When you compare an orange and a clementine, at first glance they look similar. They’re both round, they’re both fruit and they’re both orange in colour. It’s only once you cut them open that you realise the differences between the two. In the same way, Takaful and conventional insurance at first glance may look similar, in that they both share the objective of protection against financial loss, but when taking a closer look, the differences become apparent.
Takaful is a system of insurance based on the Islamic principles of mutual assistance (ta’awun) and donation (tabarru). Takaful means joint guarantee, whereby a group of participants contribute towards a pool of money and mutually agree to protect each other by compensating those participants who suffer from an insured peril.
Conventional insurance is not considered to be Shari’ah1 compliant because it includes three key elements prohibited by Islamic law: uncertainty (gharar), gambling (maysir) and interest/usury (riba).
Gharar exists since there is uncertainty of what the insurance policyholder is “buying” or paying for if no loss occurs and the policyholder receives nothing.
However, when a loss does occur there is gharar present again due to the uncertainty in the compensation amounts which vary.
The element of maysir is present because the payment of the sum insured depends on pure chance.
The third element of riba comes in when funds are invested in interest- bearing securities. Takaful is an alternative to conventional insurance which presents itself as a form of mutual help in furthering good by helping others who are in need orin hardship. The concept of tabarru eliminates gharar and maysir - the donation ensures that the uncertainty concerning the contributions and compensation is eliminated. There are various models for Takaful in practice. One of the models, the Mudharaba model, divides the contributions made by participants into two parts: an amount for tabarru which is earmarked to cover policyholder losses and a second portion used for investment.
There are two main stakeholders in Takaful, namely the policyholder and the Takaful operator who runs the insurance scheme on behalf of the policyholders. The Takaful operator is typically a commercial entity, backed by shareholders, that manages the Takaful fund with duties including underwriting the risks and investing the pool of funds. In return for performing these duties, the operator is either paid a fee or shares in the investment profit and/ or underwriting surplus.
The Takaful operator will also have a Shari’ah Advisory Board who monitors the activities of the operations in order to ensure that it is Shari’ah compliant.
Takaful and conventional insurance companies share the same objective of providing protection to you, your loved ones and your valuable possessions. The main difference between conventional insurance and Takaful is that the former is a risk-transfer model whereas the latter is a risk-sharing model.
With conventional insurance, there is a transfer of risk from the policyholder to the insurance company in exchange for a premium. The loss is indemnified by the insurance company according to the terms and conditions of the policy. The risk is therefore, transferred from the policyholders to the insurer. In this manner, the insurance company is the risk-taker.
Under Takaful, the Takaful operator is playing the role of a risk manager and not a risk-taker. However, this does not mean that the operator bears no risk. In the event of a deficit arising in the fund, the shareholders of the Takaful operator typically finance the deficit by means of an interest-free loan. These loans are repaid from the future surpluses that arise from the fund.
Another key difference between Takaful and conventional insurance is that all investments managed by the Takaful operator are to be made in accordance with Shari’ah.Shari’ah prohibits investment in sectors involved in alcohol, tobacco, pork, adult entertainment, weapons, gambling and conventional banking and insurance. In addition, a Shari’ah fund may not invest in interest–based instruments.
Unlike conventional insurance, the participants of Takaful retain an ownership interest in the Takaful fund. Contributions from the participants are invested in Shari’ah compliant funds to derive investment income. In the event that the fund generates a surplus, it is then shared among the participants - and, in some cases with the Takaful operator - or donated to charity. Under conventional insurance, for proprietary insurers, the surplus belongs to the shareholders. In the case of a mutual insurer the situation is similar to Takaful, in that the policyholders share in the experience of the fund. Takaful also bears a resemblance to the way that a stokvel2 is operated, as they are both risk-sharing mechanisms.
The Takaful industry in Africa is growing steadily, with Takaful operators offering a variety of products from basic motor Takaful products to complex pension schemes, such as a Takaful Umbrella Fund.
Many Takaful products can be seen as parallels of their conventional insurance counterparts. Even so, with close to half the population of Africa being Muslim, there is room for Takaful operators to be innovative in their marketing strategies and to actively promote education on both insurance and Takaful.
On the other hand, one of the challenges is the misconception that Takaful is only for Muslims. This is assisted by the fact that Takaful is predominantly found in countries that have majority Muslim populations, including Nigeria, Tunisia and Sudan. However, due to its explicit ethical structure, the principles of fairness and the sharing of burdens among members of a given community, Takaful can be marketed to both Muslims and non-Muslims. An illustration of this can be found in multiracial Malaysia, where Takaful products have also attracted non-Muslim communities.
Another challenge faced by the Takaful industry is the scarcity of Shari’ah-compliant investments. As a result, Takaful companies have had to seek instruments in different markets to diversify their risk, including sometimes volatile equity and property markets.
After slicing through the layers of Takaful and conventional insurance, it can be seen that although they may share the same objective, the differences in surplus distribution and investment allocations make the two quite distinct.
With the growth in Takaful and rising need for protection in Africa, it seems like only a matter of time before Takaful companies will begin attracting new clients from the existing conventional insurance franchises.
© 2021 KPMG Services Proprietary Limited, a South African company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.