Takaful, an Islamic insurance system, is derived from the Arabic term "Kafalah", meaning to jointly guarantee or support one another. Rooted in the principles of Sharia Law, Takaful emphasizes mutual cooperation, understanding, and trust, providing a framework where all participants collectively safeguard against financial risks. This system contrasts with conventional insurance, which involves a contract in which one party indemnifies another for specific risks in exchange for a premium. Unlike conventional insurance, Takaful operates in full compliance with Sharia Law, ensuring ethical and community-centered practices.
The first Takaful companies in the MENA region were established in the Kingdom of Bahrain and Sudan, marking the beginning of a growing industry that has since gained widespread recognition. Both Takaful and conventional insurance in the region are governed by regulatory frameworks set by the Central Bank of Bahrain (CBB), particularly the CBB Rulebook Volume 3: Insurance, which includes dedicated modules for Takaful and Retakaful operations.
This article explores the structure and operation of Takaful and Retakaful, their regulatory environment, and their distinctiveness from conventional insurance practices, particularly focusing on the Wakala and Mudaraba models, the segregation of funds, and the ethical considerations that underpin these systems.
What is Takaful and Retakaful?
In a Takaful arrangement, participants make "tabarru" (donation) payments into a common fund that is used to provide mutual assistance to members against specified loss or damage. Such arrangements must conform to the principles of Sharia in order to be considered mutual insurance.
In a Retakaful arrangement, there is a type of risk transfer contract that resembles an insurance contract. This contract involves an Islamic institution that is licensed as an insurance or reinsurance firm and may be referred to as "Islamic Insurance" or "Cooperative Insurance" in certain markets.
Regulation of Takaful and Retakaful Companies
The CBB and MOICT are responsible for supervising and regulating all financial institutions, including insurance and reinsurance companies.
The CBB recognizes that Takaful and Retakaful insurance differs in certain aspects from conventional insurance. The rules and guidance outlined in the CBB Rulebook Volume 3- Insurance (Takaful/Retakaful Module) are intended to enable Takaful firms to function within the CBB's insurance regulatory framework in Bahrain, in a manner that is consistent with the requirements imposed on conventional insurers. Accordingly, the CBB's regulatory framework does not show preference for one type of insurance over the other, and both Takaful and conventional structures can operate in a competitive environment.
Basis of operating a Takaful business
Takaful firms operating in Bahrain are required to follow the al Wakala model in organizing and conducting their business. This involves the payment of a specific consideration, known as a "Wakala fee", to the shareholders of the Takaful firm in exchange for management services provided to participants' funds.
Additionally, the al Mudaraba model must be used for investing the insurance assets on behalf of participants' funds. The Takaful operator must receive a predetermined percentage of the profits generated from the investment portfolio, and no performance or incentive fees are permitted to be paid to the shareholders or to the Takaful operator of the Takaful firm. Only the Wakala fees and the set percentage of the profits generated from the investment portfolio can be paid.
Wakala Fee
The Wakala fee, which can be expressed as a percentage of contributions, must be an upfront fixed fee. Once established, the Wakala fee must remain unchanged for the reporting period and be explicitly stated in the Takaful contract, and the participant must agree to it.
The Wakala fee should encompass the overall sum of the following components:
- Management expenses;
- Distribution expenses, including the remuneration of intermediaries, agents commission, and other costs associated with making Takaful products available to the public; and
- An appropriate and fair margin of operational profit.
Mudaraba Fee
Mudaraba is a term that refers to an arrangement where one party provides the capital, while the other party provides the management expertise required to invest the capital. In the context of Takaful insurance, the Takaful operator receives a Mudaraba fee for investing the insurance assets on behalf of the participants funds. The fee is based on a fixed percentage of the net investment income generated by the fund and is approved by the Sharia Supervisory Board.
The term 'net investment income', as mentioned previously, indicates the gross investment income minus any investment expenses, with the exception of the Mudaraba fee paid to the Takaful operator, which is not included in the calculation.
Segregation of Funds
If an insurer engages in Takaful business, the following requirements must be met:
- Compliance with Chapter CA-3 of the CBB Rulebook – Volume 3: Insurance (Capital Adequacy Module)for a family Takaful business.
- Maintenance of separate books of account for each type of business.
- Maintenance of any additional books of account required by this module, for either the general Takaful or family Takaful business; and
- Maintenance of transactions related to each type of business to be maintained separately and form a distinct fund or funds.
Except for the explicit exemptions outlined in paragraphs CA-8.3.4 and CA-8.3.5 of the CBB Rulebook – Volume 3: Insurance (Capital Adequacy Module), a Takaful firm's assets which are assigned to the participants' funds, must solely be used for the benefit of the fund to which they are attributed, as mandated by Paragraph CA-8.3.2 of the CBB Rulebook – Volume 3: Insurance (Capital Adequacy Module), and must not be utilized for any other purpose of the Takaful firm. However, this does not prevent the reimbursement of expenses incurred by the shareholders (in the current or preceding financial year) in settling liabilities that are wholly or partly attributable to a fund or funds. Furthermore, a Takaful firm is permitted to swap insurance business assets of any fund for other assets of the insurer, including those held by another fund or the shareholder, at a fair market value.
If a Takaful firm conducts insurance business in Bahrain, it must establish sufficient measures to ensure that transactions involving the Takaful firm's assets (excluding transactions beyond its authority), do not create unfair conditions between any of the participants' funds and the shareholder assets of the Takaful firm.
In situations where the Takaful firm has more than one 'identified fund', these measures must also prevent unfairness between those funds.
If the CBB imposes a financial penalty on a Takaful firm or orders the firm to compensate participants for any misconduct (including any misconduct committed by a representative appointed by the firm), the Takaful firm is prohibited from paying that compensation or financial penalty from any participants' funds. Additionally, the firm must not attempt to recover that compensation or financial penalty as part of its management fees.
Takaful in Comparison to Conventional Insurance
The consensus among Muslim Jurists is that conventional insurance is not in compliance with the principles and regulations of Sharia. Takaful firms, alternatively, provide products and services equivalent to those offered by a conventional insurer to an insured (policyholder) but in a lawful co-operative way that aligns with Islamic principles. Therefore, Takaful contracts are structured to be devoid of any gharar (uncertainty that would render them non-compliant with Sharia), riba (interest), and other prohibitions.
The idea of Takaful encompasses the payment of contributions that are entirely or partially donated to establish an insurance portfolio. The combined resources are subsequently utilised to provide indemnity when the insured risk materializes. The consolidation of donations and the provision of aid to those in need via indemnity payments do not conflict with Sharia but rather comply with the principles of compensation and communal shared responsibilities.
Concluding Remarks
Takaful and Retakaful not only offer an alternative to conventional insurance but also present a model of financial cooperation grounded in Islamic values of mutual support, fairness, and shared responsibility. These systems, while adhering to Sharia principles, demonstrate the potential for ethical, community-focused financial solutions that cater to the needs of individuals and businesses alike. As they continue to evolve and gain recognition, particularly in the MENA region, Takaful and Retakaful highlight the growing importance of integrating cultural and religious considerations into the global financial landscape, offering a unique approach to risk management that aligns with both modern regulatory frameworks and timeless ethical values.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
