Applied Islamic Banking

By:
Prof. Dr. Mohd. Ma’sum Billah
masum@applied-islamicfinance.com
masum2001@yahoo.com
+6019-3699542

Some are in the opinion that, conventional insurance is the best packet available in the corner without knowing that Islamic Banking is perhaps the first successful model demonstrating the practical application of religion of economics and business. The idea of sharing risks was actually taken from Islam when the Prophet Muhammad approved the system of Aqilah custom, which has the relevance to the establishment of Takaful or insurance company. But the need is much more transparent in today’s world as we are now more exposed to future risks especially in these recession periods. However, the Malaysian economic is now shaping back into a normal curve. That is why, Malaysia has been a platform for the Takaful companies in the world to refer on its implementations despite of its good Islamic financial institutions.

Actually, Muslims in other parts of the world, also wants to have their own insurance system. That is why many researchers and academicians are now more involved in finding a way out for all rising problems like riba, gharar, maisir and also other elements that is not align with Shari’ah to be extracted out from the insurance products offerings. For that anything that doesn’t comply with Shari’ah should be revised by takaful companies in providing Islamic products. Therefore, tailoring the needs of Muslims and modifying the existing conventional insurance company would not be an easy task. For a start, the fund management would be an idle task to be looked upon.

Some say that prostitution is the oldest profession; history actually suggests that the oldest profession may indeed be that of the moneylender.

Riba or interest has been a destructive weapon used by the rich in those days and even now, as the most reliable income to earn a living. Interest or riba, which is now more familiar as usury, is an aspect of financing, which is questioned by most orientalists. They said “riba” is not synonymous with interest, simply because riba refers to the act of doubling or redoubling of the capital amount that is loaned to them, which is mentioned in the following verse:

What the orientalists is trying to confuse the Muslim here is that, riba would be only known as riba if the amount is doubled or redoubled as stated above. This means that any amount which is less than the double amount; is not considered as riba. This has led to many debates in the discussion of Islamic Banking and Finance, which has a direct relation with the establishment of Takaful insurance. However, Fazlur Rahman, an Islamic Scholar puts a stop to these speculations by referring back to the whole definitions to the Holy Quran. He said any additional amount that is extra regardless of the size would be known as riba as Allah gave an option of trading to riba;

“Those who devour usury will not stand except as stand one whom the evil One by his touch hath driven to madness. That is because they say: “Trade is like usury,” but God hath permitted trade and forbidden usury….”

So the key issue here is that, in order for Takaful operators to gain prudence from the people especially Muslims, they must provide a good and reliable Islamic financial system. Supervision of departments plays a key role in safeguarding the soundness and stability of the financial system. For that, we must know how the company is operating especially the fund management.

Syarikat Takaful Malaysia Berhad was incorporated on 29 November 1984 with an authorized capital of RM1000 million and paid-up capital of RM10 million. The company is a group of Bank Islam Malaysia with 87.15% of its equity held by the bank. The other shareholders are the Islamic State Religious Councils, Baitmals of Terengganu, Pahang, Negeri Sembilan, Melaka, the Federal Territory and Perlis. But now shares in the company and the holding company, Bank Islam Malaysia Berhad (BIMB) are follows.

Where else, the rules governing the Takaful company are Shari’ah rules and practices. It is also regulated by:

Section 8 article 3(a) of Takaful Act 1984, in which; the act states that; a religious supervisor council should be made up of Muslim religious scholars in the country and shall advice the company on the operations of Takaful business.

Therefore; what is prohibited in Islam; such as the elements of gharar and riba would be totally eliminated in the takaful business operation. But, the question here is that, in what manner the operation is done? It is very sad to say that, there are still confusion and some disagreements among Muslim scholars regarding the application of Islamic rules. But that does not mean they are not united. Yes, they are knowledgeable enough to handle the matter. But, when there is a mixture of conventional insurance into an Islamic context, and the implementation of new Islamic insurance products leads to a lot of unanswered questions.

To be very clear and precise, let us deal with the very minor part of Takaful Insurances; Takaful Fund Management- very tiny part but essential. Before that, it is important to say that; what guides the Takaful Fund Management is the ‘principles’. Therefore, if the principles that is developed is the root for the management of funds. In other words, there is one old Indian saying;’ if the head is correct, the tail will also automatically be straight’. Normally this saying is mentioned for an adult son or daughter in a family; implying the meaning, ‘if you are showing a good example; automatically your brothers or sisters will become good’. What this has to do with our Takaful Fund Management?

Actually; what we are trying to say here is that, for a tree to have a good fruits; the ‘fertilizer’ must be form a very good quality. Then only the root can be developed to produce a branch of good fruits.

Fertilizers as the Muslim scholars
Roots are the principles developed by the knowledgeable Muslim scholars. (For example: Muslim scholars must not only know that riba is prohibited; but they must provide other means or solutions for not allowing riba to be implemented. Therefore, knowledge in Fiqh Muamalah, Fiqh Ka’edah and also economics aaare essentials).
Fruits refer to the successful and legal Islamic insurance product.

The idea that we would like to highlight here is that, in order to manage funds in an Islamic way, the principles governing it or being developed by Muslim scholars must be very clear, convincing, and not doubtful and definitely follows the Islamic Shari’ah. In other words, if we have a good intention, the good things will happen; as Prophet said;

“It is narrated by authority Amirul Mu’min, Abu Hafs ‘Umar Ibn Khattab ® who said: I heard the messenger of Allah say,” Actions are (judge) by motivates (niyyat), so each man will have what he intended. Thus, he whose migration is to Allah and His Messenger, his migration is to Allah and His Messenger; but he whose migration was for some worldly thing he might gain, or for a wife he might marry, his migration is to that for which he migrated.”

Therefore, good actions will come from a good niyah- so does the principle that governs the fund management.

There are two keys features to be discussed here. First; tabarru’ and second; mudharabah. Tabarru’ is the contribution or donation allocated in both general and family Takaful fund. However, what differs a family Takaful fund from general Takaful is that in general Takaful, 100% contribution is for tabarru’ account. No contribution is given for participant account or also known as mudharabah account. Where else, the Takaful paid by…..

participants account or also known as mudharabah account. Where else, the Takaful paid by the participant will be credit into the family Takaful fund which is segmented into two separate accounts; namely the Participant’s Accounts and the Participant’s Special Account. A substantial proportion, up to 98% of this contribution will be credited into the participant’s account solely for the purpose savings and investments. The balance will be credited into the participant’s special account as tabarru’ to enable the company to pay Takaful benefits to participants who are facing difficulties. Therefore the tabarru’account belongs to Allah and only those liable will receive the fund.

The Takaful contributions credited into these (PA and PSA in a family Takaful) accounts will be pooled as a single fund for the purpose of investment. Obviously, avenue of investment shall be in a manner permitted by Shari’ah. Any profit generated from the investment shall be entitled to 60% of the profits whilst the company shall receive 40%. The participant’s share of profits shall be credited into his Participant Account. As the profits steadily accumulated, the balance in the Participant Account will increase over a period of time.

Where else, in general Takaful operations; the participants shall agree the payment of compensations or indemnity as a form of mutual help be made to fellow participants which have suffered difficulties. Actually the fund came from the participant in a tabarru’ form which will be credited into the General Takaful Fund. The fund will also be used to pay other operational costs of the General Takaful business such as Re-Takaful placements and the setting up technical reserve.

After taking into account these costs, should there be any profit from the General Takaful fund; the profit will then be shared between the participants and the company provided the participant have not incurred any claims and that no Takaful benefits are paid to them. Similarly, the sharing of the profit will be in a mutually agreed ratio between the participants and the company.

The poet eulogies that the generosity of the two chieftains of Dhubyan tribe, Harith b. Awf and Harim b. Sinan, who had shed no blood themselves but paid the blood money to bring the war of Dahis to a close. Here the word beasts refer to camels, the currency of Jahiliyyah. The rules come into operation when a member of tribe is killed or injured by a member of another tribe. This idea of compensating life with money will not return the life of the victim. But in order to discourage the feelings of vengeance; “blood can only be substituted with blood”, and to discourage violence from members of the asabiya tribes, the proposed solution would be an ideal way of setting problems in a harmonious way.

There are 2 Takaful fund administrated by Syarikat Takaful Malaysia. 9The funds are:

Where else, the income of Syarikat Takaful Malaysia is derived from the following sources:

Profit from the investment of its shareholders’ fund
Its share of profit from the management of both the Family Takaful Business and General Takaful Business in accordance with the profit sharing agreement of al-Mudharabah.

This model has been around for so long and has been practiced in the Middle East countries especially the Bank Ai-Jazira in Arab. Here in this model, whatever left after the deduction done for Re-Takaful, general reserve, claim reserve and unearned Takaful contribution (premium) is known as underwriting surplus. Then, this premium is further divided into two parts-first to the participants and second to the company, based on the agreed ratio. But some company, adopting the policy that, participant are not liable for any surpluses except if the condition changes, that is if there happen any claims. Thus, those who did not face any risk will get nothing. All the surplus will straight away goes into the company’s account and also the shareholders’ fund.

This tijari model is adopted by STMB, Malaysia and its associate and subsidiaries companies in Sri Lanka, Bahrain, Indonesia and also on Brunei. But in Singapore, they are having a mixture of tijari and wakalah model.

In this model, the underwriting of surplus is done based on the agreed ratio, for example 60:40, 70:30, and 80:20. However, this depends on the company condition and also collection of premium done in that particular year. If the economy is doing well, then a 60:40 is preferred. But when there is a recession, 80:20 would be a choice. Normally, the company will hold the bigger equity of profit sharing ratio in order to cover the operating expenses that is increasing every year. Even though, these Takaful companies are not meant for doing lucrative profit, but the company have to keep up with other conventional insurances firms in order to compete in the industry. Therefore, one of the advantage given to the participants who have not made any claims for that particular year, is the mudharabah bonus benefit. In other words, those who did not make any claim, are liable for the further redistribution of profit sharing in underwriting surplus. Besides that, those participants who remain to be in that company, as a ‘gift’ they will get both benefits-first, bonus from mudharabah account and second from NCB (non claim benefit)

But for those, who is not interested anymore to be a policyholder in STMB for instance, can be NCB cert, to be submitted to the intended company they want to buy the policy, in order to get percentage deduction or discount in that newly renewed policy. But as for mudharabah bonus, he will not get it unless if still remains in that particular company.

It is also known as an agent or broker model. Companies have adopted this model in Bahrain, Singapore also including Malaysia-Takaful Nasional and Maybank Takaful. It is a very popular model and competitive with the conventional insurance. The distinct feature from the other two models mentioned above, is that in wakalah model the agent will be getting commissions straight away from the premium given by the participants. However, there are subject to certain conditions like written consent is taken from the participants; that a certain amount of percentage will be deducted from their premium to be given to the agent. Only with consent from the participants the contract will be valid. If not it is void. It is the same like what we have mentioned in proposed model 2 and 3.

Where else, the flow of the premium is same like what is mentioned in tajiri model, except the earlier part; the deduction made to the premium to be given to the top participant. However, what differentiated wakalah from tajiri model is that, in tajiri model the participants and company will get bigger amount of profit sharing ratio than wakalah model. Since there is deduction made earlier to the agents before any amount is allocated for general reserve, unearned premium, reTakaful and claim reserve, than the following amount will be lesser. This is then will be further deducted for surplus.

Before we move further on describing the overall operation of Takaful Fund Management, let us define one by one the technical terms found in the models 1,2 and 3. refer to Appendix 1&2 (Management of General Takaful)

Actually, we will touch each and every definition as we go along the discussion. Firstly, in the Family Takaful Fund, the fund in the participants’ account is further divided into 3 categories namely; SSF(Special Saving Fund), PA (Tabarru’) and PSA (Participants’ Special Account or Mudharabah). Anyhow, in a practical life, Syarikat Takaful Malayisia Sdn. Bhd. is only dividing it mainly into 2 accounts- PA and PSA, regardless whether it is a family takaful fund or general Takaful fund.

If we see carefully, the contribution made in the family Takaful fund and a general Takaful fund; the percentages allocated for both PA & PSA accounts are interchangeable. For example, shown in the table below:

10 Mohd Ma’sum Billah,(2002), Principles & Practice of Takaful&Retakaful, Department of Business Administration, International Islamic University Malaysia

(Tabarru’)

PSA

(Mudharabah)

SSF

Total

Family

90%

100%

General

90%

100%

Why is this so? One of the reasons would be general Tabarru’ fund. If anything happens in the future, then only compensating would be given. But if nothing happens, the Mudharabah fund would be returned back to the participant this is why many of the non-Muslims prefer a Takaful product compared to other conventional insurance.

For example, Ramasamy insured his car, paying RM 1,000 per annum, if nothing happens he will get a return of RM 350 (Mudharabah fund). If he decides to continue the policy, he does not have to pay RM 1,000 anymore but only RM 650 (because he got the returned of RM 350 from Mudharabah fund). That is why small a mount is allocated as an incentive for the participants to get discounts in renewing their policies.

The nature of insurance in Islam is permissible since it utilizes the concept of “saving”. For example, is a person bought a life insurance of 15 years, then he died in the 2 nd year in an accident, the nominee will get the 2 years paid contribution.

TOTAL XXX

In another case, where participants an all the nominees dies in an accident, Syarikat Takaful Malaysia Berhad will rest the case to the following bodies to search for eligible person to receive the fund:

The idea behind the Re-Takaful is to reditribute the fund to other Re-Takaful company. It is for the purpose of seeking protection from future risk by sharing it with other Re-Takaful company under a medium known as Asean Re-Takaful International Labor (ARIL), a subsidiary company of Syarikat Takaful Malaysia, which holds 70% of equity in the company.

A premium collected in small amount would not gong through the Re-Takaful process, as the Syarikat Takaful Malaysia Berhad is capable of paying the amount of the compensation. Only the policy that worth millions of dollar would be Re-Takaful by the company s that if there happens to be a large amount of claims, they would not wipe out the premium collected; disposed into its capital and reserves

There are two types of reserves-claim and general. The distinction is that; if any claim is made, the reserve will be used.

For example, if there is RM 1 Million Claim Reserve but there are no claims made, the shareholder n reduce the percentage allocated for the next years fund, say from 10% to 8 %. But if there are lots of claim occurs, the percentage may be increased.

This happens when a participant do not pay the premium accordingly. For instance, a policyholder is required to pay a monthly premium of RM 100. Because of certain reason, he or she failed to pay the exact amount.

For example, there is an excess of RM 50 in the month of January. The excess will be carried forward to the next month making an addition of RM 20 for the month of February to make the amount equal at RM 100 per moth. The excess of RM 30 will be carried forward for future usage if there is any default in payment of premium.

Takaful operator will use the Participant Account for investments purposes and later divide the profit according to the agreed profit-sharing ratio.

Takaful involve in few types of investment such as project financing and Bai Bithaman Ajil (BBA). Refer to appendix 7 (Investment of STMB)

The profit generated form investment, would then be divide into the agreed profit-sharing ratio let say, 60:40 (60 % for the company and 40% for the participant). The 40% will further be added to the paid capital from PA for the participants. The 60 % will be put into shareholders’ fund.

Surplus will be given to the participants and company only after the fund in PSA deducted for Re-Takaful, Claim Reserve, Unearned Takaful Contribution and General Reserve.

The different between model 1 & 2 from this proposed model is the distribution profit which is cut straight away from the Takaful fund contribution of the participants. Here is a mixture of conventional and Islamic model of insurance plan. However, Syarikat Takaful does not constitute this model as there is doubt in its implementation process, especially when taking of commissions comes from the participant's contributions. Other than this element, the flow is quite similar with model 1&2

The important features the last four model are the derivation of profits from the shareholders und. In this model, the shareholder fund is divided into two parts. First, the deduction of expenses second, the net profit from shareholders (only after deduction of expenses)

There are two kinds of expenses; the management cost and general expenses (establishment and administration expenses). As explained earlier, the commission (expenses) are taken out from the shareholders fund. This is true for model 1&2 but not for model 3&4

Basically, there are three sources of income of Takaful Malaysia Berhad namely return on investment of its shareholders find and its shares for managing both the and Takaful Business and Family Takaful Business

The family Takaful fund is segmented into Individual sector and Group sector. The individual sector comprises of products with maturity period of 10,15,20,25,30, 35 and 40 years as well as Mortgage Plan and Takaful Plan Education, all of which may essential be participated by individuals. On the other hand, the Group sector includes the Family Takaful plan, Group Medial Takaful. Where else, Takaful Hawa Plan is a supplementary contract attaché and endorsed to the individuals plan, as compared to Takaful Rawat (Medical and Health Plan)

The general Takaful fund provides various general schemes as a form of coverage from misfortune upon properties like building, motor vehicle, house and etc. there are 5 types of Takaful schemes under general Takaful:

Takaful fund must be managed according to the Islamic principles. It includes the avoidance of doubt to the policyholder as well as the insurer. When there is doubt on the product, there will be complications arises which will make it difficult to manage the fund properly. Muslim must be fully briefed on the principle of Tabarru’. The absolute owner of the fund is Allah SWT and those who fall under the category of needy people are liable to receive support from the fund.

Another issue that needs to be clarified are regarding commissions. In conventional insurance, the agent will receive their commission taken from the principal amount paid by the insured to the insurer. Syarikat Takaful Malaysia Berhad hires staff that also acts as the agents to promote Takaful products and pay their salaries and commission from the profit of shareholders funs. The rational here is that, the sole purpose f selling or buying a policy is to share the joint liability of any unexpected risks from happening in the future, therefore, any policy, which is intended to make profits or burden are assured, would void the contract ab initio.

The principles underlying Islamic transactions are the non-Riba basis. The values apply even to non-Muslim. Before promoting the product to the clients, it is vital that two things must be clarified. Firstly, it is vital to understand the product before promoting it along with carefully promoting the products pertaining to the flow of fund, how it is done, whether using Ta'auni Model, Tijari or Wakalah. This is essential to get the consent from the participants.

Secondly, to provide Islamic Family Insurance with a competitive advantage, the scheme needs to be carefully explained. One way to illustrate this is by converting the Islamic life family insurance into family package for Umrah or Hajj. Close collaboration wit Tabung Haji may ensure the successful of this idea.

The third concern was regarding the general Takaful products; for example in motor policy. For non-Muslim, in which Shariah rulings is not a concern, the participants can always make an agreement with the mechanics to get a percentage of mount from the Takaful operators, if there happens to be major accidents.

For example, the cost damage is actually RM 5,000 but it is said to be RM 10,000. The excess of RM 5,000 are fraud shared by both participant and the mechanics. To avoid such thing from occurring, he Takaful operator should have a list of reliable mechanics. In addition, if there is any case of cheating, the Takaful operator must take the matter into the court of justice.

Fourthly, STMB should expand its branch worldwide, covering wide area of investment that is recognized by the Shariah. In addition to the investment made in Indonesia and Sri Langka, STMB should further their investment into other third-world country.

Lastly, the role of education system in Malaysia must be upgrade to recognize Islamic Insurance practices rather than conventional insurance only. There are no proper guidelines, lecturers' and expertise since it still new (around 20 years). Therefore, a proper channel and research institutions should be established to guide those who interested in the area of Takaful business.