FAQ #22

A Takaful operator offers a motor takaful coverage for a sum cover of RM290,000  with total contribution of RM4,000.  However, a conventional insurance company willing to offer at a lower sum cover of RM160,000 with a cost of only RM2,300.  After a heated argument, the takaful operator finally willing to reduce the coverage to RM160,000 provided that the participant sign a document pertaining the average clause provision.  Takaful operator is seemed to be less  flexible to accommodate the participant and charging much higher cost. 

This is a typical scenario in the motor takaful business in Malaysia and perhaps few other countries which practice dual financial system.

At a glance, we might be inclined to conclude that Takaful is not fair, inflexible and expensive.  The additional contribution (premium) of  RM1,700 (RM4,000-RM2,300) is definitely significant and creates the impression that Takaful is very expensive compared to  conventional insurer.  This may contradict the concept of fairness and equitable as promoted by Takaful operators as well as any other Islamic Financial Institutions (IFI) nowadays.

Let’s delve the case thoroughly using two different perspectives, namely Shariah and technical point of view.  As Shariah justification may not appeal to non-Muslim, the discussion using technical aspect is hopefully able to explain the rationale on the situation.  Nevertheless, Shariah concept is also a universal concept which is acceptable and understandable to all. 

What is the major different between Takaful and conventional insurance?  Takaful is based on the concept of helping one another where all participants (policyholders) contribute a certain amount of money to a pool, with the main objective to help those who might meet with defined misfortunes as outlined in the contract.  This is indeed a righteous act and commendable act strongly encourage by all religions.  In the Quran (2:261), Allah says “The parable of those who spend their substance in the way of God is that of a grain of corn: it growth seven ears, and each ear hath a hundred grains.  God giveth manifold increase to who He pleaseth: and God careth for all and He knoweth all things.”

Thus, Allah promises at least 700 times of reward for those who contribute their wealth for the sake of Allah.  The more you give, the more return you will reap from Allah swt.  Based on the Takaful practices, most of the contributions are pooled into a fund under the concept of Tabarru’at which literally means donation.    Under the concept of Tabarru’at (donation), paying RM4,000 would definitely yield more reward as compared to RM2,300, as the amount going into the way of Allah swt is significantly higher.  Based on the multiplying effect, our investment for the hereafter will result in significant outcome to be reaped thereafter.

The richest of the rich, just to name a few, like Bill Gates and Warren Buffett were reported to have given away a large chunk of their wealth to charity, with Gates donating money amounting to US$60 billion to help those in need and Buffett giving shares worth nearly US$20 million to eight unnamed charities.  Despite of their huge amount of charity, they are still among the richest men in the world bestowed with more wealth.

Now, let’s look at from technical point of view.  Ask yourself, why would you purchase an insurance policy or participate in a Takaful plan?  Obviously, for protection against any unexpected misfortunes,  in the event of which, our asset is exposed to the maximum probable loss equivalent to the cost of repair or replacement of the asset based on the current market value. 

Based on the above case, when a takaful operator offers to cover the vehicle for a total coverage of RM290,000, it is based on the current market value of the vehicle.  Meaning that, in the event of a misfortune which may lead to the total loss of the vehicle, the takaful operator will compensate the claimant  up to a maximum amount of RM290,000 to enable him to purchase a new vehicle of similar condition as a replacement. On the other hand, the conventional insurer would only compensate him with the maximum amount up to RM160,000 which will definitely upset him and put him at the disadvantage as he won’t be able to purchase another vehicle of similar condition as replacement.  He may save RM1,700 at the inception of the business transaction but he expose himself to a potential maximum total shortfall of RM130,000 compensation should misfortune befalls him. 

Some people may say that their chances of total loss is very slim or insignificant thus making them reluctant to seek a coverage for their asset equivalent to  the market value.  This is similar to a gambling or a betting where you try your luck with the hope that it does not happen.   In fact, the lower probability of total loss has been factored into the pricing where he is only charged approximately RM4,000 for a potential benefits of RM290,000.

In summary, Takaful business is the most fairness and equitable as the fundamental objective is to help each other to protect against unexpected misfortunes.

FAQ #21

Global communities were stunned by the news with regard to the missing Malaysian Airlines aircraft MH370 without any trace until today.  From Takaful perspectives, what are the lessons we can learn from the incidents?

The missing of MH370 and the search and rescue operation are making headlines in almost all major media be it the print media, electronic media and new age media.   It is no longer a domestic controversy  debated exclusively in  Malaysia but all over the world.  Numerous speculations and theories were suggested, mainly by netizens, nevertheless we can only confirm which one is correct once the black box is found and recovered from the now mystery location.  

 
Who are the stakeholders of MH370 or any other plane which ferry passengers as well as aircrews from one location to its final destination?  Obviously, first layer of stakeholders  are the airline owner i.e. Malaysia Airlines for MH370, the air crews and the passengers themselves. The next layer would be the relevant regulators, families of the aircrews and that of the passengers.  This discussion is limited to the first layer of stakeholders only.

The airline owner owns the plane and shall ensure that the plane is fit as prescribed by the aviation authorities to provide the required services for the designated passengers.  Despite of having world class Standard Operating Procedures (SOPs) and the best resources to execute the SOPs, nobody can refute that the probability of loss due to exposure to various kind of risk still exists.  In simple words, we cannot  guarantee 100% that there will never be any misfortune or accident during the course of the flight.  Potential risks like engine malfunction, system  software  errors,  bad weather, human errors or hostile action, etc might still occur.

In the event of an accident or misfortune, there would be potential significant losses to the asset or plane as well as injuries or losses of lives of those people travelling on board.  In terms of monetary values, we are looking at hundreds of millions (US$) worth of potential losses, whether to the hull (body) of the plane or liabilities to the lives on board.

The airlines, therefore, should ensure that adequate Takaful coverage for the hull and liabilities are  obtained from a suitable Takaful operator or consortium of operators.  In this respect, engaging services from a professional Takaful broker is advisable as the broker is able to advise on the appropriate coverage to be taken, as well as the sum to be covered.  Besides, the broker may also negotiate the best terms and conditions with the lead takaful operator to ensure that the client, i.e. the airline, can obtain the most reasonable protection at a competitive pricing.

Today, none of the Takaful operators are ready to offer a complete and comprehensive Takaful coverage to the aviation industry due to its limited capacity in terms of coverage as well as lack of technical expertise about the industry itself. However, they should form a consortium to share the risk among themselves and slowly build the necessary expertise internally.  Active and aggressive participation by  retakaful companies will definitely speed up the learning and growth process of the takaful industry in this sector.

Individually, each passenger as well as  crew should obtain adequate Takaful coverage for their travelling.  Should the covered risk happens, this coverage is usually settled much earlier as compared to liabilities compensated via the airline certificate which takes longer to settle due to legal processes.  As in the case of MH370, the search and rescue operation still continues until now (time of this article written) and even after more than a year of search and rescue operation, there is still   no significant lead.  Thus, the families of the victims may encounter difficulties or hardship to meet their monthly dues if they do not have any other income as compensation from the airline has yet to be received.

The fact is, travel takaful coverage is very affordable for everyone as the duration of coverage is strictly coincide with the travelling period.  For instance, during a one week trip to Europe, the most comprehensive travelling takaful coverage only cost about  RM14.  It covers death and total permanent disability, in-patient and out-patient medical, repatriation cost, loss of baggage, delay of flight, etc. Despite of the very affordable coverage, most travellers are ignorant about the availability of such takaful coverage or the importance of having a coverage while you are travelling.

For those who require higher coverage for death and disability, they may add personal accidental Takaful coverage which usually span for a minimum period of 12 months.  This protection is also very affordable where a RM100,000 sum of coverage for a period of 12 months will usually cost about RM150.

It is strongly recommended that employers  obtain the necessary and adequate Takaful coverage for all their employees who are required to travel for business reasons.

Besides having adequate Takaful coverage, another lesson to be learnt is pertaining the good risk management practices. In order to minimize the potential of sudden loss of several key executives,  many multinational corporations have practiced the unspoken rule to disallow  their key executives to travel together in the same transport.  This measure is  taken to minimise the potential loss of several key executives at one event should any unforeseen misfortune happen if they were to travel together.  Losing several key executives would mean  significant interruption to the business operation and ultimately impact their bottomline.

Due to the same reason,  I was told  that a few corporate figures hardly travel together with their families in the same transportation.  Instead, they will schedule a different transportations, like a different flight  going to the same destination, for the family members to take.

FAQ #20

A customer took a loan from conventional bank to purchase a house.  However, he decides to cover his house against fire and related perils with a Takaful company.  Is this possible?

Many countries like Malaysia, Indonesia, Brunei, Pakistan, and Middle Eastern countries practice dual financial system where conventional and Islamic finance runs in parallel.  Thus, a customer may choose to obtain financial assistance from a conventional or Islamic bank. 

Besides interest or profit rate, factors like ease of doing business, maximum amount offered, one-stop centre, and flexible approval process are few considerations that influence the customers to do business with a particular banking system.  Under certain circumstances, homeowner who opt to purchase his resident with the assistance from conventional loan may decide to cover his house against fire and related perils with a Takaful company. 

In this respect,  Shariah experts had no objection against the decision.  This is in line with the resolution by Shariah Advisory Council (SAC) of Bank Negara during their meeting in October 2005 which resolved that a Takaful company may offer a takaful coverage for a customer’s asset even though the asset is financed through conventional loan, provided that both are offered separately and not as a package.

SAC has considered that the takaful coverage contract which focus on the risk of the asset and the conventional loan contract which offer the financing are two separate and independent contracts.  As such takaful company is allowed to provide takaful coverage for a customer’s asset which is financed by a conventional loan since the takaful company is not directly involved in the conventional loan transaction concluded between the customer and the conventional financial institution.

Based on the same rationale, takaful company can also offer family takaful products like mortgage reducing term takaful  to homeowners who financed their assets through conventional loan.

FAQ #19

What is a Life Annuity Takaful and why the Annuity products are not available in Takaful industry?

Today, we observe great concern with respect to health-related issues within the community.  In addition, there have been significant improvement in medical facilities offered to the public and easily access to a better quality of life.  As a result, most part of the world are observing increasing life expectancies among their population in recent years.     

Consequently, there is a need to provide retirement products that will cater for a stream of income upon retirement and old ages.  The income is meant to sustain certain level of lifestyle which may not be equivalent to pre-retirement period but at least provides a comfortable life.

 

Life annuity is a concept of a series of future regular payment to be paid by Takaful operator commencing from a particular age as an exchange of an immediate lump-sum payment or series of regular payment.  This is usually offered by Takaful Operator to cater for retirement benefits to their participants.  Nevertheless, life annuity is not allowed by Shariah due to uncertainty element of the number of future regular payment therefore it is replaced with Annuity Certain with specific number of years specified for future regular payments.  For instance, a person aged 40 participates in an Annuity Certain Takaful of 20 years term commencing from aged 55.  He has the option whether to pay a lump-sum contribution at inception or regular contributions till certain age.  Upon reaching 55, Takaful operator will commence paying him a regular payment as agreed earlier for 20 years ahead.  In the event of his death, the balance of future payments will be made to his beneficiaries or as allowed by Shariah laws.

Nevertheless, there are several challenges facing the takaful annuity business  which hamper their development as follows:

Lack of suitable sukuk

Annuity business require a suitable investment instrument which can generate a stream of regular income to match the annuity payout to participants.  As the payout liability is a long term commitment usually 10, 20 or 30 years, the investment instrument shall be a long term duration.  The most suitable instrument to meet with the above criteria is sukuk or Islamic bond. 

 

Unfortunately, the offering of long term sukuk is very scarce and limited as most sukuk offered are short to medium term in nature.  Moreover, the offering of sukuk is easily fully subscribed by the bigger corporations such as Islamic banking.

As such, most takaful operators are hindered from venturing into the annuity business.

Issues with product features on annuities

One of the features of annuity product is the guaranteed future income payout.  This guaranteeing of future benefits are not acceptable to some Shariah scholars.  Besides, the future guaranteed benefits may resulted in deficit in the fund to cater for the liabilities.  In the event of deficit, Qard (interest-free loan) may be required from shareholders to rectify the shortfall.  As it is a loan, then the question on how to recover the amount for shareholders emerge.  

Issues of permissibility

Some Shariah scholars are of the opinion that the tabarru’ contributions from takaful fund can only be used as benefits to participants who suffer financial loss or misfortune arising from pre-defined events.  However, takaful annuity pays out the benefits to the participants as a result of survivorship without any financial loss or misfortune occur.  Thus, the nature of takaful annuity benefits contradict with the Shariah requirement for benefits payout from the takaful fund.

Impact of Risk-based capital (RBC)

It is mandatory for Takaful business to comply with RBC requirement.  Due to the nature of the annuity product of guaranteeing future benefits, meeting the RBC threshold may result in additional capital requirement.  In the end, annuity products will be priced slightly expensive to cater for RBC requirement and making the product less attractive to the potential customers.

Due to the above challenges, takaful as well as conventional insurance are not very keen to offer such product to the market nowadays.