Islamic
insurance (Takaful) means the act of group of people reciprocally granting
each commercial profit sharing contract between the providers of funds for
a business venture and the entrepreneurs who actually conduct the
business. In other words, the Takaful business conducted by the company
and the individual members of a group of participants who desire to
reciprocally guarantee certain loss or damage that may be inflicted upon
any one of them. This chapter deals with the conceptual issues, principles
of contract insurance, types of general insurance policies, insurance in
an Islamic perspective, modas operandi of Islamic Insurance
Company, and other relevant matters.
We all
know that life is full of uncertainties and it is general human tendency
to avoid the uncertainties of life as far as possible. Social scientists
of modern age have, therefore, stressed much need for the study of the
subject of risk. In fact scientific study and management of risk is very
important in the present context of worldly affairs. We know that
different types of risk are involved in the society and one should know
how to avoid or deal with it.
In the
present day society, insurance is one of the most used, desired and prime
methods of handling risks. However, insurance is a complex subject and is
also a subject of much misunderstanding. It has been observed that much of
the misunderstanding has arisen due to two main reasons:
i) We have
failed to understand the basic nature of risk
ii) The
relationship and difference between insurance and other methods of
handling risk have not been properly understood.
Therefore,
in order to grasp the functions and nature of insurance we will try to
understand some basic concepts of risks and insurance.
Risk and
Insurance
Risk has
been defined as the uncertainty as to the occurrence of an economic loss.
Risk and probability are not synonymous. Before analyzing the relationship
between risk and insurance, we must understand the difference between risk
and probability. The term's hazard and peril are more closely
related to probability than they are to risk. For example, collision is a
peril that causes the automobile accident and loss. The condition that
makes the occurrence of collision more likely is called the hazard. For
example, foggy weather is the hazard that creates the peril of collision.
This means probability of collision increases when the hazard of foggy
weather creates the peril of collision. Therefore, one can say that
probability is the long run chance that out of a given number of
possibilities, certain number of specific events will occur. But risk is
the uncertainty as to occurrence of a loss. This is measured in the terms
of degree of variation that actual events bear to probable events. The
larger the number of exposures, the smaller is the risk. This is because
under this situation, the smaller is the variation that actual events bear
to the probable events. This called the law of large numbers.
The law
of large number states that for a very large number of exposures, one
can predict precisely the actual number of occurrence of an event. This
law has proved very significant in the study of the subject of
insurance. This is mainly because, the risks of the insurer is that
he does not know what is the actual probability of a loss. It is,
therefore, necessary to estimate the actual probability. The law of large
number is of vital significance in analyzing this problem (Majumdern &
Dewan 1999, p.23). According to this law, one can estimate the probability
of occurrence of certain events more precisely by increasing the number of
observations by sampling process. It has been observed that the average
value of a very large number of observations will be very close to the
actual average of the population from which the observations were taken.
For example, probability of death at certain age can be estimated by way
of a large number of observations in a sampling process.
It may be
noted that foundation of insurance rests upon the law of large numbers.
The insurers obtain a very large number of observations. In the case of
life insurance mortality records of people at different ages are analyzed
and summarized to find out the probability of death at certain age. In the
case of general insurance the insurers usually have the statistical
records of loss against different perils and thus they can fairly measure
the underlying probability of a loss against, fire, accident, mechanical
breakdown etc.
How to
Handle Risk
An
individual is always concerned because of the uncertainties of life. He
does not know whether or not a given loss will occur to him individually.
For an individual, the risk is very large. This is simply because an
individual cannot obtain a sufficient number of exposures to have an
accurate prediction as to the occurrence of loss. It is not the
probability of loss which causes difficulty, but rather the uncertainly as
to whether an individual will be among those who are expected to suffer
loss. Had the loss been certain, one could perhaps prepare him for it in
advance. Since this is not the case, one should try to reduce risk through
insurance and other means.
One can
handle risk by assuming it. Most of the people do it knowingly and
unknowingly. In many cases we pass through life by way of accepting or
assuming many small risks. However, in many occasions one has to accept it
simply because one cannot afford to pay for it's reduction or
transfer. If one can afford to pay the price of risk transfer, the
insurance company or some other organization will bear the risk. In that
case the insurance company will bear the risk for a price. But how will
the insurance company bear the risk? The insurance company handles risk by
utilizing the combination method as the basis of their insuring operation.
The method of combination is the system of handling risk that usually
involves the use of large numbers. The insurance companies persuade a
large number of individuals, known as insured to pool their individual
risks in a large group. When sufficiently large numbers are grouped the
actual loss experience over a period of time will closely approximate the
probable loss experience. The insurance company has little or no risk at
all if this method is used properly When all of the individual objects are
pooled into one group, the risk is no longer present, if the requisites of
insurable risks are met with.
It may be
noted here, that insurance companies do not cover all risks. That is to
say, all risks are not insurable. Usually it is only the “pure” risks that
are insurable and not the “speculative” risks. A pure risk can cause only
loss but a speculative risk causes either a profit or loss. For example,
there is risk in any investment and business venture due to market
fluctuations. This is a speculative risk and therefore, not insurable.
However, a businessman can insure the assets and legal liabilities against
specified perils like fire, flood, cyclone, negligence, collision, etc.
Similarly, one cannot insure the risk of gambling. However, all pure
risks are not insurable as there are many situations that can cause loss
where the loss a of large number does not operate satisfactorily.
For many situations large number of required statistical records are not
available. If the insurers cannot obtain statistics over a sufficient
length of time on losses resulting from a particular peril, they cannot
accurately predict the probable loss experience. In that situation it is
not prudent to cover such risk. So it is evident that the prime requisite
of insurable risk is that the number of objects must be of sufficient
number. This means that the probable loss must be subject to advance
estimation in order that it can be made accurate and the objects to be
insured must be similar so that reliable statistics of loss can be
formulated. For example, in case of fire and theft insurance, commercial
buildings and private dwellings should be grouped separately as the
hazards against these risks are different. Similarly the properties
situated in the cyclone belt should not be grouped with that of the
properties located in the cyclone free zone. This means the physical and
social environment of the group ought to be roughly similar. Therefore, it
is evident that from the viewpoint of the insurer, one of the prime
requisites of insurable risks is that the number of objects must be
sufficient in number and quality so that a reasonably close calculation of
probable loss can be made (Greene 1962, p.47).
Requisites
of Insurance for Covering Risk
Apart from
what has been discussed above, the other requisites of insurance may be
summarized as following:
(a)
Insurance
must be effected by means of a legal contract and must meet the general
requirements of contract as follows:
i)
It must
be made by parties with legal capacity to contract; and
ii)
It must
be affected with a meeting of the minds of the
parties.
(b)
For any
insurance contract to be valid it is necessary to have insurable interest
of the insured on the subject of insurance. This means that an insured
must suffer a financial loss himself.
(c)
Property
and liability insurance are subjected to the principle of indemnity which
states that a person must not be indemnified more than his actual loss in
the event of damage caused by a insured peril.
(d)
Principle
of subrogation ought to be followed where the principle of indemnity is in
existence. Under this principle, the insurer is entitled to subrogation,
which means that they acquire the right to recover from liable third
parties. This is necessary to reinforce the principle of indemnity i.e. to
prevent the insured to receive more than actual loss.
(e)
Principle
of utmost good faith must be followed in every insurance contract and for
that matter breach of warranty, material misrepresentation and concealment
of facts makes the contract void.
(f)
Last, but
not the least, there are the principles of loss determination and payment.
Uninsurable
Risks
Not all
risks are insurable. This is mainly because there are some risks, which in
the true sense cannot be termed as risks. Therefore, the authors of risk
management have differentiated between pure risk and speculative risk.
Normally the pure risk is insurable and speculative risk is handled by
methods other than insurance. In pure risk, there is uncertainty as to
whether the loss will occur or not, but there is a chance of producing a
profit out of that event. But in case of speculative risk there is
uncertainty of an event that could produce either a profit or loss. For
example, a business venture and a gambling contract are the risks of
speculative nature and, therefore, not insurable. Market risks such as
price changes and/or changes in the exchange rate of currency are not
insurable. These risks are not subject to advance calculation, hence the
insurer would have no realistic basis for computing his premium. Further,
in times of rising prices no one would be interested to have insurance
coverage against such risk and in times of failling prices an insurer can
not afford to take on the risk because he can not avail the opportunity of
spreading the risk over which to average out good years with bad
years. The speculative risks are handled businessmen by way of
hedging, whereby a speculator assumes the price risk.
Insurance
and Gambling
Although
it is common to confuse insurance with gambling, from economic and legal
point of view gambling and insurance are two distinct matters. It is true
that insurance company pays an insured a great deal more money than it has
received, in terms of premiums, but this does not mean that insurance is
thereby a gambling contract. The very purpose of insurance is to eliminate
risks, whereas gambling creates a new risk.
For
example, “A” and “B” may agree that if the property of “C”
comes under fire, “A” will pay taka 1,000.00 to “B” and if there is
no fire, “B” should pay taka 100.00 to “A”. In this case
before this gambling contract neither party had any risk of loosing or
gaining any money from this source. When “A” and “B” agree to the above
proposition, each party becomes subject to a new risk of loosing money.
Moreover, neither “A” nor “B” has any insurable interest on the property
of “C”. However, if an insurance contract has to be effected it is only
“C” (who can insure) to the extent of loss (up to agreed value) against a
fixed premium. “C” in this case in fact has exchanged a large uncertain
loss for a small but certain loss called the premium.
Although,
insurance as being practiced in the modern world cannot be termed as
gambling, this cannot be called also Islamic, simply because it is not
gambling. However, insurance as a device to combat loss can rightly be
used in an Islamic Society by way of applying the basic principles of
insurance and eliminating the forbidden practices.
Principles
of Insurance Contract
Insurance
is affected by means of a legal contract and must meet the general
requirements of contract. Thus the insurance contract must not be against
public policy, must be enacted by parties with legal capacity to contract,
must be affected with a meeting of the minds of the parties and must be
supported by a consideration. Insurance is a contract of adhesion and any
ambiguities are construed against the insurer. The following legal
doctrines are vital to the understanding of insurance contract.
Insurable
Interest:
A fundamental legal principle underlying all insurance contracts is the
principle of insurable interest. This means insurance is operative only in
respect of the interest of the insured in the event of property concerned
and it is this interest that is the subject matter of insurance contract.
It means it is not the bricks and materials used in building which is the
subject matter of insurance. The subject matter of insurance is the
legally recognized relationship of the owner of the building whereby he
will suffer loss if the building is caught in fire. This is
essential; otherwise an individual would claim indemnification, even when
he had not suffered any loss. The doctrine of insurable interest is also
necessary to prevent insurance from becoming gambling.
Principle
of Indemnity:
The principle of indemnity ensures that a person does not get more than
his actual loss, in the event of
damage caused
by an insured peril. It is important to note that only the contracts of
property and liability insurance is subjected to this doctrine. Life
insurance, health insurance and personal accident insurance policies are
not contracts of indemnity (as no money payment can actually indemnify for
loss of life or for bodily injury to the insured).
There are
several ways by which an insured can be indemnified i.e. by cash payment,
repair, replacement and reinstatement. In every instance the onus of
proving that that the loss was caused by an insured peril rests upon the
insured. The onus of proving that the loss was caused by other than in
insured peril rests upon the insurer.
Without
application of this principle, the insured would be tempted to make profit
out of the happening of loss. There would be a tendency in the direction
of over insurance. There are, however, some exceptions to the application
of this principle in property insurance. For example, in marine insurance,
for commercial convenience, it is customary to issue “value” policies i.e.
the insured value is mutually agreed between the insured and the insurer.
In the event of loss, the indemnity is measured in terms of the value
fixed by the policy.
Principle
of Subrogation:
This principle states that the insurer, if and when indemnifies the
insured, is entitled to recover from third
party liable
for the loss. One of the important reasons for this doctrine is to
reinforce the principle
of indemnity i.e. to prevent the insurer from collecting more than his
actual loss. Another reason for subrogation
is to hold premiums below what they would otherwise be. This, however,
does not allow the insurer to lodge claim against the insured, even if the
insured is negligent. The principle of subrogation also does not apply to
personal accident and life policies.
Principle
of Utmost Good Faith:
This principle imposes a higher standard of honesty on parties to an
insurance contract. The proposer must disclose before the contract
is concluded all material facts, which he knows or ought to know. Failure
to make such disclosure renders the contract avoidable at the insurers
option. It is, important to note that avoiding the contract does not
follow unless the misrepresentation is material to the risk. 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 the contract.
The insurer, however, in good faith pay the claim even if there is breach,
and a breach of warranty may also be
waived by the insurers. However, unless it is waived, a warranty must be
complied with strictly and literally. It makes no difference whether the
breach of warranty is material or immaterial, fraudulent or innocent.
TYPES
OF GENERAL INSURANCE POLICIES
Marine
Insurance:
Marine
policies relate to three areas of risk: the hull, the cargo and the
freight. The risks against which these items may be insured are
“perils of the sea,” fire, theft, collision as well as a wide range of
other perils. Cargo is usually insured on a warehouse (of departure) to
warehouse (of arrival) basis and frequently covered against "all
risks."
Aviation
Insurance:
Most
policies are issued on an "all risks" basis subject to certain
restrictions. The buyers of these policies are the large commercial
airlines, the corporate or business aircraft owners, private owners
and flying clubs. Usually a comprehensive policy is issued covering
the aircraft itself (the hull), the liabilities of passengers and
liabilities to others.
Fire
Insurance:
A
standard fire policy is used for almost all business insurance, the basic
intention of the fire policy is to provide compensation to the insured
person in the event of there being damage to the property insured. The
standard fire policy covers damage to property caused by fire, lightning
or explosion, where this explosion is brought about by gas or boilers used
for domestic purposes.
This is
limited in its scope as property can be damaged in other ways, and to meet
this need a number of extra perils, known as special perils, can be added
on to the basic policy. These perils can include:
»
Storm,
tempest or flood
»
burst
pipes
»
earthquake
»
aircraft
Accident
Insurance:
Personal
Accident Insurance - The intention of the basic policy is to provide
compensation in the event of an accident causing death or injury. What are
termed "capital sums," is paid in the event of death or certain specified
injuries, such as loss of limbs or sight as may be defined in the policy.
The policy is usually extended to include a weekly benefit up to 104 weeks
or more for compensation if the insured is temporarily totally disabled
due to an accident and a reduced weekly benefit if he is temporarily only
partially disabled from carrying out his normal duties. In the event of
permanent total disablement (other than loss of eyes or limbs) an annuity
is paid. Practice varies among insurers, some of whom pay a lump sum.
Sickness
Insurance
- Personal
accident cover can be extended to provide a weekly benefit for an agreed
upon period which may be restricted to 52 weeks, in the event the insured
is temporarily totally disabled from engaging in his usual occupation due
to sickness.
Engineering
Insurance: The cover
is intended to provide compensation to the insured in the event of the
insured plant being damaged by some extraneous cause or its own breakdown.
Engineering
insurers provide an inspection service on a wide range of engineering
plants and this is a service much sought after by industry. Engineering
covers can be summarized thus:
a)
damage
to or breakdown of specific items of plant and machinery
b)
an
inspection service of those items
c)
cost of
repair of own surrounding property due to (a)
d)
legal
liability for injury caused by (a)
e)
legal
liability for damage to property of other caused by
(a).
Theft
Insurance:
Theft
insurance was first introduced towards the end of the nineteenth century
and was originally called "burglary insurance." Insurance companies
included in their policies a phrase to the effect that theft, within the
meaning of the policy, had to involve force and violence either in
breaking in to or out of the premises of the insured for cover to apply.
Motor
Insurance:
The
minimum requirement by law is to provide insurance in respect of legal
liability to pay damages arising out of injury caused to any person. A
policy for this risk only is available and is termed as an "Act Only"
policy. A “'Third Party Only'” policy would satisfy the minimum legal
requirements and in addition would include cover for legal liability where
damage was caused to some other person's property. The most common form of
cover is the “'Comprehensive Policy”' which adds accidental loss of or
damage to the vehicle to the third party, fire and theft cover.
Miscellaneous
Insurance
Money
insurance - The
policy provides compensation to the insured in the event of money being
stolen either from his business premises, his home or while it is being
carried to or from the bank.
Glass
insurance
-
Accidental damage to glass, mainly plate glass windows but also glass
doors and shelves, is covered by the Glass Insurance Policy. It is also
possible to include damage to the shop front and the contents of the
window.
TYPES
OF LIFE INSURANCE POLICY
Life
assurance contracts available are many and the basis of all these policies
can be found under the following headings :
Terms
Insurance:
This is
the simplest and oldest form of insurance and provides for payment of the
sum assured on death, provided death occurs within a specified term.
Should the life assured survive to the end of the term then the cover
ceases and no money is payable. This is a very cheap form of cover and is
suitable, for a young married man who wants to provide a reasonable sum
for his wife in the event of his death. It can also be used for a variety
of specific purposes such as business journeys.
Whole Life
Insurance:
The chosen
sum assured is payable on the death of the assured whenever it occurs.
Premiums are payable throughout the life of the assured until retirement
of the assured. Although premiums may cease at, say, age sixty, the policy
is still in force. Should the person die at age seventy-five, the
policy would provide the benefits for his widow or family.
Endowment
Insurance:
The chosen
sum assured is payable at the end of a given term of years or upon earlier
death. These contracts are taken out as savings plans for the future with
the added attraction of life cover. Endowment contracts will always
be popular because each proposer earnestly hopes that he will live to the
end of the term and spend the proceeds himself.
Annuities:
When a
person has a reasonably large sum of money and wants to provide an income
for himself after he retires, or at some other time, he can approach a
life assurance company and purchase an annuity. The annuity may start at
once, when it is called an immediate annuity, or may start at some date in
the future (a deferred annuity). Regardless of when it starts it can take
various forms. It may provide an annuity for the life of the person, the
annuitant, or it may be payable irrespective of death for a certain
period, as in the case of the "annuity certain." The guaranteed annuity is
similar in that it provides the annuity for a guaranteed period and
thereafter until the annuitant dies.
Pension
Schemes:
These
schemes are designed to provide an income at retirement. So far as
insurers are concerned they may be asked to arrange a scheme, rather than
a firm doing all the work itself. This involves collecting the premiums,
investing them and paying pensions to retired people. Many schemes are
endowment policies with group life insurance cover to provide benefits,
should the death of a member occur before retirement age, but there are
different ways in which this can be done.
INSURANCE
IN AN ISLAMIC FRAMEWORK
Insurance
is a socio-economic institution that reduces risk both to society and to
individuals. This accomplished by combining, under one management, a large
group of objectives so that the aggregate loss to which society is subject
become predictable. Insurance has scientific basis and is effected by
legal contract, under which the insurer for consideration promises to
reimburse the insured for any loss suffered during the tenure of the
contract.
There are
many social and economic value of insurance, but the greatest value lies
in the benefits following from the reduction of risk in society. Insurance
has the advantage as a device to handle risk and, therefore, it is
necessary that its services be extended in order to bring about the
greatest economic advantage to a given society. In order to establish the
validity of this point we must have clear concept about the
socio-economic objectives of an Islamic Society.
Belief in
Allah is central in the Islamic concept of society. This is the organizing
force without which life losses it’s full meaning. Belief in a
supernatural power reduces man's vanity and despair. Belief in one Allah
does not mean that the individuals in the society are just the dolls in
the hand of the Almighty. In fact, Islam fosters initiative and
responsibility. The Quran insistently and consistently reminds people that
they are judged on their own merits as independent, responsible
individuals.
Another
important aspect of Islam is that the society at large is based on the
concept of humanity and brotherhood of the Muslim community. Concepts of
universalism on the one hand and individualism on the other must be
understood in its true spirit and applicability. Muslims in their minds
should have a sense of awareness of mutual rights and obligations binding
each individual of the society in their faith and Islam have a set of
goals and values encompassing all aspects of human life including
social, economic and political. The Islamic way of life being goal
oriental, can be best understood by the practices of an organized
community, which is governed in accordance with the tenets of Islam.
We all
know that Allah has provided all necessary resources on this earth. Man,
being the vicegerent of Allah on this earth, has the responsibility to
utilize these resources for the general human welfare. According to
Islamic principle, it is basically the moral responsibility of the
individual to cater for his own needs through his own efforts.
The ethic
of Islam clearly counsels against begging, against being a parasite living
on the labor of others. In Islam, man's economic endeavor is praised and
economic resignation is condemned. Islam suggests a great attention to
every aspect of material life of men and women. The Shariah has
given us a pattern of material wealth distribution with which to order our
lives. In Islam every Muslim by law is entitled to get support from fellow
Muslims if he can prove his need. The purpose of Islamic Law is always to
inject morality and responsibility into the fabric of human relations.
Islam is not only a religion but also the supreme unifying social bond.
From history we know that the Madinites affiliated themselves as brothers
and sisters with the Makkan-immigrants. They voluntarily and gladly shared
their entire property with Makkan. This type of affiliation was not
motivated by any kind of gain or profit or even a promise of gain or
profit. It was simply motivated by conviction, commitment and dedication
towards a common cause. The new principle of sharing was established. The
Muslims drew a great amount of satisfaction from offering ones help,
property and life for the cause what they believed to be the ultimate
truth. In fact, the Islamic way of life is inconceivable without an
organized community governed in accordance with tenets of Islam.
Therefore,
in an Islamic society, all organizations and institutions including the
State should cater to the welfare of the people. Islam considers mankind
as one family. All members of this family are alike in the eye of Allah.
There is no difference between the rich and the poor, the high and the low
or the white and the black. There is to be no discrimination due to race,
color or position. The only criterion of a man's worth is character,
ability and service to Islam and humanity. Since Islam emphasizes
distributive justice and incorporates in its system a program for
organized community with the commitment of human welfare, there ought to
be compulsory arrangement for insurance against unemployment and
occupational hazards, old age pension and survivors benefit. The Islamic
society should also provide assistance to those who because of disability,
physical or mental handicaps or obsolescence, are unable to support
himself or herself or to attain a respectable standard of living by their
own efforts.
The
objective of an Islamic Economic System is to create an exploitation free
society and upliftment of the society as a whole. Therefore, any system or
organization that is for the welfare of the mankind is not in
contradiction with Islam. The objective of the Shariah is the
promotion of welfare of people that lies in safeguarding their faith,
life, intellect, posterity and property. Whatever ensures the safeguarding
of these elements of human beings serves public interest and is desirable.
This is because the basis of Shariah is wisdom and welfare of the
people. Further, anything that departs from justice to injustice, welfare
to misery, from mercy to harshness and from wisdom to folly has nothing to
do with Shariah.
The
principle foundation of insurance as an economic institution is the
equitable distribution of the financial losses of a few over many. In
insurance, each policyholder contributes an amount commensurate with the
risk he introduces to a fund; established and administered by the insurer
and out of the fund the losses are paid to the insured members. The main
functions of an insurance organization then becomes the management of the
fund and the assessment of the equitable contributions to be made by the
policyholders.
In the
business world without insurance, businessmen would have to set aside some
of their capital resources against the possible losses that might occur.
The capital thus safeguarded is freed for further development of the
business. Apart from that, insurance removes the anxiety and thus
helps to increase the efficiency of the business community. Insurance also
helps to achieve a consistency of trading results and an avoidance of wide
fluctuations. In this way insurance helps to develop and consolidate
business on stable basis.
In the
field of overseas commerce, the banks will not negotiate the bills of
exchange unless the goods are insured against marine, and, sometimes, war
risks. Even when the bank does not finance shipments, common prudence
calls for marine insurance protection, as the cost of insurance is but a
small fraction of the market value of the goods. Similarly, the large
industrial organizations could not operate, as the banks would not be
prepared to finance them without insurance arrangement. No large-scale
enterprise could function, were it not possible to transfer many of its
risks to insurer. Vast amount of capital in the form of premises, plant
and machinery are at risk in industrial concerns. Without insurance, these
risks would remain uncovered.
Human life
has value for many reasons. The main economic problem that arises when
someone in the family dies is the loss of earnings of the deceased
person. In a business firm, if a key employee dies, the firm may
lose valuable customers whose loyalty depends on this individual. The
value of human life, apart from death, may also be diminished through loss
of health by way of loss of earning due to disability and expenditure for
medical care. Old age is another peril that affects earning capacity, just
as premature death or loss of health.
Because
human life is recognized to have great economic value, a demand has grown
for life and health insurance. As a social and economic device, life
insurance is a method by which a group of people may co-operate to even
out the burden of loss resulting from the premature death of any member of
that group. The purpose of life insurance is, therefore, primarily to
accumulate wealth or property and, even if death intervenes, to ensure
that the intended wealth will be available. Two distinct objectives of
life insurance must be understood clearly. The first objective is termed a
'saving need' and the latter is termed as 'protection need'.
The basic
theory of life insurance is that all who pay life insurance premiums to
the common fund do so with the willingness that the fund should be used to
compensate the estate of those contributors at whatever age in life they
may die. However, increasing emphasis on the investment aspects of life
insurance has tended to overshadow the primary purpose of protection
against premature death.
The
uncertainties of life are such that no man can say how long his life will
last and every prudent and considerate person desires to make some
provision for his dependants in the event of his death. The fundamental
economic purpose of life insurance is to mitigate such possible loss.
Technically
speaking, insurance is a socio-economic device, which implies sharing of
losses sustained by some members of a group by all the members of that
group. It provides economic security against loss of life or property or
pecuniary interest. Insurance also provides indemnity to the persons for
legal liability. Therefore, insurance as a system is acceptable to Islamic
Society as it resembles the concept of Bait-ul-Maal (Ali 1989).
MODUS
OPERANDI OF ISLAMIC INSURANCE (TAKAFUL) COMPANY
An Islamic
insurance company transacts business on a co-operative basis in accordance
with and subject to the principle of Islamic Shariah. All the
functions of conventional insurance companies, i.e. underwriting, claims,
reinsurance, marketing, investment, company management, etc. of Islamic
Insurance Company should fully conform to Islamic Shariah Code. At
the same time, the Islamic insurance companies should also make the scope
and benefits of insurance coverage traditionally provided by the
conventional companies available. Islamic insurance companies have
developed extensive facilities to transact all classes of general
insurance such as life, marine, fire, motor, accident, aviation,
engineering, etc. Islamic Insurance Companies are now functioning very
efficiently on most economic and competitive terms consistent with safety
and security.
The cost
of insurance is one of the most important factors in a sound analysis of
risk. Both the insured and the insurer are interested in a rate that
is fair. The basic criteria for rate making are:
a)
The
premium should be adequate but not excessive to meet the claims;
and
b)
The
premium should be allocated among the insured on "fair" basis.
These
criteria will be followed by an Islamic Insurance Company on a more
rational basis. For example, a participant (policyholder) of a general
Takaful (insurance) scheme shall enter into contract with the company on
the basis of the principle of Mudaraba as per "partnership" clause
of the policy. This clause stipulates the rights and obligations of the
participants as well as the company. The Company, acting as an
entrepreneur collects the Takaful contributions (insurance premium) from
the participants and manage the various classes of general Takaful fund.
The amount of the premium to be paid by the policyholder of an Islamic
insurance company depends upon the class of Takaful and the rate fixed on
the basis of sound principles of rate making. The participants shall pay
the premium to an Islamic insurance company as "Tabarru". These
Takaful contributions are credited into the "General Takaful Fund" of the
company. The company in accordance with the requirements of the
Shariah will invest the funds. All the profits from the investment
shall be pooled back to the fund. The company shall pay from the General
Takaful Fund compensation or indemnity to fellow participants, who have
suffered a defined loss caused by one or more than one of the insured
perils during the policy period. From this fund, operational costs of
General Takaful Business, required reinsurance premiums are to be borne.
Further, a “reserve” for unusual losses is to be built up from this fund.
The surplus (profit) if any after meeting all these expenses and required
reserve, will be shared between the participants and the company. However,
the participants who had suffered losses should not have any share of
profit as they have been already compensated out of this fund. This
sharing of the surplus will be in a ratio agreed to in accordance with the
principle of Mudaraba. The operation of the General Takaful is
illustrated below.
Chart I: General Takaful Scheme of Islamic
Insurance
The mode
of operation of a General Islamic Insurance Company can be best described
by taking an example. Say, the participants of fire risk contribute one
crore taka in a particular year as Tabarru to a company, the
company will keep this in a special account to be called Fire Takaful
Fund. At the end of the year it may transpire as follows:
i) Claims paid or to be
paid
(25%)
Taka
25,00,000
ii) Operational cost during the
year
(15%)
"
15,00,000
iii)
Reinsurance premium
(20%)
"
20,00,000
---------------------
Taka
60,00,000
The company may decide to keep reserve for unusual year (30%)
Taka 30,00,000
---------------------
Taka 90,00,000
Therefore,
the surplus money Tk. 10,00,000 can be distributed to the policyholder as
per terms of the contract. If the ratio agreed is 70:50, then 70% of this
surplus i.e. Tk. 7,00,000 will be distributed among the participants. This
means a policyholder who has paid at the time of taking a cover as
contribution Tk. 1,000/- will receive (Tk. 70/-) return on the amount of
premium paid. This is only an example, the return can be as high as 20% to
25% depending upon the net underwriting surplus of a particular portfolio.
This surplus will vary from year to year. In rare case, the
policyholders may be asked to contribute additional premium.
FAMILY
TAKAFUL SCHEME
The
modus operandi for Islamic Insurance companies operating life
business are almost similar but more clarification is needed. Life
policies are issued in the name and style of Family Takaful Scheme. The
participant or the policyholder of a Family Takaful Plan should pay the
agreed amount of installments on a regular basis. Each installment paid by
the participants is divided and credited into two separate accounts namely
"The Participant Account" and the "The Special Account". Normally
the major portion of the installment amount (say 90%) is credited to the
Participants Account and the balance of 10% is credited to Special
Account. The deposits are paid back to the participants as per terms of
the contract with profit. The amount that is credited to the Special
Account is meant for those participants who will not be able to pay full
installments because of their early death. Thus the company will be able
to pay Takaful benefits to all fellow participants who become members of
the scheme. The amount that is credited into these two accounts is
invested as per Shariah Code and profits are shared between the
Participants and the Company in an agreed ratio. The major portion of the
profit (say 80%) is paid to the policyholders and the company is entitled
to get the balance amount of the profit only.
In the
event of surrender of the policy, the incumbent participant will receive
the proportion of his Takaful installment, which had been credited to
Participant Account together with his share of profits accumulated up to
the date of the surrender. But he will not be entitled to get any refund
from the Special Account.
If a
participant expires before the maturity of his Family Takaful Scheme, then
his or her heirs will be entitled to get the total amount of the
installments deposited in the Participants Account before his death along
with his share of profit credited into Participants Account. His/her heirs
will also be entitled to the total outstanding installments that would
have been paid by the deceased participant, had he/she survived. If a
participant is alive until the date of maturity of the Takaful Scheme,
he/she is entitled to get the total amount of Takaful installments
deposited in the Participants Account along with his share of profit. He
will also be entitled to a proportion of net surplus, if any, which is
available in the Special Account as per last valuation of this account
before the maturity date. We can illustrate this in Chart 2 of Family
Takaful of Tk. 2,00,000.00 -
Chart 2:
Flow of Family Takaful Contribution
In the
above Chart it has been assumed that for a Takaful plan of an individual
for a twenty-year term the participants should contribute annually Taka
10,000. At the end of the year the Participants Account will be credited
with Tk. 10,080.00 and the Special Account will be
credited Tk. 1,120.00. In every year, these two accounts will be credited
with more or less the same figure. The profit amount may vary depending
upon return on investment. If the participants want to surrender
i.e. not willing or are not capable he gets back his money credited in the
Participants Account. For example, if a participant wants to
surrender, at the end of the fifth year of the plan, he gets back Tk.
50,400.00 ( 10,080 X 5). He receives only the credit
along with the profit in Participants Accounts. At the maturity i.e. at
the end of the 20th year, presuming that the rate of return is
the same throughout the period he will get Tk. 2,01,600.00. He is
also entitled to get his share of surplus money in the Special Account
after paying for premature claims from this fund.
If we
assume that the participant expires at the end of the 10th year
of the policy term, his nominee will get (Tk. 10,080 X 10 = Tk. 1,00,800 +
1,00,000). An additional 1,00,000 taka will be granted by the other
participants in the scheme and will be paid from the fund created in the
Special Account. Even if a participant expires after payment of a single
annual contribution of TK 10,000, his nominee/heirs will get a guaranteed
outstanding balance of Tk 1,90,000 plus his portion of Participants
Account along with profit i.e. Tk. 10,080, total Tk. 2,00,080 under this
scheme (Ali 2000).
HISTORICAL
PERSPECTIVE OF CONVENTIONAL AND ISLAMIC INSURANCE
In the
seventeenth century, there were no insurance companies as we know them
today. The practice was for individuals, who came to be called
"underwriters," because they wrote their names TO benefit the wording of
insurance policies, to guarantee commercial ventures on a personal basis.
'Lloyds Coffee House' in Tower Street of London (owned by Mr. Edward
Lloyd) proved to be a favorite venue for them to conduct their business
informally over cups of coffee. Mr. Lloyd promoted the trend towards
business by providing his customers with pen, ink, paper and shipping
information. Lloyds Coffee House thus became recognized as a like place
for persons wanting insurance cover to find underwriters.
During the
course of the eighteenth century, the British Mercantile Fleet had
increased in size and operations. It was found that many individuals who
underwrote marine risks were undependable, and after receiving substantial
premiums failed to pay claims. Therefore, in 1720, an Act was passed which
provided for the incorporation of the Royal Exchange Assurance and the
London Assurance Companies for the purpose of effecting marine insurance.
Each of these two companies had a substantial stock. Since the companies
offered cover of a very restricted nature and consistently refused to
underwrite any but the safest risks, the purpose of the Act was defeated
and Lloyds Coffee House was established as the most important center of
marine underwriting.
This
system resulted in considerably less security to the insured than would
have been provided by associations of individuals. Although many merchants
would have much preferred to insure with the companies, and would have
been prepared to pay higher premiums to them, they were not able to do so.
Since the companies and Lloyds Coffee House operated from London, the
difficulties encountered by traders from other ports in the UK were much
greater. As a result, groups of ship owners at various ports joined
together to settle own hull loss (averages) on a mutual basis, each member
underwriting share of the risks, for which he was individually
responsible. In such clubs each member is both insured and insurer. All
the other members in proportion to their respective properties in it
insure him to his own property in the club, and he is at the same time an
insurer in the proportion of his own property in the club for the property
of the each of the others.
In 1824,
when the monopoly to the London Assurance and the Royal Exchange Assurance
was removed, several other companies were founded. However, in practice,
it was found that the underwriters established at Lloyds were able to
quote rates. The result was that the better class of vessel was insured at
Lloyds and the Clubs were left with the risks that were unacceptable
elsewhere. This led to the decline of hull clubs in the long run. But in
marine insurance, the P & I Clubs were very important market component
in the field of ship owners liability insurance.
In the
context of the above we will look into the background of the formation of
the first Islamic Insurance Company. With the establishment of the Dubai
Islamic Bank and the Islamic Development Bank, as the starting point of
Islamic Banking Movement, H.E. Prince Mohammed-al-Faisal-Al-Saud of Saudi
Arabia took initiative for the establishment of a number of Islamic Banks.
In one such initiative, in February 1976, he held discussions with H.E.
Gafar Nimeiry (the then President of the Democratic Republic of Sudan) and
asked for permission to establish an Islamic Bank to be operated in Sudan.
Executive and Legislative authorities in the Sudanese Government at all
levels gave every encouragement and acceded to the proposal. In August
1977, Faisal Islamic Bank was registered as a public limited company under
the Sudanese Company Act-1925.
When
Faisal Islamic Bank was established, the bank authorities initiated
studies on the establishment of a co-operative insurance company. In this
respect the opinion of the Bank's Shariah Supervisory Board (SSB)
was sought. The SSB studied the scheme at the first meeting. Studies
continued and several steps followed. The Faisal Islamic Bank Authorities
prepared the Memorandum of Association and Article of Association. The SSB
proposed some amendments, which were implemented. The SSB ensured that the
scheme was sound from a Shariah point of view as well as feasible
from a practical point of view. Therefore, the Islamic Insurance Company
Ltd. Sudan was incorporated as a Sudanese Public Company (under the
Companies Act 1925) in January 1979. This is the first ever-insurance
company established in the world to transact business according to the
Islamic Shariah. The Faisal Islamic Bank has subscribed to the
entire authorized capital of this company. The company enjoys numerous
concession and exemptions. All its assets and profits are exempt from all
types of taxes. Further, the assets of the company are not subject to
confiscation, nationalization etc. The Company is also exempt from the
application of acts regulating insurance in Sudan.
In
Malaysia, the Islamic Insurance Company was established as a private
limited company (in accordance with companies Act 1965) in November 1984
and started its operation in August 1985 as a composite insurance company.
This was made possible by the Malaysian Government who, in 1982, took a
positive step by forming a special body known as the "Task Force" for the
study of the establishment of Islamic Insurance in Malaysia. This
Task Force was formed on the basis of the recommendations of the National
Steering Committee on Islamic Bank, which highlighted in its report to the
Malaysian Government the need for an Islamic Insurance. The Committee felt
that it was necessary in order to cater the insurance requirement of the
Islamic Bank that was about to be launched. Members of the Task Force were
drawn from personalities and groups representing religious scholars, legal
experts, economists and insurance practitioners. The members of the task
force visited a number of Islamic countries and also had discussions with
three Islamic Insurance Companies already established or about to be
established. Finally, in its report to the Government, the task force
suggested that an Islamic Insurance company should be established in
Malaysia as soon as possible. The Malaysian Government then promulgated
legislation entitled as the Takaful Act, which regulates the Islamic
Insurance (Takaful) of Malaysia. It may be of interest to note that
in Malaysia, the Islamic Insurance Company (known as the Syarikat
Takaful Malaysia) is practically a subsidiary of Bank Islamic
Malaysia Berhad, which owns 51% of the paid up capital of the Takaful
Company. The balance 49% of the shares are owned by the
various state religious councils and state religious foundations within
Malaysia.
DISTINGUISHING
FEATURES OF ISLAMIC INSURANCE
From
historical background of conventional companies we find that three
predominant legal forms have been used as follows:
a)
Association
of Individuals (Lloyds)
b)
Stock
Companies
c)
Mutual
Companies, and Clubs
A Lloyds
Association is an organization of individuals joined together to
underwrite risks on a co-operative basis. Here the individual underwriter
assumes risks in his own name and does not bind the organization for his
obligations. Each underwriter is individually liable for losses on which
he has assumed risks. Thus it can be said that a Lloyds Association is
proprietary organization bent on profit and the underwriter is always an
individual. On the other hand, a stock company is the corporate body of
stockholders that is organized as a profit-making venture in the insurance
field. However, the Mutual companies and the clubs are organized as a
non-profit corporate body that is owned by policyholders as there are no
stockholders.
However,
in the case of Islamic insurance, we observe that the corporate objective
of the Islamic Insurance Company is to provide Islamic Insurance or
'Takaful' service on a commercial basis in accordance with Islamic
Principles in order to provide the service of insurance as permissible in
the Shariah.
In this
respect, it has been observed that an Islamic Insurance Company be
established on condition that its co-operative nature be made evident.
This necessitates clear stipulations in the insurance contract and certain
additional clauses to signify that the premiums paid by the insured are
grants from him to the company to be remitted to fellow contributors in
need of assistance according to the regulations agreed upon. Therefore, it
has been suggested that certain special clause should be added to the
insurance contract to signify its co-operative nature. The additional
terms provide the insurer the right to revert back to the insured for
additional premium and the right of policyholders to share in the
surpluses. The insurer also enjoys the right to invest the surplus fund in
any way that it deems fit in projects and other fields of investment as
allowed by Shariah and under the relevant insurance rules or
regulations.
Islamic
Insurance Co. (Sudan) has
incorporated these principles by way of inserting additional clause in the
policy condition as follows:
Co-operative
(Mutual Clauses):
"The
Insurance granted under this policy is subject to company's Memorandum and
Article of Association which provide inter alia that the
company shall transact business on a co-operative basis in accordance with
the subject of the Islamic Shariah. The Company accordingly
maintains a distinct and separate account for its policyholders known as
the policyholders Account. The Policy holders account is credited with all
the premiums paid by them gratuitously and debited with their share of
service charges, claims and the surplus, if any arrived at after making
provision for depreciation, bad and doubtful debts and establishing
traditional technical services at the end of each financial year shall be
treated as follows:
(a)
The Board
may set aside all or part of the surplus as general reserves or other
special reserves and such reserves shall be considered as gratuity from
the policyholders.
(b)
If the
whole of the surplus has not been set aside as reserves the balance shall
be distributed amongst the policy holders in proportion to the surplus
generated by the premiums paid by them".
Investment
Fund Clause: "The
Company invests the funds held by it on behalf of the policy holders in
accordance with the principles of Islamic Shariah Code".
Dr. Abdul
Halim Bin Hazi Islamil, the Chairman of Syarikat Takaful Malaysia, has
explained the above principles as follows:
"The
provision of insurance cover as a form of business in conformity with
Shariah is in essence based on the Islamic principles of Al-Takaful and
Mudaraba -
Al-Takaful briefly means the act of a group of people reciprocally
granting each commercial profit sharing contract between the provider or
providers of fund for a business venture and the entrepreneur who actually
conducts the business. The Islamic insurance or Takaful business conducted
by the company may thus be envisaged as the profit sharing business
venture between the Company an the individual members of a group of
participants who desires to reciprocally guarantee certain loss or damage
that may be inflicted upon any one of them."
From what
stated so far we obverse that an Islamic Insurance company should have
following features:
(a)
The
policyholders should have the right to participate in surplus profits
.
(b)
The
policyholders should be liable to contribute additional amounts if the
initial subscriptions (contributions) made during a particular year are
not sufficient to meet all the losses.
(c)
The
policyholders may be given representation on the Board of Directors of the
company.
(d)
The
company would invest its funds in sources that are not forbidden by Islam
and should not indulge in the harmful and forbidden practice of
Riba in any form.
(e)
The
company would maintain two separate and distinct accounts. One known as
the policyholder’s account and the other the shareholders
accounts.
(f)
The
policyholder’s account is credited with all the contributions made by the
policyholders and their share of profits on investment of funds. The
policyholder account is debited with their proportion of service charges
and claim.
(g)
The
surplus after the establishment of necessary reserves is distributed
amongst policyholders. The deficit, if any, is written off against the
general reserve.
(h)
If there
is no general reserve or the amount of the general reserve does not cover
the deficit fully, such deficit is met from the shareholders reserve and
capital in the form interest-free loan to be recovered from the future
surpluses.
(i)
The
shareholders do not participate in any part of the surpluses
of the policyholders account.
(j)
The income
derived from the investment of the share capital is credited to the
shareholders account the surplus left after meeting their share of current
expenses etc., is distributed amongst shareholders.
(k)
A
Zapata fund will be developed by way of charging 2.5% annually on
the share capital, reserves and profit.
(l)
There
should be a Shariah supervisory Board. The Board will be
responsible for supervising the day-to-day functions of the company in the
light of Shariah (Ali 1991).
INVESTMENT
OF PREMIUM UNDER ISLAMIC INSURANCE
The
insurance industry as a whole, and an individual insurance company in
particular, plays a vital role in the development of a capital market.
However, investment of an insurance company is mostly guided by relevant
provisions in the Insurance Act, which provides formulae for minimum
investments required by a particular company depending upon the type or
types of businesses and on the basis of liabilities involved in a
particular year. The Act also specifies the percentage of investment to be
made in Government Securities, Approved Securities and other Approved
investments as may be notified from time to time. Subject to the
restrictions made by the Government, investments of an insurance company
are made in the following categories:
·
Government
Securities (including Bills, Bonds and Certificates)
·
Shares
·
Debentures
·
Real
Estates
·
Deposits
with Banks
·
Bridge
Finance
Investment
Guidelines are set out in Section 27, 27A, of Insurance Act 1938 as
adopted in Bangladesh. About 60% of the life funds require to be invested
in Government or other approved securities. The balance is allowed in
approved investments.
Investment
operations are incidental yet crucial to the business of insurance.
Insurers are required to generate reserves for claims that might arise and
over a period a large corpus of funds is built up. It is essential that
insurance companies invest these funds judiciously with the combined
objectives of liquidity, maximization of yield, security, and most
importantly, ensuring that they can meet the liabilities when required.
The choice of investments will depend on the type of liabilities. Returns
on investments from life insurance funds influence, to a large extent,
premium rates and bonuses. It has been recommended that the insurers must
at all times maintain a prescribed minimum level of solvency as a
protection for the policy holders' legitimate interests. Because of public
interest, investment of life insurance funds is regulated in some
countries. Most countries do not prescribe the investment pattern,
but instead set ceilings on the maximum value as a percentage of the fund
in each of the different categories of investments that are admissible for
the purpose of determining the solvency margin.
In
Singapore, up to 35% of the fund can be invested in equity shares,
preference shares, subscription rights and share warrants. Up to 5% is
allowed in unquoted shares and up to 20% is allowed in property. The
admitted value of outstanding premiums and agents' balances (in respect of
general business only) is 12.5% of written premiums. In Malaysia, the
value of investment securities should not be less than 25% of the total
value of the fund and not less than 80% of the fund should be invested in
Malaysia.
The life
insurance industry will be competing against other financial institutions,
life banks, mutual funds, and unit trusts for the investor's moneys. A
level playing field is required to promote healthy competition between
these different types of financial institutions. Therefore, it is
recommend that the requirement for life insurance companies to be heavily
invested in Government Securities be removed. Investing in equities is
more volatile than investing in Government Securities but it is possible
to improve returns by efficient and timely market operations and to reduce
risks by properly matching assets against liabilities. A dynamic approach
to the management of equities with requisite information support and the
application of the techniques of security analysis is called for in the
interests of the insuring public.
The
general insurance sector will have liabilities, which are shorter in term
as compared with the life sector. Equity investments are generally made
with a medium to long-term perspective and hence the maximum investment
allowed in equities should be lower for the general insurance companies
than in the life sector.
An Islamic
Insurance Company shall have to be guided by the relevant law of the
country, but, at the same time, it must use the investible funds in
financing and participating in permissible economic activities according
to Shariah provided modes on profit and income sharing basis.
Therefore, investment of Islamic Insurance Companies should be made as per
the following modes:
(a)
Musharaka
(Sharing profit and loss on a productive investment).
(b)
Mudaraba
(project finance for a fixed time with profit and losses being
shared)
(c)
Real
Estate
(d)
Deposits
with Islamic Banks.
Government
and other approved Securities are interest bearing. Naturally, the Islamic
Insurance Companies cannot invest the permissible required surpluses in
these Securities. Therefore, in order to meet the requirements of
Islamic Insurance Companies, it would be necessary to amend the relevant
sections of the Insurance Act, so that it allows the Islamic Insurance to
invest funds only as per Shariah approved means and modes (and not
in any interest bearing Securities and deposits). Alternatively, it
is necessary that the Parliament frames out and passes the required
Islamic Insurance Act as per the model of Malaysia Takaful Act 1984.
In fact the proposed Act has to be modeled on the existing Insurance Act
with modifications and amendments, which are necessary to conform to
Islamic Insurance practices.
