Conventional insurance has elements that are forbidden in Islam, but mutual schemes are possible both as insurance and reinsurance. Rodziah Zainudin explains the system of takaful and retakaful.

Conventional insurance schemes have elements that are forbidden in Islam (discussed below). Islamic insurance is the only facility designed with the needs of Muslims in mind, but the national and international Islamic insurance industry is underdeveloped despite increasing demands by the public and private sectors.Takaful is a noun stemming from the Arabic verb kafal, meaning to take care of one's needs. Takaful embodies the principle of mutual help, co-operation and shared responsibility. It describes the practice whereby participants in a group agree to jointly guarantee themselves against loss or damage. The damage may be inflicted upon them or the result of an accident, as defined in the insurance contract. If any member or participants suffer a catastrophe or disaster, he would receive a certain sum of money or financial benefit from a fund, also as defined in the insurance contract, to help him to meet the loss or damage.

Essentially, the concept of takaful is based on solidarity, responsibility and brotherhood among members where participants agree to share defined losses to be paid out of defined assets. This is similar to mutual insurance as was practised in the early days of insurance and even today by certain groups.Malaysia, as a forerunner of the Islamic insurance industry in Asia, became the first country to regulate the takaful industry with the introduction of the Takaful Act, 1984. In most other countries, takaful operators are controlled by their respective authorities under the same law, if any, as that which supervises and regulates conventional insurance.

The first known takaful operator is the Islamic Insurance Co Ltd, Sudan (1979). Syarikat Takaful Malaysia Berhad (1984) was the first registered takaful operator in Malaysia and ASEAN. With the continuing surge of commitment to revive the Islamic way of life, more takaful and retakaful operators are setting up worldwide.We have seen how Islamic banking business developed throughout the world and not only in Islamic countries. In Malaysia, most domestic conventional banks are now offering “interest-free” banking and Islamic banking products. Many projects including national projects are financed through Islamic financing. Irrespective of the religion of the proprietor, many businesses are benefiting from Islamic funding.

The insurance and reinsurance industry will inevitably see the same change and development. The greatest challenge for takaful operators worldwide is twofold. Firstly, it is to create demand among the Muslims by informing them of the social and economic benefits. And secondly, to demonstrate to the non-Muslims that Islamic insurance is a better alternative to conventional insurance. Positive steps such as forming dedicated research and development centres with a view to researching and developing new takaful products, producing qualified professionals in Islamic insurance and providing consultancy and advisory services will hopefully boost the takaful industry worldwide.

Labuan, with its tax efficient environment and many incentives in the insurance industry is a conducive place to establish takaful and retakaful branches for existing conventional operators or new players.

The Offshore Insurance Act, 1990 (OIA) governs the (re)insurance industry and related insurance matters in Labuan. Unlike in the domestic scene, there is no specific takaful legislation. The requirements for setting up an offshore takaful company and retakaful company are similar to those of conventional insurance provided in the OIA 1990.

Objections to insurance
This article will not dwell into the different views of Muslim scholars regarding insurance and reinsurance. It is accepted that insurance and reinsurance are allowed in Islam subject to certain conditions. A basic background is, however, essential.

In June 1972, the National Fatwa Committee of the Malaysian Islamic Affairs Council decreed that the existing conventional insurance (life) provided by conventional insurance companies was inconsistent with the principles of Syariah since it contained the element of
• gharar (risk of something which is unknown, which introduces the element of uncertainty (juhala in an insurance contract),
• maisir (gambling pursuant to the existence of gharar. There is hope of gain and fear of loss when entering into the insurance contract) and
• riba' (usury).
Later, in 1985, the Fiqh Academy under the auspices of the Organisation of Islamic Conference resolved that all forms of conventional insurance (life and general) do not conform with Islamic principles.

An alternative is a takaful scheme under which members of a scheme agree to help each other by contributing financially on the basis of tabarru' and mudharabah.

• Tabarru' is a concept incorporated in the takaful contract to eliminate the element of uncertainty. A participant agrees to relinquish as tabarru' (like a donation) his takaful contribution. It is “like a donation” because it is given to indicate that he agrees or undertakes to pay his contribution (premium) to enable him to fulfil his obligations of mutual and joint guarantee should any of his fellow participants suffer a defined loss. Tabarru' will enable the participant to perform his duty by sincerely assisting fellow participants who might suffer a loss or damage due to a catastrophe or disaster.

Without tabarru', the transaction becomes an exchange. The problem with buying and selling is that such a promise may or may not be fulfilled (ghara), depending on whether or not the insured event happens. Because insurers have “sold” a promise, they have earned the right to keep the premium. Thus, if a claim does not occur, they will make a gain. On the other hand, if the event insured against occurs, they stand to lose (maisir).
• Mudharabah - (profit sharing) is an agreement between two parties in which the client (also known as Sahib ul-mal) provides the funds/takaful contributions for the takaful operator (known as Al-Mudharib) to manage the respective takaful business, including its investment activities, with the condition that they share the profit according to the percentage which they agreed upon at the drawing up of the contract.

In addition, the insurance contract clearly states how the the takaful operator is to use the takaful contributions. It also specifies that either the whole or part of the contribution (premium) will be paid as tabarru' for the purpose of assisting fellow participants suffering from loss or damage.

The important aspects of takaful operation, as detailed in the report produced by the working committee established by Malaysia's Islamic body to study the formation of an Islamic insurance company, are as follows:
• In takaful practice, losses are not calculated in advance, but are shared when they actually occur.
• The company is acting as a trustee on behalf of the participants to manage the operation of the takaful business. As such, the company does not have any right to the takaful benefits.
• All takaful contributions (premiums) paid by the participants will be accumulated in the takaful fund.
• The takaful fund will pay all the takaful benefits (claims). At the same time, money credited to the fund can be invested in areas approved by Syariah.Where there is a surplus from the operation, the company will share the surplus with the participants according the principles of mudharabah.
• According to these principles, the company as the mudhareb is also entitled to part of the surplus according to a pre-agreed ratio. At the same time, the company is eligible to earn profits from the investment of the shareholders' funds.
• Under the Islamic insurance system, the premium contribution by each participants should be with the intenton of tabarru' and not exchange of goods because with the existence of tabarru', Syariah considers the transaction permissible.

The Syariah principles applying to retakaful are similar to those applicable to takaful. The inherent principles of retakaful are these:• there must be insurable interest;
• the contract is one of utmost good faith (uberrimae fidei);
• the reinsurance contract is one of indemnity, compensation without obligation with mudharabah concept;
• the subject matter of the contract must be in existence at the time the contract is made.

The retakaful contract is driven by the following characteristics:
• the parties have the capacity to contract;
• there is an intention to create a legal relationship;
• there has been an offer and acceptance;
• there is financial transaction involved.

Retakaful is a necessity to enable small takaful operators to compete effectively with the conventional reinsurers. It also allows all takaful operators to have access to a wider capital base which gives a viable spread of risk and strengthens their finance.

Syariah parameters for retakaful
Acknowledging the small numbers of retakaful company worldwide, a takaful company may reinsure on a conventional basis, but only after exhausting all avenues to reinsure on anIslamic basis.

Takaful operators are not allowed reinsurance commissions from a conventional reinsurer as it encourages them to be agents for placing business with the conventional reinsurer which defeats the “takaful element”.

Expense sharing is not permitted, as this amounts to being partners in business with a conventional company.

Risk premium basis of reinsurance is the option that most closely satisfies the Syariah criteria.

Profit sharing on risk premium basis is permitted so long as these are derived from reinsurance underwriting surplus and excludes conventional investments profits.

Investments by takaful and retakaful operators
The fund management and investment made by takaful and retakaful operators must be approved by an in house Syariah advisory council. In the domestic arena, the Syariah Advisory Board (a national body) is responsible for designating certain investments halal (acceptable to Islam) in the Kuala Lumpur stock exchange.For comparison in the domestic scene, the available avenues for investment of takaful funds include:

Short/medium term option
• Special investment account with Islamic banks;
• Investment account with Islamic banks;
• Government investment certificates (GIC);
• Islamic accepted bills.

Medium/long term
• Investment account with Islamic banks;
• Financing facilities;
• Quoted shares (those approved by the Syariah advisory board);
• Unit/property trust;
• Properties.

With increasing interest in Islamic banking practices throughout the world, the Islamic insurance industry is poised to chart further advances. The challenge faced by the current and future Islamic insurance operators is to develop products and manage funds as competitively as conventional operators.

Ms Rodziah Zainudin is in-house counsel for the ZI Labuan Trust Company Sdn. Bhd., Malaysia.
Tel: +60 87 451 688;
fax:+60 87 453 688;