Takaful Operations

The Takaful agreement is similar to other standard contracts requiring contracting parties, legal capacities, offer and acceptance, consideration, subject matter, insurable interest, and good faith. However, the subject matter of a Takaful agreement must be agreed upon between the parties through Ijab (Offer) and Qabul (Acceptance).

Takaful contracts have certain element of unavoidable uncertainty as no one can accurately predict the future. This uncertainty has been allowed by the scholars. But the agreement cannot contain uncertainty about the price, method, amount and time of payments between parties, or terms of the contract. Takaful contract must also avoid any dealings in Riba (Interest/Usury), trading in unlawful property or rights, Haram investments, gambling, and manipulation or unjust practices. Takaful agreements are not sales contracts since Shari’ah prohibits Gharar (uncertainty) in sales contracts.

The following conditions must also form part of the Takaful agreement:

Specialty Condition: The contract must follow Shari’ah principles in its entirety. No element of the contract can contravene Shari’ah principles. This condition stipulates that the Takaful operator functions according to the Islamic cooperative principle.

Cooperative Condition: Takaful follows insurance plan based on cooperation among participants. This is the only form acceptable under the Islamic law. The participant pool their funds and those who suffer a loss can draw upon these funds. This is not based on profit motive but rather on cooperation for the benefit of the community. The participants pay a part of their premium as Tabarru (donation).

Mutual Condition: Mutual Insurance is based on membership of participants. They become shareholders in the venture and they also manage the institution. Again, the purpose is mutual protection, not profit.

Partnership Condition: This condition gives the policyholders the right to share any surpluses and also obligates them to pay additional amounts if the losses exceed the available funds. Generally, these losses would be covered from any reserves or written off against future surpluses. A series of losses could require the operator to seek interest-free loan (Qard Hasan) from the shareholders. As a last resort, the premiums may be increased to recover the deficits. The operator gets compensated through an agency fee plus part of the investment profits of the participants’ funds. They can also collect the profits on their own investments.

Investment Condition: This condition mandates that the operator will not invest funds in any interest based securities or in businesses that are involved in activities prohibited in Shari’ah.

Management Condition: This gives the participants representation in the Board of Directors of the operator and allows them to review the transactions and accounts. In practice, this function is performed by the Shari’ah Supervisory Boards in the interest of the participants. 

Tabarru (Donation)

All insurance schemes contain uncertainty as insurance is a protection against unexpected events. Conventional insurance promises to pay a claim in return for premiums, if needed. This constitutes excessive uncertainty about future events and is not considered valid in Shari’ah. Takaful contracts eliminate or minimize uncertainty through Tabarru (donation). Under Tabarru, the Takaful participant agrees to make part of his premium contribution a donation without any expected returns. This allows the operator to settle claims of losses from other participant under the concept of mutual help and joint guarantee. Due to Tabarru, the element of Gharar (uncertainty) is considered to be within allowable limits by Shari’ah scholars.

The principle of mutual help through Tabarru allows the participants to help one of them if he or she suffers an unexpected loss. Though Takaful funds may earn returns on investments or may have surplus funds, but the sharing of such funds is materialized only after all the claim of the participants have been settled.

It is the responsibility of the Takaful operator to maintain sufficient funds from Tabarru to settle any claims that may rise from the participants. Meanwhile, they should take prudent actions to ensure protection of the funds. Tabarru provides protection to the participants to cover losses of property or life. Participants pool their funds to help each other in case of need while earning a return on funds invested by the operator. This has elements of both profit and risk sharing. The profits are shared between the operator and participants while risk is shared among the participants with the help of the operator.

Takaful operators take the funds collected and divide it into two parts. One part is the donations for covering material or human losses of the participants and the other part is invested to earn returns. Tabarru is part of the Takaful contract. The division of funds in the two parts in based on actuarial tables and statistical methods to predict what amount will be required to cover the losses. The rest is available for investment.

A takaful contract might specify separate clauses for investments and protection or combine the benefits of both. The Tabarru funds are utilized to provide security to all participants against losses. Individuals do not have rights over this pool as it is used to secure the entire group. The investment pool belongs to the individuals and they earn profits based on Mudarabah principle after expenses and once the share of the operator has been deducted.. Discuss the principles for the distribution of the surplus in Takaful operations.

Distribution of Surplus

Since Takaful is based on a cooperation principle any surplus funds after claims and operational expenses can be distributed back to the policyholders. It may take one of the several forms:

1. Takaful operator determines if the Participants Takaful Fund has net surplus at the end of a fiscal year, which can then be shared among the participants.
2. An appointed actuary determines the surplus or deficit for Family Takaful business and the operator management does the same for the General Takaful. The surplus is the net of contributions collected for the Participants Takaful Fund and claims paid (minus recoveries and claims paid by Re-Takaful), operational expenses, commissions, and changes in reserve funds.
3. The operator may decide to hold a portion of the surplus as reserves for contingency and distribute the balance amount policyholders based on their contributions.
4. For Family Takaful, the surplus is usually distributed annually after actuarial evaluation. Shari’ah scholars do not allow for the distribution of General Takaful surpluses.
5. The surplus could be calculated for the entire business or separately for each risk class.
6. The management and the board of the operator determine the frequency and methodology of surplus distribution. This is done with the consent of Shari’ah Supervisory Board.
7. The surplus could be paid in cash or apply as a discount to future contributions. For Family Takaful, the surplus could be added to the participant’s investment account.
8. A participant could decide to donate the surplus to charity though the operator or the shareholders and participants may authorize the operator to distribute the surplus for social or charitable causes.

Takaful operators use a number of different methods to distribute the surplus. In the first method, the determination of any surplus available is made after all the claims have been settled and operational expenses have been accounted for. The surplus is distributed annually to all participants in proportion to their premiums regardless if they had any claims. In the unfortunate event that a participant had suffered a loss and filed a claim during the year does not disqualify him from the receiving the surplus. Since each participant has paid his premium as donation into the participants’ fund, the fund belongs to all participants. Only exception is made if the claims paid were more the sum of the premium and surplus share.

An alternative scheme is to reward only those participants who did not have a claim. The relation of claim amount to the premium is irrelevant and any claim during the year disqualifies the participant from the surplus. This is encourages the participants to be more vigilant in safeguarding their property and business and avoid losses where possible for the benefit of all participants.

Another alternative considers the amount of claims paid to a participant versus the premium paid. If the claims exceed the premium then the participant does not share in the surplus. This scheme aims to protect the participant community against those who file excessive claims and to reduce the compensation that one person can retrieve through insurance. This is in line with the cooperative nature of Takaful to collectively distribute the risk of loss and not use it as a primary profit generating mechanism.