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And now for something truly off the beaten track. Exotic Financial Courses run in exotic tropical locations with trainers dressed in even more exotic Batik and Hawaiian shirts. Brought to you by Finance Training Courses

The first in this series is the ALM and Liquidity Risk workshop in Subang, Malaysia in January, quickly followed by the ALM for ICAAP and Interest Rate Modeling Workshop in Langkavi and the Treasury Risk workshop in Nairobi.

All workshops end Friday afternoons, leaving you two days and a half to unwind and get back to work on Monday morning.

Sign up at Finance Training Courses for advance notification and registration.

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Collateral Valuation: Credit Risk: Definition and Types
Collateral Valuation: Credit Risk: Extent of collateral & Performance indicators for collateral
Collateral Valuation: Credit Risk: Role of collateral in Financial Intermediation
Collateral Valuation: Credit Risk: Collateral and Collateral Law

Collateral Valuation: Credit Risk: Importance of collateral valuation to credit risk management
Collateral Valuation: Credit Risk: General principles
Collateral Valuation: Credit Risk: Real Estate Valuation Approaches
Collateral Valuation: Credit Risk: Sales Comparison Approach for real estate
Collateral Valuation: Credit Risk: Income Capitalization Approach for real estate
Collateral Valuation: Credit Risk: Cost Approach for real estate
Collateral Valuation: Credit Risk: Approaches for other assets

Collateral Valuation: Credit Risk: Security Interest – creation and perfection
Collateral Valuation: Credit Risk: Collateral Management of Security Interest
Collateral Valuation: Credit Risk: Enforcement of Security Interest
Collateral Valuation: Credit Risk: Termination or the extinguishing of Security Interest

Interest Rate Simulation: Introduction

Model processes may depend on the evolution of a single factor such as the short rate, as in the case of the CIR one factor equilibrium model. We start with the simplest of interest rate models, the Cox Ingersoll Ross interest rate simulator and review the model as well as the steps required in its calibration.

Interest Rate Simulation: Using CIR (Cox Ingersoll Ross) Model: Introduction
Interest Rate Simulation: Using CIR (Cox Ingersoll Ross) Model: Estimating Parameters & Calibrating the CIR Model
Interest Rate Simulation: Using CIR (Cox Ingersoll Ross) Model: Simulating the term structure of interest rates

Interest Rate Simulation Models: Building BDT in Excel: Introduction
Interest Rate Simulation Models: Black, Derman and Toy (BDT) model in Excel: Define Input Cells
Interest Rate Simulation Models: Black, Derman and Toy (BDT) in Excel: Define Output Cells
Interest Rate Simulation Models: Black, Derman and Toy (BDT) model in Excel: Define Calculation Cells: Construct short rate binomial tree
Interest Rate Simulation Models: (BDT) model in Excel: Define Calculation Cells: Construct State Price Lattices
Interest Rate Simulation Models: (BDT) model in Excel: Calculate Prices from Lattice
Interest Rate Simulation Models: (BDT) model in Excel: Calculate Yields & Yield volatility from Lattice
Interest Rate Simulation Models: (BDT) model in Excel: Define & Set Solver Function & Results
Interest Rate Simulation Models: (BDT) model in Excel: How to utilize the results of a BDT interest rate model: Derivation of Short Rates
Interest Rate Simulation Models: The results of a BDT interest rate model: Pricing Bonds
Interest Rate Simulation Models: The results of a BDT interest rate model: Pricing Options

Interest Rate Simulation Models: HJM (Heath Jarrow Merton) Model: Define input cells
Interest Rate Simulation Models: HJM (Heath Jarrow Merton) Model: Interest Rate Model in Excel – Define calculation cells
Interest Rate Simulation Modeling: HJM (Heath Jarrow Merton) Model: Interest Rate Model in Excel – Determine Prices

Interest Rate Forecasting: Principal Component Analysis (PCA): Overview
Interest Rate Forecasting: Principal Component Analysis (PCA): Data
Interest Rate Forecasting: Principal Component Analysis (PCA) : Principal Component Analysis in Excel: Covariance Matrix
Interest Rate Forecasting: Principal Component Analysis (PCA): Eigenvectors
Interest Rate Forecasting: Principal Component Analysis (PCA): Diagonal Matrix
Interest Rate Forecasting: Principal Component Analysis (PCA): Solver Setup & Results

Internal Capital Adequacy and Assessment Process (ICAAP): Basel II – Background: Great Depression, Regulation Q, Basel I
Internal Capital Adequacy and Assessment Process (ICAAP): Basel II

One forward looking aspect of the Internal Capital Adequacy and Assessment Process (ICAAP) is stress testing of all risk factors in order to arrive at the capital requirements for the worst case scenario. Stress testing also allows the bank to plan and prepare for unexpected situations that may arise in the future. We look at some of the stress tests that can be applied to credit, market and liquidity risk.

ICAAP Submission: Credit Risk: Stress Test: Non – Performing Loan (NPL) Stress Test
ICAAP Compliance: Credit Risk: Stress Test: Simple Sensitivity Analysis – Increase & Shift in NPL
ICAAP Compliance: Credit Risk: Stress Test: Simple Sensitivity Analysis – Fall in Forced Sale Value (FSV) of mortgaged collateral
ICAAP: Credit Risk: Stress Test: How to construct a Transition Matrix
ICAAP: Credit Risk: Stress Test: How to Determine Expected Classification Rates
ICAAP: Credit Risk: Stress Test: Profitability Analysis of a bank’s loan portfolio
ICAAP: Credit Risk: Stress Test: Transition Matrix Stress Test
ICAAP: Credit Risk: Stress Test: Profitability Analysis Stress Test
ICAAP: Stress Test: Market Risk
ICAAP: Stress Test: Liquidity Risk

ICAAP: Process Requirements: Purpose, Pre-requisites, Board of Director Responsibilities and Documentation
ICAAP: Assessment Requirements: Approach, Nature , Comparative View to MCR and Review Process
Internal Capital Adequacy and Assessment Process (ICAAP): Report – main elements
ICAAP: Internal Capital Adequacy Assessment – Sample ICAAP report format and table of content

Internal Capital Adequacy and Assessment Process (ICAAP): Modeling Building Process
Internal Capital Adequacy and Assessment Process (ICAAP): Model Risks
Internal Capital Adequacy and Assessment Process (ICAAP): Prevention and Limitation of Model Risks

In order to quantify credit risk for the internal ratings based approach of the Internal Capital Adequacy and Assessment Process (ICAAP) the bank would need to be able to calculate the probability of default (PD). We discuss one methodology of calculating PD which is based on historical behavioral data.

ICAAP Submissions: Probability of Default (PD) Calculation

If you would like to buy this complete course as a PDF file or a Sample ICAAP report as a PDF file or the sample credit risk EXCEL sheet, please see the ICAAP section at our online finance course store. The online finance course store includes easy-to-read-and-work-with downloadable PDF files, excel templates and ready-to-work with models that are shared to illustrate usage and speed up learning and pick-up for advanced financial modeling, forecasting and simulation topics including interest rate forecasting and simulation, value at risk analysis, collateral valuation, asset liability management, ICAAP and other related middle office and risk topics.

The Council of Islamic Ideology’s Report on Islamic Insurance System cited the expressed opinion of the Majlis-i-Fiqhi Islami about the system of insurance in vogue as follows.[1]

1. ‘gharar-e-fahish’ (risk)

“Praise be to Allah and prayers and peace for Allah’s messenger, his progeny, companions and for all those who are guided by Him. Now then:-

“In its first session which was held at Makkah Mukarrmah on Sha’ban10, 1398 A.H. in the Majlis-i-Fiqhi Islami (the Assembly of Islamic Jurisprudence) deliberated on insurance and its different kinds. The vast amount of writings by the Ulmā on this subject was also kept on view. Also kept in view was resolution No. 55 of Saudi Arabia’s Majlis-e-Hayat-i-Kibar-ul-Ulamā (The Constituent Assembly of Most Eminent Religious Scholars) passed in its tenth session at Riad held on 4.4.1397 A.H. declaring all kinds of commercial insurance as unlawful in Islam.

With the exception of Honourable Sheikh Mustafa-uz-Zarqa, the rest of the member of the Majlis-i-Fiqhi agreed to conclude that all kinds and types of commercial insurance, whether related to life or commercial goods and wares or other articles are unlawful in Islam for the following reasons:

“As has been mentioned earlier, in the above referred report, the council expressed the opinion that the main laws relating to insurance and the prepondering bulk of insurance business is in conflict with the injunctions of Islam, because:

1. 1. There is ‘gharar’ in these contracts.
2. 2. The element of gambling is present in its extreme form.
3. 3. There is an element of interest in these contracts and
4. 4. Such arrangements come within the definition of ‘akal-mal-batil,’ e.g. unlawful acquisition.

“The report mentioned the view points of six different school of thought; Hanafites, Malikis, Shafites, Humbalies, Zaides, (i.e. the Shiites) and Zahiris on what is ‘gharar’. (The word ‘gharar’ is a derivative from the the word ‘gharar’, which means to lure; allure; entice; tempt; beguile; deceive; delude.’) According to these viewpoints a contract suffers from ‘gharar’ if it is about:

1. 1. An occurrence about which the parties do not know whether it would happen or not;
2. 2. A thing which is not within the knowledge of the parties;
3. 3. A thing whose existence or acquisition is in doubt;
4. 4. A thing about which it is not known whether it exists or does not exist;
5. 5. A thing whose acquisition is doubtful;
6. 6. A thing whose quantum is unknown.”

The Council of Islamic Ideology analyzed various forms of insurance contracts, and has ruled that gharar is present in the contract of insurance, because:

1. The parties are uncertain (apart from a life assurance policy) whether the loss contemplated under a contract of insurance would ever be payable by the insurer.
2. At the time of the inception of the insurance contract, the parties are unaware of the exact amount of compensation payable by the insurer, and the time of such payment.

Gharar also implies: uncertainty, hazard, chance or risk, such as, sale of a thing which is not present at hand; or sale of a thing whose consequences or outcome is not known; or a sale involving risk or hazard in which one does not know whether it will come to be or not, such as fish in water or a bird in air. (Glossary of Islamic financial terms. Online)

The Prophet (pbuh) decreed prohibition on transactions of “sale” involving an element of ‘gharar’. The Council of Islamic Ideology deduced that any transaction containing ‘gharar’ will be deemed to have been prohibited. Fuqaha differ regarding presence of ‘gharar’, ‘ribā’, and ‘qimar,’ in insurance contracts. Qimar and ribā are condemned in the Qur-ān while condemnation of gharar (uncertainty) is supported by the following Ahadith.

“The sale of fish which is not yet caught is not in the state of property. Likewise, the sale of fish which the vendor may have caught and afterwards thrown into a large pond, from which it cannot be taken without difficulty, is null and void because there the ‘delivery’ is doubtful.” (Hedaya page 268)

“The sale of a bird in the air, or of one, which after having been caught, is again set free, is null, because in the one case it is not ‘property’ and in the other the ‘delivery’ is doubtful. (Bukhari Vol.III, page 199, and Abu Daud Vol. II page 634)

The above and other ahadith cited by the Council of Islamic Ideology in its report are with specific reference to the transactions of sale of tangibles only where ‘delivery’ and ‘goods sold’ by the vendor to the vendee is doubtful. The elements of explicit doubt regarding the performance of such contracts make these transactions as containing gharar. And, thus, would result into controversies, casting fraudulent intentions on the part of the vendor.

The ship owner faces the risk of loss by the sea perils such as storms, collisions, drowning, grounding, pirating, high jacking, or fire, etc. A trader or manufacturer faces the risk of his merchandise fluctuating in value or being lost by fire, floods, or theft, etc. It is relevant to know the differences between insurable and uninsurable risks i.e. uncertainties. These are of two types:

1. Dynamic, speculative, or business risk is bilateral where the uncertainty is the possibility of gain or loss such as can happen in any business venture because of market fluctuations, changes in customer preferences, government regulations;  adverse economic conditions, which may result into  global economic depression,  and  insolvency of others stakeholders which causes a domino effect, etc.
2. Static or pure risk is unilateral wherein the probability is only of loss therefrom, such as,, death, personal injuries, sickness, hospitalization, partial or permanent disabilities; road or industrial accidents, fires, and thefts; forgeries, personal, professional or product liabilities; sea perils and high-jacking; tsunamis, earthquakes, windstorms, floods, water damages; kidnapping for ransom, terrorism, strikes, riots and civil commotions, etc., are forms and events involving pure or static risks.

Risk management in the insurance business deals with pure or static risk which is transferred from an individual to the insurer who charges a service fee for agreeing to accept the risk. Pure risk exists when there are no potential gains, only possibility of financial loss.

Insurers do not address dynamic or speculative risks that involve chance of loss or gain; whereas, in static or pure risk there is only the probability of loss or no loss.   The insurers accept only pure risks within theirs retaining capacity, inclusive of reinsurance treaties, to absorb the quantum of the probable loss. The risk must normally be accidental in nature, free from moral hazards, predictable, measurable, spread over a large number of similar eventualities and acceptable to the insurer.

In fiqh literature the term gharar is associated with risk and uncertainties in contractual agreements. Bay’al-gharar prohibited by the Prophet (pbuh) includes selling runaway slave and fish in the pond. [2] In shari’ah a contract becomes null and void where presence of gharar in contractual obligations is found.

Allah hath permitted trade and forbidden riba (Quran: Al-Al-Baqarahh: 275). In trading ‘al-bay’ is a contract of sale, and no sale transactions in Islam or any other religion is free from risk of market, physical or natural calamities. Taking these risk is the legitimate way of doing business which is called ghorm i.e. price and market risks, etc. A person cannot expect to make profit without assuming probability of loss or risk in his ventures.

Gharar is indeed different from ghorm, although the English translation of both has applied the same term interchangeably: risk and uncertainty. Rosly, Saiful Azhar, writes:

“Gharar or ambiguities about the buyer or the seller, the object of the sale and its price must be avoided. In fact, using the term “ambiguities” is more accurate than risk and uncertainties when one is dealing gharar in contractual agreement.” [3]

1. Insurance contract involves:

‘maisir’, or ‘qimar’ or gambling:

The Islamic Ideology Council has quoted the definition of ‘qimar’ from the book, “Al-Iqtasad ul Islam”, as that, ‘qimar is a contract under which the parties agree with each other that one of the parties would pay to other a certain sum upon the happening of a certain event.’ The Fuqaha cite the Qur-ānic verses

Scholars relying upon the above verses of the Holy Qur-ān rule that, “Any contract containing the element of ‘maisir’ would be void ab-initio.” Further, in a contract of insurance the insurer promises payment till a certain event takes place, as such, the contract contains the element of  ‘maisir’ rendering it void in Shari’ah.

The Council of Islamic Ideology defines:

“Briefly, qimar/maisir means every form of gain of money the acquisition of which depends purely on luck and chance and as opposed to others equally eligible, one man may acquire income as a result of lottery, draw or as a result purely of  any other chance. Gambling, wagering and all of the games of chance are included in ‘qimar’. [4]

Since maisir’s main effect is to get something too easily without hard labour where one wins or loses by chance alone. The adverse consequences of maisir/qimar on an individual, families and upon the nations are highlighted succinctly in the Qur-ān as: Satan’s plan is (but) To excite enmity and hatred Between you, with intoxicants And Gambling, and hinder you From the remembrance Of Allah, and from prayers: Will ye not then abstain? (5:91)

Bickelhaupt, David L., writes:

“Gambling operations may involve many of the attributes of insurance, such as large numbers, spread and homogeneity of risk, and predictability. Probably this is the reason so many uninformed persons think of insurance as gambling and sometimes even feel that they have “lost the bet” if they fail to have loss equal to the cost of insurance. The distinction is not in the method of operation, which may appear similar, but in the fact that insurance concerns itself with an existing risk. Speculation and insurance are both based upon socially and economically useful risks, too, while gambling is generally regarded as a less desirable method of speculation.” [5]

The presence of the common element of “chance “in both maisir and insurance has led many learned  fuqaha scholars to perceive that insurance in vogue tantamounts to maisir/qimar or gambling and, as such, is prohibited in Shari’ah. Resemblance between insurance and gambling in both does not cast them identical in purpose, phenomenon and consequences.  To comprehend the point of perception the Qur-ān clearly emphasizes that, “… because they say:“Trade is like usury,” but Allah hath permitted trade and forbidden usury.” (Al-Bakarah 2:275).

Colinvaux, Raoul, describing the nature of insurance contracts, writes:[6]

”Contract of insurance, like wagering contracts, are aleatory contracts “depending on an uncertain event or contingency as to both profit and loss;”  for financial or other consideration the insurer agrees to pay or otherwise benefit the assured on the happening of a specified event or contingency. ”Insurance is a contract upon speculation.”

To expunge the element of gambling or wager from insurance operations the Life assurance Act 1774, commonly called the Gambling Act, which is still in force, states in its preamble:

”Whereas it hath been found by experience, that the making insurance on lives, or other events wherein the assured shall have no Interest, hath introduced a mischievous kind of gambling. For remedy whereof, be it enacted … That from and after passing of the Act, no insurance shall be made by any person or persons, bodies politic or corporate,  on the lives of any person or persons, or any other event or events whatever, wherein the person or persons for whose use, benefit or on whose account such policy or policies shall be made, shall have no interest , or by way of gaming and wagering; and that every insurance made contrary to the true intent and meaning thereof shall be null and void to all intents and purposes whatsoever”.

The Life Assurance Act, 1774, laid down three rules as follows:

1. That no life insurance should be made unless the person effecting the assurance has an interst in the life assured; and, that any life insurance made without such interest shall be null and void.
2. That there shall be inserted in the policy the name of the person or persons interested in it.
3. That no greater sum shall be recovered than the amount or value of the interest of the assured.

The nature and extent of insurable interst has been ascertained principally from case law. An insurable interest is a right or relationship in regard to the subject matter of insurance contract of such a nature that the occurrence of the event would cause pecuniary loss to the insured from damage, loss, or destruction of the subject matter of the contact which may be a property, a life, or another interest. Without insurable interest, a contract of insurance is a wager or gambling contract and shall be null and void.

In Lucena v Craufurd, Lawrence J defined insurable interest as: [7]

“The having some relation to, or concern in, the subject of the insurance, which relation or concern, by the happening of the perils insured against may be so affected as to produce a damage, detriment or prejudice, to the person insuring and where a man is so circumstanced with respect to the matters exposed to certain risks or danger, he may be said to be ‘interested in’ the safety of the thing with respect to it as to have benefit from its existence – prejudice from its destruction.” (1806) 2 B&P 269, 301 (NR).

The concept of insurable interst has been elucidated in a recent case of “The Martin P” {Queens Bench Division (Commercial Court)  O’Kane v. Jones (The “Martin P”), 2004}. Some of the general points deduced on insurable interest in the above case are as follows: [8]

1. The concept of insurable interest was introduced as a means of distinguishing “legitimate” contracts of insurance from gaming and wagering contracts.
2. The concept had been very broadly defined “by interest in a thing every benefit and advantage arising out of or depending on such thing, may be considered as being comprehended.”
3. That which made a contract of insurance by way of gaming or wagering objectionable was that neither party thereto had, apart from the contract, any interest in the outcome of the future uncertain event, namely the possible occurrence of any of the perils insured against, upon the occurrence of which money would be payable.
4. The definition of insurable interest in section 5(23) of the Marine Insurance Act, 1906 (of UK) was not an exhaustive one.
5. However, the above section identified three characteristics which would  normally be required for insurable interest to be present, namely:

a)      That the assured may benefit by the safety or due arrival  of the insurable property or be prejudiced by its loss or damage or detention or in respect of which he may incur liability;

b)      That the assured stands in a legal or equitable relation to the adventure or to any insurable property  at risk in such adventure; and

c)      That the benefit, prejudice or incurring of liability referred to at (a) must arise in consequence of the legal or equitable relation referred to at (b)….

Some of the marked differences between insurance and gambling are as follows:

1. Risk element is of the essence of insurance contract; the insured seeks insurance cover in view of the inherent risk of loss, and does not create the risk of loss by contract itself, as is the case with wager or gambling.
2. Insurance contract aims at neutralizing and offsetting already existing risk or chances and their consequences, whereas gambling purposely create new ones.
3. In gambling one of the parties prays that a certain event may happen, while the other party wishes that the event may not happen. This is not the case in the contract of insurance. Both the parties to the contract whish that the insured event may not happen at all.
4. The parties in gambling pose a threat of loss on each other. Whereas aim of insurance contract is to save the insured from the inherent loss.
5. The parties in a contract of insurance agree to certain mutual obligations which they have to discharge. The element of carrying out of mutual obligations is not necessary in wagering..
6. The money pooled by way of contribution in the insurance operations is mostly employed for productive purposes, whereas in gambling the money generated is likely to be diverted on unethical or non-productive ventures.
7. Gambling may lead to windfalls whereas under a contract of insurance generally the insured is monetarily indemnified to the extent of the loss suffered.
8. The distinction between insurance and wagering contracts is that insurance contracts are enforceable under law while wagering contracts are not, by legal process.

1. C. It contains the element of ‘ribā’ i.e. interest.

The Council of Islamic Ideology’s report quotes, verse 279 of Al-Baqarah[9]:

For, upon a claim on an insurance policy the insured receives more than what he has paid (the premium) to the insurer, the excess amount constitutes ‘Ribā’. Usury is condemned and prohibited in the strongest possible terms. I cite below four verses 2:75-76, 3:130, 4:161 of the Holy Quran and the meaning with commentary, on ribā:

Following is the commentary on the verse 2:275 of Al-Baqarah[10]:

Usury is condemned and prohibited in the strongest possible terms. There can be no question about the prohibition. When we come to the definition of usury there is room for difference of opinion. Hadhrat ‘Umer, according to Ibn Kathir, felt some difficulty in the matter, as the Prophet (PBUH) left this world before the details of the question were settled. This was one of the three questions on which he wished he had had more light from the Prophet. Our ‘Ulmā’, ancient and modern, have worked out a great body of literature on Usury, based mainly on economic conditions as they existed at the rise of Islam”.

An apt smile: whereas legitimate trade or industry increases the prosperity and stability of men and nations, a dependence on Usury would merely encourage a race of idlers, cruel blood-suckers, and worthless fellows who do not know their own good and therefore akin to madmen.

Owing to the fact that the interest occupies a central position in modern economic life, and especially since interst is the very life blood of the existing financial institution, a number of Muslims have been inclined to interpret in a manner which is radically different from the understanding of Muslim Scholars throughout the last fourteen centuries and is also sharply in conflict with the categorical statements of the Prophet (peace be on him). According to the Islamic teachings any excess on the capital is ribā (interest). Islam accepts no distinction, in so far as prohibition is concerned, between reasonable and exorbitant rate of interest, and thus what come to be regarded as the difference between usury and interst; nor between returns on bonus for consumption and those for production purposes and so on.

1. D. ‘Akal-e-haram,’ (The mode of illegal extortion of money.)

The report states that the presence of ‘gharar’, ‘qimar’, and ‘ribā’, make the insurance contract a transaction totally void under the tenets of Sharia’h, because the money extorted by  each party, in such a contract, constitutes an illegal income.

The Ulamā refer to the verses 2:188  Al-Baqarah and 4:29 An-Nisaah of the Holy Qur-ān:[11]

The Shari’ah Scholars have recommended that since the conventional insurance business in vogue is not based on the idea of mutual cooperation but serves as a device for extortion of money from the people to utilize it in interest bearing ventures, therefore, it is forbidden. The business aims at multiplication of capital in the hands of insurance companies and, therefore, is liable to be considered as illegal in Shari’ah!  Islam cherishes equitable sharing of  risk and gains as the basis of co-operation between capital and enterprise. The Ulamā of the Islamic Ideology Council have deduced that:

The above verse (A-Nissa - 4:29), can be interpreted that taking away of each other’s wealth, property or capital by unlawful means such as interest, gambling or fraud is prohibited while deriving benefit from each other’s wealth, property or capital under an equitable business deal struck by mutual consent is permitted.

The essential element of “trading” is that the return on capital employed depends upon actual operating results of the business undertaken.”[12]

The Council’s report, Beema-wa-Qawaneen-e-Beema, page 12, recommended the following opinion about the lawful, Shari’ah compatible, form of insurance.[13]

” There is no repugnance in Shari’ah if insurance is undertaken with the sentiments of and is founded on cooperation, reciprocal responsibility, mutual surety and volition.  If, therefore, an insurance company is established in such a manner that each one of its members is insured and these insured persons enter into a mutual agreement of cooperation and reciprocal responsibility, then such agreement will be lawful in Shari’ah …”

The Council of Islamic Ideology examined the system and laws of insurance and, proposed in its Report, Beema-wa-Qawaneen-e-Beema, in 1984, to the Government that:[14]

In order to prepare an Islamic alternative, that is, ­ System of Collective Responsibility and Cooperation in place of the existing insurance system, a working group may be constituted in which Ulamā of the Council and the insurance experts may be included. They may expunge un-Islamic elements from the insurance system as per Report of the Council and bring out the alternate Islamic system.

The reader should keep his mind crystal clear that Shari’ah Scholars of all schools of thought do not condemn the theme, need, importance and viability of insurance system. They question and express their reservations to the conventional model of insurance currently in vogue.

On the need and importance of insurance the Council of Islamic Ideology says: [15]

In the early stage of the new economic system of the world, Insurance business related to a large extent to the coverage of sea-ships and their cargo. But along-with the growth of industry and trade and banking business in the Western countries the field of insurance also continued expanding in extent. Now it has come to this that sea-ships, aeroplanes, cars, factories, commercial and private buildings and besides human life, human limbs, voice, etc. are also being insured. Due to this, it has assured a regular and vast business proportion. On the strength of their capital big capitalists sell expensive policies to simple minded persons, involving real or imaginary possibilities or apprehensions. Like this, they make hundreds of million dollars annually. This capital is further invested in business and profit is reaped in astronomical figures. In other words, money-business is being indulged in , in many shapes and forms. On the one hand this giving rise to inflation, Secondly prices of commodities and services are under extraordinary pressure. Not only this but many economic evils like concentration of wealth, recessions, etc. are also coming into existence which in their own way are a big source of corruption. As, however, the individuals and nations devoid of the wealth of faith and belief have no remedy for these evils, they are treading on these paths only.

As far as developing countries and economically weak nations like Pakistan are concerned, in this matter they are absolutely helpless and are perforce the target of exploitation of the developed nations.

What is Sharia’h?

Before I elucidate further the Islamic perspective on insurance, the reader needs to apprise himself of the meaning of Shari’ah. Briefly, Shari’ah means the Islamic way of life as derived from the Qur-ān and the Sunnah (traditions) of Prophet Muhammad (pbuh). For Muslims the word of Allah is His law and command. Shariah refers to the Islamic system of law and way of life.

The traditions of the Prophet Muhammad (pbuh) being divinely inspired are not only interpretive of Qur-ānic verses but also complementary to them. I quote two ayath  4:59 , and 4:80 of An-Nisāa from the Holy Qur-ān:[16]

Thus the Qur-ān and Sunnah are the fundamental roots of Shari’ah on the basis of which fiqh was drawn by early Muslim scholars (fuqha). The two other important sources of Islamic jurisprudence are Ijma and Qiyas.

Judicial issues that cannot be resolved by qiyas are resolved through Ijma (consensus) among fuq’ah scholars.  The validity of Ijma is based upon Prophet Muhammad’s saying “My people will never agree upon an error.”

Qiyas, i.e. reasoning by analogy, defines laws from known injunction to new injunction.  For the validity of Qiyas, M. Hidayatullah, the former Chief Justice and Vice President of India, quotes Faizee and Amir Ali, when the Prophet sent Mouadh Bin Jabal as Chief Justice (and the Governor) of Yemen:[17]

“The Prophet questioned him (Mouadh) to know how he would conduct himself and this is what was said:

Prophet: On what shalt thou base thy decision?

Mouadh: On the Koran.

Prophet: If the Koran does not give guidance to the purpose?

Mouadh: Then upon the usage of the Prophet.

Prophet: But if that also fails?

Mouadh: Then I shall follow my own reason.

The Prophet (pbuh) fully approved of the replies of Mouadh and praised God that His servant was on the right path.”

The Columbia Electronic Encyclopaedia has the following entry for Shari’ah: [18]

Sharia, the religious law of Islam. As Islam makes no distinction between religion and life, Islamic law covers not only ritual but every aspect of life. The actual codification of canonic law is the result of the concurrent evolution of jurisprudence proper and the so-called science of the roots of jurisprudence (usul al-fiqh). A general agreement was reached, in the course of the formalization of Islam, as to the authority of four such roots: the Qur-ān in its legislative segments; the example of the Prophet as related in the hadith; the consensus of the Muslims (ijma), premised on a saying by Muhammad stipulating “My nation cannot agree on an error”; and reasoning by analogy (qiyas). Another important principle is ijtihad, the extension of sharia to situations neither covered by precedent nor explicable by analogy to other laws. These roots provide the means for the establishment of prescriptive codes of action and for the evaluation of individual and social behaviour. The basic scheme for all actions is a fivefold division into obligatory, meritorious, permissible, reprehensible, and forbidden….

In accordance with the recommendation of the 11^th Report, “the Council’s Working Group for Insurance,” was constituted in 1986. The Working Group comprised of the Ulmā members of the Council, Chairmen of the four Government Insurance Corporations, and the then Controller of Insurance, (late) Abdur Rahman Mohammad Khalfay, a Fellow of the Institute of Actuary.

After extensive research and review the working group of the Council held twelve sessions.  Beside the takaful modes of Malaysia, Jeddah, Manama, Sudan, and Bahrain, the mutual insurance companies working in various countries[19], particularly USA, Japan and Canada were examined in detail. The members of the working group found that all the examined takaful models are incompatible with the injunctions of Shari’ah.

The concept of cooperative risk sharing is the oldest form of insurance. The Grand Council of Islamic Scholars, Majma-al-Fiqh, Mecca, Saudi Arabia, approved Takaful model as a Shari’ah-acceptable alternative to traditional insurance system in 1985.

The working group was of the view that any insurance arrangement, which was not of the mutual type, will not be acceptable in Islam. There was also a general agreement that since the constitution of the various Islamic Insurance Companies was not based on mutual sharing of the risks and the shareholders and policy holders of the companies under review are different entities, none of these could be adopted to serve as a model for the working group.[20]

The Council of Islamic Ideology reviewed the operations of the existing takafuls in order to find a Shari’ah compatible model for Pakistan. Finally, after seven years of hard labour, the Council members unanimously approved its recommendations on 29^th April, 1992, in its report on Islami Nizam-e-Beema. The Council instead of adapting any of the examined takaful models, proposed its own structure, “the Blue Print of the Islamic Assurance System,” which formed a part of the recommendations. The recommendation of the Council was printed and presented to the government on 2^nd Zul Hijja, 1412 A.H. i.e. 4^th June, 1992.

The worthy effort of the Council to establish an Islamic country’s system of Insurance on true Islamic mode will prove to be a milestone as a fundamental document. The system of Insurance which may be set up in future on its proposed basis will be free of the elements of gharar, qimar and ribā on account of which the conventional system of insurance in vogue failed to win the confidence of the Muslim Um’mah of over one and a half billion (now, in 2009, one billion eight hundred and thirty million) who have had few options when shopping for products that conform to their faith.

The Council of Islamic Ideology in its report recommended that:

The Government may promulgate a regular detailed and codified law as the first stage towards establishment of the new institutions of Takaful. This law should have, like the companies and modarabah ordinances, from the basic and essential orders down to all necessary and sectional details as well as detailed procedures of different matters, business, investments, outlines/sketches and proformas etc; full and complete.[21]

It is interesting to note that the government did not act for thirteen (13) years on the recommendations of the Council. Insurance Reform Commission was constituted in mid 1987 under the Chairmanship of Justice (R.) M. Mahboob Ahmad. Life insurance market reopened to private local insurers through the Finance Act, of 1990, and to foreign insurers in 1994. Privatization of the State Life Insurance Corporation of Pakistan was constantly the topic of the day. Takaful companies were being established around the world in several Islamic countries. This inordinate delay on the part of the government to implement Council of Islamic Ideology’s recommendations does not seem to have any justification.

My exclusive interview in regard to Private Insurance Companies and State Life was published by the Insurance Journal, Karachi, Pakistan, in July-Aug-Sep 92. In response to one of the question in this interview I suggested a blue print and the strategy of privatization of the State Life Insurance Corporation of Pakistan (SLIC) through mutualization. I reproduced it below:

Insurance Journal: In your opinion how best can the government privatize SLIC?

Rizwan Farid:

The Paid-up Capital of State Life Insurance Corporation is only Rupees fifty-five (55) million, wholly owned by the Federal Government. The corporation has also a life fund of over Rupees twenty (20) billion which belongs to the policyholders. Every year the corporation invests substantial fund in government securities, real estate, stock and bonds and loans to the policyholders against their cash values.

In my view the government should offer its total share holding of Rs. fifty-five (55) million at a reasonable price. These shares should be bought by the corporation through its life fund as is the practice of the corporation to buy any share of an approved company. By this transaction the corporation would automatically be converted into a mutual insurance company i.e. a company wholly owned by its policy holders.

Thereafter the policy holders would elect their own Board of Directors consisting about 15 to 18 members who should first be the policy holders of the corporation and be nominated by election by the professional bodies such as Pakistan Insurance Association, Pakistan Medical Association, Pakistan Bar Council, Pakistan Chamber of Commerce and Industry, University Teachers Federation, Pakistan Engineering Council, Association body of the Chartered Accountants, Pakistan Newspapers owners Association, Federation of Working Journalist, one nominee each elected by Karachi, Lahore and Islamabad Stock Exchanges ,besides one director each elected by the Corporations officers, Area Managers, Staff and Field Workers Federations. To get the elected nominee the corporation would also have to use postal ballots

These elected directors then would select and appoint professionally qualified and experienced persons for the positions of the Chief Executive Officer, and Executive Directors for each function division of the corporation such as, Marketing, Policy Holders Services, Actuarial, Investment, Audit and Accounts, Real Estate, Group & Pension, Personnel & General Service, etc.

In the United Estate most of the mutuals started as stock companies and converted to mutual at a later date. Out of 2153 life and health insurance companies in the United Estates117 are mutual at the end of the year 1990.It would be interesting to note that the largest life and health insurance companies are mutual. Mutual insurance companies are very important in the U.S.A, although by number they are less than 6% but possess almost two third of the total assets of life insurance industry and accounts for about one half of the total amount of life and health insurance business in force in the United States. Similarly out of thirty (30) companies sixteen (16) are mutual writing life and health insurance business in Japan during the year 1990.

In 1984 out of 169 life and health insurance companies in Canada fifty (50) were mutual companies and many stock companies were seriously considering converting from stock to mutual companies.

In mutual insurance company the policy holders are owners of the company and theoretically they control the company. Each policy holder is eligible to vote in the elections of the board of directors on the basis of one vote for each policy holder regardless of the amount or number of policy that the policyholder owns. The operating profits are distributed to the policyholders. Since a mutual company has no stock to sell it cannot be bought by another company as a stock company can be. By means of mutualization the government can successfully avoid future takeovers by any interested and influential group of people.

By converting State Life Insurance Corporation into a mutual the Government would also succeed in its objective of Islamization as all Islamic schools of thought around the world have the consensus that mutual life insurance companies are permitted in Islam. In view of the above I would strongly suggest whenever the government should think to privatize SLIC, the best way would be to convert SLIC into a mutual company, and as a matter of fact it would be justice with the policyholders and good gesture on the part of the government. [22]

Insurance industry professionals were anxiously expecting some dynamic legislation on some system of insurance operations compatible with Shari’ah. Earnest and Young with a local partner was engaged to draft new insurance legislation. The Insurance Act 1938 was thoroughly reviewed. Some powerful lobbies and vested interest groups who were behind the scene influenced the consultants to delete and totally drop the theme of cooperative or mutual insurance companies, and the Policy Holders Directors on the Board elected by the life insurance policyholders of the company, in the new legislation that was introduced on August 19, 2000, namely,  “Insurance Ordinance 2000”. Thus with a single and silent stroke in drafting the new legislation regarding insurance business in Pakistan the consultants deprived the life insurance policyholders of the say in the management of the affairs of the company; and also killed the doctrine of mutual insurance entities — popular name ‘Takaful’ when operated in consonance with the established Shari’ah principles — which was strongly and unanimously recommended by the Islamic Ideology Council in its recommendations of 1992.

I earnestly request the government and the parliamentarians to make an immediate amendment in the Insurance Ordinance 2000, and to insert a specific provision for ‘mutual insurance company’ operations and appointment of Policyholders’ Directors on the Board of companies.

Takaful, Family Takaful and re-Takaful.

The conventional insurance system in vogue was declared against Shari’ah over a century ago. The search was on for an Insurance Operation Model in consonance with Islamic Shari’ah principles. Muslehuddin made a careful and in depth objective study of the emerging Islamic reservations and issues faced by the Ummah for the need and operation of the insurance industry compatible with Shari’ah. He traced the history, assessed the insurance contacts in vogue, carried exhaustive commendable research in the context of ”Insurance & Shari’ah” to qualify, in 1966, for the  Doctorate of Law, from University of London. His outstanding work and knowledge capital on the subject, “Insurance and Islamic Law,” was first published[23] in 1969.

Short of using the current insurance terminology ‘Takaful’, meaning “guaranteeing each other,” Muslehuddin used the expression “Pure mutual institutions” in the conclusion to his pioneering and exhaustive research as, “Mutual Insurance under Islamic Law,” he suggested as follows:

Pure mutual institutions accord with the spirit of Islamic law but they are criticised by some as unstable, having no reserves to stand upon. This not a serious defect as reserves may be built with the consent of the members, for the welfare of the community, in the form of a waqf (endowment). Thus, mutual associations may be formed on the principle of assessment, every member paying the agreed amount or an amount according to the value of the insured property as a first contribution, while liable to pay an additional sum (i.e., assessment), in proportion to the first contribution, in case the loss exceeds the sum-total (of the first contribution). If, according to the annual account, loss does not exceed the collected amount and there remains a surplus, a greater part of it will be returned to the member or credited to reduce his future premium, i.e. contribution (in case policy is renewed), carrying the remainder to the reserves. The reserve so built may be invested in commercial pursuits permissible in Islam…[24]

It may be recalled that life insurance provides for the payment of a stipulated amount of money upon the death of the insured, without regard to the value of his life, for it is impossible to place a monetary value on human life. The amount payable to the insured is, thus, a definite sum of money and it is the amount of contribution only which is to be determined.  This can be done by mutual agreement. And, in this regard, the procedure adopted by mutual life insurance societies may serve as a guide. [25]

These are our suggestions which may be improved upon and modified in the light of the experience.

Introduction of Television in this region in early sixties perhaps gave a boost to the debate. The Ulamā were thronged with queries to find and define a Shari’ah compatible insurance system. Sudan and Malaysia established takaful companies in 1979 and 1980 respectively by making some adjustments in the Pure mutual insurance theme and titled the Islamic Insurance configuration as takaful/solidarity.  Islamic Ideology Council of Pakistan issued its recommendations about Shari’ah compatible need of Insurance System in detail on 1^st March 1984. The Grand Counsel of Islamic Scholars in Makkah, Saudi Arabia, Majma al-Fiqh, approved the takaful system as the alternative form of insurance compatible with Islamic Shari’ah, in 1985. Thus all validating the theme, pure mutual insurance, first propagated by Muhammad Muslehuddin in 1966.

The Takaful concept is in line with the principles of compensation and shared responsibilities among the community. Muslehuddin traces the origin of insurance as follows:[26]

The insurance finds its expression in the payment of blood money by the group so as to lighten the burden of the individual member. This assumed the form of a custom to which there is a particular reference in the Hedaya, (Marghīnanānī, Vol. 4, Kitab-al-Ma’āqil, pp. ,641-50) under the title of ‘ma’aqil’.

…To explain it in more detail we give a reference from Encyclopaedia of Islam:  “ākila is the name of a man’s male relations who according to the percept of the religious law have to pay the penalty (the ‘ākl) for him, when unintentionally he has caused the death of a Moslem. This decree was based on a verdict of the Prophet. One day in quarrel between two women of the Hudhail tribe one of them, who was with child, was killed by the other with a stone, which hit her in the womb. When, soon after, the other woman also died, the Prophet decided, that her kin (ākila, or, according to a different reading, her, āsaba, i.e. i.e. agnates), in accordance with an old custom, had to pay the penalty to the relatives of the woman who had been killed.”

This reflects the original custom of the ancient Arabs whereby the whole tribe had to pay the weregild. It is this community pooling and the spirit of cooperation which has been aptly described as the essence of insurance. (Insurance, in EC (new edition), Vol. 7, p. 617.)

After a lapse of thirteen and a half years since the recommendation of the Council, the Federal Government of Pakistan ultimately issued “Takaful Rules 2005” on 3^rd September 2005, giving the country a viable compatible Islamic operational model — Takaful.

The Rules defines “Takaful operator” as a person who is permitted by the SECP to carry on the Takaful business. The role of the Takaful operator shall be the management of the ‘Participants Takaful Fund’ (PTF) and related risks. At the initial stages of the set-up of the PTF the Takaful operator and any of its shareholders may at their discretion make an initial donation or qard-e-hasna to the PTF. When the PTF including reserves are insufficient to meet their current payments less receipts, the deficit shall be funded by way of an interest-free loan (qard-e-hasna) from the Shareholders Fund (SHF).  The Takaful operator shall undertake to give qard-e-hasna to the PTF to make good of the deficit. The qard-e-hasna may be recovered from future surpluses without any excess on the actual amount given to the PTF. The objectives of the PTF shall be to provide relief to participants against defined losses as per the PTF rules and the Participants Membership Document (PMD).

The Council of Islamic Ideology in its Report emphatically stated as follows:

There was also a general agreement that since the constitution of the various Islamic Insurance Companies was not based on mutual sharing of the risks and the shareholders and policy holders of the companies under review are different entities, none of these could be adopted to serve as a model for the working group[27].

It is to be noted that the Takaful and Family Takaful structures, prescribed by the Takaful Rules, 2005, the shareholders and policy holders of the Takaful Operators ( companies) are different entities. The Insurance Ordinance, 2000, and the Takaful Rules, 2005, need to be changed.

The rhetoric of Islamic financial institutions often claims that the industry employs mutual modes wherein participants are in fact partners and/or shareholders of the corporate body. The approved models of the Takaful Operator, under the Takaful Rules 2005, the participants (policyholders) neither have the protection of being creditors of the Takaful Operator, nor do they have the protection of being equity holders with representation on the boards of directors of the Takaful Operator which by design is a commercial corporate body.

For the ready reference of readers I cite below extracts of the ruling of The Council of Leading Scholars of Saudi Arabia about two main types of insurance contracts: (1) conventional insurance in vogue which they deemed forbidden based on gharar; and (2) “cooperative insurance (al-ta’min al-ta`awuni) built on the principles of voluntary contribution (tabarru`) and mutual cooperation (ta`awun)”, which they approve permissible, since gharar does not affect non-commutative contracts:

The decision of the Council of Leading Scholars of Saudi Arabia, no. 51, dated 4/4/1397 (1976) on the permissibility of cooperative insurance and its compliance with the principles of Islamic law:[28]

All praise is for Allah only; blessings and peace be upon the prophet after whom there will be no other prophet. The Tenth Session of the Council of Leading Scholars, held in the city of Riyadh, in the month of Rabi’ al-Awwal:

The Council has taken into account the announcement made by a group of experts on cooperative insurance, which is said to be a viable alternative for Muslims wanting to avoid commercial insurance. It is also mentioned by the experts that cooperative insurance will be able to realize the objectives of Islamic law.

After the proposal was studied and researched and the opinions of the scholars sought, the Council decided, with the exception of his Excellency, Shaykh ‘Abdullah bin Manee‘, that Islamic cooperative insurance is a viable alternative to commercial insurance, as it will help to fulfill the needs of the Muslim society for the following reasons:

1. The cooperative insurance firm is founded on the concept of a transaction of voluntary contribution, which is fundamentally intended for cooperation to ameliorate risk by sharing in bearing the responsibility in case of crisis. This is accomplished by means of contributions of money that are designated for compensation to those who suffer harm.
   1. The aim of the shareholders of a cooperative insurance firm is not trade or profit from other people’s money; their goal is solely to distribute risk among themselves and to cooperate in bearing harm.
   2. Cooperative insurance does not contain elements of either type of (riba); neither the type related to barter (riba al-fadl) nor the increased return on a loan (riba al-nama). Unlike commercial insurance, it is not a contract of interest. Also, the premium/donation received will not be used for riba-based transactions.
   3. Unlike commercial insurance, whereby profit maximization is key, in cooperative insurance, the main purpose is to help each other in the spirit of solidarity; so the premium paid is considered a donation. Thus, it does not matter if the participants/donors are not sure what benefit they will get in return for their contributions, for they are giving in the spirit of donation; they are not trying to saddle someone else with responsibility for risk or harm, as is the case with commercial insurance.
   4. The cooperative insurance firm will be managed by the representatives of the donors. The representatives will act as the management team and will invest the premiums, with the goal of realizing the purpose of the corporation. In this matter, the management team can work on a voluntary basis or receive salaries, just like any other company.

With the exception of his Excellency, Shaykh ‘Abdullah bin Manee‘, the Council considers the optimum arrangement for cooperative insurance to be in the form of a mixed [i.e., private/public] cooperative insurance company, for the following reasons:

1. It is in line with Islamic economic thought, which leaves it up to individuals to undertake and manage various economic projects. The role of the government is only to compliment the efforts of individuals, intervening only when they are unable to fill a societal need, provide them with the necessary assistance, and establish guidelines to ensure the best practices and the success of the projects undertaken.
2. [A private company] is in line with the concept of cooperative insurance in that the participants are not dependent on any outside entity. They set it up, operate it and bear the responsibility for its performance.
3. It provides the opportunity for the population to get hands-on experience with the process of cooperative insurance, to undertake individual initiative and to reap the benefits of personal motivation. No doubt, the participation of members in the administration of the process will make them more vigilant and alert in avoiding risks since it is they who will collectively pay the compensation for their occurrence. This arrangement is, thus, likely to realize their best interests as it provides the motivation that optimizes the chances for the success of the cooperative insurance enterprise. That is because the avoidance of risk occurrence results in lower premiums for them in the future, just as their occurrence is likely to lead to higher future premiums.
4. 4. Structuring the enterprise as a mixed public/private corporation precludes insurance from being regarded as a grant from the government to those who benefit from it. Rather, the government shares with them to protect and support them since they are the principal beneficiaries. This leads to a more positive mindset, in that it makes the participants aware that, although the government is willing to play a supporting role, it doesn’t absolve them of their [primary] responsibility.

El-Gamal, Mahmoud A., of Rice University writes:[29]

Interestingly, while the Islamic insurance industry has adopted a name suggestive of a mutual cooperative system, takaful companies have generally been structured as for profit shareholder-owned companies, or subdivisions thereof. In other words, the corporate form of those takaful companies is identical to that of the commercial insurance companies whose contracts the Ulama forbade. Takaful companies invoke non commutativity by stipulating that the shareholders pay policyholder claims as a form of voluntary contribution (tabarru`), where the operator is usually set up in the form of silent partnership (mudaraba), with the exception of few recent attempts at using agency (wakala) – while still falling short of mutual forms. In both structures, there are unresolved fiqhi issues about bindingness of promises in such voluntary tabarru`. It would appear, thus, that in the Islamic insurance (risk intermediation) industry as well as in the Islamic banking (credit intermediation) industry, mutuality can align rhetoric with reality and resolve simultaneously a number of corporate governance, religious, and financial problems.

The element of ribā – the receiving of interest – as well as the forbidden ventures, such as gambling, dealing in alcohol, and night club activities, ambiguity or deception, etc. leaves many financial products, including conventional insurance, in opposition to Shari’ah. Thus one billion eight hundred and twenty-three million people in 2009, which number is increasing at the rate of 1.84% annually, have but few options when shopping for products that conform to their faith.

After years of efforts and representation, the provision of Policy Holders Directors in the Insurance Act, 1938, was increased from one fourth to one third through the Insurance Amendment Ordinance in 1970. Sectioin 48(1) of the Insurance Act, 1938, which was repealed on 19^th August 2000 through the promulgation of the Insurance Ordinance, 2000, stated that:

Where the insurer is a company incorporated under the Companies Act, 1913, and carries on the business of life insurance, not less than one third of the directors of the company shall not withstanding anything to the contrary in the Articles of Association of the company be elected in the prescribed manner by the holders of policies of life insurance issued by the company.

However, as I have stated earlier that local and foreign powerful lobbies and vested interest groups who were behind the scene, influenced the consultants to delete and totally drop the provision of Mutual insurance companies and the important provision of the Policyholder Directors on the Board of the company, to watch the interests of the life insurance policyholders from the new legislation, Insurance Ordinance, 2000.

To be fair with policy owners, their representatives and beneficiaries and other stakeholders, the government and the parliamentarians must make an immediate amendment in the Insurance Ordinance 2000, and insert a specific provision for ‘mutual insurance company’ operations as well as representation of not less than two-third Policyholders’ Directors on the Board of a commercial Family Takaful Operator to watch and safeguard the interests of the policyholders.

Takaful Models are based on mutual cooperation, responsibility, assurance, protection and assistance among groups of participants. Its principles are similar to those that underpin mainstream mutual insurance contracts. Besides, a Takaful product needs to strictly follow the norms of Shari’ah compatible principles. The Board of Islamic Shari’ah Scholars’ role has been specifically assigned to vet business decisions.

Each Takaful operator under Ruletion 34 (1) of the Takaful Rules 2005 is required to appoint a Shari’ah Board (SB) of not less than three members which shall be responsible for the approval of products, documentation as well as approval of all operational practices and investment of funds. The Takaful operator shall appoint only high caliber scholars who are specialized jurists in fiqh almu’amalat (Islamic commercial jurisprudence) to such Boards. In addition, they shall have knowledge of modern financial dealings and transactions.

So far, two Family Takaful Operators (life insurance companies) Pak-Qatar Family Takaful Limited, and Dawood Family Takaful Limited, launched their Family Takaful products, respectively in 2007 and 2009. Pak-Kuwait Takaful Company Limited, Pak Qatar General Takaful, and Takaful Pakistan Limited are also registered for causality insurance business.

Under the conventional structure of insurance the insured shifts the risk to the insurer, but under takaful mode by incorporating risk bearing condition the insured is also the insurer. The golden principle of ‘bear ye one another’s burdens’ applies as on the occurrence of a loss the members share the risk themselves. The participants’ (voluntary) contributions towards the pool to mitigate losses expunge the element of gharar from the contract.  Conditions of risk-bearing, indemnity in kind and shari’ah compliance investments change the character of insurance in vogue and free it from the odium of contractual riba, qimar and, to some extent, gharar.

Conventional insurance falls down because it involves the taking of a financial risk that the policyholder will make a loss if a claim does not occur. This uncertainty of happening of the insured event, which many Shari’ah scholars pronounce constitutes qimar i.e. gambling. Unlike conventional insurance, where risk is transferred from the policyholder to the insurance company, takaful mode requires all participants to share risk among them. They pay contributions for the quantum of risk as that with conventional insurance practice, and are calculated on the basis of the published morbidity and mortality tables. These tables are being developed regularly and validated for the last two hundred and thirty years to ascertain the probable number of years any man or woman of a given age and of ordinary health will live. A mortality table expresses on the basis of the group studied the probability that, of a number of persons of equal expectations of life who are living at the beginning of any year, a certain number of deaths will occur within that year[30]. These contributions are then pooled in ‘Participants Takaful Fund’ which is invested strictly in Shari’ah approved ventures, under Rule 19 of the Takaful Rules 2005.

Mortality and Morbidity Tables.

Muslehuddin raised questions in his writings, [31]

The measurement of risk becomes possible if large numbers of risks or the past occurrences are grouped together and their general average taken. In other words, the probability of many phenomena becomes predictable in groups of sufficient size. Hence large numbers and probability are said to be the basis of risk theory.  But how far does it hold good? What is the limit of the large numbers and how extensive should be the size of groups to predict the regularity and probability of the phenomena?

Mortality tables are used by insurance companies to determine the amount of contributions for mortality and other risk elements to be charged for those in the respective age groups. Basically two types of mortality tables are important for a general readers’ understanding:

1. Those based on the experience of the general population.

2. Those based on the experience of the insured lives.

Mortality Tables data base contains more than one thousand mortality, longevity, sickness, morbidity, annuitants, male or female, and other types of tables constructed and published globally for the last two centuries by insurance and other organizations and countries, such as, the USA, UK, Canada, European Countries, Australia, New Zealand,  Pakistan, India, China, Malaysia, Egypt, Indonesia, etc.

The Northhampton Table was constructed on an unsound method by Dr. Price in 1783 from the deaths in the Parish of all Saints, Northhampton, during the years 1735-1780.[32] Joshoua Milne in 1815 constructed on sound lines The Carlesli Table based on the deaths for the years 1779-1787, and two censuses taken on 1780 and 1787, of the two parishes in the City of Carlisle. Realizing the tremendous importance and benefits of such tables not only for insurance but for country’s economic planning, mortality and other tables were regularly constructed and validated from time to time in U.K. and thereafter globally.  Few random examples are tabulated for readers’ sake  as follows:

Takaful operational model:

The Family Takaful Model, prescribed by the Takaful Rules, 2005, can easily be grasped by studying the enclosed Flow Chart of the Operational Model for some important financial transactions.

The principal operational model for insurance risk management and the investment component, under Rule.8 (1) of the Takaful Rules 2005, shall be based on the Islamic concept of wakala and modarba, respectively. Accordingly, there are seven elements that must co-exist to establish a proper framework for a Takaful Operational Model:

1. 1. Takaful operator – The Rules define: “Takaful operator” as a person who is permitted by the Security Exchange Commission of Pakistan (SECP) to carry on the Takaful business. The Takaful Operator is a corporate body formed under Companies Ordinance, 1984, and which is eligible to transact insurance business in Pakistan under Section 5 of the Insurance Ordinance 2000. Further, it has also been granted, under Section 6 of the Insurance Ordinance 2000, a certificate of registration by the    SECP to carry on insurance business in Pakistan.

2. 2. The Shari’ah Board - Each Takaful operator shall appoint a Shariah Board (SB) of not less than three members, under Rule. 34(1) of the Takaful Rules 2005, which shall be responsible for the approval of products, documentation as well as approval of all operational practices and investment of funds
3. Management of the Takaful Fund – Management is by the Takaful Operator who, depending on the adopted model, utilizes either of the two Shari’ah compliance contracts, namely wakala or mudaraba or a combination of both. The Investment of participants’ contributions within the Participants Takaful Fund (PTF) as well as in the Participants Investment Fund (PIF) shall be managed under a Wakala contract, a Mudarabah contract or a combination contract as determined to be sound and workable by the Shari’ah Board of the Takaful operator. The Takaful operator shall set the fee structure and the profit sharing ratio on the investment management based on the advice of the Shari’ah Board and the Appointed Actuary, if any.
4. Mutual Guarantee – The basic objective of Takaful is to pay a defined loss from a defined fund. The loss is borne by a fund, PTF, created by the contributions (premium) of policyholders. The liability is spread amongst the policyholders and all losses divided among them. In effect, the policyholders are both the insurer and the insured. Rule 9(1) states that at the initial stages of the set-up of the PTF the Takaful operator and any of its shareholders may at their discretion make an initial donation or qard-e-hasana to the PTF. The objective of the PTF shall be to provide relief to the participants against defined losses as per PTF rules and the Participants Membership Document. Under Rule. 9(3) (g) any donation made by the shareholders shall be the income of the PTF.
5. Elimination of Uncertainty – Contributions to the PTF are for the purpose of pooling of the risks amongst participants to provide relief to them against defined losses as per PTF rules and PMD. As such, participants (policyholders) are the owners of the fund and entitled to its surplus (profits), if any.
6. Investment Conditions: – Rule 8(4) of the Takaful Rules 2005 prescribes ….Investment of funds may be made in consonance with the Islamic concept of the mudaraba, wakala or a combination of mudaraba and wakala at the option of the Takaful operator (or its Appointed Actuary in case of Family Takaful) and the Shari’ah Board as clearly spelled out in the participants’ membership documents (PMD).

Rule27(3)(c) of the Takaful Rules 2005 states that … investments in non-Shari’ah compliance preferred stocks, debentures and interest based redeemable capital securities are not allowed. Further , by  Rule 27(3) (c) (i): It is not permissible to acquire the shares, debentures or certificates of the companies providing financial services like conventional banks or the companies involved in business prohibited by Shari’ah like alcohol production, gambling or night club activities, etc.

1. Integration of Shari’ah principles — In particular, , avoidance of ribā, gambling, and al Gharar, and inclusion of the al Mudharabah (profit sharing arrangements) and/or  Wakalah (Agency) principles for management practices.

Ownership of Funds and participation in the Management - The Federal Government’s prescribed structure, under the Takaful Rules 2005, is not at all based on cooperative or mutual modes as strongly recommended by the Council of Islamic Ideology and Saudi Arabia’s Majlis-e-Hayat-i-Kibar-ul-Ulamā (The Constituent Assembly of Most Eminent Religious Scholars). Further, there is no provision for the participants in the management or affairs of the Takaful operator (corporate body) by its policyholders. Instead of implied ownership, the Takaful Rules, 2005, should clearly spell out that the Participants Takaful Fund, Participants Investment Fund and all types of Reserves generated through these funds are wholly and solely owned by the participants.

Ayub, Muhammad, the State Bank of Pakistan’s former Senior Joint Director of Islamic Banking Department, has traced various Takaful operator structures in vogue in various countries as follows: [33]

Al-takaful is the pact among a group of people, called participants, reciprocally guaranteeing each other; while Al-mudharabah is the commercial profit-sharing contract between the provider or providers of funds for a business venture and the entrepreneur who actually conducts the business. The operation of takaful may thus be envisaged as the profit-sharing business venture between the takaful operator and the individual members of a group of participants who desire to reciprocally guarantee each other against a certain loss or damage that may be inflicted upon any one of them.

Based on the nature of relationship between the company and the participants, there are various models like Wakalah (agency) Model, Mudarabah Model and the combination of agency and Mudarabah models. In the Sudanese Takaful Model that is preferable to majority of the contemporary Shariah experts, every policyholder is also the shareholder of the Takaful Company. There is a Board that runs the business on behalf of all the participants and there is no separate entity managing the business. The legal framework in other Islamic countries normally does not allow this arrangement and Takaful companies work as separate entities on the basis of Mudarabah (as in Malaysia) and on the basis of Wakalah (as in the Middle East region). In Mudarabah model that is practised mainly in the Asia Pacific region, the policyholders get profit on their part of funds only if Takaful Company earns profit. The sharing basis is determined in advance and is a function of the developmental stage and earnings of the Company. The Shariah committee approves the sharing ratio for each year in advance. Most of the expenses are charged to the shareholders.

In Wakalah Model, the surplus of policyholders’ funds investments – net of the

management fee or expenses – goes to the policyholders. The shareholders charge

Wakalah fee from contributions that covers most of the expenses of business. The losses, if any, are first absorbed by reserves known as Participants Equity, then from interest free loans from shareholders of Takaful Company and then by a general increase in pricing by the Company.Rate is fixed annually in advance in consultation with Shariah committee of the company. In order to give incentive for good governance, management fee is related to the level of performance.

Ernst & Young’s inaugural World Takaful Report 2008, launched at the Annual World Takaful Conference 2008, shows that 59 of the 133 Takaful operators worldwide are within the GCC countries of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates.

[2] Rahim, Abdur, Muhammadan Jurisprudence, p.291.

[3] Rosly, Saiful Azhar, Critical Issues on Islamic Banking and Financial Markets, Published by Author House 03/15/05, p. 75.

[4] Report on Islamic Insurance System,  June 4, 1992, p.59.

[5] Bickelhaupt, David L. General Insurance, 10^th Ed. Published by Richard D. Irwin, Inc. (1979)  p.11.

[6] Colinvaux, Raoul, The Law of Insurance,  4^th Ed. (1979) p. 3.

[7] Murthy, K.S.N., Modern Law of Insurance, 4^th Ed. Butterworths, p.61.

[8] Principles of Insurance Law, 8^th Ed. Edited by Justice Misra, Ranganath. Publisher: Wadhwa and Co. India, (2006) pp. 24-25

[9] The Holy Qur-ān, English translation of the meanings and Commentary.

[10] The Holy Qur-an, English translation of the meanings and Commentary. P. 126.

[11]The Holy Qur-ān, English translation of the meanings and Commentary.

[12] Elimination of Ribā from the Economy & Islamic modes of Finance, 2^nd Revised. Ed. Council of Islamic Ideology, Government of Pakistan, p. 11.

[13] Report on Islamic Insurance System, June 4, 1992, p. 23.

[14] op. cit,. pp. 14-15.

[15] Ibid.,  p. 14.

[16] The Holy Qur-an, English Translation of the Meanings and Commentary.

[17] Mulla’s Principles of Mahomedan Law, 19^th Ed. 14^th Reprint (2006) p. xxiv.

[18] The Columbia Electronic Encyclopedia®  Columbia University Press (2007). Visited on 29 January 2010.

[19] Report on Islamic Insurance System, June 4, 1992, p. 32.

[20] Ibid, p. 44.

[21] Op.cit., p. 80.

[22] Insurance Journal, Karachi, Pakistan,  July-Aug-Sep 92, pp 8-9.

[23] Muslehuddin, Mohammad, Insurance and Islamic Law, 2^nd Ed. (1976) pp.5-6.

[24] Ibid., pp. 189-90.

[25] ibid.,  p. 191.

[26] Op. cit.,  pp. 13-14.

[27] Report on Islamic Insurance System, op.cit., p. 44.

[28] ISRA © 2008 | Website Disclaimer

[29] A Simple Fiqh-and-Economic Rationale for Mutualization in Islamic Financial Intermediation, (June 2006). Online..

[30] Online: The Free Dictionary

[31] Muslehuddin, Mohammad, Insurance and Islamic Law, 2^nd Ed. Islamic Publications Ltd. (1976)  pp. 5-6.

[32] Sir Willium Elderton et. all, The construction of Mortality and Sickness Tables, 5^th Ed. (1959, p. 110 .

[33] An Introduction to Takaful — An Alternative to Insurance, Muhammad Ayub, (Online)