Takaful insurance: definition, concept and functioning of the Islamic insurance

Being an “ethical” alternative to the conventional insurance system, Takaful insurance is a financial product that is currently on everybody's lips. Its main characteristic lies in its compliance with the moral requirements as regulated by the religious law, the Sharia.

Its existence is closely linked to the recent development of the Islamic financial institutions whose birth dates back to the 1970s through the impetus given by the Islamic Conference Organisation which has brought out the economic precepts of Islam.

The expansion of the Islamic financial system and the birth of Takaful insurance

assurance takaful islamiqueIslamic Development Bank, Jeddah

With oil prices skyrocketing, and the rise in power of producing countries, the 1974 oil shock did trigger the emergence of a new generation of financial institutions keeping with the rules of Islam.

The first institution to see the light of day, the Islamic Development Bank, whose headquarter is in Jeddah, (Saudi Arabia), inaugurated a mutual assistance scheme based on solidarity. It was followed by the Dubai Islamic Bank in 1975 then in 1979 by the overall islamization of Pakistan's banking system. The plan, then, spreads to Iran and Sudan which created the first Islamic insurance company in 1979: the Islamic Insurance Company of Sudan.

Ever since, the trend has continued to gather momentum in its home ground the Middle East countries (Saudi Arabia, United Arab Emirates) and South East Asia (Malaysia, Brunei, Indonesia) spreading even further to African countries and Western Europe where numerous Muslim migrant and non-migrant communities got established.

Takaful insurance: definition and foundations

Takaful insurance is essentially distinguished from conventional insurance by the fact that premiums are regarded as “contributions” to a mutual fund established with a view to sharing out occurrence risk of an unfavorable event affecting a member of the group.

Takaful stems from the Arabic word “Kafalah” which refers to an agreement of mutual assistance and of solidarity among the members of a community in case of loss or damage suffered by one of the members. Takaful is, therefore, a mutual guarantee.

Basically, the system of Islamic finance rests on four key principles:

  • risk sharing between contract parties,
  • materiality: any transaction must be aimed at a “material target”, related directly or indirectly to the real economic transaction,
  • non-exploitation: any transaction must be aimed at a “material target”, related directly or indirectly to the real economic transaction,
  • the ban on any move designed to financing “haram” or illicit activities in connection with alcoholic drinks, pork, pornography and gambling.

The only investments allowed by religious law are those whose remuneration results from fate sharing between investors and beneficiaries. These principles stem from the prohibition by religious law of three practices:

  • the Riba: literally meaning increase, addition. In fact, it refers to lending at usurious rates of interest for money borrowed or deposited in a bank account
  • the Gharar: the sale of a non-owned property
  • the Maysir: game of chance, speculation

Takaful insurance: working principles

The takaful system operates on the basis of the separation of two entities: the affiliates or insured and the fund manager or capital contributor.

The affiliates' fund

According to the Takaful system, the insured person, the affiliate, pays a contribution. In return, the fund members, the other affiliates accept to provide a collective support for the risk.

It is the affiliates' fund that collects premiums and disburses claims. At the close of the year, the surplus, which is not retained as technical provisions, is disbursed to the affiliates or paid in the form of “Zakat” (an Islamic tax, one of the five pillars of Islam) to a charity.

The fund manager

It is the fund manager who contributes to the capital required for the company's creation and solvency. The fund's possible deficit is bailed out by the manager.

The remuneration of the fund manager may be achieved in two ways:

  • the Wakala that may be likened to an agency contract. The manager receives a fixed sum in advance in order to run the fund (This sum is deducted from the premiums collected by the fund).
  • the Moudharaba which is an association of the fund manager to the profits reported by the fund.

The emergence of Islamic and Takaful insurance

assurance takafulFor a long time, and in most Muslim countries, recourse to insurance was done through foreign companies. The latter dispatch their products either directly, through their local subsidiaries or through national companies in which they are shareholders.

Insurance density and penetration rate in these countries remained low due to two major reasons: one economic and the other religious.

Insurance is still in an embryonic state given the recent economic development at the level of investment as well as that of institutions, legislation, training …

At the religious level, the society has a negative idea of insurance that carries some elements of uncertainty (Gharar), gambling (Maysir) and interests (Riba), which are not accepted by Islamic law.

In the face of the challenges pertaining to modern economic development and to social and political mutations, Islamic countries have, through the Islamic Conference Organisation (ICO), called upon legal experts and theologians to make legislation on insurance accountancy operations in relation with religious law. The updated concept of Takaful came up with a compromise that overcomes the discrepancy between what is licit (hallal) and what is not (haram).

In all the countries where the system is in force, it is submitted to the oversight of an advisory committee made up of specialists whose task is to verify the compliance of the practices with Sharia. For Muslim legal experts, insurance is acceptable as long as it operates in the pattern of a cooperative.

Takaful Insurance: A market with great potential

Assurance takafulBesides the numerous surveys and publications dedicated to it, the Islamic insurance segment is drawing the attention of a growing number of international operators. Currently, it is the object of everyone's desire.

While the geographic distribution of Takaful insurance remains largely confined to the Muslim countries, investment in western countries with large Muslim communities should, soon, speed up the trend. Already, some European and American financial institutions are dedicating specific counters to it.

The International Monetary Fund (IMF) attributes the success of Takaful insurance to the growing demand by a high number of Muslim countries, to the rising oil wealth in the Gulf countries, to the attractive nature of Islamic financial services for non-Muslim investors seeking “ethical” investments.

About 250 Takaful insurance companies operating in about 75 countries are currently listed. The Takaful direct insurance has been accompanied by a reinsurance labelled Retakaful. Standing among the pioneers of the Islamic reinsurance, the company Best Re, founded in 1985, has been the driving force behind the creation of several Takaful insurance companies in Senegal, Egypt, Lebanon and Algeria.

The world's biggest insurers and reinsurers are among the new kids on the block who are positioned on the Takaful and Retakaful market:

  • In October 2005, ARIG created Takaful Re based in Dubai
  • The Lloyd's syndicates got positioned on the market in 2005
  • In 2006, Hannover Re has opened up a specific Retakaful entity in Bahrain
  • Allianz was equally established in 2006 in Bahrain to develop the Takaful niche
  • In 2007, SCOR has applied for a Retakaful license in Malaysia
  • Munich Re has announced at the end of September 2007 the marketing of Retakaful products in South East Asia through its subsidiary of Kuala Lumpur (Malaysia)

According to a survey conducted by the international rating agency Moody's and published in 2006, the total turnover, valued at 2.30 billion USD in 2005, is likely to rise to 7.7 billion USD in 2015. The turnover breaks down as follows:

  • 2 billion USD of annual premiums in the Gulf countries
  • 3.1 billion USD in Asia and Pacific 1.4 billion USD of which for Malaysia and Indonesia
  • 2.6 billion USD for the markets of Europe, China, Turkey and USA.
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