Takaful

Takaful originates from the Arabic word Kafalah, which means ‘guaranteeing each other’.  It is the Islamic counterpart of conventional insurance.

The concept of takaful is based on the principles of mutual cooperation and the separation between the takaful fund and the operations of its shareholders, covering the elements of shared responsibility, joint indemnity, common interest and solidarity.

In a takaful company, the policyholders are the joint investors with the takaful operator.  The profits or losses of the investment pool are shared amongst the policyholders according to a pre-determined ratio.

Takaful works with all the participants guaranteeing each other and making contributions to a mutual fund, as opposed to paying premiums.  The amount that each participant contributes is dependent upon the type of cover required and his/her personal circumstances.

A takaful operator manages and administers the takaful fund on behalf of the policyholders and is paid a fee for miscellaneous expenses such as the costs of sales and marketing, underwriting, and claims management etc.

From an operational perspective, a takaful company must maintain two funds, a policyholders’ fund and a shareholders’ fund.  The two funds cannot be mixed with each other.  The funds are invested on a profit and loss sharing basis, as approved by the takaful company’s Sharia Supervisory Board (“SSB”).

The policyholders’ fund is comprised of amounts corresponding to the insurance premiums received, re-insurer’s claims, investment profits, salvages and recoveries.  The said fund is utilized towards paying claims to the policyholders, reinsurance and administrative costs and technical reserves (but excluding the investment department expenses).

Any surplus amount after the aforesaid utilization is allocated to the policyholders’ special reserves and distributed amongst them.  In the event the policyholders’ fund is deficient to meet their expenses, the shortfall amount is funded from the shareholders’ fund.  The shareholders also guarantee to discharge all liabilities of the policyholders’ fund, proportionate to their respective shareholding in the takaful company.

The shareholders’ fund, on the other hand, consists of the paid-up capital and shareholders’ reserves, capital investment profit and subsequent equity injections.  The investment department’s administrative expenses are deducted from the said fund.  Any surplus amount is distributed amongst the shareholders on a pro-rata basis.

A takaful can be structured based on the nature of the relationship between the company and the participants.  Three kinds of structures are most widely used, namely, Wakalah, Mudarabah and a combination of the two.

Under the Wakalah structure, the takaful operator works as an agent on behalf of the participants.  The takaful operator manages the fund and receives a management fee (i.e., a Wakalah fee).  An incentive fee can also be charged by the takaful operator to manage the fund in the best way possible.  The fee is fixed in advance after consultation with the SSB.  Any surplus generated by the takaful fund or the investments goes to the policyholders.

Under the Mudarabah structure, the policyholders are the investing partner (i.e., the Rab-ul-Mal) and the takaful operator is the working partner (i.e., the Mudarib).  The policyholders put in their respective participations in the takaful fund and the takaful operator uses its expertise and knowledge to manage the said fund.  Profits are shared according to an agreed ratio whereas losses are borne by the policyholders only.

The third type of structure, namely, the Wakalah-cum-Mudarabah structure, is commonly used in the takaful industry.  This structure uses a hybrid of Wakalah and Mudarabah contracts.  Under the Wakalah contract, the takaful company is appointed as the agent for managing the fund and is given a fee for underwriting the fund.  Under the Mudarabah contract, the takaful company is appointed to act as the fund manager and shares any profit resulting from the investment of the fund.