Takaful Business Models

The evolution of Takaful is a relatively new phenomenon in Islamic Finance and comparatively less research has been done on this topic. All Takaful business models have their pros and cons. In order to select the best business model, we must understand the real motivation behind Takaful. The primary of objective of Takaful is to provide a Shari’ah compliant alternative to conventional insurance. Takaful offers sharing the risk of unexpected loss to individuals or businesses through mutual cooperation. The primary motive is not profit making.

The predominant models are based on Mudarabah (profit sharing)and Wakalah(agency) or a combination of both. For example, Mudarabah model is well suited for the investment aspect of Takaful funds, while Wakalah works better from risk-sharing perspective in Takaful operations. The pure Waqf and Tabarru models have also evolved to reduce reliance on profit motive. In the both models the participants’ premium is turned into Tabarru (donation) and they have no right to any investment income or surplus.

The participants or the operator and shareholders might overemphasize profit making in pure Mudarabah which could jeopardize the cooperation aspect of Takaful. Wakalah resolves this issue as the operator gets a set fee for his services but there is a risk that the Operator may not put its best efforts in management of funds. The Mudarabah–Wakalah model offers the best of both but risk of overemphasis on profit making remains. The pure Tabarru and Waqf two models give mutual cooperation higher priority but due to lack of profit motive these remain egalitarian models and only work in social or governmental organizations. The Wakalah–Waqf model is a hybrid of Wakalah and Waqf business models and provides a balanced approach to Takaful business.

Wakalah–Waqf supports mutual cooperation objective of risk sharing for participants. It involves the appointment of a Takaful Operator as an agent (Wakeel) of the Waqf under a Wakalah contract of agency. This is a refinement of pure Waqf as it relieves the participants from managing the Takaful business themselves.The Takaful operatorcollects the premiums as Tabarru from the participants into a Waqf. The operator’s job is to manage the business of underwriting and invest the funds in profitable ventures for the Waqf. The operator will get a defined payment for his underwriting services and also a share in the income of the participants’ funds invested based on Mudarabah. This is different from pure-Wakalah where the operator receives an agreed upon fee for both activities. The investment income after taking out expenses and the operator’s share is rolled back into the Waqf. Any surplus from underwriting expenses are kept with Waqf to cover future claims, distributed to participants, or given out as charity.

The role of Takaful operator is to underwrite various classes of Takaful business and manage the risks within each class. The operator also manages the investment pool that is at their disposal. The operator is usually a commercial company which specializes in insurance underwriting and investments. They have to adhere to Shari’ah guidelines for Takaful operations as well as investments. The shareholders or entrepreneurs who setup the company expect to derive financial gains from the venture. The operator collects the premium from the participants and indemnifies them against unexpected business or personal losses. In some Takaful business models, such as Waqf or Tabarru an individual, a company, or a charitable organization might undertake the role of the operator. Some conventional insurance providers may also set up a separate takaful company or operate a window to offer takaful products. The operator usually provides the underwriting services for an agreed fee structure and also shares in the income from investing the participants’ funds.

The first area of business managed by the operator is Takaful underwriting operations. This includes selection of risks to insure, premium determination and collection, claims settlement, and maintaining re-Takaful to indemnify the operator itself. The operators use sophisticated statistical models and actuarial services to predict likelihood of future claims activity against a policy and determine the premium to charge accordingly. In Takaful, they have to not only comply with Shari’ah principles of mutual cooperation but also keep the rates competitive with commercial insurance to make the products viable. They also maintain re-Takaful or reinsurance through Retakaful providers to protect against high claims and overexposure. In this sense, the services provided by the operator are very similar to those of a conventional insurance company. However, contrary to conventional insurance, the operator itself is not insuring the risk of loss; rather it is managing the pool of participants’ funds for mutual risk sharing.

The second area of business for a Takaful operator is funds management. They are required to administer two separate funds: The participants’ funds (contributions from policyholders) and the shareholders fund (the capital contributed by the investors of the Takaful Operator for development of the Takaful business or for investment). The operator must maintain segregation between the two funds for transparency. The participants pay their contributions to indemnify themselves. Usually, the operator divides contributions where one part is considered Tabarru and is used to cover the claims. The other part is for investment purposes. Some business models use 100{decebffaf8f25eb0a85c221f62bbc22c324e812b773b74c7945f3fd99473db6b} of the contribution as Tabarru. The determination of fund division is based on mortality data and actuarial methods. Any surplus from those funds and from the investment activity is either redistributed back to the participants, given to charity or put back in the pool for future use. This varies according to the Takaful business model of and contract. If a Mudarabah model is used, the operator also shares in the profits of investments.