Takaful -Insurance- Part III (How it Works, Interest & Reinsurance)

How does Takaful Work

All participants (policyholders) agree to guarantee each other and, instead of paying premiums, they make contributions to a mutual fund, or pool. The pool of collected contributions creates the Takaful fund.

The amount of contribution that each participant makes is based on the type of cover they require, and on their personal circumstances. As in conventional insurance, the policy (Takaful Contract) specifies the nature of the risk and period of cover.

The Takaful fund is managed and administered on behalf of the participants by a Takaful Operator who charges an agreed fee to cover costs. These costs include the costs of sales and marketing, underwriting, and claims management.

Any claims made by participants are paid out of the Takaful fund and any remaining surpluses, after making provisions for likely cost of future claims and other reserves, belong to the participants in the fund, and not the Takaful Operator, and may be distributed to the participants in the form of cash dividends or distributions, alternatively in reduction in future contributions.

Pricing Transactions linked to Interest-rate Benchmark

There are continuing debates on whether the spirit of Shari`ah is being violated by the practice of "benchmarking" linked interest rate benchmark such as London Interbank Offered rate (LIBOR) plus an agreed mark-up in also pricing returns on Islamic finance transactions . At a very fundamental level, the reason for the debates is the lack of understanding to clearly discern the difference between the use of LIBOR as a benchmark for pricing and the use of non-Shari’ah compliant assets as a determinant for returns.

However, benchmarking touches upon the integrity of Islamic Finance as a whole, and the concept of Shari’ah-compliance vs Shari’ah-based approach in particular. There are practical challenges delaying a switch to participation-based structures, such as Musharakah and Mudarabah, that require financiers to participate in the underlying asset in a financing transaction.

Retakaful or Reinsurance

Frequently, the scale of insurance risks underwritten is too great for one insurer to carry safely. In these circumstances, companies use reinsurance to mitigate their own risk exposure. When insurers insure a risk again with another company, it is called reinsurance which allows the insurance industry to spread its losses, lessening the impact of claims on any one company.

There is currently a shortage of retakaful capacity and the lack of companies in the market presents a challenge as well as an opportunity. The challenge is to have a large enough Takaful market to justify ReTakaful business. There is also a global need for strong and credible retakaful operators to assist the growth and expansion of takaful business. Shari’ah scholars have allowed takaful operators to reinsure conventionally when no retakaful alternative is available, although retakaful is strongly preferred.

However, this conventional reinsurance represents a dilemma, as it is contrary to the customer’s preference of seeking cover on Islamic principles. Structurally retakaful operating principles are similar to the takaful operating principles, and the same Shari’ah principles apply.

[source: Institute of Islamic banking and Insurance (IIBI)]

Islamic Banking Part IV ( Pricing Transactions & Ethical Investment)

Pricing Transactions Linked to Interest rate Benchmark

There are continuing debates on whether the spirit of Shari`ah is being violated by the practice of "benchmarking" linked interest rate benchmark such as London Interbank Offered rate (LIBOR) plus an agreed mark-up in also pricing returns on Islamic finance transactions . At a very fundamental level, the reason for the debates is the lack of understanding to clearly discern the difference between the use of LIBOR as a benchmark for pricing and the use of non-Shari’ah compliant assets as a determinant for returns.

However, benchmarking touches upon the integrity of Islamic Finance as a whole, and the concept of Shari’ah-compliance vs Shari’ah-based approach in particular. There are practical challenges delaying a switch to participation-based structures, such as Musharakah and Mudarabah, that require financiers to participate in the underlying asset in a financing transaction.

Islam's Approach to Ethical Investment

Given that many ethical funds have similar characteristics as Islamic funds, it is important for ethical investors attracted by the appeal of Islamic principles as well as the performance of Islamic investments to understand that there are additional prohibitions that must be applied on the products offered. These restrictions which are essentially self-imposed based on belief and conviction act a moral compass; the monitoring of the prohibitions by a Religious (Shari’ah) Supervisory Board may have prevented Islamic financial institutions to deviate from a faith-based system and absorb the shocks within the conventional financial system.

The important principles for Islamic financial instruments for participation and investments that require strict adherence, while providing good returns, are:

• Investments must be free of interest, speculation and gambling, all are considered as forms of exploitation.
• Investments are made in permissible activities.
• Investments must be separately approved by an independent Shari’ah supervisory board to ensure Shari’ah principles are strictly adhered to and deviations and wayward business practice penalized, for example in Islamic finance requires penalties to be paid to charity.

"The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service," the Vatican's official newspaper Osservatore Romano said in an article its latest March 2009 issue.

[source: Institute of Islamic banking and Insurance (IIBI)]

Islamic Banking Part II ( Permissibility & Interest)

Rules of Permissibility

Muslims believe that all things have been provided by God, and the benefits derived from them, are essentially for man’s use, and so are permissible except what is expressly prohibited in The Qur’an or Hadith. When guidance is not clearly given in he Qur’an there are several other sources of law. For example, guidance can be sought from Fiqh, which means ‘understanding’ and is the science of jurisprudence: the science of human intelligence, debate and discussion

Prohitbition of Interest

Riba best translated today as the charging of any interest, meaning money earned on the lending out of money itself. The prohibition on paying or receiving fixed interest is based on the Islamic tenet that money is only a medium of exchange, a way of defining the value of a thing; it has no value in itself, and therefore should not be allowed to give rise to more money, via fixed interest payments, simply by being put in a bank or lent to someone else. The human effort, initiative, and risk involved in a productive venture are more important than the money used to finance it.

Money in Islam is not regarded as an asset from which it is ethically permissible to earn a direct return. Money tends to be viewed purely as a medium of exchange. Interest can leads to injustice and exploitation in society; The Qur’an (2:279) characterises it as unfair, as implied by the word zulm (oppression, exploitation, opposite of adl i.e. justice)

There is no real 'lending' in Islam since all 'lenders' obtain ownership interests in the assets that they finance, or earn a profit-share or purely fee-based remuneration. In order for an Islamic bank to earn a return on money lent, it is necessary to obtain an equity, or ownership, interest in a non-monetary asset. This requires the lender to also participate in the sharing of risk.

Individuals and the world as a whole probably know too well the burden of interest and misery and suffering that irresponsible lenders have inflicted on individuals and societies. It has become so completely institutionalised and accepted in modern economies that it is almost impossible to conceive that there are some who completely oppose it and refuse to enter into any transactions that involve interest.
Islam's prohibition of interest and usury was not unprecedented. The early Jewish and Christian traditions also forbade riba. Even the renowned Greek philosopher, Aristotle, condemned acquiring of wealth by the practice of charging interest on money.

“Very much disliked also is the practice of charging interest: and the dislike is fully justified for interest is a yield arising out of money itself, not a product of that for which money was provided. Money was intended to be a means of exchange; interest represents an increase in the money itself. Hence of all ways of getting wealth, this is the most contrary to nature." Aristotle, The Politics, tr. Sinclair, pg. 46, Penguin

“Do not charge your brother interest, whether on money or food or anything else that may earn interest.” (Deuteronomy 23:19)

“If you lend money to My people, to the poor among you, you are not to act as a creditor to him; you shall not charge him interest.” The Holy Bible (American Standard Bible)

[Jesus said], “If you have money, do not lend it at interest, but give [it] to one from whom you will not get it back.” Gospel St Thomas, V95

Other Key Prohibitions

Islam not only prohibits dealing in interest and investment in unlawful activities that Islam deems harmful to society, but also transactions involving excessive uncertainty (gharar) and all forms of gambling (maysir).

[source: Institute of Islamic banking and Insurance (IIBI)]