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Introduction to Islamic Muamalat 1

PART A

BASIC TAKAFUL

AND MEDICAL

&

HEALTH TAKAFUL

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2 Basic Takaful Practices

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CHAPTER A1

INTRODUCTION TO ISLAMIC

MUAMALAT

OVERVIEW

The Islamic teaching was revealed since the prophet of Adam a.s

and the teaching is not only confined to belief and moral values,

but also include laws that are suitable to be implemented bymankind. Islam to the Muslims is not just a religion but a way of

life. The Arabic word 'Islam' simply means 'submission', and

derives from the word meaning 'peace'. In a religious context it

means complete submission to the will of Allah s.w.t.

Islam, the same truth that Allah s.w.t revealed through all His

prophets to the ummah. In fact the word Islam is not mere religion

but is deen because it carries the meaning of the way of lifetouches virtually every spectrum of life not only restricted to ritual

and spiritual, but also encompasses not limited to political and

economic as well. It is, in essence, the same message and guidance

which Allah revealed to all Prophets, from Adam, Noh, Ibrahim,Ismail, Daud, Musa and Isa a.s and right through His last prophet

Mohammed s.a.w, but the message which was revealed to Prophet

Mohammed s.a.w is Islam in its comprehensive and complete

form. The Quran has emphasized the completeness of its teaching

and this is in line with a Quran verse;

This day I have perfected your religion for you, complete My

blessing on you and approve Islam as the way of life for you (Al-Maidah : 3 ).

A1.1 INTRODUCTION TO SHARIAH

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1.1.1 Objective of Shariah

Shariah is the entire body of Islamic law, and the term literally

means "the way to the water source." It is a wide-ranging body of

law and personal rules, regulating matters not limited tojurisprudence, politics, business, banking, family, and society. The

main objectives of the Shariah are to ensure that human life is

based on maruf (good) and to cleanse it of munkar (evils). The

term maruf denotes all the qualities that have always beenaccepted as good by the human conscience, and conversely, the

world munkar denotes all those qualities that have always beencondemned by human nature as evil.

1.1.2 The Concept of AdDeen (Shariah)

Source: Kitab mughnil muktaj (Imam Shafie), Kitab al-mughni (Imam Hanafi),

Kitab Bidayatul mujtahid wa nihayah, (Imam Malik)

ISLAM

SHARIAHAQIDAH AKHLAK

IBADAT MUAMALAT JINAYAT

POLITIC SOCIAL

MUNAKAHAT

ECONOMIC

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Broken down to its bare elements, Islam comprises of Aqidah (a

set of beliefs), Shariah (a set of laws) and Akhlak (a code of

moralitie).

Aqidah means a set of beliefs. From the Islamic point of view,Aqidah means strong belief in Allah s.w.t, His Prophets and the

hereafter, also belief in the angels, the holy books and

predestination.

Shariah or Islamic law is also known as Fiqh. Fiqh is Islamic

jurisprudence. Fiqh deals with the observance of rituals, moralsand social legislation in Islam. Branches of Fiqh include Ibadat,

Muamalat, Munakahat and Jinayat.

Fiqh IbadatThe rules of ritual purification, prayer, pilgrimage, fasting,zakat, jihad and some other forms of worship are dealt under

this heading. Most of these rules deal with the rights owed to

Allah s.w.t by the individual alone or by the community as a

whole.

Fiqh MuamalatThis area deals with property, contracts, business organisation,

security of debts and insolvency, pre-emption, gifts, bequests

and waqfs.

Fiqh Munakahat/UsrahThis area deals with marriage, divorce, inheritance,

guardianship and related matters. This is similar to

conventional version known as personal law.

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Fiqh JinayatThis area deals with major offences like illicit sexual (zina),

theft (sariqah), robbery, pirate and brigandage (hirabah), and

other matters collectively known as hudud laws.

Akhlaq is a term referring to the practice of virtue, morality and

manners in Islamic theology and falsafah (philosophy). It refers to

ones disposition, nature, temper, ethics, morals or character (of a

person). Akhlaq covers all aspects of Muslim behaviour, attitude

and work ethics which influence his acts.

1.1.3 Mandatory Law (Hukm Taklif)

Taklifi law is the law that describes the commands, prohibitions

and the option to run or leave an activity / job. According to

Islamic terminology, the acts of a Muslim must be guided by these

five commandments (al-Ahkam al-Khamsah) classified as follows:

Wajib (obligatory)The term wajib means an act the performance of which is

obligatory for the subject. Example: performing solat andfasting in month of Ramadhan. In its technical sense, it is an

act whose commission is demanded by the Lawgiver (Allah

s.w.t) in certain and binding terms.

Mandub (recommended)Mandub is defined as a demand by the Lawgiver (Allah) for

the commission of an act without making it binding and

without assigning any blame for its omission. The rule for

mandub is that for doing so there is reward (thawab) for thedoer, while omitting it entails no penalty such as giving

charity to the others.
http://en.wikipedia.org/wiki/Virtuehttp://en.wikipedia.org/wiki/Moralityhttp://en.wikipedia.org/wiki/Mannershttp://en.wikipedia.org/wiki/Islamichttp://en.wikipedia.org/wiki/Theologyhttp://en.wikipedia.org/wiki/Philosophyhttp://en.wikipedia.org/wiki/Philosophyhttp://en.wikipedia.org/wiki/Theologyhttp://en.wikipedia.org/wiki/Islamichttp://en.wikipedia.org/wiki/Mannershttp://en.wikipedia.org/wiki/Moralityhttp://en.wikipedia.org/wiki/Virtue

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Haram (prohibited / unlawful)Haram is defined as one which omission is required by the

Lawgiver (Allah) in binding and certain terms. An example of

prohibited act (Haram) is the misappropriation of anotherswealth.

Makruh (reprehensible or disapproved)Makruh is defined as one which omission is demanded by the

Lawgiver (Allah) in non-binding terms. An example ofreprehensible act (Makruh) such as debt which is not

documented (unrecorded).

Mubah (permissible)The Mubah or permissible act is one in which the Lawgiver

(Allah) has granted a choice of commission and omission,

without blame or praise for omission or commission.

According to this principle, all contracts and transactions arepermissible, unless there is evidence indicating otherwise.

1.1.4 Sources of Shariah

Nos. Primary Source Description

i Quran The Quran is the very word of Allah s.w.t

revealed to the Holy Prophet s.a.w for the

benefit of all mankind. It is a divine

revelation and is the first and main source of

Islamic Law and to the Muslims, the absolute

authority in deciding the legality and every

legal obligation. The Quran is a

comprehensive and indivisible guide and

must be accepted and implemented in its

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entirety

ii As-Sunnah The Sunnah, means method, that includes

all that is from the Holy Prophet s.a.w

comprises what the Prophet s.a.w said

(Qaulan), did/action (Filan) and agreed

(Taqiran). Whatever originated from the

Holy Prophet does come out from his own

desire, but it is an inspiration from Allah

s.w.t.

The word Sunnah should be distinguishedfrom the term Hadith, which is a narration of

the saying of the Holy Prophet.

Nos. Secondary

Source

Description

i Ijma Ijma is Juristic consensus of opinion of the

imams mujtahid among Muslims in a particular

time after the death of the Prophet s.a.w

regarding the legal position of a matter or

problem.

In its application, Ijma is an agreement of

Muslim jurist in the event the ruling being

sought is not found in either of the main sources

ie the Quran and the Sunnah. All the mujtahidin

must reach a consensus on a juridical opinion at

the time an issue arises.

ii Qiyas

(Analogy)

Qiyas means to equate the legal position of a

matter that has no ruling from the Quran and the

Sunnah to one that has due to the illat

(underlying cause or reason) of the ruling. In

other words, the mujtahids refer back to the

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Quran and the Sunnah and make an analogical

reasoning between new matters that has no

ruling with the one that already has a ruling.

Literally, it is the extension of a Shariah value

from the original case to a new case, because

the new case has the same effective cause as the

original case.

iii Maslahah Maslahah ('public interest') is a concept in

traditional Islamic Law, invoked to prohibit or

permit something on the basis of whether or notit serves the public's benefit or welfare. The

concept is related to that of Istislah. While the

meaning of maslahah is 'public interest', the

meaning of istislah is 'to seek the best public

interest'.

iv Urf Urf is a term referring to the custom or

'knowledge' of a given society, leading to

change in the fiqh. `Urf is a source of Shariah

rulings where there are no explicit primary texts

of the Qur'an and Sunnah specifying the ruling.

`Urf can also specify something generally

established in the Quran and sunnah.

v Istishab Istishab means presumption of existence or non-

existence of facts. It can be used in the absence

of other proofs (dalil). Istishab relates to the

sense that the past accompanies the present

without any interruption or change.

vi Istihsan Istihsan means juristic "preference". Muslims

scholars may use it to express their preference

for particular judgments in Islamic Law over

other possibilities. It is one of the principles of

legal thought underlying personal interpretation

or ijtihad.

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1.1.5 Objectives of Shariah (Maqasid Shariah)

Maqasid is the Arabic word for goals or purposes. In Islamic

context, it can refer to the purposes of Islamic faith. In terms ofShariah, there are five Maqasid (foundational goals). The five

maqasidare as follows:-

The preservation

of:

Description/Remarks

Religion Shariah requires the preservation andprotection of Deen (religion) under all

circumstances. Example defending the

Islamic faith particularly if it attacked by

the enemies of Islam.

Life Shariah requires the preservation and

protection of life under all circumstances.

Example in order to protect life is enacting

a severe punishment for those who kill

another. The punishment for those who kill

innocent human being is the death penalty

in Islam.

Lineage Shariah requires the preservation andprotection of descendants and honor under

all circumstances. Example Islam prohibit it

followers in committing adultery or other

immoral behaviors.

Intellect Shariah requires the preservation and

protection of intellect and mind under all

circumstances. Protection of mind requires

safeguarding it from anything that might

harm the ability and functions of the brain,

Example the consumption of liquor or

similar substances that will upset the

functions of the brain.Property/Wealth Shariah requires the preservation and

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protection of property under all

circumstances. Example the pro-activeinitiatives and planning in safe guarding

ones property against misfortunes or

disasters.

A1.2 BASIC MUAMALAT

1.2.1 Introduction to Muamalat

The literal meaning of the term Muamalat (plural of Muamalah)

is the transactions while its technical idea is any form of mutualdealings held between men to solve their everyday needs,

especially in matters relating to trade and commerce. Muamalat is

a social relationship which consists of various economic and non-

economic activities.

Basic Principles of Muamalat

Among the basic principles that play the role in forming Shariah

rulings in Muamalat are:

Freedom of contractMuslims are free to put conditions in their agreements except

that which prohibits something which is permissible or

permits something which is prohibited.

Permissibility as original status of mattersThe status of all matters other than rituals is permissible untilevidence is given that a certain matter is prohibited.

Custom is of force

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A fiqh legal maxim states that Custom is of force. In manyShariah commercial contracts many things become

permissible following customs.

1.2.2 Prohibition in Muamalat

All economic activities are legally permissible as long as these

activities do not transgress any of the tenets of Shariah. In line

with this maxim, it is the unanimous opinion of all four major

Islamic Shariah School of thought (Shafii, Hanafi, Hanbali, and

Maliki) that all forms of business transactions that transgress any

of the tenets of Shariah are considered invalid.

General Principles:

No contract should be made for selling or buying forbiddenproducts such as alcohol or any other forbidden substances.

Likewise, no contract should be made for any financial dealon the basis of usury (riba).

Contract involves in gambling (maisir) is forbidden in Islam. Contract that involves major uncertainty (gharar) is also

forbidden as gharar may made the contract voidable

Riba (Usury)The Arabic word 'riba' literally means 'increase in' or 'addition

to' anything for example, to the effect made through thefollowing Qur'anic verse:

"O you who believe, devour not usury, doubling and

quadrupling, the sum lent. Fear Allah and observe your duty to

Him, that you may really prosper." Qur'an (3:130)

The Prophet Muhammad s.a.w said,

Gold is to be paid for by gold, silver by silver, wheat bywheat, barley by barley, dates by dates, and salt by salt - like

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for like, equal for equal, payment being made on the spot. If

the species differ, sell as you wish provided that payment is

made on the spot'. [Reported by Muslim]

From the above hadith, gold and silver represent money while

wheat, barley, dates and salts represent fungible item or foodstuff. These items are known as ribawi item.

It would appear that the prohibition regarding riba has two

dimensions. The first one prohibits increases arising from

debts/loans (duyun), known as Riba Duyun, while in barter

trades (buyu), unequal exchange of ribawi item of same kind

and same basis in is known as Riba Buyu. This can besummarised as follows:

Riba Duyun (singular dayn) is formed through financial loan:

i. Riba Qard - where the increase (interest) on the principalsum of the loan is agreed upon at the point of contract;

ii. Riba Jahilliyah - this refers to the increase levied on theborrower for late repayment or failure to repay the

financial loan.

Riba Buyu (singular Bai) is formed through exchange

contract in barter trade; i.e Riba Fadhl (happen in unequalexchange of its counterpart) and Riba Nasiah (due toextension of time of delivery).

The following rules of exchange apply in deciding whether the

said transactions fall underRiba Fadhl orNasiah.

Rule 1:

Exchange between ribawi materials of the same kind (and of

the same basis) must be with equal weight, measurement or

number and payment delivery must be made at the same time.

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o If payment and delivery are made at the same time but theweights, measurements or numbers of the materials

exchanged are not equal, thenRiba Fadhl occurs.

o If payment and delivery are not made at the same time butthe weights, measurements or numbers of the materials

exchanged are equal, then Riba Nasiah occurs.

Rule 2:

Payment and delivery between ribawi materials of different

kinds and of the same basis must be made at the same time,

though they may be made at different prices. Equal weights,measurements or numbers of the materials exchanged are not

required to be observed here.

o If payment and delivery are not made at the same time (onspot), then Riba Nasiah occurs

Maisir (Gambling)Any transaction or activity relating to games of chance or

gambling. A contract that involves element of maisir(gambling) is Batil (void). Maisir can be concluded as betting

or charging something that will be forfeited if one fails toobtain the greater gain that one hopes for. It is also defined as

zero-sum game i.e the sum of those who gain and those who

lose equal to zero. For a transaction to be equated to gambling,it must involve the devouring and unlawful appropriation of

the property of others.

Allah s.w.t says: "They will ask thee about intoxicants and

games of chance. Say: In both there is great evil as well as

some benefit for man; but the evil which they cause is greater

than the benefit which they bring" Al-Quran (2: 219)

Gharar(Uncertainty)

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Gharar or uncertainty makes a transaction or activity un-

Islamic as it will result into an unjust or unfair outcome for the

parties involved. It is where the quantity and the quality

involve in the transaction is not predetermined and known.

Gharar means hazard, chance, stake or risk. Gharar occur

when there is element of uncertainty in a transaction whoseexistence or characteristics are not definite, due to the risky

nature which may makes the contract void or voidable.

The Messenger of Allah also forbade us from Gharar, Al-Baji

Al-Andalusi states:

The Prophet s.a.ws prohibition of the sale of al-ghararrenders such a sale defective. The meaning of sale of al-gharar

refers to sale in which gharar was the major component,

leading it to be justifiably described as sale of al-gharar. This

is the type of sale which is unanimously forbidden. On theother hand, minor gharar does not render a sale contract

defective, since no contract can be entirely free of gharar.

Gharar can be divided into Minor Gharar and Major Gharar.

(i) Minor (Yaseer) Gharar

Minor Gharar is forgiven as it does not render a salecontract defective. It is a Gharar which does not affect the

principal components (arkan or essential elements) of the

contract and necessary conditions of the essential elements(e.g. requirements relating to asset, price, language of the

contract etc).

(ii) Major (Fahish) Gharar

The Gharar that causes a contract to be invalid is major

(excessive) Gharar. In general terms, major Gharar is:

an uncertainty which is so great that it becomesunacceptable; or

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It is so vague that there is no means of quantifying it.

1.2.3 The Concept of Contract in Muamalat

Barbati defined aqad or contract in his kitab Inayah ala Fath al-Qadri as follows:

Legal relationship created by the conjunction of two declarations,from which flow legal consequences with regard to the subject

matter.

The literal meaning ofaqad is join or tie. The English wordfor aqadis contract. Contract can also be defined as being anexpression of the matching between a positive proposal made by

one of the contractors and the acceptance of the other contractor in

way which has an impact on the subject of the contract. A contract

must consist of:

Elements of

Aqad

Descriptions/Remarks

Aqidan (the

parties to the

contract)

It is a condition of a valid contract that the parties

possess capacity. Capacity is a quality which makes a

person qualified for acquiring rights and undertaking

duties and responsibilities.

Sighah Sighah is the form of the contract consisting of ijab

and qabul (offer and acceptance). The offer made by

the first party to the contract is called ijab because it

gives and confirms the freedom of acceptance to the

second party.

Maaqud alaih The subject matter and price. They are conditions to

be taken into consideration according to Islamic

jurisprudence for subject of contract has to be legal,

in existent and identified.

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A1.3 APPLICATION OF SHARIAH CONTRACT

COMMONLY USED IN TAKAFUL BUSINESS

Nos Underlying Contract Supported Takaful Contract

i. Kafalah

A contract of guarantee

whereby a person adds to

himself a responsibility or

liability on behalf of

another person.

In Takaful business, the

participant contributes to the

Takaful fund by a mutual

agreement that the Takaful

Operator is entrusted to undertake

in managing the Takaful fund

prudently and to pay the Takaful

benefits to the participants in the

event a misfortune.

The Kafalah contract is prevailing

in the Takaful operational system

in Malaysia and worldwide.

ii. Tabarru

Means gift or donation

which is given by one in

favor of someone without

seeking any

consideration.


participants mutually agree to

contribute to the Takaful fund

based on the contract of Tabarru.

Tabarru contract is the core

element in takaful business and is

not only practiced in Malaysia

but also the Tabarru contract is

practiced worldwide.

iii. Wakalah

A contract of agency, in In Takaful business, the

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which a person delegates

his business to another

and substitutes the other

in his place. The person

delegated is called Wakil.

Thus, both the principal

and the wakil are equally

bound by each other

under contract of

Wakalah.

participants appoint theTakaful

Operator as their wakil and to

manage their Takaful coverage

and the Takaful fund.

The wakalah contract is practiced

by all Takaful Operators in

Malaysia most of the Takaful

Operators worldwide operational

under the Wakalah model.

iv. Ujrah

A contract of hiring

whereby one person hires

someone for definite

services, in which the

hirer is under the duty to

provide a reward for the

services rendered to him.


participant contributes to the

Takaful fund by a mutual

agreement that the Takaful

Operator is entrusted to manage

the Takaful fund prudently in

terms of investment and pay out

takaful benefits to the eligible

participants in the event of a

misfortune. The Takaful Operator

is entitled to a fee for the service

rendered.

The Ujrah contract is practiced by

all Takaful Operators in Malaysia

most of the Takaful Operators

worldwide operational under the

Wakalah model.

v. Ju'alah

A contract of hiring for

services, in which one

party undertakes to pay a

specified amount of

money for rendering a

defined service in

accordance with the termsnegotiated between them.


participants contribute a sum of

money to the Takaful fund. The

Takaful Operator is entrusted to

manage the Takaful fund

prudently in terms of investment

and pay out takaful benefits to theeligible participants in the event

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of a misfortune. The Takaful

Operator is entitled to a fee for

the service rendered.

The Jualah contract practiced by

all Takaful Operator in Malaysia

and most of the Takaful

Operators worldwide operational

under the Wakalah model.

vi. Mudharabah

The nature of Mudarabah(profit sharing) practices

is that, it is a financial

contract whereby one

party called Rabbu al-Mal

provides fund to the other

party called Mudharib

who undertakes to

manage the fund through

investment or trade and

generates profits, in which

both the Rabbu al-Mal

and also the Mudharib

shre in the profit in a pre-

agreed proportion.

In Takaful business, theparticipants contribute a sum of

money to the Takaful fund in

which the participants are like

Rabbu al-mal, while the Takaful

Operator is like Mudharib who

agrees to manage the fund in

view of making profit in which

both, the participants and also the

operator share the profit

proportionately.

Mudharabah contract as

practiced by Syarikat Takaful

Malaysia when it first started

operation. However, for some

Takaful Operators in Malaysia

Mudharabah is still practiced only

on certain products.

vii. Musharakah

The contract of Shirkah

(partnership). Musharakah

is an agreement between

two or more parties to

operate a particular

business in which allparties contribute to the


respective shareholders mutually

agree to contribute a sum of

money to initiate the Takaful

business. This mutual agreement

among the shareholders is calledmusharakah.

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capital in view of profit.

In al-Musharakah dealing,

the parties involved

herein share the liability,

profit, and also loss

according to their

agreement.

Musharakah contract is practiced

among all the Shareholders of all

Takaful Operators in Malaysia

and most of the Takaful Operator

worldwide.

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Concept of Risk 21

CHAPTER A2

CONCEPT OF RISK

OVERVIEW

Risk is uncertainty about the future outcome of an event. The term

risk has a variety of meaning in business and everyday life. Risktraditionally means possibility of harm, injury or loss. It is to

describe any situation where there is uncertainty about what will

be the outcome. Risk is generally related to an unfavourableoutcome or unfortunate event whereas a chance is something

which relates to a favourable outcome. An example of a riskwould be of being diagnosed with lung cancer among smokers as

there will always be an uncertainty as to whether a smoker will

suffer from cancer of not.

A2.1 CONCEPT OF RISKS

Since our purpose is to relate risk to Takaful, focus will be on a

risk which entails the possibility of a financial loss. Financial loss

may be defined as a decline in or disappearance of value due to a

contingency.

Apart from risk being the uncertainty of whether or not a loss may

occur as a result of unexpected event, it is also about the

relationship between frequency and severity. The level of risk is

determined by this relationship. This relationship is explained by

the Heinrich Triangle. The Heinrich Triangle explains that where

there is a high frequency the severity will be low and for incidentsthat have a low frequency the severity will be high e.g. a plane

crash happens very seldom but when it takes place the severity

will be high.

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2.1.1 Peril and Hazard

Term Description Example

Peril Peril is referred to as the

main cause of a loss. Any

accidental losses that are

caused by a peril may be

subject to a claim under the

respective policy. Example

of perils include fire, flood,

collision, accident,

earthquakes, sickness,premature death.

The insured vehicle undera motor policy is damaged

in an accident, (accident is

the insured peril under a

motor policy and a claim

can be made under the

policy).

If a restaurant is destroyedin a fire, (fire is theinsured peril and a claim

can be made under the fire

policy).

Hazard Refers to the condition that increases the chance of loss. There

are two (2) types of hazards:

1. Physical HazardRefers to the physical

condition of the subject

matter that increases

the chance of loss.

Defective wiring in a building

that increases the chance of

fire

2. Moral HazardRefers to the attitude of

an individual that

increases the chance of

loss. Moral hazard is

difficult to determine.

Intentionally burning unsold

merchandise that is insured to

collect from an insurer or a

dishonest insured who

exaggerates the claim amount

2.1.2 Categories of Risk

Risk can be classified into several distinct categories. The mostimportant categories are the following:

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Concept of Risk 23

Risk Description Example

Pure Refers to the possibilities

that can result in only a loss

or breakeven. The possible

outcome can be adverse

(loss) or breakeven (no

loss). Pure risks can

generally be covered.

Fire, lightning, flood,

storm, premature death,

accident, theft etc

Speculative Refers to the possibilities

that can result in loss, no

loss or profit (gain). It is anuncertainty about an event

that could produce either a

profit, neutral (no loss) or a

loss. Speculative risks

generally cannot be covered.

Investments in the

stock market, foreign

currency fluctuations,venturing into a new

business

2.1.3 Fundamental and Particular Risk


Fundamental A fundamental risk will affectthe whole society or a large

numbers of people within the

economy. It is not within the

control of individuals.

Damage toproperty due to

earthquake, war

etc

Particular A particular risk will affect

only individuals and not the

entire community and is within

the control of individuals.

Damage to

property from

accidents, thefts,

robbery

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2.1.4 Types of Pure Risk

Pure risks are generally insurable and the topic of Insurance and

Takaful will emphasize primarily on these risks. Pure risk can be

categorized into three (3) types that create financial insecurity,

namely Personal Risks; Property Risks; and Liability Risks.


Personal Refers to risks that directly affect individuals. It will lead

to the possibilities of loss or reduction of income, extra

expenses incurred and depletion of assets. Personal riskcan be further divided into the following four (4) types:

Risk of Premature Death The death of a bread winner

can cause financial hardship

to the dependants. This

premature death risk will

cause financial problems

for dependents.

Risk of Insufficient Income

during Retirement

Possibility of retirees losing

their earned income if they

dont have sufficient

financial assets or other

sources of retirement

income. The risk may cause

reduced standard of living.

Risk of Poor Health

Possibility of having to pay

catastrophic medical bills

and loss of income.

Risk of Unemployment

Major threat to financial

security resulted from

business cycle down

swings, technological and

economy changes etc.

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Concept of Risk 25


Property Refers to the possibility of loss due to damage to property

from various causes, such as fire, flood, earthquakes and

other natural disasters. There are two (2) types of risk

related to property:

Direct Loss

Financial loss that results

from the physical damage,

destruction or theft of the

property.

A factory damaged by a fire,

(the physical damage to the

factory is a direct loss).

Indirect Loss or

Consequential Loss

Financial loss that results

indirectly from the

occurrence of a direct

physical damage or theft

loss of the property.

In addition to the physical

damage to the factory, the

owner would lose his

income due to reduction in

turnover whilst the factory is

being repaired. This will

cause a loss of income and

would be a consequential

loss.

Liability Refers to the risk of third

party bodily injury or

property damage. In this

case the court may order

you to pay substantialdamages to the person you

have injured.

Business firms can be held

legally liable for defective

products that could cause

bodily injury or property

damage to consumers whouse these products.

2.1.5 Characteristics of Insurable Risks

Characteristic DescriptionPecuniary Value The risk must involve a loss that is capable of

financial measurement where monetary

compensation is capable following a loss, e.g. fire

damage to home, stolen motorcar. An article may

have pecuniary and personal value but it can only

be insured according to its pecuniary value and not

the sentimental value attached to the subject matterof insurance.

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Homogeneous

Exposure

There must be a large number of similar,

homogeneous risks before anyone of that number is

capable of being insured.

a) the measurement of risk by probabilities andstatistic relies on there being a reasonable

experience of past events.

b) if there were only 3 or 4 exposures that eachone would have to contribute a very high

amount (uncompetitive premium) for the loss

to be met from these contributions, e.g.models legs.

Pure Risks In general, only pure risks (loss or break-evensituation) are insurable as insurance cannot be used

to make a gain. A speculative risk involves loss,

gain or break-even and therefore is not insurable.

Particular Risk Particular risk are insurable if they satisfy other

criteria of insurable risks.

Fundamental risks are generally uninsurable, e.g.

war, changing customs although certain such risks

may be considered depending on the geographical

location of the risks.

Fortuitous It is not possible to insure against an event that willoccur with certainty as in such a case there would

be no risk, or uncertainty of loss. The frequency

and severity of any risks must be completely

beyond the control of the person insuring, eg Life

insurancetiming of death is uncertain. Risk that

are intentional cannot be insured, eg suicide.

Insurable Interest Defined as the legal relationship between insured

and the subject matter of insurance.

The risk to be insured must result in some form of

financial loss recognized by law. The Insured

person insuring must be the one who stands to

suffer some financial loss if the risk materializes,

e.g. homeowner insuring own house.

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Concept of Risk 27

A2.2 CONCEPT OF RISKS IN ISLAM

Many Muslims misunderstood the concept of fate (Qadha and

Qadar). Some Muslims believe that their future is in the hand of

Allah. Muslims are required to be proactive in order to be able tochange their conditions as God says:

" Verily never will Allah change the condition of a people until

they change it themselves (Ar Rad 13:11).

Prophet Muhammad s.a.w once asked a Bedouin who had left hiscamel untied, "Why do you not tie your camel?" the Bedouin

answered, "I leave it to the will of God". The Prophet then said,

"tie up your camel first then put your trust in God". This

conversation depicts not only how should Muslims accept their

fate but also indicates how Muslims should make efforts to reducethe risk of loss and calamities.

Risk management is a concept that is not only accepted by Islam,

but embraced as one of the ways to ensure the fulfillment of goals

and objectives, that ultimately should arrive at saadah (happiness)in this world and the hereafter.

A2.3 RISKS AND TAKAFUL

Risks that relates to the operation of Takaful business includes butare not limited to the following:

Types of Risk Description

Operational risks The risk of loss resulting from inadequate or failed

internal processes, people and systems or from

external events inter alia:

Employment practice and workplace safety:losses arriving from acts inconsistent with

employment, health, or safety laws or

agreement, workers compensation. Internal fraud: losses due to acts of a type

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intended, misappropriate property or circumvent

regulations, the laws or company policies,

bribery

External fraud: loss due to the acts of a typeintended to defraud forgery, misappropriate

property or circumvent the laws, by third party.

Damage to physical assets: losses due to loss ordamage of physical assets from natural disaster

or other events such as terrorism, vandalism.

Business disruption and system failures: lossarising from disruption of utility disruptions,

software failures, hardware failures

Execution, delivery and process management:loss from failed transactions processing or

process management, from relation with trade

counter parties and vendors such as data entry

errors, accounting errors, failed mandatory

reporting, negligent loss of client assets.

Clients, products and business practices: lossdue to unintentional or negligent failure to meet

professional obligation to specific client

(including fiduciary and suitability

requirements), or from the nature or design of a

product.

Legal risks The risk of loss from possible litigations from thirdparties.

Strategic risks The risk of loss from erroneous decisions or

strategies that result in negative consequences.

Reputational

risks

Any questionable or erroneous decisions, activities

or initiatives that marred the reputation of the

Takaful operator.

Underwriting

risks

Risk that contributions will not be sufficient to

cover future incurred losses and that losses and loss

adjustment expenses' current reserves are notsufficient

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Concept of Risk 29

Investment risks The risk that an investment will result in a loss.

Nearly all investments have some investment risk: a

stock/share may decline; a bond or sukuk may

default, and the underlying assets of a derivative

may not behave in a certain way.

Governance risks Typically encompasses activities such as corporate

governance, enterprise risk management (ERM)

and corporate compliance with applicable laws and

regulations.

BusinessContinuity risks

It is a risk in planning which identifies theorganization's exposure to internal and external

threats and synthesizes hard and soft assets to

provide effective prevention and recovery for the

organization, whilst maintaining competitive

advantage and value system integrity, in order to

ascertain the viability and continuity of the

company.

Shariah

Compliance risks

The risk of takaful operations and transactions may

not be in compliance to Shariah principles. The

takaful operator may faces risk of non-recognition

of income and reputational risk. For example, risks

that have been accepted could turn out to beunacceptable, requiring the takaful operator to

cancel the contract or donate the income to charity.

A2.4 METHOD OF HANDLING RISKS

Once risks have been identified and assessed, all techniques to

manage the risk fall into one or more of these four major

categories:

Risk Avoidance Risk Reduction Risk Retention

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Risk Transfer2.4.1 Risk Avoidance

Avoid or eliminate the riskif the risk is so unacceptable then the

individual or organization may decide not to continue with the

activity or business that presents such a risk. If this decision ismade, then the individual or organization will decide to avoid the

risk. Avoidance may seem the answer to all risks, but avoiding

risks also means losing out on the potential gain that accepting

(retaining) the risk may have allowed. Not entering a business to

avoid the risk of loss also avoids the possibility of earning profits.An example would be not buying a property or business in order

not to take on the liability that comes with it.

2.4.2 Risk Reduction or Loss Control

This is an action taken to improve the risk to achieve a standardand acceptable level. A constant review process will be required in

order to ensure that the correct standard is achieved. It involves

methods that reduce the severity of the loss or the likelihood of the

loss from occurring. For example, fixing sprinklers designed to put

out a fire to reduce the risk of loss by fire.

2.4.3 Risk Retention

If the current level of the risk is already at an acceptable level, the

individual or organization may decide to retain the risks. It

involves accepting the loss when it occurs. Risk retention is a

viable strategy for small risks where the cost of insuring against

the risk would be greater over time than the total losses sustained.

2.4.4 Risk Transfer

This involves the transferring of risks to an organization or

individual. When a risk is transferred, losses will be paid by the

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Concept of Risk 31

organization or individual to whom the risk is transferred. There

are two ways of transferring risks:

Insurance/Takaful Contract- example: A house owner can transfer

the risk of loss incurred when his house is destroyed by fire by

entering into a fire Takaful contract.

Non Insurance/Takaful Contract: Example, a supermarket can

transfer potential risk (liability) arising from sale of defective

products by entering into agreement whereby the manufacturer

agrees to compensate the supermarket from any liability arising

from the defective product.

A2.5 RISK MANAGEMENT

2.5.1 Risk Identification

Risk identification is the most important step in risk management

process. It is necessary to identify the risks that could damage the

finances of an individual or a firm before a solution can be

provided. Once the risks are identified, they must be measured

and evaluated individually to determine the probability or chanceof loss and the financial impact it can have on individual or a firm.

Risk management takes the view that a firm is exposed to risk in a

variety of ways, which may cause financial losses. Risk is viewed

therefore in its widest sense, and not limited to those risks that canbe insured. A risk manager's job is to identify exposed areas where

a company is likely to suffer.

Methods of Risk Identification Physical Inspection

A brief walk over the plant is essential to help in giving a

feel for the place which may later direct the formal risk

identification.

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Organization ChartsA chart showing the organizational structure of the

company and the relationship between different personnel

and departments can highlight the weaknesses an

organizational structure

Flow ChartA chart showing materials or work flowing throughvarious stages of process in which a weak link of the

process can be identified

Check ListA list asking questions or a questionnaire relating to themain areas of activity can highlight areas that present

risks.

2.5.2 Risk Screening and Evaluation

Risk screening and evaluation is the process of determining the

risk impact or potential losses so that appropriate action can be

taken, considering the resources available. Risk evaluation

involves the estimation of frequency and severity of the riskexposures and ranking them to their relative importance. Those

risks with high potential losses will be given priority in the riskmanagement plan.

Risk Frequency refers to the number of times a loss producingevent will occur during given time period (probability of its

occurrence).

Risk Severity refers to the cost or amount of loss, in moneyterms, arising from a loss producing event.

Not all risks are significant and need to be handled or to be

insured/covered. For the smaller risk, it can be ignored even there

is a great chance that it may occur. However, size alone does not

determine whether the risk should deserve priority. A risk whichhave a slight chance of occurrences but carry potentially severe

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Concept of Risk 33

financial impact on the individuals life or the firms well-being, itshould be handled first. Example: A loss exposure with the

potential for bankrupting the firm is much more important in a risk

management plan than a frequent risks exposure that cost a small

amount.

2.5.3 Development of a Risk Management Plan

Once the risks have been evaluated completely, it is time to choose

the appropriate risk mitigation method. The selection of methods

should take place in the early development stage. Selection must

consider cost and effectiveness. There are four methods of riskmitigation Risk Avoidance; Risk Control; Risk Retention andRisk Transfer.

2.5.4 Implementation of Risk Management Plan

Once the selection of a suitable method is made, the plan is ready

for implementation. In performing this step, the risk should be

prioritized and matched with the actions to be taken. One of the

action of course is to insure/cover the risk.

2.5.5 Reviews and Monitoring of Risk Management Plan

Reviews and monitoring is another important step in the riskmanagement process. These activities involve periodical

reviews, monitoring the implementation process as well as

progressive revision on the plan in light of any changes in the

business and economic environment.

The monitoring and risk review stage would include theproduction of risk manuals, claims performance reports and

experience studies and audits. It is quite possible that different

risks would have different types of monitoring, with insurance

risks in particular monitored on a more frequent basis and

reported directly to the management.

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Periodical reviews can help to identify any deficiencies oradjustments and also ensure the objectives of the plan are met.

Reviews should be done at least once a year.

2.5.6 Communication of Risk Management Objectives and

Plan

It is often said that it is not the plan which is important, it isthe planning itself. This is very true in this case, meaning that

proper communication at all phases of the risk management

planning is needed. The need of communication is often

ignored and usually as a result the implementation andmonitoring stages are compromised leading to the objectives

of the plan not being achieved.

The drivers of risk management need to include both internalas well as external sources. Both sources will need to be

included in the risk management policy. These drivers can be

further split into their area of risk specialization.

Risk management has to be integrated into the corporateculture. In modern risk management practices every person in

the company will bear responsibility in achieving the firms

risk management objectives. Hence during all phases of riskmanagement, communication between the concern parties is

vital.

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Introduction to Takaful 35

CHAPTER A3

INTRODUCTION TO TAKAFUL

OVERVIEW

During the pre Islamic period, it is customary of the pagan Arabs

to pay diyat. It was the custom of the pagan Arabs for a killer topay Blood-Money (diyat) as compensation to the family of the

slained. It was the right of the family of the deceased to demand

compensation from the tribe or the family of the offender. Diyatcustom is to replace the primitive custom blood called for blood.

Diyat was introduced to curb the fury of war. The system ofblood-money was retained after the advent of Islam because of its

virtue and benefits as follows;

It reduced bloodshed and feud. Replace individual responsibility to collective responsibility. Lessened financial burden of the individual. Developed a spirit of co-operation and brotherhood.The doctrine was approved by the Holy Prophet s.a.w and

subsequently made mandatory during the period of the second

Caliph. This is the foundation doctrine based on which todaysIslamic insurance practices have been developed.

In Islam, all economic activities are legally permissible as long as

these activities do not transgress any of the tenets laid down

through the two formal sources of Shariah law, i.e the Quran and

the Hadith. In line with this maxim, it is the unanimous opinion ofall four major Shariah School of Thoughts (Shafii, Hanafi,

Hanbali, and Maliki) that all forms of business transactions that

contain the elements of riba (interest), gharar (uncertainty) and

maisir (gambling) are considered invalid.

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The doctrine of Maqasid Shariah imposed a duty upon all Muslims

on the protection of tangible assets, property and the well beings

of the person. The means of such protection must conform to

Shariah rulings and its legal guidelines and principles.

Unfortunately, most conventional means of insurance are based

upon practices that are prohibited by Shariah.

A3.1 DEFINITION OF TAKAFUL

The word Takaful is derived from the Arabic verb kafalawhich simply means to take care of ones need. Therefore the pact

between at least two parties agreeing to jointly guarantee oneanother in the event of a loss, as a consequent of being afflicted by

a calamity defines the term Takaful.

Likewise, the joint-guarantee as embedded in the concept of

takaful can be translated into practical operation in the form of

business or commercial transaction within the tijari or privatesector as one of the Islamic financial players in a market economy.

In this manner, like banking, Takaful can be the alternative to the

conventional insurance. Under the tijari sector the public as

consumers will have the right to choose the types of product andservice suitable to their taste and need.

A3.2 TAKAFUL CONCEPT

The Academic Council of the Muslim world league, after makingappropriate modification concluded that the co-operative form of

insurance is acceptable and considered an alternative to insurance.

The system within the confine of Islamic framework should be

founded on the following concepts:

3.2.1 Takaful

Muslim jurists unanimously agreed that cover which fits therequirements of Shariah may be based on the Islamic conceptof Takaful. Takaful is a noun stemming from the Arabic verb

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Kafala meaning to take care of ones needs. Takaful meansmutual help among the group i.e. each member of the group

pools efforts to support the needy within the group. The

takaful concept is based on solidarity, shared responsibility

and brotherhood among members. Takaful can be defined as

the act of a group of people who desires to reciprocalguarantee each other within the group against certain loss or

damage that might be inflicted upon anyone of them.

The salient features of Takaful operations are as follows:o The company is not the one assuming the risk, theParticipants who are mutually covering each other.o The company is acting as trustee on behalf of the

Participants to manage the operation of the Takaful

business.

o All contributions (premiums) paid by the Participants willbe accumulated in the Takaful fund for payment of theTakaful benefits.

o The Takaful fund at the same time can be invested in areasapproved by Shariah Council.

3.2.2 Mudharabah

Mudharabah can be defined as the commercial profit sharingcontract between the provider or providers of fund and the

entrepreneur for a business venture.

Mudharabah is profit sharing partnership whereby one party,

known as Sahibul Mal, provide all of the capital for abusiness venture. The other party, known as Al-Mudharib orthe entrepreneur, does not put in any capital but puts in effort

and entrepreneurship. Any profit from this venture will be

shared between the two parties on an agreed ratio of say 50:50

or 60:40 or whatever is mutually agreed.

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For the Mudharabah contract to be permissible the variouselements should be present:-

o Capital Providero Entrepreneuro Capitalo Activityo Profit Ratioo Offer and Acceptance

Salient Features of the Mudharabah Contract.o In the event of a loss, it is the duty of the capital provider

to make good the loss.

o In the event of a loss and the loss is due to themismanagement of the Takaful Operator, the Takaful

Operator will make good the loss.

o In the event of a profit the profit will be shared betweenthe Takaful Operator and the capital provider.

o The contract is cancellable and upon cancellation allcumulative capital plus profit (in Family Takaful only)

must be returned to the capital provider less administrative

expenses.

o The capital provider will have to give consent to appointthe entrepreneur to work on his behalf.o The capital provider will not dictate the Takaful Operator

or getting involved in the management of the Takaful

business.

3.2.3 Tabarru

Tabarru is an Arabic word that means donation or gifts.Tabarru is where the Participant shall agree to relinquish asdonation all or certain portion of his contribution thus enabling

him to fulfil his obligation of mutual help and joint guarantee.

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In the contract of Takaful, what it means is a voluntaryspecific amount of donation made by the Participant for a

specific cause as stated in the agreement on the spirit of

brotherhood and mutual cooperation. The fund will be utilised

to help the unfortunate member.

Tabarru apparently Islamises the insurance contract byremoving most of the objectionable elements. This is actually

the fundamental difference between insurance that is Shariah

compliance and conventional insurance.

Without this concept of donation, the transaction will be thatof buying and selling of insurance i.e the purchase of a

promise that some form of benefit will be paid in the event

that the insured faced a misfortune. The promise may or may

not be fulfilled depending on whether or not the event insured

against occurs. Should there be no claim the insurer will stand

to earn the premium paid.

However, the spirit embedded in the concept of tabarru is thatthe Participant is not thinking only of his own protection buthe should also be thinking of helping other Participants. The

Participant must be aware that his contribution if paid with the

right intention would not only entitle him a protection for himand his fellow brothers but also be rewarded in the hereafter.

This is unlike insurance where one buys certain protectioncoverage for oneself only.

What makes Tabarru concept appealing is the double benefitsthey get when participating in Takaful scheme, firstly, they get

insurance cover that is halal and secondly, the benefits of

doing a good deed at the same time

3.2.4 Wakalah

The term Wakalah in Arabic means agency. Therefore underthe structure, an agency relationship is agreed between two

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parties to conduct a certain business undertaking. Based on

this premise, the model describes an agency agreement

between the operators, acting as the agent or wakil to theparticipant as the principal to manage the participation of the

latter in a variety of Takaful products provided by the

operator.

In return for rendering the agency services, the operator ispermitted to charge a fee under the agreement. The fee is

payable from the Takaful contribution paid by the participant.

In this sense under the above model, management expenditure

can be charged to the Takaful fund as upfront charges.

A3.3 TAKAFUL APPLICATION AND BENEFITS

Takaful ApplicationJurist resolved that the system of insurance which falls within

the confine of Islamic framework should be founded on the

following basis;

TaawunTakaful, is based on the concept of Taawun meaningmutual assistance. Participants mutually agree to assisteach other financially in case of certain defined needs (as

defined in the takaful contract) by contributing to a

common fund.

Allah s.w.t commanded: "... co-operate ye one another in

righteousness and piety but help ye not one another in sin

and rancor" (Surah al-Maidah:2)

Al-Hadith : Allah will always help His servant for aslong as he helps others (Narrated by Imam Ahmad and

Imam Abu Daud).

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OwnershipUnder the principles of Al Milkiyah (ownership): Thebenefits of the certificate are the sole ownership (Al

Milkiyah) of the participant. Upon demised of the

participant the benefit are entrusted to the nominee.

Shared Responsibility and Shared GuaranteeIn tandem with the Shariah discipline on Takaful (which

means shared responsibility and shared guarantee), the

participants are mutually agreed to provide compensation

in the event of a misfortune.

Responsibility and Mutual ProtectionThe participant of the Takaful Scheme all agreed to be

mutually responsible or shared responsibility.

Mutual CompensationThe validity of Takaful is derived from the Arab custom

(urf) of Al-Aqila. This is an early form of insurance by

way of mutual protection within a group of people takingsteps to cover the losses incurred. The Participant of the

Takaful Scheme to cooperate and to help one another.

Masalih al-Mursalah (Public Interest)Takaful is also based amongst others on the doctrine of

Masalih al-Mursalah or public interest. The primary

purpose is to lessen the burden of members of the

community caused by the occurrence of certain loss ordamage.

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ContractA Takaful certificate binds the parties by an offer and anacceptance in reliance on the principles of contract. The

relationship between the Takaful Operator and the

participants has to be governed by a special contract i.e

Wakalah orMudharabah contract.

The niche of Takaful Fulfils the social obligation towards community and

family

Enables financial assistance for the unfortunate Avoidance of riba (interest), maisir (gambling) and gharar

(uncertainty) and similar prohibited elements

Promote moral values, ethical dealings and full disclosurein all its business activities and operations

Through charitable donations (tabarru) it allowsparticipants to achieve self purification and peace of mind.

Promote the spirit of solidarity, mutual help andbrotherhood

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Comparison between Takaful and Insurance 43

CHAPTER A4

COMPARISON BETWEEN TAKAFUL

AND INSURANCE

OVERVIEW

Insurance provides financial protection against a loss arising out of

happening of an uncertain event. A person can avail this protection

by paying premium to an insurance company.

A pool is created through contributions made by persons seeking to

protect themselves from common risk. Premium is collected by

insurance companies which also act as trustee to the pool. Any loss

to the insured in case of happening of an uncertain event is paid out

of this pool.

Insurance works on the basic principle of risk-sharing. A great

advantage of insurance is that it spreads the risk of a few people

over a large group of people exposed to risk of similar type.

A4.1 DEFINITION OF INSURANCE AND ITS HISTORY

Insurance can be define as a contract whereby one person called

the insurer, undertakes in return for the agreed consideration, called

the premium to pay to another person, called the insured, a sum of

money, on the happening of a specific event during a specific

period.

Thus, in very simple words, a contract of insurance is a contract

between two parties, the Insurer and the Insured, the former

promises to compensate the latter on the happening of a definite

event in return for his contribution.

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Insurance has existed for many centuries. Some historians trace the

origin of insurance to 215 CE, when the roman government was

required by military supplies to accept all risks arising from enemy

attacks, storms, and other natural disaster for supplies carried on

their ships. (Omar Fisher, 2009). The earliest evidence of insurance

contracts dates back to the period around 2,800 B.C. where theBabylonian legal code showed regulations on insurance. Basically

the concept of insurance was developed to deal with perils faced by

merchants and traders at sea. This varied from protection of the

cargo and goods carried by ships to the protection against the loss

of lives of sailors and officers.

In other words, there is a need for human to prepare for the loss.

And modern insurance can be traced its beginning to the 1600s,when British merchants and ship owners began to meet a

coffeehouse near Lombard Street in London. The coffeehouse was

called Llyods, there they made an agreement to mutually share inthe profits and losses of sea voyages (Omar Fisher, 2009).

There is evidence showing that such practices were also prevalent

among the Chinese, Greeks and Europeans. The first case of life

insurance dates back to 1583 in England where a term contract wasissued on the life of a certain William Gybbon. A significant

development in the life insurance industry was the development ofthe mortality table by Edmund Halley in 1693. However, it was

about a century later that any degree of accuracy was achieved in

predicting mortality rates.

The introduction of insurance in Malaysia dates back to the 18th

and 19th centuries where trading firms and agency houses acted as

agents for insurance companies from the United Kingdom. Upon

the achievement of independence, there was an effort to establish

domestic insurance companies. The early 1960's saw the growth of

many life and general insurance companies. Some of these

companies operated on an unsound basis with improper

underwriting guidelines.

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The Government subsequently intervened and the Insurance Act,

1963 was introduced. Under the Act, the general conduct and

supervision of the insurance industry was vested in the Director-

General of Insurance under the Ministry of Finance

A4.2 BASIS OF INSURANCE

Insurance is a process through which losses suffered by a few is

spread to and borne by many. In modern practice, insurance is a

medium through which the financial burden of a misfortune is

transferred from the Insured to Insurer. The concept behind

insurance is that a group of people exposed to similar risk cometogether and make contributions towards formation of a pool of

funds. In case a person actually suffers a loss on account of such

risk, he is compensated out of the same pool of funds. Contribution

to the pool is made by a group of people sharing common risks and

collected by the insurance companies in the form of premiums.

In general, any person who has a legal right in financial interest in

a property may insure under a contract of insurance if as a result of

loss or damage he will suffer financial loss. An insurance contract

is an agreement or promise that is legally enforceable between twoparties, i.e., the Insurer and Insured whereby the Insurer in return

for a consideration (premium) agrees to undertake for a statedlength of time (period of insurance) to indemnity the Insured up to

an agreed amount (sum insured) for the value of such defined

property (property insured) if damaged by an insured peril.

A contract of insurance is a contract of indemnity (excluding Life

and Personal Accident Insurance) and this principle is to put the

Insured in the same financial position as he was in before the

misfortune occurs. The sum insured must be fixed at a level, which

will provide an adequate compensation at the time of loss. For

insurance in real property, depreciation must always be taken into

account. The cost of insurance would depend on the scope of cover

as additional cover requires additional premium. Generallyspeaking, only unforeseen and fortuitous losses are insurable.

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Therefore, foreseeable misfortune or losses are generally not

insurable (except in Life Insurance).

A4.3 TYPES OF INSURANCE

Sections 4 of the Insurance Act 1996 provides that:

1. For the purposes of this Act, insurance business shall bedivided into two classes

a) life business, which in addition to all insurance businessconcerned with life policie6s shall include any type ofinsurance business carried on as incidental only to the life

insurers business; and

b) general business, which means all insurance businesswhich is not life business.

2. For the purposes of this Act, reinsurance of liabilities under apolicy is treated as insurance business of the class and

description to which the policy would have belonged if it had

been issued by the reinsurer.

Insurance business is divided into life insurance, general insurance

and reinsurance.

A4.4 SHARIAH RESOLUTION ON INSURANCE

The concept of conventional insurance has not achieved full

agreement from scholars whether it is permissible (halal) or

prohibited (haram). Since conventional insurance as it is being

practiced now did not exist during the Prophets time, ijtihad isused to determine whether it is permissible or otherwise.

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4.4.1 Fatwas on Prohibition of Insurance

The National Fatwa CommitteeFatwa Committee of the National Council for Islamic

Religious Affairs Malaysia, at its meeting on 15 June 1972

discussed and deliberated on the issue of Life Insurance.

Resolved:

That Life Insurance provided by present-day insurance

companies is a business transaction which is voidable becauseit contradicts the Islamic business principles in view that the

contract contains the elements of Gharar, Maisir and Riba.

As such from the Shariah point of view, insurance is haram. Acommittee known as Badan Petugas Khas was set up by the

government in 1982 to study the feasibility of setting up

Islamic Insurance in Malaysia. The Badan Petugas Khasconcluded that conventional insurance contract is fasid,

however, the objection is not against the concept of insurance

per se but against the existence of certain weaknesses in the

insurance contract. The Takaful Act 1984 was enacted and

subsequently the first takaful company namely SyarikatTakaful Malaysia Bhd was formed in 1984.

The Islamic Fiqh Academy, OICThe Islamic Fiqh Academy, emanating from the Organisation

of Islamic Conference, meeting in its Second Session in

Jeddah, Kingdom of Saudi Arabia, from 10 to 16 Rabiul

Thani, 1406 H. (corresponding to 22 - 28 December 1985).

And after reviewing the presentations made by the

participating scholars during the Session on the subject of

`Insurance and re-insurance, and after discussing the same,

and after closely examining all types and forms of insuranceand deeply examining the basic principles upon which they are

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founded and their goal and objectives, and having looked into

what has been issued by the Fiqh Academies and other

edifying institutions in this regard;

Resolved:

The Commercial Insurance Contract, with a fixed periodical

premium, which is commonly used by commercial insurance

companies, is a contract which contains major element of risks,

which voids the contract and therefore, is prohibited (Haram)

according to the Shariah.

The alternative contract which conforms to the principles of

Islamic dealings is the contract of co-operative insurance,

which is founded on the basis of charity and co-operation.

Similarly is the case of re-insurance based on the principles of

co-operative insurance.

The Academy invites the Muslims countries to work on

establishing co-operative insurance institutions and co-

operative entities for the re-insurance, in order to liberate the

Islamic economy from the exploitation and violation of thesystem which Allah has chosen for this Ummah.

4.4.2 Prohibited Elements in Insurance Practices Gharar

Gharar means deficient clarity with regard to the subject-matter

being contracted or as uncertainty where the results arehidden or not known. In business terms it means to undertake

anything blindly without sufficient knowledge; or to risk

oneself in a venture not knowing exactly what will be the

outcome.

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o Prohibition Justification It is not permissible to sell an article without making

everything (about it) clear, nor it is permissible for

anyone who knows (about its defects) to refrain from

mentioning them. Al Hakim and Al Bayhaqi. Gharar in insurance contract occurs when one party

takes what is due to him but the other does not receive

his entitlement. - Ibn Taymiyyah

o Types of Gharar Al Gharar al Kathir.

Excessive gharar, this would render the contract

invalid.

Al Gharar al Yasir.Trifling gharar, this is tolerable and permissible.

Al Gharar al Mutawassit.Average gharar which falls between the two.

o Gharar in insurance practices: Both parties to the insurance contract do not know

exactly what their obligations and responsibilities areto each other, neither the insurer nor the insured knows

the outcome of the contract

The insured does not know the amount ofcompensation he is likely to get in case of an accident

or a peril as the insured does not know if there will be

compensation as the outcome of the contract is not

known

The insurer does not know when the peril will occur. There is no equity in insurance in that the insured has

got to pay the premium but if the peril insured against

does not happen, the insured is not paid anything at all.

Insurance is a promise to pay compensation which issometimes fulfilled and sometimes not. Uncertainty in

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the results of the exchange as at the point the contract

is made, the result of the exchange is still uncertain.

o RibaThe word riba literally means increase in or additionto anything. Islam has prohibited lending of money forprofit because it is often ruinous to the borrower and at the

same time makes the lender obnoxious and sullen.

o Prohibition JustificationO you who believe, devour not usury, doubling andquadrupling, the sum lent. Fear Allah and observe your

duty to Him, that you may really prosper. Al-Imran3:130

o Types of Riba RibaDuyun. Riba Qardh. - Where interest is agreed upon at time of

contract.

Riba Jahilliyah. - The increase levied on the borrowerfor late or failure to repay the loan.

RibaBuyu.i. Riba Fadhl. - The difference in weight, volume

and quantity.ii. Riba Nasiah. - The difference in time.

o Riba in insurance practices; Insurance company invest the premium in interest

bearing investment.

Insurance company pay interest on their product. Insurance company consider future interest when

calculating the premium.

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Insurance contracts contain usury; promise to paymore than the premium paid.

Interest charged on late payment of premium. Interest charged on policy loan.

o MaisirThe word Maisir means getting something too easily or

getting a profit without working for it. Islam forbids all

forms of business in which the monetary gain comes from

mere chance or speculation and not from work. Unlike

gharar which is tolerated to a certain degree, maisir is notaccepted at all.

o Prohibition JustificationO Believers! Intoxicants and gambling - and diviningarrows are an abomination of satans handywork. Leave itaside in order that you may prosper. - Al Maidah 5:90

o Maisir in Insurance Contract: Insured could receive huge amount of money, without

equivalent input. Paying premium without getting any amount in return. Insurer loses if there are too many claimants. Premium collected exceeds the claims, Insurers could

make huge profits.

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A4.5 DIFFERENCES BETWEEN TAKAFUL AND

INSURANCE

Items Pertinent

Issues

Takaful Insurance

01 Essence of

Intention

Intention is to create

both spiritual and

legal relationship.

Intention is to

create legal

relation only.

02 Formalities Unilateral contract. Bilateral contract.

03 Accounts

Treatment

For General Takaful

the account isTabarru, means

donation. For FamilyTakaful, there are two

accounts, PA treated

in line with principles

of Mudharabah, while

PSA treated in in line

with the basis of

Tabarru.

For General

insurance the paid

premium is

credited into theGeneral Insurance

Account. In life the

premium is

credited into the

Life Insurance

Account.

04 Subject matter Subject Matter must

be Shariah Justified.

Subject matter

must be Common

Law justified.

05 Guarantee The Takaful

Operator is only the

Fund Manager. TheParticipant mutually

guarantees each

other.

The company

provides the

guarantee.

06 Fund The fund belongs to

the Participant and

managed by the

Takaful Operator for a

legitimate

consideration for the

services rendered.

The fund belongs

to the Company

though separation

of assets is

maintained

between the

Shareholders and

the policy holders.

07 Payment of

contribution/premium

Paid contribution is

treated as donation(Tabarru).

Paid premium

creates anobligation against

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the insurer on a

sale and purchase

contract.

08 Forbidden

Elements

Islamic model is

based on Islamic

principles and free

from any of the

forbidden elements.

Insurance policy

evolves around

the element of

Gharar, Riba and

Maisir.

09 Religious

Supervisory

Religious Supervisory

is made mandatory by

the Takaful Act 1984.

There is no

Religious

Supervisory in

Insurance.

10 Profits The profit is sharedbetween the

Participant and the

Company.

In insurance theprofit is at the

discretion of the

Company.

11 Contract A combination of

tabarru contract

(donation) and agency

or profit sharing

contract.

An exchange

contract (sale and

purchase) between

insurer and

insured.

12 Indemnity The indemnity is

provided by the

Takaful Fund.

The Company

provides indemnity

from the

Companys fund.

13 OperationalPrinciple

Operational principlein Insurance is Shariah

compliance.

Operationalprinciple in

Insurance is not

Shariah

compliance.

14 Risks

Treatment

Risks sharing concept

among Participants.

Concept of risks

transfer.

15 Taxation Taxation and Zakat Tax

16 Benefits Paid from the defined

funds under joint

indemnity borne by

the participants.

Paid from the fund

legally owned by

the company.

17 Profits /Bonus Specifies from the

outset how the profitsare to be shared

May offer bonus or

profit in generalterms only

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between the

participant and the

company.

especially with

profit participating

policies.

18 Responsibility

of

Policyholders /

Participant

Participants make

contributions to the

scheme. Participants

mutually guarantee

each other under the

scheme.

Policyholders pay

premium to the

insurer.

19 Liability of the

insurer /

operator

Takaful Operator acts

as the administrator of

the scheme and pays

the Takaful benefitsfrom the Takaful

funds.

In the events of

deficiency in the

Takaful funds,

operator will provide

interest free loan to

rectify the deficiency.

Insurer is liable to

pay the insurance

benefits as

promised from itsassets (insurance

funds and

shareholders

fund).

20 Investment of

Fund

Assets of the Takaful

funds are invested in

Shariah-compliant

instruments.

There is no

restriction apart

from those

imposed forprudential reasons.

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Principles and Business Models of Takaful 55

CHAPTER A5

PRINCIPLES AND BUSINESS MODELS OF

TAKAFUL

OVERVIEW

Takaful contracts are not only subject to the general principles of the

law of contract but also certain special legal principles that are

embodied in takaful contracts.

Based on the established legal maxims of the fiqh concept of al-Asl

fi al-Ashya al-Ibahah (all things are permissible unless prescribed

otherwise), takaful contract assimilates with the normal

conventional insurance principles in its practices that embody the

concept of fairness in dealings as expounded by Shariah. These

principles however must not contravene the Shariah.

These special legal principles embodied in Takaful contract

principles are:

Insurable Interest;

Utmost Good Faith; Indemnity; Subrogation; Contribution; Proximate Cause; Warranty and Tabarru

A5.1 BASIC PRINCIPLES OF TAKAFUL

5.1.1 Insurable Interest

Insurable Interest refers to the legal right to participate in a Takafularising out of a financial relationship recognized at law between the

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participant and the subject matter of Takaful, that is, the person

covered.

Insurable Interest exists when there is a relationship between

participants and the subject matter, normally arising from several

situations as follows:

Ownership of property the owners of property will losefinancially if their property is damaged or destroyed.

Potential legal liabilityInsurable Interest can also exist whenthere is a financial loss arising from legal liability. For example

employers have legal liability to pay compensation to theiremployees if accidents occurred during employment.

Contractual right the above interest can be established ifthere is a provision in the contract that one party is financially

responsible for any loss or damage to the property and third

party liability.

The financial relationship between the participant and the subject

matter covered should be such that the participant will financially or

economically benefit by the survival or safety or existence of thesubject matter or alternatively will suffer financial or economic loss

due to the destruction or loss to the subject matter. Insurable Interest

must therefore be capable to be measured or valued financially inorder to be covered by Takaful.

For the General Takaful contracts, Insurable Interest must exist at

the beginning and at time of lossotherwise, the Takaful affected isvoid. Example: a person cannot validly arrange for motor Takaful

on a car which he anticipates to own in the future.

However, this general rule is not applicable to marine Takaful. In

marine Takaful, the participant needs to have Insurable Interest at

the time a loss occurs to be able to enter into a valid contract.

Example: Due to the nature of business transaction, an importer of

goods will be able to validly arrange for Takaful on the goods ormerchandise he expects to import so long as he later acquires

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Principles and Business Models of Takaful 57

Insurable Interest that is by becoming the owner before covered

peril happens.

In accident Takaful coverage, the Insurable Interest must exist both

at the time the contract is put into effect and at the time of loss.

For Family Solidarity Takaful, Insurable Interest must exist at the

beginning only. The participant needs only to have Insurable Interest

at the time of effecting the Family Takaful contract.

Some examples of persons having Insurable Interest are:-

a) An individual has an unquestionable Insurable Interest in hisown life and body to any amount. Such an interest is not capable

of valuation and no proof of it is necessary. (Wainwright v.

Bland [1835])

b) Spouses have Insurable Interest in each others lives andproperty.

c) A person to his child or ward being under the majority age at thetime takaful cover is effected, and of anyone on whom that

person is at that time wholly or partly dependent.

d) A creditor can cover the life of a debtor (up to the amount ofdebt) but not debtor on the life of creditor.

e) Surety on the life of his principal. A lender may not be entirelysatisfied by the security offered by a borrower but he may bewilling to accept the guarantee of a surety. By giving such

guarantee the surety has an Insurable Interest in the life of theborrower.

f) Employer covering employees life.g) Property owners (sole, part of joint owners) and his property.h) Mortgagors & Mortgagees of properties have their own

respective interest in the properties.

i) Lessees & Lessors of properties also have their own respectiveinterest in the properties.

j) Bailers - e.g. pawnbrokers, carriers or watch repairers have aninterest in the properties of the bailors as the properties are intheir possession.

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k) Agents - If the principal has Insurable Interest his agent canaffect Takaful cover on his behalf.

l) Trustee - In respect of the legal right or interest in the trustproperty vested in him, if the trust deed permits or directs this.

m) Takaful Operator and Retakaful Operator - Takaful Operatorhave an Insurable Interest in participant lives sufficient tosupport Retakaful Operator.

5.1.2 Duty of Utmost Good Faith (Uberrima Fides)

Utmost Good Faith can be defined as a positive duty to voluntarily

disclose, accurately and fully all facts material to the risks beingproposed, whether requested or not

Takaful contracts, both Family and General are entered into by all

parties in utmost good faith, meaning that they are both required to

disclose all relevant facts, whether asked for or not, that are material

to the other partys decision to enter into the contract. Fa

part a & c(1)

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