'ah compliant. There is thus some uncertainty as to the effect on this obligation of the moratorium accorded by Shari'ah scholars.
5.3.6 Manipulation of Contractual Clauses
Takaful, like conventional insurance, is based on the principles of insurable interest, indemnity, subrogation, and utmost good faith (uberrimae fidei).20 Insurable interest itself ensures that a client can obtain insurance only if susceptible to loss for which insurance is sought. Indemnity implies that a claim can be made only to the extent of the actual financial loss to the insured. Subrogation entitles insurers to claim from a third party on behalf of the insured. Indemnity and subrogation together ensure compliance with the requirements of insurable interest. The utmost good faith clause is required for the disclosure of all material facts, a condition commended in Islam.
In the hybrid form of takaful undertakings, the managers of a takaful undertaking owe fiduciary duties to both the takaful participants and the shareholders, and therefore, need to satisfy the reasonable expectations of both. As highlighted in Chapter 4, since their appointment, remuneration, and tenure of position are entirely determined by the shareholders instead of the takaful participants, managers and directors of takaful operators may have fewer incentives to safeguard the interests of the takaful participants. Moreover, the takaful operator expects to make profits from its endeavor. Hence, in their attempts to maximize profits, some insurance companies including takaful operators try to avoid or delay payment of claims, and sometimes takaful participants are not made aware of fine print that states the main conditions, qualifications, and waivers.
Hence, contracts of takaful, just like those of conventional insurance, are prone to disputes between the insured and the insurers whenever a claim is not promptly met. Disputes may result whenever the hope of monetary gains overrides the principles of honesty. Each party tries to shift the incidence of risks, including by means of legal battles, by finding fault with the other party. The onus of proving that the loss was caused by an insured peril rests upon the insured. The onus of proving that the loss was caused by an excepted peril rests upon the insurer. It is generally held that even an innocent misrepresentation of a material fact is no defense to the insured, if the insurer elects to avoid a contract.
Bearing in mind that such manipulation and exploitation are not tolerated in Islam, takaful participants (like conventional insurance policyholders) should be duly protected by the financial regulatory authority, and as much as possible, contractual clauses should be standardized. In addition, some takaful participants may make dishonest claims, and thus, adequate legal protection should be given to the other honest participants.
5.3.7 Qard Facility to Meet Fund Deficit
In most jurisdictions where takaful operators are present, the financial regulatory authority would expect the takaful operators themselves to grant an interest-free loan under the principle of qard to the takaful fund in case there is a deficit; more precisely, the operator is expected to offer a qard loan facility which can be drawn down if the fund is unable to meet its obligations (because of a deficit or simply a lack of liquidity). The loan does not remove a deficit, as it increases the fund's liabilities simultaneously with the assets, but it provides liquidity to enable the fund's obligations to be met. The loan should be recoverable by the takaful operator (with particular reference to the shareholders) through future underwriting surpluses, including those from new business developed over time by the takaful operator.
Considering that the takaful fund is under the direct management of the takaful operator, under normal circumstances, such a loan arguably could fall under the broader context of a “related party.” As we are aware, it has been well established under company law that related-party transactions must be publicly disclosed and only carried out on an arm's-length basis without any unduly favorable terms. In some jurisdictions, independent valuations and appraisals are required before the regulatory authorities will allow substantial related-party transactions to take place. This is in order to avoid the directors and management of the company manipulating the movement of funds or assets of the company in favor of certain parties who are related to or favored by them.
The question is, should the requirement to publicly disclose such a qard facility be similarly imposed on takaful operators, on the basis that it falls within the ambit of a related-party transaction? Should the existence of the facility be disclosed, or only the loan if the facility is actually drawn down? The latter type of disclosure might be problematic because it might create panic among the public and have a negative effect, rather than enhancing the stability of the financial system. However, while it would seem desirable on transparency grounds to disclose the existence and amount of the facility, transparency would also require disclosure of the draw-down if it has been made. Certain safeguards may also be needed in order to ensure that the qard is not employed in a manner that favors certain pools among the many pools of takaful funds under the management of a takaful operator. While intervention from the regulatory authorities would be reasonable and relevant in this case, there might also be room to consider market discipline mechanisms, such as by allowing the takaful participants to demand lower future contributions or higher shares in the underwriting surplus.
It is to be noted that in countries such as Malaysia, takaful operators are obligated to give an undertaking to the regulator to provide a qard facility to be drawn down in the event of a deficit of a takaful fund.
5.3.8 Investment Activities of the Takaful Operators
Takaful operators are directly involved as fund managers on behalf of the takaful participants, and are thus wearing the hats of insurance operators and fund managers. This calls for appropriate legal, financial, and administrative firewalls.
Noting that takaful operators are supposed to invest only in portfolios that are Shari'ah compliant, it follows that they would require an additional governance structure and processes that facilitate (i) the consistent screening of the investment portfolios in order to ensure they remain Shari'ah compliant; and (ii) the purification of any return on the investment from non-Shari'ah-compliant income.
Here, considering that only three jurisdictions are known to have specific legislation governing takaful operators, it is reasonable to assume that other jurisdictions would have no legal framework that requires takaful operators to set up an appropriate Shari'ah governance system to meet the aforesaid objectives. Without such legal backing, the regulatory authorities may not be in a position to monitor adequate governance of takaful operators. Reference to their broader powers of monitoring the soundness and stability of the financial system may not provide a satisfactory solution for the regulatory authorities, especially if there are also other “religious authorities” within the jurisdiction. Furthermore, the financial regulatory authority might be interested to know how the takaful operators dispose of their non-Shari'ah-compliant income, particularly vis-à-vis related-party transactions that may involve conflicts of interest.
It is submitted that it would be useful to take a cross-sectoral approach in the supervision of the investment activities of the takaful operators, whereby insurance regulators might wish to borrow some of the principles used by the securities regulators in supervising the investment activities of the takaful operators.
5.3.9 Status of the Shari'ah Boards
It has been a well-accepted practice for takaful operators to have their own Shari'ah boards to ensure compliance with Shari'ah rules and principles throughout their operations. However, it is also well established that only in a handful of jurisdictions21 does there exist a central Shari'ah board that serves as the highest Shari'ah authority to issue fatawa for the Islamic financial services industry. The advantage of having such a central authority is mainly (i) to ensure a unified opinion throughout the jurisdiction on Shari'ah issues relevant to the industry, thus avoiding confusion among the consumers; and (ii) to provide a solid legal backing to a fatwa so that Shari'ah compliance will be effective and enforceable in courts.
The lack of explicit legal backing for the establishment of Shari'ah boards, as well as adequate rules to safeguard their integrity, will continue to raise doubts regarding the effectiveness and enforceability of the contracts employed by takaful operators and the legality of their practices. The magnitude of this problem would only be realized once a dispute is raised in court about the extent of Shari'ah compliance by a takaful operator.
5.4 THE CALL FOR AN EFFECTIVE FRAMEWORK
The previous section attempted to illustrate the need for a comprehensive and effective legal framework that would adequately address the concerns of takaful operators and participants. It is believed that such a framework is crucial for preserving the stability of the takaful industry, instilling public confidence, promoting strong corporate governance standards in the management of takaful operators, ensuring that consumers are well informed for decision making, integrating and coordinating more effective supervision across borders and sectors, and promoting better understanding of the business and risks of takaful operators.
In this respect, reference is made to the Malaysian model whereby through the Takaful Act 1984, which has undergone revisions from time to time, the regulatory authority (in particular, Bank Negara Malaysia) has been successful in setting out a solid framework for takaful business to grow. The Brunei and Pakistan legislations have also referred to the Takaful Act as their benchmark.
Bank Negara Malaysia continues to solidify the regulatory framework for takaful operators by issuing several guidelines, including:
(i) Guidelines on Operating Costs of Family Takaful Business;
(ii) Guidelines on Claims Settlement Practices;
(iii) Guidelines on Directorship for Takaful Operators;
(iv) Guidelines on Prohibitions against Unfair Practices in Takaful Business;
(v) Takaful (Prescribed Financial Institution) Loan and Investments Regulations 2003;
(vi) Guidelines on Financial Statement for Takaful Operators; and
(vii) Takaful Operators Statistical System.
Despite worldwide fascination with the development of Islamic finance, one should not forget that this industry is still at a nascent age and much remains to be achieved. From the market player's perspective, among the key challenges are the following:
(i) While Bahrain, Malaysia, and the Dubai International Financial Center have put in place a considerable amount of regulatory framework and infrastructural support to enable Islamic finance to coexist with its conventional counterpart, arguably other countries are still at the stage of “arranging the bricks.”22
(ii) The greater involvement of banks and other financial institutions in investment management, as illustrated by the repeal of the Glass-Steagall Act in the U.S., should be advantageous to Islamic finance because its banking business model involves a universal approach. The problem is that investment management in modern conditions crucially involves risk management, which requires further development in Islamic financial theory and practice. Hence, there is a pressing need to intensify the development of Shari'ah-compliant risk management techniques, even more so in jurisdictions where the regulatory framework and infrastructural support are still not well developed.
Therefore, it is only reasonable for financial regulatory authorities to make a thorough review of the insurance framework in their jurisdictions and to consider whether the existing specificities of takaful undertakings have been adequately addressed. While a takaful law might be beyond their reach at the moment, it is reasonable to expect the regulators to consistently engage their counterparts with extensive experience in regulating takaful undertakings in order to learn from them. Appropriate support and recognition should be given to the IFSB and the IAIS for initiating the development of international prudential standards for takaful.
The growth in the takaful industry, although to a certain extent initiated by political objectives riding on religious zeal within Muslim-majority countries, seems to have gained momentum due to free market forces and global economic potentials leveraged by industrialists.23 There is growing evidence to suggest that Islamic finance is no longer just on the fringes of global finance; it has now come into the mainstream of international finance and is here to stay.
Among other things, the membership of the IFSB has expanded to include financial regulators from non-Islamic countries, including major Asian economic players such as Japan, China, South Korea, and Singapore. Early in 2008, it was announced to the British Parliament that legislation will be introduced to provide neutral tax treatment to Islamic bond issuances to put them on a similar footing to any conventional issuances.24 The British public has already been made aware of the emergence of the Islamic finance sector, when the recent sale of the automobile company Aston Martin was financed through a sukuk deal. In 2007, the Swiss Federal Banking Commission awarded a full banking license to an Islamic private bank.25 In addition to the German state of Saxony-Anhalt, which issued a US$100 million sukuk in 2003, another G7 country, Japan, has announced that it is preparing to launch what would be the first sovereign Islamically compliant bond by a G7 nation, through the Japan Bank for International Co-operation (JBIC), a sovereign trade promotion and international development institution.26
In this respect, the takaful industry is comparable to Islamic banking at the stage of its initial development about three decades ago. Its progress has been slow and painful, as many legal and regulatory issues remain as potential stumbling blocks. However, once this phase is past, God-willing, we will see it grow exponentially just like other components of the Islamic financial services industry.
Notes
1 These include, among others, the system of aqilah where merchants assist each other to mitigate losses when bandwagons are lost in the desert, as well as the system of diyat or blood money, where tribe members pool their funds to indemnify and compensate the victims when the assaulter is a member of their tribe.
2 Among others, see Mohamed Ma'sum Billah (2003), Islamic and Modern Insurance: Principles and Practice (Kuala Lumpur: Ilmiah Publishers); Nik Norzrul Thani, Mohamed Ridza Abdullah, and Megat Hizaini Hassan (2003), The Law & Practice of Islamic Banking and Finance (Petaling Jaya: Sweet & Maxwell Asia); Mohamed Ma'sum Billah (2007), Applied Takaful and Modern Insurance: Law and Practice (Petaling Jaya: Sweet & Maxwell Asia); and Sohail Jaffer (ed.) (2007), Islamic Insurance: Trends, Opportunities and the Future of Takaful (London: Euromoney).
3 See, for example, IFSB-IAIS Joint Working Group Paper on Issues in Regulation and Supervision of Takaful (Islamic Insurance), August 2006; and Ajmal Bhatty, “Aspects of Business Operations in Different Takaful Modalities,” paper presented at the Global Islamic Finance Forum, organized by Bank Negara Malaysia, Kuala Lumpur, March 29, 2007.
4 However, it is noted that some cooperative societies may offer products similar to takaful (often known in Malaysia as khairat) but do not fall within the supervision of financial regulatory authorities.
5 It should be recalled that, according to Shari'ah, a takaful cover must not be provided on a commercial basis or with a view to profit. However, the management functions may be provided by a takaful operator with a view to earning profit from investment management and from efficient provision of administration, including that of underwriting (without any insurance risk being taken on by the operator itself).
6 In this respect, participants may find it easier to do so in cases where contracts can be terminated after a relatively short period (for example, one year) and a new takaful operator can be chosen, as is the case in most general takaful arrangements. The situation is different with long-term contracts and lock-in effects (for example, in family takaful).
7 (No. 1), [2004] England & Wales Court of Appeals Civ 19; [2004] 1 Weekly Law Report 1784; [2004] 4 All England Report 1072; [2004] 2 All England Report.
8 [1994] 3 CLJ 735; [1994] 3 AMR 44.
9 [1996] 4 MLJ 295.
10 Welcoming speech at the Malaysian Judges Conference 2008, Marriot Putrajaya, April 8–11, 2008.
11 Insurance and Takaful (Motor Vehicles Third Party Risk) Act, Cap. 90.
12 Takaful Rules 2005.
13 An-Nisa' (Q4: 11–12, 176).
14 Syed Khalid Rashid (2007), “Islamization of Insurance—A Religio-Legal Experience in Malaysia,” in M. Kabir Hassan and Mervyn K. Lewis (eds.), The International Library of Critical Writings in Economics: Islamic Finance (Cheltenham: Edward Elgar). First published in Religion and Law Review, Vol. II, No. 1, Summer, pp. 16–40, reset.
15 PLD (1970) Karachi 683.
16 34th National Syariah Advisory Council Meeting held April 21, 2003.
17 Under its section 167, a nominee of a Muslim policy owner shall, on receipt of the policy monies, distribute the policy monies in accordance with Islamic law.
18 The Islamic Financial Services Board is developing its Guiding Principles on Conduct of Business for Institutions offering Islamic Financial Services (IIFS), the scope of which includes takaful operators.
19 Ramin Cooper Maysami and W. Jean Kwon (1999), “An Analysis of Islamic Takaful Insurance—A Cooperative Insurance Mechanism,” Journal of Insurance Regulation, Vol. 18, No. 1, Fall, pp 109–32.
20 Muhammad Anwar (2007), “Comparative Study of Insurance and Takafol (Islamic Insurance),” in M. Kabir Hassan and Mervyn K. Lewis (eds.), The International Library of Critical Writings in Economics: Islamic Finance (Cheltenham: Edward Elgar). First published in Pakistan Development Review, Vol. 33, No. 4 (Part II), Winter, pp. 1315–28.
21 These include Brunei, Indonesia, Malaysia, Pakistan, and Sudan.
22 See the analysis of the legal framework for Islamic finance in more than 30 jurisdictions in Nik Norzrul Thani and Aida Othman (2007), “Effectiveness of Legal Framework for the Islamic Financial Services Industry,” paper presented at the IFSB Third Seminar on Legal Issues in the Islamic Financial Services Industry, Kuala Lumpur, March 28–29.
23 Adnan N. Ozair (2006), “Who's on First? What Role do U.S. Policy Makers Want to Play in the Islamic Financial Services Industry?” Muslim Public Affairs Journal, Debut Issue, January, pp. 15–18.
24 “Work together to boost Islamic financing, urges Price Andrew,” Bernama, August 30, 2007.
25 “The first Islamic private bank is launched in Switzerland,” Halal.Journal.com, October 5, 2006.
26 David Pilling, Guy Dinmore, John Burton, and Gillian Tett (2006), “JBIC in talks on Islamic bond issue,” Financial Times, August 17.