Takaful: An Alternative

Approach to Insurance
APRIL | 2024
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Takaful: An Alternative Approach to

Insurance

AUTHORS Shariq Sikander, FSA, CERA SPONSOR General Insurance Research Committee

Caveat and Disclaimer

The opinions expressed and conclusions reached by the authors are their own and do not represent any official position or opinion of the Society of
Actuaries Research Institute, the Society of Actuaries or its members. The Society of Actuaries Research Institute makes no representation or warranty to
the accuracy of the information.

Copyright © 2024 by the Society of Actuaries Research Institute. All rights reserved.

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Table of Contents
Overview................................................................................................................................................................................. 5
Section 1: Understanding Takaful ............................................................................................................................................ 7

1.1 WHAT IS TAKAFUL ........................................................................................................................................7

1.2 HISTORICAL PERSPECTIVE ............................................................................................................................7
1.3 KEY PRINCIPLES OF TAKAFUL .......................................................................................................................8
1.3.1 MUTUAL ASSISTANCE (TABARRU) ................................................................................................................8
1.3.2 SHARED RISK (MUDARABAH) ........................................................................................................................8
1.3.3 PROHIBITION OF INTEREST (RIBA) ................................................................................................................8
1.3.4 NO UNCERTAINTY (GHARAR) ........................................................................................................................9
1.3.5 AVOIDANCE OF SPECULATION (MAYSIR) ......................................................................................................9
1.4 COMPARISON BETWEEN TAKAFUL AND CONVENTIONAL INSURANCE .......................................................9
1.5 TAKAFUL VS. MUTUAL ................................................................................................................................11
1.6 IS TAKAFUL A MUTUAL? .............................................................................................................................11
1.7 GENERAL TAKAFUL .....................................................................................................................................12
1.7.1 EXAMPLES OF PRODUCTS UNDER GENERAL TAKAFUL ...............................................................................13
1.8 FAMILY TAKAFUL ........................................................................................................................................14
1.8.1 EXAMPLES OF PRODUCTS UNDER FAMILY TAKAFUL ..................................................................................14
Section 2: Benefits of Takaful .................................................................................................................................................16

2.1 MORAL AND SHARI’AH COMPLIANCE ........................................................................................................16

2.2 SHARED RESPONSIBILITY ............................................................................................................................16
2.3 BROAD ACCEPTANCE OF TAKAFUL .............................................................................................................16
2.4 EXCESS SHARING ........................................................................................................................................16
2.5 TRANSPARENCY AND FAIRNESS .................................................................................................................16
2.6 CUSTOMIZATION AND FLEXIBILITY ............................................................................................................16
2.7 STABLE REGULATORY ENVIRONMENT .......................................................................................................16
2.8 SOCIAL WELFARE AND CORPORATE SOCIAL RESPONSIBILITY ....................................................................16
Section 3: Takaful Framework ................................................................................................................................................17

3.1 ESTABLISHMENT OF TAKAFUL FRAMEWORK .............................................................................................17

3.1.1 REGULATORY FRAMEWORK FOR TAKAFUL .................................................................................................17
3.1.2 OPERATIONAL FRAMEWORK ......................................................................................................................20
3.1.3 TAKAFUL FRAMEWORK ..............................................................................................................................21
3.2 TAKAFUL FUNDS .........................................................................................................................................21
3.2.1 ESTABLISHMENT OF TAKAFUL FUNDS ........................................................................................................21
3.2.2 PARTICIPANTS’ TAKAFUL FUND ..................................................................................................................21
3.2.3 PARTICIPANTS’ INVESTMENT FUND ...........................................................................................................22
3.2.4 SHAREHOLDERS’ FUND ...............................................................................................................................22
3.3 INVESTMENT MANAGEMENT UNDER THE TAKAFUL FRAMEWORK ..........................................................22
3.3.1 INVESTMENT CONSIDERATIONS FOR TAKAFUL ..........................................................................................22

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3.3.2 INVESTMENT STRATEGY .............................................................................................................................23

3.3.3 MANAGEMENT OF PARTICIPANTS' SURPLUS ..............................................................................................23
3.3.4 CONSOLIDATION OF PARTICIPANTS’ FUNDS ..............................................................................................23
3.3.5 SHARI’AH-COMPLIANT INVESTMENTS ........................................................................................................24
3.3.6 ROLES AND RESPONSIBILITIES OF THE INVESTMENT COMMITTEE .............................................................25
3.4 RESPONSIBILITIES OF THE SHAREHOLDERS ................................................................................................25
Section 4: Takaful Models ......................................................................................................................................................27

4.1 HYBRID (WAKALA & MUDARABAH) MODEL ..............................................................................................27

4.2 WAKALA MODEL ........................................................................................................................................28
4.3 COOPERATIVE MODEL ................................................................................................................................29
4.4 TAKAFUL-SPECIFIC TRANSACTIONS ............................................................................................................30
4.5 TAKAFUL MODELS IMPLEMENTED GLOBALLY............................................................................................30
4.6 ILLUSTRATIVE PROFIT & LOSS STATEMENTS UNDER VARIOUS TAKAFUL MODELS ...................................31
4.7 COMPARISON – ILLUSTRATIVE EXAMPLES .................................................................................................41
4.8 ACTUARIAL CONSIDERATIONS ...................................................................................................................43
Section 5: Retakaful ...............................................................................................................................................................46

5.1 THE NEED FOR RETAKAFUL ........................................................................................................................47

5.2 RETAKAFUL WINDOW ................................................................................................................................47
5.3 RETAKAFUL COMPANIES ............................................................................................................................47
Section 6: Rationalizing Takaful’s Global Adoption .................................................................................................................49

6.1 UNTAPPED MUSLIM POPULATION .............................................................................................................49

6.2 INCLUSIVITY AND SOCIAL SOLIDARITY .......................................................................................................50
6.3 DIVERSIFIED INVESTMENT PORTFOLIOS WITH ETHICAL ASSETS................................................................50
6.4 CROSS-CULTURAL UNDERSTANDING AND COLLABORATION ....................................................................50
6.5 RISK-SHARING AND FAIRNESS ....................................................................................................................51
6.6 REGULATION AND CONSUMER PROTECTION ............................................................................................51
Section 7: Shari’ah Supervisory Board ....................................................................................................................................52

7.1 ROLES AND RESPONSIBILITIES OF THE SHARI’AH SUPERVISORY BOARD ...................................................52

7.2 SSB AND CORPORATE GOVERNANCE ISSUES .............................................................................................52
7.3 ENHANCING SSB PROFICIENCY AND SHARI’AH COMPLIANCE ...................................................................53
Section 8: Global Expansion and Barriers: Takaful Growth in Key Markets and Challenges Ahead ..........................................55

8.1 TAKAFUL IN SELECT GCC AND ASIAN COUNTRIES ......................................................................................55

8.2 IMPEDIMENTS TO TAKAFUL PENETRATION ...............................................................................................60
8.2.1 LACK OF KNOWLEDGE AND COMPREHENSION OF TAKAFUL .....................................................................60
8.2.2 REGULATORY CHALLENGES AND LACK OF STANDARDIZATION ..................................................................60
8.2.3 CHALLENGES FROM CULTURAL AND REGIONAL DISCREPANCIES ...............................................................60
8.2.4 THE LACK OF SHARI’AH EXPERTS WITH THE NECESSARY QUALIFICATIONS ................................................60
8.2.5 WAKALA LEVIES AND COST OF CAPITAL .....................................................................................................61
8.2.7 CHALLENGES IN RISK ACCEPTANCE ............................................................................................................61
8.2.8 LACK OF PERMITTED INVESTMENT AVENUES ............................................................................................61
Section 9: The Solution - Window Takaful...............................................................................................................................62

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Acknowledgments ..................................................................................................................................................................64
Appendix A: Definitions and Acronyms...................................................................................................................................65
References .............................................................................................................................................................................68
About The Society of Actuaries Research Institute ..................................................................................................................71

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Takaful: An Alternative Approach to

Insurance

Overview
Takaful came into existence in the backdrop of an increased demand for a financial system that brings the concept
of insurance in line with Islamic values and the fundamental principles of Islamic finance. Many individuals,
particularly in Muslim majority countries like Pakistan, Malaysia, Bahrain, the Kingdom of Saudi Arabia, and the
United Arab Emirates, face limited acceptability to formal insurance due to concerns around Riba (interest), Gharar
(uncertainty and ambiguity in contracts), Maysir (speculative risk), and other factors.

Takaful insurance emerged as a key component of Shari’ah-compliant financial services that aims to cater to
individual’s insurance needs, while also conforming to Islamic beliefs and norms. Since the establishment of the
first Shari’ah-compliant insurer in Sudan in 1979, Takaful has been operating on a cooperative model much like
mutual insurance, but the similarities between the two financial systems are only on the surface. A deeper analysis
reveals differences in the two models that set Takaful apart from other conventional forms of insurance in terms of
risk sharing and fairness. The very essence of the Islamic form of insurance is the participation of members in the
contribution of funds into a common pool, where resources are collectively available to support members facing
specified adverse events or losses.

This paper aims to analyze Takaful as an ethical form of insurance, its brief history, challenges, comparison of the
financial reporting framework under conventional insurance with various Islamic insurance models, and the
potential growth in the regions it’s currently operating in, while highlighting the growth potential in the
international markets as an ethical game-changer in the insurance industry.

The paper also analyzes the issues within the Takaful framework that makes standardization the biggest challenge
in its widespread implementation, exploring the regulatory frameworks in countries like the Kingdom of Saudi
Arabia (KSA), the United Arab Emirates (UAE), Bahrain, Pakistan, and Malaysia, highlighting the role of the
Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in standardization, and delving into
actuarial considerations in Takaful, including assumption setting and product pricing/reserving.

In addition, the paper aims to analyze the impact of Takaful on society, including its contributions to financial
stability, risk mitigation, and the empowerment of individuals and businesses. Despite the complications in
implementation, policymakers recognize the potential of Takaful in promoting financial inclusion. This multifaceted
analysis aims to bridge the gap between conventional insurance and Takaful, providing insights for Western
markets to efficiently adopt the Takaful framework to compete against their conventional counterparts.

Most importantly, the paper also proposes a viable solution for markets where the Takaful framework is not
regulated, enabling conventional insurers to offer Takaful products and addressing operational aspects.

The Takaful business is set for significant development and growth between 2023 and 2028. It brings a significant
and ethical shift in insurance, aligning with Shari’ah principles and emphasizing community welfare. Takaful's focus
on ethical practices ensures fair insurance choices. This innovative approach promises a financially secure and
compassionate future for everyone involved.

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Section 1: Understanding Takaful

1.1 WHAT IS TAKAFUL

Takaful finds its roots in the provisions of the Holy Quran (5:2), “Cooperate with one another in goodness and
righteousness" that, in essence, represents an innovative and alternative approach to insurance, with the
emphasis on shared accountability and mutual support that is reflected and deeply rooted in Islamic finance
principles. Derived from the Arabic word "Kafalah," which signifies mutual guarantee or joint responsibility or
benefit, Takaful can best be explained as a group of contributing participants entering into an agreement to pool
investments and mutually guaranteeing each other in the event of a loss.

Tabbaru (contribution) and Ta'awun (cooperation) are the fundamentals of Takaful on which the whole framework
has been established, thereby upholding the values of cooperation, solidarity, and social responsibility that are
deep-rooted in the Islamic injunctions pertaining to financial matters (Zulkifli et al., 2012). In contrast to
conventional insurance, which may involve practices that conflict with Islamic principles, Takaful aligns insurance
operations with Shari’ah-compliant guidelines, emphasizing fairness, transparency, and inclusivity.

To put it simply, Takaful is a system of mutual cooperation amongst policyholders whereby they reimburse each
other in the event of a loss out of the contribution pool or fund to which they have agreed to contribute a regular
amount, managed by a Takaful operator (Omar and Dawood, 2000).

The Central Bank of Bahrain (CBB) defines Takaful as,

“The concept of Takaful involves the payment of contributions that are wholly or partially donated to form an
insurance portfolio. The pooled resources are then used to pay indemnity when the insured risk occurs. The
pooling of donations and assisting those in need through indemnity payments does not contradict Sharia, but is in
line with the principles of compensation and shared responsibilities among the community.”

While the Security and Exchange Commission of Pakistan (SECP) defines it as,

“Takaful is an Islamic insurance concept which is grounded in Islamic Mua’malat (banking transactions), observing
the rules and regulations of Islamic law. Takaful is basically a system of Islamic insurance based on the principle of
Ta’awun (mutual assistance) and Tabarru (voluntary contribution), where the risk is shared collectively by the
group. It is operated based on shared responsibility, brotherhood, solidarity and mutual cooperation or assistance,
which provides for mutual financial security to safeguard participants against a defined risk.”

1.2 HISTORICAL PERSPECTIVE

Takaful finds its origins in the early Islamic era in 622 when Muslims of Makkah and Madina established the
practice of shared responsibility and mutual assistance to indemnify the members of any loss. This method of
insurance came into practice in various forms in the backdrop of a growing need to be insured against the losses
one bears in the case of a major financial setback, but conventional methods of insurance were disallowed by the
people of faith due to Al-Gharar (uncertainty), Al-Maysir (Gambling), and Riba (Interest) (Al-Amri & Hossain, 2015).

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For many years since the practice began in the early Islamic era, members of the Muslim community came
together to support one another during times of crisis and loss, forming the foundation of mutual assistance,
shared responsibility, and cooperation. The concept, over time, evolved into a formalized Takaful model, deep-
rooted in the core Islamic values of equity and brotherhood. The idea of Gharar stresses the aversion of
uncertainty in monetary exchanges, while Maysir puts any type of betting or gambling down. Riba strictly goes
against the acquiring of interest from monetary exchanges. Considering these standards, the Muslim people
looked for a way to defend against gambling that would be in accordance with their strict convictions. The early act
of Takaful involved individuals from the community pooling their resources to establish a fund aimed at providing
financial assistance to those encountering crises. This practice of mutual aid extended beyond immediate family
units, cultivating a feeling of common obligation and brotherhood.

Over time, this casual arrangement of shared responsibility developed into a formalized framework maintaining
the possibility that policyholders or participants collectively bear the weight of risks perceived by each individual.
The commitments made by individuals are diverted into a typical asset. This asset is then used to give monetary
help to those individuals who experience unexpected conditions. Any excess produced from the commitments is
shared among the members, ensuring fairness in the framework.

1.3 KEY PRINCIPLES OF TAKAFUL

Structured on the fundamental principles of cooperation, mutual protection, and shared responsibility, a Takaful
agreement must eliminate actions of interest (Riba), gambling (Maysir), and uncertainty (Gharar), in line with
Islamic values. Each rule reflects the Islamic values of collaboration, decency, and shared responsibility, while being
in accordance with the forbiddance of interest and speculative practices. The key principles outlined below help us
understand the Takaful framework and its essential traits.

1.3.1 MUTUAL ASSISTANCE (TABARRU)

One of the most rudimentary principles of Takaful is the concept of “Tabarru”, where participants willingly
contribute a portion of their premiums into a common pool. This pool serves as a fund to help those who
experience losses or face unexpected circumstances, adhering to the Islamic principle of aiding one another during
times of difficulty. (Adawiyah and Scott, 2008)

1.3.2 SHARED RISK (MUDARABAH)

Takaful operates on the principles of Mudarabah, establishing a partnership between the participants and the
Takaful operator. Participants contribute to the pool with their premiums, while the Takaful operator manages the
fund. Any surplus coming out from the pool is equally given back to the participants in the form of surplus sharing,
promoting a sense of equity and partnership.

1.3.3 PROHIBITION OF INTEREST (RIBA)

Islamic finance imposes strict prohibition on the payment or acceptance of interest (Riba). This prohibition extends
to contributions and distributions within Takaful, ensuring compliance with Shari’ah principles. Transactions in
Takaful are structured to be free from any interest-based elements, maintaining compliance with Islamic finance
guidelines that prioritize fairness and ethical financial practices.

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1.3.4 NO UNCERTAINTY (GHARAR)

Takaful contracts avoid elements of uncertainty and gambling, ensuring that the risks covered are well-defined and
explicitly understood by all parties involved.

1.3.5 AVOIDANCE OF SPECULATION (MAYSIR)

Maysir, or speculative practices, are discouraged in Takaful arrangements to ensure that operations are conducted
on principles of certainty, transparency, and ethical conduct.

1.4 COMPARISON BETWEEN TAKAFUL AND CONVENTIONAL INSURANCE

A careful study of Takaful and conventional insurance models would reveal various conceptual similarities between
the two frameworks. However, the most important and fundamental difference between the two lies in the profit
and loss sharing system and the complete eradication of interest from the equation. Another key difference is that
Takaful framework cannot be completed without the establishment of a Shari’ah Supervisory Board whose primary
responsibility and function is to determine whether a financial transaction or an insurance product is in its very
essence compliant to the Shari’ah rules pertaining to Islamic finance. More on this is discussed later in the paper.

Some of the most important and significant differences between Takaful and conventional insurance are discussed
below:

Table 1
COMPARISON BETWEEN TAKAFUL AND CONVENTIONAL INSURANCE

TAKAFUL CONVENTIONAL INSURANCE

Based on mutual cooperation. Based entirely on commercial factors.
Devoid of interest (Riba), gambling (Maysir), and uncertainty
Necessary elements of interest, gambling, and uncertainty.
(Gharar).
Participants’ contributions to the Takaful fund, whether in full or Insurance company retains the premium paid by the
part, helps others in the event of a loss or risk. policyholder in exchange for bearing all expected risks.
Subject to the rules, regulations, and governing laws of the Subject to the rules, regulations, and governing laws of the
region, as well as a Shari’ah Supervisory Board. region.
There is segregation between the Participants’ Takaful Fund and Premium paid by the policyholder is considered as income to
the Shareholders' Fund. the company, belonging to the shareholders.
Surplus in the Participants’ Takaful Fund is shared among
Participants only, and the returns on investment are distributed
All surpluses and profits go directly to the shareholders.
between the participants and the shareholders based on the
principles of Mudarabah.
In the event of a deficit within the Participants’ Takaful Fund,
In case of deficit, the conventional insurance company covers
Takaful Operator provides for an interest free loan (Qard-e-
the risks.
Hasn) to the participants.
Investment activities carried out by the Takaful Operator are Investment activities carried out by the conventional insurers
Shari’ah compliant. may not be Shari’ah compliant.
For reinsurance, Takaful operators go to the Retakaful
Conventional insurance companies do not have the obligation
companies or conventional reinsurers that abide by certain rules
to have reinsurance with Shari’ah compliant reinsurers.
of Shari’ah or offer Retakaful through windows.

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Figure 1
CONCEPTUAL UNDERSTANDING OF TAKAFUL BUSINESS

The following table illustrates the terminological differences between Takaful and conventional insurance. These
terminological variances highlight Takaful's distinct principles and structures, which differ from the conventional
insurance framework.

Table 2
TERMINOLOGICAL DIFFERENCES BETWEEN TAKAFUL AND CONVENTIONAL INSURANCE

CONVENTIONAL TAKAFUL

Policyholder Participant

Premium Contribution

Reinsurance Retakaful

Claims Benefits

Moreover, it's worth highlighting that the Wakala Fee, Mudarib Share, and Qard-e-Hasn are Takaful-specific
concepts that do not exist under conventional insurance. The later sections of this paper provide details
surrounding Takaful-specific concepts, as well as an illustration of financial reporting under various Takaful models.

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1.5 TAKAFUL VS. MUTUAL

At first glance, Takaful and mutual seem to operate in a similar way. However, a closer examination of both
frameworks reveals notable differences between the two.

In mutual, members are responsible for indemnifying other members in the event of a deficit whereas, in Takaful,
the shareholders provide an interest-free loan (or Qard-e-Hasn) to cover the loss, which is later recovered from
future surpluses.

Another distinction is capital provision: members contribute capital in mutuals while, in Takaful, the operator
supplies it. Additionally, Takaful investments strictly adhere to Shari’ah principles, ensuring compliance with
Islamic ethical guidelines.

Moreover, a critical divergence is the presence of a Shari’ah Supervisory Board (SSB) within Takaful operations.
This board validates, oversees, and advises on the Shari’ah compliance of products and services, a feature absent
in mutual insurance.

1.6 IS TAKAFUL A MUTUAL?

Mutual and Takaful are cooperative insurance programs with a similar core concept: sharing assets and risks
among the members/participants to ensure financial security. However, their underlying ideologies, organizational
structures, and ethical standards differ significantly.

Takaful is based on the tenets of solidarity, mutual cooperation, and shared responsibility, rooted in Shari’ah
(Islamic law) which forbids interest, speculation, and uncertainty. In a Takaful arrangement, participants contribute
to a pooled fund (the Takaful fund) to cover specific risks.

Qualified participants can seek compensation from the Takaful fund in case of a loss. Any surplus in the fund may
be distributed among participants as dividends or allocated to charitable organizations.

Takaful operators prioritize ethical investment practices investing in Shari’ah-compliant assets. In contrast, mutual
insurance operates as a cooperative approach based on mutuality. Policyholders and the insurance company
owners collectively bear the risks. Premium payments from policyholders contribute to a common fund, which is
used to settle claims. Instead of distributing profits to external shareholders, mutual insurers return gains to
policyholders through dividends or reduced premium rates.

Unlike Takaful, mutual insurance, utilized by various organizations worldwide, religious and non-religious alike,
does not consistently adhere to specific religious or ethical principles.

The moral and religious adherence is the main distinction between Takaful and mutual insurance. Takaful strictly
abides by Islamic law, ensuring all investments and transactions comply with Shari’ah rules. To the contrary,
mutual insurance may or may not adhere to religious principles, and its ethical standards can vary based on
individual insurers' values.

Another key difference lies in organizational structure. Mutual insurance operates on mutuality, with policyholders
acting as owners, while Takaful operates as a cooperative based on the concepts of "Tabarru" (contribution) and
"Mudarabah" (profit-sharing).

In summary, both mutual insurance and Takaful embrace cooperative models, yet substantial differences exist in
their guiding ideologies, organizational structures, and ethical considerations.

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Table 3
DIFFERENCES BETWEEN TAKAFUL AND MUTUAL

TAKAFUL MUTUAL

Islamic Principles: Takaful is governed by Shari’ah law and is

founded on Islamic principles. It abides by moral and ethical Non-Religious: Mutual insurance operates independently
standards, refraining from interest-based transactions and of religious ties or stipulations, unrestricted by any specific
investing in ventures that engage in forbidden activities like religious doctrines.
gambling and/or the sale of alcohol.

Risk-Sharing Principles: Participants under a Takaful

framework are expected to share risks and work together Transfer of Risk: Mutual insurance entails risk transfer,
cooperatively. To assist one another in times of need, whereby policyholders pay premiums in exchange for the
participants make contributions to a communal pool insurer taking on all associated risks. Transferring risk from
(Tabarru). The main goal is to protect and support one individuals to the insurance firm is the main goal.
another financially.

Distribution of Surplus: Any surplus that remains after claims

Policyholder gains: In mutual insurance, policyholders are
and operating costs have been paid is divided among
regarded as corporate shareholders. Insurance company
participants in accordance with predetermined rules. This
profits are given to policyholders in the form of dividends
surplus sharing demonstrates the idea of shared advantages
or lower premium rates.
and strengthens the cooperative aspect of Takaful.

Ethical Investments: Takaful investments follow Shari’ah Investment Scheme: Mutual insurance companies place
guidelines and concentrate on morally upright and Shari’ah- their money in a variety of financial products and
compliant assets. The investments stay away from interest- industries according to the knowledge of their fund
bearing products and industries that go against Islamic managers. Their financial choices are not constrained by
principles. any ethical principles.

In conclusion, the comparison between Takaful and mutual insurance reveals their distinct operational norms and
fundamental governing principles. Takaful is purposefully crafted to align with Islamic principles, emphasizing
ethical financial planning, risk-sharing, and surplus distribution among members. To the contrary, mutual insurance
operates with a strong emphasis on the connection between its members. It follows a model where profits earned
are shared among members or used to reduce premium rates when needed.

Ultimately, the choice between these two security models hinges on personal convictions, individual values, and
the preferred approach to managing risk and finances.

1.7 GENERAL TAKAFUL

General Takaful refers to insurance protection designed to cover losses or damages to properties, assets, or
possessions resulting from specified events, typically lasting a year or less. Participants in Takaful contracts

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contribute to a fund, and operators manage risks. The contributions form the General Takaful fund, which is invested,
and profits are returned to the fund. Two primary types of General Takaful are motor and non-motor.

Motor Takaful covers accidents or damages to personal vehicles. Participants pay premiums for the contract
duration, usually a year. Non-motor Takaful includes various schemes like fire, marine cargo, personal accident,
burglary, and machinery failure insurance.

Contributions made, termed as “tabarru,” go into the risk fund to cover participants' potential losses within the
specified period. This fund invests in Shari’ah-compliant products, with returns added to it. Surpluses, after settling
claims and deducting direct charges (such as Wakala fees), are distributed to participants. If costs exceed the fund,
a Qard-e-Hasn (interest-free loan) from the shareholders' fund may be used to cover the shortfall.

1.7.1 EXAMPLES OF PRODUCTS UNDER GENERAL TAKAFUL

● Property Takaful: Protects against damages due to fire, lightning, and explosions, including buildings,
inventory, and machinery.
● Marine Takaful: Offers compensation for losses or damages to cargo transported via ships, planes, or roads.
● Motor Takaful: Ensures coverage for vehicle damages resulting from accidents.
● Miscellaneous General Takaful: Tailored coverage designed to meet diverse corporate needs.

Figure 2
THE FUND TRANSFER PROCESS IN GENERAL TAKAFUL

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1.8 FAMILY TAKAFUL

Family Takaful encompasses long-term Takaful products extending beyond a year, ranging from 5 to 20 years, such
as pension, children's education, and mortgage Takaful plans. These contracts aim to cater to participants' long-
term savings and investment needs, as well as provide protection in case of a covered contingency.

Family Takaful plans, structured with or without a savings component, allocate contributions differently. In plans
featuring savings, a substantial portion goes to participants' investment funds, earmarked for savings, while a
smaller segment, known as the risk premium, feeds into the participants' Takaful fund. Conversely, plans without a
savings component direct all contributions to the participants' Takaful fund, designed to cover potential losses
during the contract term.

Surpluses within the Takaful fund, which remain after settling claims and deducting charges like Wakala fees, are
distributed among participants. However, in cases of deficits, an interest-free loan, termed Qard-e-Hasn, may be
drawn from the shareholders' fund to offset shortfalls, which can be recovered from future surpluses.

Both funds engage in Shari’ah-compliant investments, but their expected returns may differ. Investments from the
participants' Takaful fund aim to generate additional surpluses within the fund and avoid investment loss,
emphasizing liquidity and low risk. Conversely, investments from the participants' investment fund carry the
investment risk, which is effectively borne by the participants, offering a choice between conservative, balanced,
or aggressive asset classes at the contract's inception.

1.8.1 EXAMPLES OF PRODUCTS UNDER FAMILY TAKAFUL

● Term Life Takaful: Provides a payout if the insured person passes away during the coverage period.
● Whole Life Takaful: Offers lifelong coverage with fixed contribution payments.
● Endowment Takaful: Provides endowment benefits upon maturity or to dependents if the insured person
passes away during the endowment period.
● Investment-Linked Takaful: Merges investment and Takaful coverage for families, adhering to Shari’ah-
compliant investments.
● Medical Takaful: Covers the costs of inpatient and outpatient care at private hospitals.
● Marriage Plan: Aims to offer financial support for children's marriages.
● Child Education Takaful: Offers financial security for children in case of a parent's passing or permanent
disability.

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Figure 3
THE FUND TRANSFER PROCESS IN FAMILY TAKAFUL

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Section 2: Benefits of Takaful

Some of the key benefits of Takaful are listed below.

2.1 MORAL AND SHARI’AH COMPLIANCE

Takaful operates in accordance with Islamic principles, ensuring transactions are free from interest (Riba),
uncertainty (Gharar), and gambling (Maysir). It gives people and organizations a protection choice that lines up
with their religious beliefs and values.

2.2 SHARED RESPONSIBILITY

Encouraging shared responsibility among members, Takaful fosters cooperation and support during challenging
times. The Tabarru principle motivates individuals to contribute to a common pool, aiding those facing losses.

2.3 BROAD ACCEPTANCE OF TAKAFUL

Takaful encompasses most traditional insurance products, such as health, travel, and motor insurance, while
remaining Shari’ah-compliant. Its compatibility with Islamic principles makes it an appealing choice. Despite
challenges faced by conventional insurers entering the Takaful market, its wider acceptance extends to diverse
audiences, including those in non-Muslim countries. Takaful's ability to embrace conventional insurance products
enhances financial protection accessibility.

2.4 EXCESS SHARING

In Takaful, surplus from the pool is shared among members. This surplus sharing model allows members to benefit
financially beyond mere loss coverage.

2.5 TRANSPARENCY AND FAIRNESS

Takaful operators are mandated to maintain transparency in their operations and financial transactions. Members
gain a clear understanding of how contributions are managed and distributed, fostering trust and fairness within
the system.

2.6 CUSTOMIZATION AND FLEXIBILITY

Takaful offers flexibility in designing coverage that aligns with the specific needs of individuals and businesses.
Members can tailor their plans to suit their unique circumstances, ensuring appropriate coverage without paying
for unnecessary elements.

2.7 STABLE REGULATORY ENVIRONMENT

Many countries with substantial Muslim populations have established robust regulatory frameworks for Takaful,
providing legal recognition and support for the industry. This fosters growth and development in both Muslim-
majority and non-Muslim-majority countries.

2.8 SOCIAL WELFARE AND CORPORATE SOCIAL RESPONSIBILITY

Takaful aligns with social welfare principles and corporate social responsibility by promoting individual well-being
and contributing to societal development. Encouraging mutual assistance and charitable initiatives, Takaful
nurtures a culture of social responsibility and compassion.

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Section 3: Takaful Framework

3.1 ESTABLISHMENT OF TAKAFUL FRAMEWORK

A framework refers to the structured system designed to outline and guide the operations of a particular objective
or service. In the context of Takaful, this encompasses the regulatory infrastructure, industry-wide operational
procedures, applicable models, and a set of rules governing Shari’ah supervision and conflict resolution. The
framework provides the structure and guidelines necessary for the effective functioning of Takaful operations.

3.1.1 REGULATORY FRAMEWORK FOR TAKAFUL

In the realm of Takaful, a regulatory framework encompasses specific laws, rules, and guidelines established for the
functioning of Takaful entities. Each country implements its distinct regulatory framework, either through legislative
measures or through private organizations dedicated to overseeing Takaful operations.

International bodies, such as the Islamic Financial Services Board (IFSB), the International Association for Insurance
Supervision (IAIS), and the Accounting and Auditing Organization for Islamic Financial Institutions (AAIOFI), have
formulated standards and guidelines governing Takaful businesses across regions like the Gulf Cooperation Council
(GCC) and Asia.

BAHRAIN

Takaful operations in Bahrain are governed by the Central Bank of Bahrain (CBB) through its comprehensive
Rulebook, which covers various aspects, including licensing, governance, capital requirements, and financial
reporting. Under Article HC-9.2, Takaful and Retakaful operators are mandated to establish a Shari’ah Supervisory
Board (SSB) comprised of at least three Shari’ah scholars. This board, in compliance with AAOIFI’s Governance
Standard No. 1, plays a critical role in advising on all Takaful operations, ensuring adherence to Shari’ah principles,
and overseeing product design, claims handling, investments, and management and distribution of participants’
surplus.

Chapter 8 of the Rulebook provides detailed guidance on Takaful models and operational requirements. It mandates
the use of a Hybrid Model (Article 8.2.1) and requires operators to disclose wakala and mudarabah fees within the
Takaful contracts (Article 8.2.2). Section 8.4 addresses Qard-related matters, specifying that investment income
generated from assets forming part of the Qard belongs to the participants’ fund (Article 8.4.12), and outlines
procedures for Qard write-offs after five years (Article 8.4.16). Moreover, Section 8.5 outlines rules for surplus
distribution, in compliance with AAOIFI’s standards, necessitating recommendations by the actuary and
endorsement by both the SSB and the board of directors, with final approval from the CBB (Articles 8.5.1 and 8.5.3).

These regulations underscore the CBB's commitment to ensuring Shari’ah compliance, financial stability, and
consumer protection within Bahrain's Takaful industry. By providing clear guidelines and oversight mechanisms, the
CBB's Rulebook promotes transparency, accountability, and ethical conduct, fostering a robust and resilient Takaful
sector in Bahrain.

MALAYSIA

In Malaysia, the regulatory framework governing Takaful operations is supported by a robust set of legislative and
policy documents aimed at ensuring Shari’ah compliance, promoting financial stability, and safeguarding consumer
interests within the Islamic insurance sector.

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The Central Bank of Malaysia Act 2009 represents a key piece of legislation. Under Part 7 Chapter 1, this act
establishes the Shari’ah Advisory Council (SAC), serving as the authoritative body for interpreting Islamic law in
financial matters. The SAC issues rulings, provides guidance to Islamic financial institutions, and ensures
consistency in Shari’ah interpretations nationwide.
Complementing this legislation, the Islamic Financial Services Act 2013 (IFSA) furnishes a comprehensive regulatory
framework for Islamic financial institutions, including Takaful and Retakaful operators. IFSA mandates Shari’ah
compliance, with Part 4 Division 1 underscoring the SAC's authority and the imperative to adhere to its rulings.
Division 2 mandates the formation of Shari’ah Committees within the Takaful entities.
Further augmenting transparency, consistency and accountability is the policy document on Financial Reporting for
Takaful Operators. Article 13.8 of this document mandates disclosure of the Takaful operator's role based on
contractual (wakala and/or mudarabah contracts) terms, facilitating clarity among stakeholders.
Similarly, the policy document on Takaful Operational Framework provides detailed guidelines for Takaful
operations, covering the establishment of an operational framework that includes policies and procedures
governing various aspects of Takaful operations. Notably, Takaful contracts must receive mandatory approval from
the Shari’ah Committee. The document also addresses fund establishment, investment management, surplus
distribution, and qard provisions. Importantly, the document provides flexibility by allowing Takaful operators to
utilize any of the three Takaful models covered under Section 4 of this paper.
Furthermore, the policy document sets forth comprehensive requirements governing various facets of Takaful
operations. This includes mandates for the establishment and maintenance of Takaful funds, ensuring that the
participants’ Takaful funds are separate from the shareholders’ funds. In cases where applicable, the document
also requires the establishment of a participant’s investment fund under the family Takaful fund. Moreover, it
stipulates the disclosure of key aspects within the Takaful contract, such as the determination and assessment of
wakala and/or mudarabah fees.
Of particular significance within the policy document are the provisions concerning qard and hibah. The framework
mandates provisions for repayment, and potential write-off of qard, while allowing the operators to service the
participants’ funds deficit through hibah, effectively transferring ownership of assets without any consideration.
In summary, the regulatory framework surrounding Takaful operations in Malaysia is characterized by its depth
and specificity. Through legislative acts and comprehensive policy documents, the industry benefits from clear
guidelines and robust oversight mechanisms. These measures not only enhance transparency, consistency, and
accountability, but also provide flexibility for operators to adapt to evolving market needs while upholding the
fundamental tenets of Islamic finance.
PAKISTAN

Pakistan's regulatory landscape for Takaful, governed by the Insurance Ordinance 2000, the Insurance Rules 2002,
and the Takaful Rules 2005, underscores the nation's commitment to Islamic finance principles. The Securities and
Exchange Commission of Pakistan (SECP) oversees these regulations, ensuring adherence to Islamic tenets and
governing various aspects of Takaful operations.
Key regulatory measures dictate that the Takaful operators comply with the Takaful Rules 2005 and prioritize them
in case of discrepancies. Registration mandates setting up separate entities for Family Takaful and General Takaful
operations, with specific capital requirements for each. Additionally, Shari’ah compliance is integral, with a
mandatory Shari’ah Board overseeing Takaful operations and product design.
Operational models, such as the Wakala Model or Hybrid Model, are permissible, with mandatory requirements to
maintain separate funds for the participants and the shareholders, each adhering to Shari’ah principles.

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The determination and assessment of wakala and/or mudarabah fees in family Takaful operations necessitates
mandatory approval from the Appointed Actuary while, in general Takaful operations, approval from the Shari’ah
Board is requisite. Likewise, the determination and distribution of the participants’ surplus must be approved by
the Appointed Actuary for family Takaful operations and by the Shari’ah Board for both family and general Takaful
operations. Surplus distribution may involve either cash payments or a reduction in future contributions. The Rules
also allow surplus being credited to the participants’ investment fund in the case of family Takaful contracts.
Pakistan's Takaful regulations signify a commitment to Islamic finance principles, financial stability, and
transparency. The establishment of a Central Shari’ah Board by the SECP underscores a proactive approach toward
fostering Shari’ah-compliant financial practices. With rigorous oversight and adherence to Islamic principles,
Pakistan's Takaful industry thrives as a beacon of ethical and inclusive insurance practices in the global Islamic
finance landscape.
KINGDOM OF SAUDI ARABIA (KSA)

In the Kingdom of Saudi Arabia (KSA), Takaful operates on the principles of cooperative insurance, adhering to
Shari’ah law, without a specific governing regulation around Takaful. However, the regulatory oversight for
cooperative insurers in the KSA is managed by the Insurance Authority, ensuring compliance with various aspects,
such as solvency requirements, adequacy of technical provisions, and investment activities conducted by
cooperative insurers within the Kingdom.
Saudi Arabia has witnessed remarkable growth in its Islamic financial services business, positioning the country
prominently in Islamic finance. The oversight of health insurance providers falls under the purview of the Council
of Cooperative Health Insurance (CCHI), while the Insurance Authority regulates insurance and reinsurance firms.
Local insurers are required to register as publicly traded joint-stock companies, subject to regulation by the Capital
Markets Authority (CMA), while foreign-invested insurers must comply with the Foreign Investment Act and obtain
a foreign investment license from the Saudi Arabia General Investment Authority (SAGIA). (Abdullah et. al, 2012)
The regulatory framework for cooperative insurance companies in the Kingdom of Saudi Arabia is governed by the
Implementing Regulations of the Cooperative Insurance Companies enacted in 2003. This framework aims to
protect policyholders and shareholders, ensure fair competition, and maintain financial stability within the
insurance industry. Key provisions include licensing requirements, the mandatory appointment of an actuary,
retention and cession of premiums, valuation of assets, and surplus distribution, with 10% of the net surplus
allocated to policyholders.
Cooperative insurance and reinsurance companies in the Kingdom are required to maintain a solvency margin to
cover potential losses, following a risk-based methodology. Additionally, the Cooperative Insurance Company
Control Law of 2021 stipulates that insurance in the Kingdom must be provided by companies operating in
accordance with the practice of cooperative insurance and consistent with Shari’ah principles. Investment
regulations mandate separate investment policies for policyholders’ and shareholders’ investments, reflecting
differing objectives and targets.
Overall, Saudi Arabia's regulatory framework for cooperative insurance underscores the commitment to Shari’ah
compliance, financial stability, and transparency in the insurance industry, reinforcing its position as a leading
jurisdiction in Islamic finance and Takaful.
UNITED ARAB EMIRATES (UAE)

In 2014, the United Arab Emirates (UAE) set a milestone by introducing specialized regulations for Takaful within
the MENA region. Currently, the insurers and Takaful operators in the UAE are regulated by the Central Bank of the
UAE (CBUAE) through distinct financial regulations applicable to insurers and Takaful operators separately. These

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regulations encompass a wide range of aspects, including investment activities oversight, adequacy of technical
provisions, and solvency requirements for both the company and individual Takaful funds.
The integration of the Insurance Authority into the Central Bank of the UAE, governed by Decretal Federal Law
25/2020, has transformed the insurance industry in the UAE. Given this, insurers, brokers, and related businesses
fall under the regulatory purview of the Central Bank. However, free zone insurers and Takaful operators, such as
those in the Dubai International Financial Centre (DIFC) and Abu Dhabi Global Market (ADGM), have separate
regulatory authorities.
The regulatory framework established by the CBUAE aims to ensure Shari’ah compliance in Takaful operations,
requiring providers to align their businesses with Islamic principles. A Shari’ah Supervisory Board (SSB) oversees
investments, underwriting procedures, and claims management. The regulations mandate separate investment
strategies for participants’ and shareholders’ funds, reflecting their distinct investment objectives and targets.
Additionally, guidelines are provided for the provision of qard to cover deficits within Takaful funds, with a
mandate to write off any outstanding qard after three years. Surplus distribution guidelines are also outlined.
Financial regulations offer operators the flexibility to choose between the Wakala Model or the Hybrid Model, with
prescribed limits on wakala fees for general Takaful operations and actuarial recommendation in the case of
chargeable wakala fees for family Takaful operations.
The Financial Regulations for Takaful Insurance Companies lay down specific requirements with respect to financial
reporting for Takaful operators and prescribe that these be in line with the AAOIFI standards.
In various jurisdictions, such as Oman and Kuwait, the formulation of Takaful-specific regulations is either in progress
or not explicitly defined. Qatar, presently in the process of shaping regulatory frameworks, is expected to integrate
Takaful requirements within its insurance laws for onshore operations. These nations are navigating the evolution
of insurance regulations, potentially extending to Takaful, to cater to the growing interest and unique operational
aspects of Islamic insurance.

3.1.2 OPERATIONAL FRAMEWORK

The operational framework in Takaful pertains to the strategy adopted by insurance companies engaging in Takaful
operations. This primarily encompasses whether companies are established solely for Takaful operations, operate
Takaful through subsidiaries, or integrate Takaful within existing structures via a dedicated window.

Internationally, major conventional insurance and reinsurance companies, including Munich Re, Swiss Re, Hannover
Re, and AIG, function either through subsidiaries or Takaful windows to engage in Takaful operations. Nigeria allows
both standalone Takaful operators and traditional insurers using Takaful windows. Pakistan follows a similar
strategy, allowing conventional insurers to offer Takaful products through Takaful windows.

However, Malaysian regulations favor standalone Takaful operators exclusively, disallowing the operation of Takaful
windows. These regulations also mandate the segregation of funds for General and Family Takaful businesses by
Takaful operators, promoting distinct financial management within the sector. In the UAE, conventional insurers are
restricted from partaking in Takaful operations via windows. Takaful companies in the UAE strictly comply with the
Executive Regulations and directives from the Central Bank of the UAE, following specific financial regulations
designed for Takaful entities in the country.

In Bahrain and Qatar, the regulations don't expressly prohibit window Takaful operations, but specific guidelines
addressing this aspect are not explicitly outlined in their rulebooks. In the Kingdom of Saudi Arabia, insurance
operates under cooperative principles, which differ conceptually from the Takaful model. There aren't specific
regulations governing Takaful operations, and the cooperative insurance model is the prevalent approach.

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3.1.3 TAKAFUL FRAMEWORK

The Takaful structure typically includes a Shari’ah Advisory Board comprised of knowledgeable scholars overseeing
its compliance with Islamic principles. This board guides the effective administration of Takaful operations and
supports risk and commercial strategies. Its primary role is to endorse a Shari’ah-compliant framework for business
conduct that ensures long-term success.

This framework entails policies and processes covering Shari’ah contracts, establishment, and management of
Takaful funds, product design, underwriting, Retakaful administration, investments, claims, remuneration, operating
costs, surplus distribution to participants, and addressing deficits. Specific contractual obligations to participants,
participant cooperation, and board approval for surplus or profit distribution are detailed within these policies.

Senior management holds the responsibility of ensuring the framework's effective implementation, necessitating a
strong foundation, robust IT systems, adequate human resources, internal communication strategies, and
transparency. Regular assessments are imperative to ensure the framework's compliance and to seek ongoing board
approval (Bank Negara Malaysia).

3.2 TAKAFUL FUNDS

3.2.1 ESTABLISHMENT OF TAKAFUL FUNDS

Article 90 of the Islamic Financial Services Act (IFSA) 2013, outlined by Bank Negara Malaysia, mandates licensed
Takaful operators to create distinct general or family Takaful funds independent of their shareholders' funds. This
separation is crucial as Takaful funds are participant-owned and necessitate management to safeguard their
interests. The operator is obliged to develop comprehensive policies and procedures for setting up these funds,
encompassing the formation of participants’ risk funds or participants’ investment funds. Each fund holds unique
liability profiles and objectives, differentiating them from one another.

The categorization of Takaful funds commonly includes three types:

1. Participants’ Takaful Fund

2. Participants’ Investment Fund
3. Shareholders’ Takaful Fund

3.2.2 PARTICIPANTS’ TAKAFUL FUND

The Participants' Takaful Fund, also referred to as Participants’ Risk Fund, is a Shari’ah-compliant fund established
within the Takaful framework, designed to pool contributions from participants for the purpose of mutual
assistance. It serves as a risk-sharing pool where a portion of the contributions is designated as Tabarru to aid
other members in the event of covered contingencies or losses. This fund typically consists of contributions from
participants and, after deductions such as Wakala fees, it is used to cover various expenses like claims, ReTakaful,
administrative costs, and investments in Shari’ah-compliant avenues. Any surplus generated within this fund is
returned to the participants. The Participants' Takaful Fund functions to ensure financial protection, security, and
support for the participating members while adhering to Islamic principles.

The main features of the participants’ fund are as follows:

● It caters to the risk - gross contribution is received into this fund and Wakala charge is levied (wakala is
then expensed out and transferred to the shareholders' fund)

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● Participants' investments are made from this fund with the objective of healthy risk-free returns also
ensuring liquidity.
● In case of a deficit in the Participants' Fund, an interest free loan (Qard-e-Hasn) is provided from the
Shareholders' Fund
● There can be multiple participants' funds - one for general Takaful, one for family Takaful, and possibly a
third one for health Takaful. However, the overall purpose and function of this fund remains the same.

In the UAE, for example, it is mandatory to have separate participants' funds for the general and family Takaful
portfolios. In Pakistan, regulations prevent the coexistence of general and family Takaful operations within the
same company, prompting the operation of distinct entities for each.

3.2.3 PARTICIPANTS’ INVESTMENT FUND

The Participants’ Investment Fund comes into play when a Takaful Operator offers savings products within its
Family Takaful Fund. Here, participants’ investments, also referred to as unit investments, are specifically
segregated and managed within this fund. Investments made from this fund are subject to risk, which is effectively
borne by the participants. In contrast, for a general Takaful operator, such a fund does not exist. Instead, the
investment income generated from the participants' risk fund is considered part of the same fund, where the net
investment return contributes to the participants' surplus after deducting any Mudarib share (relevant in hybrid
and wakala models).

3.2.4 SHAREHOLDERS’ FUND

The Shareholders’ Fund serves as a financial cushion for potential shortfalls in participants' funds. Should any
participant fund face a deficit, this fund steps in to offer an interest-free loan (Qard-e-Hasn). Additionally, it's
designed to cover infrastructure startup costs and any overruns, such as those exceeding the Wakala levy charged.

The main features of the shareholders’ fund are as follows:

● It caters to general and administrative expenses.

● The Wakala fee is the major source of income for this fund.
● Shareholders' investments are made from this fund with an objective of higher returns - riskier
investment avenues than the participants' funds.

3.3 INVESTMENT MANAGEMENT UNDER THE TAKAFUL FRAMEWORK

3.3.1 INVESTMENT CONSIDERATIONS FOR TAKAFUL

As per the recommendations of the Shari’ah Advisory Board, Takaful investments should strictly adhere to
Shari’ah-compliant channels. This means no direct investments in traditional interest-bearing securities or in
private or public shares involving prohibited activities (Ali, 2016).

Moreover, a Takaful operator should tailor distinct investment strategies for the participants’ fund and the
shareholders’ fund due to their different objectives.

In order to ensure compliance with Shari’ah principles and meet participants' expectations, licensed operators
must prudently manage Takaful fund investments. This involves implementing a robust system for investment
management, precise estimation of returns, and clear policies for cross-fund trading. These policies should outline

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trading objectives, compliant asset types, cross-trading procedures, control systems, and escalation protocols for
the sustainability of funds and the welfare of participants (Bank Negara Malaysia).

3.3.2 INVESTMENT STRATEGY

Takaful operators’ investment strategy is to manage assets in a sound and prudent manner matching the liquidity
requirements and focusing on preserving capital with the goal of steady investment income. To achieve this, the
operator should try to maximize returns by investing in a balanced and well diversified portfolio based on Islamic
Shari’ah principles, while at the same time preserving the value of invested assets.

The investment strategy for Takaful operators aims to prudently manage assets, ensuring liquidity, while
preserving capital and securing consistent investment income. Achieving these goals involves maximizing returns
through a balanced, diversified portfolio adhering to Islamic Shari’ah principles.

To effectively implement the investment strategy, several key steps are essential:
1. Identifying authorized individuals for asset transactions.
2. Imposing constraints on portfolio managers, such as risk limits outlined in the investment policy.
3. Selecting and utilizing brokers.
4. Clearly defining custodial arrangements.
5. Establishing the methodology and frequency for performance measurement.
6. Agreed-upon transaction reporting formats and frequency.
7. When outsourcing investment management, formalizing policies and procedures in a contract.

3.3.3 MANAGEMENT OF PARTICIPANTS' SURPLUS

Any surplus within the participants’ fund is earmarked for future risk provisions in line with the mutuality principle,
with guidance provided by the Appointed Actuary and the Shari’ah Board. Should the Takaful surplus exceed the
necessary reserve, regulations allow for surplus distribution among participants, subject to regulatory
requirements and approvals from the Shari’ah Supervisory Board and the Appointed Actuary.

However, if claims exceed contributions, a deficit within the participants’ fund is covered through an equivalent
transfer of an interest-free loan (Qard-e-Hasn) from the shareholders’ fund. Any outstanding Qard is then
recovered from future surpluses.

3.3.4 CONSOLIDATION OF PARTICIPANTS’ FUNDS

If an authorized Takaful operator believes consolidating multiple participants’ funds will increase the long-term
sustainability of Takaful funds, they may do so. The consolidation must involve a sustainability evaluation,
participant fairness analysis, actuarial evaluation, and confirmation that there is no outstanding Qard under any of
the funds being considered for consolidation (Bank Negara Malaysia).

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3.3.5 SHARI’AH-COMPLIANT INVESTMENTS

Shari’ah-compliant investments adhere to Islamic principles, avoiding activities such as gambling, riba, and
investing in businesses involved in alcohol, pork, or other forbidden activities. They also comply with ethical and
moral standards set by Islamic law. Some Shari’ah-compliant investment avenues include:

SUKUK

Sukuk refers to Islamic financial instruments, commonly known as Islamic bonds, structured to adhere to Islamic
principles. These securities are based on asset ownership or participation in specific projects, rather than debt
ownership. Sukuk holders receive a portion of the profits generated by the underlying asset or project instead of
fixed interest payments, in compliance with Shari’ah law.

SHARI’AH-COMPLIANT EQUITIES

Refers to stocks or shares of companies that operate in accordance with Shari’ah guidelines. These equities are
considered Shari’ah-compliant if the businesses they represent adhere to specific guidelines, such as avoiding
involvement in activities that go against Islamic teachings, such as interest-based financing, gambling, alcohol,
pork-related products, and other unethical or non-permissible activities. Shari’ah-compliant equities are vetted by
Shari’ah boards or scholars to ensure adherence to Islamic finance principles.

SHARI’AH-COMPLIANT MUTUAL FUNDS

These are investment vehicles that adhere to Shari’ah principles in their investment activities. These funds follow
guidelines outlined by Islamic law, avoiding investments in non-permissible industries such as alcohol, gambling,
and other prohibited activities. Instead, they invest in Shari’ah-compliant assets, like Shari’ah-compliant equities,
Sukuk, real estate, and other permissible ventures.

IJARAH FUNDS

Ijarah funds are a type of investment vehicle in Islamic finance that follows the principles of Ijarah, a leasing or
rental contract. These funds pool investments from participants to acquire assets such as real estate, equipment,
or vehicles. The funds then lease these assets to third parties, generating rental income. The returns from these
leases are distributed among the fund participants in a Shari’ah-compliant manner. The funds are managed in
accordance with Islamic finance principles, ensuring that the investments and leasing contracts comply with
Shari’ah guidelines.

MURABAHA FUNDS

Murabaha funds are a type of financial instrument in Islamic finance that operate based on the Murabaha
contract. This contract involves the sale of goods at a marked-up price, allowing for deferred payment terms. In
the context of these funds, investors pool their capital, which is then utilized by the fund managers to purchase
goods or commodities. These goods are subsequently sold to buyers at a higher price, with payment typically
deferred. The profit generated from these transactions forms the returns for investors in the Murabaha fund. This
financial structure complies with Shari’ah principles that prohibit the charging or payment of interest (riba) and
adheres to Islamic guidelines on ethical and fair-trade practices.

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3.3.6 ROLES AND RESPONSIBILITIES OF THE INVESTMENT COMMITTEE

The Investment Committee within a Takaful enterprise holds a pivotal role in overseeing and managing the
investment activities of the participants’ and shareholders’ funds. Their responsibilities typically include:

● Developing and formulating the overall investment strategy aligned with Shari’ah principles, risk
tolerance, and the company’s objectives. This includes setting investment goals, asset allocation
strategies, and risk management practices.
● Establishing investment policies, guidelines, and procedures that comply with Shari’ah principles and
regulatory requirements. This involves defining the permissible investment avenues and the framework
for evaluating and approving investments.
● Determining the allocation of assets across various investment classes, such as equities, real estate,
Sukuk, Islamic funds, and other permissible investment vehicles, in accordance with the company's risk
profile and objectives.
● Conducting due diligence on potential investment opportunities to ensure they comply with Shari’ah
guidelines, evaluating their financial soundness, risk levels, and alignment with the company's ethical
standards.
● Assessing and managing investment-related risks, establishing risk tolerance levels, and implementing
strategies to mitigate risks while optimizing returns.
● Regularly monitoring the performance of investments against set benchmarks, assessing compliance with
investment policies, and preparing comprehensive reports for the board of directors and regulatory
bodies.
● Advising the board of directors on investment-related matters, providing insights, recommendations, and
guidance on investment strategies, opportunities, and market conditions.
● Collaborating with the Shari’ah Advisory Board to ensure that all investment decisions and practices
adhere to Shari’ah principles and guidelines.

The contrast between conventional insurance and Takaful business becomes particularly evident when examining
their investment practices. Traditional insurance companies typically invest their funds in interest-based avenues,
often disregarding considerations of what is permissible or prohibited in Islamic finance. In contrast, Takaful
operators strictly engage in Shari’ah-compliant investments, and any profits generated are distributed according to
the predetermined ratios outlined in the Takaful contract.

Moreover, Takaful companies operate on a collective principle, where participants collectively share both
surpluses and losses from the shared pool. This intrinsic feature of the Takaful system acts as a built-in mechanism
to counteract any over-pricing tendencies exhibited by conventional insurance companies. Regardless of the
contributions charged, any surplus typically flows back to the participants in proportion to their individual
contributions. This aligns with the principle of fairness and equity in Takaful operations (Usmani, 2002).

3.4 RESPONSIBILITIES OF THE SHAREHOLDERS

Shareholders in a Takaful enterprise, as owners, hold significant responsibilities crucial for the company's function
and adherence to Shari’ah principles. Their duties encompass multiple facets:

• Carefully selecting and appointing a competent Takaful operator to manage Takaful funds and operations.
The operator must possess expertise in Shari’ah-compliant fund management, upholding the trust and
integrity of the Takaful enterprise.
● Financing any deficits arising within the Takaful funds through interest-free loans, recovered from future
surpluses, ensuring the stability of the participants’ funds.
● Entitled to a share of the profits generated by the company, while bearing responsibility for any incurred
losses. They support the administrator, overseeing fund activities like risk underwriting and investments.

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● Guaranteeing compliance with Shari’ah principles in all company operations, ensuring transparency and
fair dealings for stakeholders.
● Protecting the interests and rights of the participants by ensuring that the Takaful company has sufficient
funds to meet its liabilities and obligations.
● Maintaining a prudent level of solvency, liquidity, and effective risk management systems.
● Prioritizing transparency, disclosing financial performance and participant rights, informing them about
investment strategies, surplus distribution criteria, and claims settlement processes.

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Section 4: Takaful Models

The Takaful industry has evolved to offer various models catering to consumer demands, while adhering to
Shari’ah standards. This section aims to introduce and detail these models, providing insights into their structures
and unique features.

4.1 HYBRID (WAKALA & MUDARABAH) MODEL

The hybrid model combines elements of both the Wakala and the Mudarabah1 models. A Mudarabah contract is
used for investing activities, whereas a Wakala contract is used for underwriting activities.

Through a Wakala contract, shareholders manage participants' contributions in underwriting activities as their
agents. Participants pay a Wakala fee to the Takaful operator in exchange for these services. The business uses the
Mudarabah contract for investments, placing surplus contributions in Shari’ah-compliant securities.

In accordance with a predetermined and approved profit-sharing ratio, the operator serves as mudarib on behalf
of the participants for the sake of participants’ investments. In addition to serving as an investment manager under
the Mudarabah contract and splitting profits from such investments, the Takaful operator charges a Wakala fee to
manage participants’ risk funds. Some Takaful operators may retain a fraction of the participants’ surplus as an
incentive.

Investment income is distributed in accordance with predetermined ratios where the funds are invested in
Shari’ah-compliant schemes. Participants’ funds pay for claims, underwriting fees, and Retakaful charges. In the
event of losses, deficits are covered through a provision of Qard-e-Hasn from the shareholders’ fund, with future
surplus from the participants’ fund serving as payback (Akhter & Waheed, 2010).

Figure 4
HYBRID MODEL

1 Commonly referred to as the Cooperative Model

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4.2 WAKALA MODEL

In this model, the Takaful operator functions as an agent, charging a predetermined Wakala fee for its services.
This fee is fixed, ensuring a stable income for the operator irrespective of the performance of the participants’
funds. The Wakala fee compensates the operator for managing the participants’ funds, carrying out administrative
duties, and overseeing day-to-day operations. In addition to the levied Wakala, certain jurisdictions permit the
inclusion of an incentive charge equal to a portion of the surplus within the participants’ fund. This additional
charge is justified by the idea that it will encourage thorough underwriting, lower claim costs, etc.

In case the participants' fund faces a deficit due to benefit payments being higher than expected, the Wakala
model allows the Takaful operator to cover this deficit by extending an interest-free loan known as Qard-e-Hasn
from the shareholders’ fund. This loan is provided to ensure that the participants’ fund remains solvent and can
fulfill its obligations. The Qard-e-Hasn is later repaid from future surpluses generated by the participants’ fund.

Compared to the Hybrid model, which combines elements of Mudarabah and Wakala, the Wakala model doesn’t
involve profit-sharing from the investment activities conducted within the participants' funds. Instead, the Takaful
operator receives a fixed Wakala fee for managing the funds without sharing in the investment profits.

Figure 5
WAKALA MODEL

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4.3 COOPERATIVE MODEL

Mudarib, the Takaful operator, and the participants have a profit-sharing agreement. Mudarib manages
investments and claims payments, while the participants contribute to a collective fund. The underwriting surplus
and investment income are split between the participants and the shareholders using a predefined ratio. The
capital provider absorbs losses (Usmani, 2020).

One distinctive feature of the cooperative model is the existence of a single fund, much like conventional insurers
or mutuals. However, unlike conventional setups, any surplus or profits generated are divided between the
participants and the shareholders based on a predefined ratio. For instance, in the Kingdom of Saudi Arabia (KSA),
the profit-sharing mechanism is prescribed by the regulatory authority, where 90% of the generated surplus is
attributable to the shareholders and the remainder to the participants.

In the scenario of a surplus, the agreed percentage of profits goes to the participants, fostering a cooperative
approach by sharing the benefits among them and the shareholders. However, in the event of a deficit, the
shareholders bear the entire burden, covering 100% of the deficit, thus showcasing the risk-bearing responsibility
of the capital providers. This arrangement aligns with the principles of risk-sharing and mutual support within the
cooperative model.

Figure 6
COOPERATIVE MODEL

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4.4 TAKAFUL-SPECIFIC TRANSACTIONS

The description provided below of the Takaful-specific transactions is applicable only in the case of the Hybrid and
Wakala Models.

QARD-E-HASN

Qard-e-Hasn is an interest-free loan provided by the shareholders of a Takaful company to cover any deficits
within the participants' fund. In the context of Takaful, if there's a shortfall or deficit in the participants' fund due
to excessive claims or unexpected circumstances, this loan is extended from the shareholders' fund to cover the
shortage. It is provided on a goodwill basis and aims to restore the financial health of the participants' fund. Qard-
e-Hasn is interest-free and is expected to be repaid from future surpluses within the participants' fund once it
regains financial stability. This mechanism ensures that any temporary financial shortfall within the Takaful fund
doesn't affect the participants' benefits and obligations adversely.

WAKALA FEE

The Wakala fee within the Takaful framework refers to a charge levied by the Takaful operator for its services in
managing and administering the Takaful funds. It is compensation for the operator’s role in conducting
underwriting activities on behalf of the participants, as well as covering the costs of managing the fund, handling
claims, and other administrative expenses incurred by the operator. This fee is usually predefined and, in some
jurisdictions, a maximum limit is prescribed, such as in the UAE, where the financial regulations for Takaful
operators prescribe a maximum limit of 35%. The fee may vary depending on the Takaful contract, the type of
coverage, and the services provided by the operator.

MUDARABAH FEE

The Mudarabah fee within the Takaful framework is a portion of the surplus generated from Shari’ah-compliant
investments by the Takaful operator on behalf of the participants. It represents the operator's share of profits
earned through successful investment activities conducted under the Mudarabah contract.

The Takaful operator acts as the Mudarib, responsible for managing and investing the participants' funds in
permissible and profitable ventures. Any surplus generated from these investments, after deducting operational
expenses and other charges, is distributed among the participants and the operator, based on a pre-agreed profit-
sharing ratio. The fee is the share of profits that the Takaful operator receives as compensation for its expertise,
efforts, and role in generating investment income. The Mudarabah fee aligns the interests of the operator with the
financial performance of the investments made on behalf of the participants.

4.5 TAKAFUL MODELS IMPLEMENTED GLOBALLY

Numerous nations have adopted diverse Takaful models since its inception. Pakistan, Malaysia, and the Gulf
countries stand out as prominent markets. Notably, the insurance markets in the GCC region, particularly in the
Kingdom of Saudi Arabia and the United Arab Emirates (UAE), are well-developed. Takaful providers in the UAE
and Bahrain operate using the Hybrid model (Wakala & Mudarabah), while the regulatory authority in the Kingdom
of Saudi Arabia has prescribed using the Cooperative model (Mudarabah). Pakistan, on the other hand, favors the
Hybrid or Wakala model.

The Hybrid model is prevalent in the United Arab Emirates, Pakistan, Bahrain, and Malaysia. These countries offer
the option of adopting a pure Wakala model or a combination of approaches. Particularly in Malaysia, the Hybrid
model finds extensive use and proponents argue that it harmonizes the strengths of both models, promoting
standardization of Takaful practices (Obaidullah, 2005).

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4.6 ILLUSTRATIVE PROFIT & LOSS STATEMENTS UNDER VARIOUS TAKAFUL MODELS
This subsection provides for the illustrative profit and loss statements under each Takaful model discussed above
considering various scenarios, including a brief discussion around the key differences in the financial reporting
framework under each model. For the sake of readers’ ease, the following simplified assumptions have been
made:

● An Illustrative Profit and Loss Statement under each Takaful Model has been provided using three distinct
scenarios.
● Earned Contribution has been assumed to be CU 1,000 per annum.
● Expense Ratio has been assumed to be 20%.
● Wakala Fee2 has been assumed to be 25% of Gross Contributions.
● Mudarabah Fee3 has been assumed to be 20% of Investment Income.
● Participants’ Investment Income has been assumed to be CU 50 per annum.
● Shareholders’ Investment Income has been assumed to be CU 100 per annum.
● Surplus-sharing under the Cooperative Model has been assumed to be in line with that prescribed by the
Insurance Authority in the KSA, where 10% of the surplus is allocated to the participants and the
remaining 90% is attributable to the shareholders.
● Three scenarios have been considered under each Takaful Model. The first scenario provides for an entity
generating profits over the next five years, whereas the second scenario provides for an entity generating
losses over the same period. However, under the third scenario, the entity generates losses during the
first two years and profits thereafter.

Table 4
ASSUMED LOSS RATIOS

ASSUMED LOSS RATIOS

Year 1 Year 2 Year 3 Year 4 Year 5

Scenario 1 65% 65% 65% 65% 65%

Scenario 2 100% 100% 100% 100% 100%

Scenario 3 100% 100% 50% 50% 50%

2 Applicable in the case of Hybrid and Wakala Models

3 Applicable only in the case of the Hybrid Model

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HYBRID (WAKALA & MUDARABAH) MODEL – SCENARIO 1

Table 5
PROFIT AND LOSS STATEMENT FOR THE PARTICIPANTS’ FUND AND THE SHAREHOLDERS’ FUND
PARTICIPANTS' FUND
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Contributions 750.00 750.00 750.00 750.00 750.00
Incurred Claims (650.00) (650.00) (650.00) (650.00) (650.00)
Underwriting Profit/(Loss) 100.00 100.00 100.00 100.00 100.00

Investment Income (Participants' Investment) 50.00 50.00 50.00 50.00 50.00

Mudarabah Fee (10.00) (10.00) (10.00) (10.00) (10.00)

Profit/(Loss) 140.00 140.00 140.00 140.00 140.00

SHAREHOLDERS' FUND
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Wakala 250.00 250.00 250.00 250.00 250.00
Incurred Expenses (200.00) (200.00) (200.00) (200.00) (200.00)
Underwriting Profit/(Loss) 50.00 50.00 50.00 50.00 50.00

Investment Income (Shareholders' Investment) 100.00 100.00 100.00 100.00 100.00

Mudarabah Income 10.00 10.00 10.00 10.00 10.00

Profit/(Loss) 160.00 160.00 160.00 160.00 160.00

In practice, gross contribution is treated as an inflow into the participants’ fund, whereas the levied wakala is
treated as an outflow from the same fund which, in turn, is treated as an inflow into the shareholders’ fund.

In addition, a mudarabah fee is levied on the participants’ investment income, which is considered an expense to
the participants and an income to the shareholders.

Table 6
ENTITY LEVEL PROFIT AND LOSS STATEMENT
ENTITY
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Revenue 1,000.00 1,000.00 1,000.00 1,000.00 1,000.00
Incurred Claims & Expenses (850.00) (850.00) (850.00) (850.00) (850.00)
Underwriting Profit/(Loss) 150.00 150.00 150.00 150.00 150.00

Investment Income 150.00 150.00 150.00 150.00 150.00

Profit/(Loss) 300.00 300.00 300.00 300.00 300.00

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Combining the participants' fund and the shareholders' fund in a Takaful entity eliminates specific accounting
items, such as the wakala and mudarabah fees, from a presentation standpoint. These are treated as inter-fund
transactions within the same entity. In essence, the total profits or losses from both funds contribute to the overall
aggregate profits or losses for the entity.

HYBRID (WAKALA & MUDARABAH) MODEL – SCENARIO 2

Table 7
PROFIT AND LOSS STATEMENT FOR THE PARTICIPANTS’ FUND AND THE SHAREHOLDERS’ FUND
PARTICIPANTS' FUND
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Contributions 750.00 750.00 750.00 750.00 750.00
Incurred Claims (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00)
Underwriting Profit/(Loss) (250.00) (250.00) (250.00) (250.00) (250.00)

Investment Income (Participants' Investment) 50.00 50.00 50.00 50.00 50.00

Mudarabah Fee (10.00) (10.00) (10.00) (10.00) (10.00)

Profit/(Loss) (210.00) (210.00) (210.00) (210.00) (210.00)

Interest Fee Loan (Qard) from Shareholders 210.00 210.00 210.00 210.00 210.00

SHAREHOLDERS' FUND
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Wakala 250.00 250.00 250.00 250.00 250.00
Incurred Expenses (200.00) (200.00) (200.00) (200.00) (200.00)
Underwriting Profit/(Loss) 50.00 50.00 50.00 50.00 50.00

Investment Income (Shareholders' Investment) 100.00 100.00 100.00 100.00 100.00

Mudarabah Income 10.00 10.00 10.00 10.00 10.00

Profit/(Loss) 160.00 160.00 160.00 160.00 160.00

Interest Free Loan (Qard) to Policyholders' (210.00) (210.00) (210.00) (210.00) (210.00)

Under this scenario, where the participants’ fund is consistently making losses, an interest-free loan (Qard-e-Hasn)
is provided from the shareholders’ fund to cover the deficits within the participants’ fund. From a balance sheet
perspective, any Outstanding Qard would be shown as a payable (liability) under the participants’ fund, whereas it
would be shown as a receivable (asset) under the shareholders’ fund. As previously mentioned, an entity level view
of the balance sheet will eliminate Qard as an inter-fund transaction.

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Table 8
ENTITY LEVEL PROFIT AND LOSS STATEMENT
ENTITY
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Revenue 1,000.00 1,000.00 1,000.00 1,000.00 1,000.00
Incurred Claims & Expenses (1,200.00) (1,200.00) (1,200.00) (1,200.00) (1,200.00)
Underwriting Profit/(Loss) (200.00) (200.00) (200.00) (200.00) (200.00)

Investment Income 150.00 150.00 150.00 150.00 150.00

Profit/(Loss) (50.00) (50.00) (50.00) (50.00) (50.00)

HYBRID (WAKALA & MUDARABAH) MODEL – SCENARIO 3

Table 9
PROFIT AND LOSS STATEMENT FOR THE PARTICIPANTS’ FUND AND THE SHAREHOLDERS’ FUND
PARTICIPANTS' FUND
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Contributions 750.00 750.00 750.00 750.00 750.00
Incurred Claims (1,000.00) (1,000.00) (500.00) (500.00) (500.00)
Underwriting Profit/(Loss) (250.00) (250.00) 250.00 250.00 250.00

Investment Income (Participants' Investment) 50.00 50.00 50.00 50.00 50.00

Mudarabah Fee (10.00) (10.00) (10.00) (10.00) (10.00)

Profit/(Loss) (210.00) (210.00) 290.00 290.00 290.00

Interest Fee Loan (Qard) from Shareholders 210.00 210.00 (290.00) (130.00) -

SHAREHOLDERS' FUND
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Wakala 250.00 250.00 250.00 250.00 250.00
Incurred Expenses (200.00) (200.00) (200.00) (200.00) (200.00)
Underwriting Profit/(Loss) 50.00 50.00 50.00 50.00 50.00

Investment Income (Shareholders' Investment) 100.00 100.00 100.00 100.00 100.00

Mudarabah Income 10.00 10.00 10.00 10.00 10.00

Profit/(Loss) 160.00 160.00 160.00 160.00 160.00

Interest Free Loan (Qard) to Policyholders (210.00) (210.00) 290.00 130.00 -

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Under this scenario, where the participants’ fund has incurred losses during the first two years, note that an
equivalent Qard has been transferred from the shareholders’ fund; however, when the participants’ fund becomes
profitable from year 3 onwards, any outstanding Qard is paid back first before distribution of surplus to the
participants. At the end of year 2, accumulated Qard stands at CU 420.00, out of which CU 290.00 is paid back at
the end of year 3, whereas the remainder of CU 130.00 is paid back at the end of year 4, leaving a surplus CU
160.00 within the participants’ fund. This surplus can either be distributed to the active participants or carried
forward as accumulated surplus.

Table 10
ENTITY LEVEL PROFIT AND LOSS STATEMENT
ENTITY
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Revenue 1,000.00 1,000.00 1,000.00 1,000.00 1,000.00
Incurred Claims & Expenses (1,200.00) (1,200.00) (700.00) (700.00) (700.00)
Underwriting Profit/(Loss) (200.00) (200.00) 300.00 300.00 300.00

Investment Income 150.00 150.00 150.00 150.00 150.00

Profit/(Loss) (50.00) (50.00) 450.00 450.00 450.00

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WAKALA MODEL – SCENARIO 1

As explained in Section 2 of this paper, the wakala model differs from the hybrid model only in the case of the
mudarabah fee levied on the participants’ investment income. Under the wakala model, 100% of the participants’
investment income is considered income for said fund.

Table 11
PROFIT AND LOSS STATEMENT FOR THE PARTICIPANTS’ FUND AND THE SHAREHOLDERS’ FUND
PARTICIPANTS' FUND
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Contributions 750.00 750.00 750.00 750.00 750.00
Incurred Claims (650.00) (650.00) (650.00) (650.00) (650.00)
Underwriting Profit/(Loss) 100.00 100.00 100.00 100.00 100.00

Investment Income (Participants' Investment) 50.00 50.00 50.00 50.00 50.00

Profit/(Loss) 150.00 150.00 150.00 150.00 150.00

SHAREHOLDERS' FUND
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Wakala 250.00 250.00 250.00 250.00 250.00
Incurred Expenses (200.00) (200.00) (200.00) (200.00) (200.00)
Underwriting Profit/(Loss) 50.00 50.00 50.00 50.00 50.00

Investment Income (Shareholders' Investment) 100.00 100.00 100.00 100.00 100.00

Profit/(Loss) 150.00 150.00 150.00 150.00 150.00

Comparing Scenario 1 under the Hybrid Model with that shown above, note that the difference in profitability of
the participants’ fund only relates to the levied Mudarabah fee under the Hybrid Model, which is non-existent
under the Wakala Model. Similarly, profits within the shareholders’ fund would also be lower compared to those
under the Hybrid Model where the mudarabah fee is additional income to the shareholders. Shown below is the
entity level profit and loss statement, which is the same as the Hybrid Model due to the amalgamation of funds
and elimination of Takaful-specific inter-fund transactions:

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Table 12
ENTITY LEVEL PROFIT AND LOSS STATEMENT
ENTITY
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Revenue 1,000.00 1,000.00 1,000.00 1,000.00 1,000.00
Incurred Claims & Expenses (850.00) (850.00) (850.00) (850.00) (850.00)
Underwriting Profit/(Loss) 150.00 150.00 150.00 150.00 150.00

Investment Income 150.00 150.00 150.00 150.00 150.00

Profit/(Loss) 300.00 300.00 300.00 300.00 300.00

WAKALA MODEL – SCENARIO 2

Under Scenario 2, the participants’ fund generates a deficit across all years. When compared with the same
scenario under the Hybrid Model, the only difference in the bottom line of each fund relates to the absence of the
mudarabah fee/income under the Wakala Model. Presented below is the profit and loss statement for the two
funds under Scenario 2:

Table 13
PROFIT AND LOSS STATEMENT FOR THE PARTICIPANTS’ FUND AND THE SHAREHOLDERS’ FUND
PARTICIPANTS' FUND
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Contributions 750.00 750.00 750.00 750.00 750.00
Incurred Claims (1,000.00) (1,000.00) (1,000.00) (1,000.00) (1,000.00)
Underwriting Profit/(Loss) (250.00) (250.00) (250.00) (250.00) (250.00)

Investment Income (Participants' Investment) 50.00 50.00 50.00 50.00 50.00

Profit/(Loss) (200.00) (200.00) (200.00) (200.00) (200.00)

Interest Fee Loan (Qard) from Shareholders 200.00 200.00 200.00 200.00 200.00

SHAREHOLDERS' FUND
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Wakala 250.00 250.00 250.00 250.00 250.00
Incurred Expenses (200.00) (200.00) (200.00) (200.00) (200.00)
Underwriting Profit/(Loss) 50.00 50.00 50.00 50.00 50.00

Investment Income (Shareholders' Investment) 100.00 100.00 100.00 100.00 100.00

Profit/(Loss) 150.00 150.00 150.00 150.00 150.00

Interest Free Loan (Qard) to Policyholders (200.00) (200.00) (200.00) (200.00) (200.00)

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ENTITY
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Revenue 1,000.00 1,000.00 1,000.00 1,000.00 1,000.00
Incurred Claims & Expenses (1,200.00) (1,200.00) (1,200.00) (1,200.00) (1,200.00)
Underwriting Profit/(Loss) (200.00) (200.00) (200.00) (200.00) (200.00)

Investment Income 150.00 150.00 150.00 150.00 150.00

Profit/(Loss) (50.00) (50.00) (50.00) (50.00) (50.00)

WAKALA MODEL – SCENARIO 3

Under Scenario 3, the participants’ fund generates deficits during the first two years with profits thereafter. Qard
from the shareholders’ fund is provided to cover the deficits during the first two years and fully recovered by the
end of the fourth year.

Table 14
PROFIT AND LOSS STATEMENT FOR THE PARTICIPANTS’ FUND AND THE SHAREHOLDERS’ FUND
PARTICIPANTS' FUND
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Contributions 750.00 750.00 750.00 750.00 750.00
Incurred Claims (1,000.00) (1,000.00) (500.00) (500.00) (500.00)
Underwriting Profit/(Loss) (250.00) (250.00) 250.00 250.00 250.00

Investment Income (Participants' Investment) 50.00 50.00 50.00 50.00 50.00

Profit/(Loss) (200.00) (200.00) 300.00 300.00 300.00

Interest Fee Loan (Qard) from Shareholders 200.00 200.00 (300.00) (100.00) -

SHAREHOLDERS' FUND
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Wakala 250.00 250.00 250.00 250.00 250.00
Incurred Expenses (200.00) (200.00) (200.00) (200.00) (200.00)
Underwriting Profit/(Loss) 50.00 50.00 50.00 50.00 50.00

Investment Income (Shareholders' Investment) 100.00 100.00 100.00 100.00 100.00

Profit/(Loss) 150.00 150.00 150.00 150.00 150.00

Interest Free Loan (Qard) to Policyholders (200.00) (200.00) 300.00 100.00 -

At the end of year 2, accumulated Qard stands at CU 400.00, out of which CU 300.00 is paid back at the end of year
3, whereas the remainder of CU 100.00 is paid back at the end of year 4, leaving a surplus CU 200.00 within the
participants’ fund. The accumulated surplus grows to CU 500.00 at the end of the fifth year given an additional CU

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300.00 of surplus generated during the same year.

Table 15
ENTITY LEVEL PROFIT AND LOSS STATEMENT
ENTITY
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Revenue 1,000.00 1,000.00 1,000.00 1,000.00 1,000.00
Incurred Claims & Expenses (1,200.00) (1,200.00) (700.00) (700.00) (700.00)
Underwriting Profit/(Loss) (200.00) (200.00) 300.00 300.00 300.00

Investment Income 150.00 150.00 150.00 150.00 150.00

Profit/(Loss) (50.00) (50.00) 450.00 450.00 450.00

COOPERATIVE MODEL – SCENARIO 1

As discussed in Section 2 of this paper, the cooperative model significantly differs from the Hybrid and Wakala
models. The financial reporting under this model is more closely aligned with that under mutual insurance or
conventional insurance given there’s only one fund and Takaful-specific transactions, such as a wakala fee,
mudarabah fee, or Qard, are non-existent. The only key difference relates to the profit-sharing between the
participants and the shareholders, which does not exist in the case of conventional insurance.

Table 16
ENTITY LEVEL PROFIT AND LOSS STATEMENT
ENTITY
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Contributions 1,000.00 1,000.00 1,000.00 1,000.00 1,000.00
Incurred Claims & Expenses (850.00) (850.00) (850.00) (850.00) (850.00)
Underwriting Profit/(Loss) 150.00 150.00 150.00 150.00 150.00

Investment Income 150.00 150.00 150.00 150.00 150.00

Profit/(Loss) – Aggregate 300.00 300.00 300.00 300.00 300.00

Profit - Policyholders 30.00 30.00 30.00 30.00 30.00
Profit/(Loss) - Shareholders 270.00 270.00 270.00 270.00 270.00

Note that the aggregate profits are the same as under Scenario 1 of the Hybrid and Wakala Models. As explained in
Section 2, aggregate profits of the entity are shared between the participants and shareholders using a pre-defined
ratio usually prescribed by the regulatory authority. The ratios used for the purpose of these scenarios are in line
with those prescribed by the Insurance Authority in the Kingdom of Saudi Arabia.

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From a balance sheet perspective, ‘accumulated participants’ surplus’ is held as a liability with equivalent cash or
term deposits on the asset side. In this scenario, accumulated participants’ surplus would be CU 150.00 at the end
of the fifth year.

COOPERATIVE MODEL – SCENARIO 2

Under this scenario, the entity generates deficits throughout the five years.

Table 17
ENTITY LEVEL PROFIT AND LOSS STATEMENT
ENTITY
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Contributions 1,000.00 1,000.00 1,000.00 1,000.00 1,000.00
Incurred Claims & Expenses (1,200.00) (1,200.00) (1,200.00) (1,200.00) (1,200.00)
Underwriting Profit/(Loss) (200.00) (200.00) (200.00) (200.00) (200.00)

Investment Income 150.00 150.00 150.00 150.00 150.00

Profit/(Loss) – Aggregate (50.00) (50.00) (50.00) (50.00) (50.00)

Profit - Policyholders - - - - -
Profit/(Loss) - Shareholders (50.00) (50.00) (50.00) (50.00) (50.00)

Note that, in this scenario where the entity is generating deficits, 100% of such deficits are attributed to the
shareholders. Also, the entity-level aggregate deficits are the same as under Scenario 2 of the Hybrid and Wakala
Models.

COOPERATIVE MODEL – SCENARIO 3

Under this scenario, the entity generates deficits during the first two years with surpluses thereafter.

Table 18
ENTITY LEVEL PROFIT AND LOSS STATEMENT
ENTITY
Year 1 Year 2 Year 3 Year 4 Year 5
Earned Contributions 1,000.00 1,000.00 1,000.00 1,000.00 1,000.00
Incurred Claims & Expenses (1,200.00) (1,200.00) (700.00) (700.00) (700.00)
Underwriting Profit/(Loss) (200.00) (200.00) 300.00 300.00 300.00

Investment Income 150.00 150.00 150.00 150.00 150.00

Profit/(Loss) – Aggregate (50.00) (50.00) 450.00 450.00 450.00

Profit - Policyholders - - 45.00 45.00 45.00
Profit/(Loss) - Shareholders (50.00) (50.00) 405.00 405.00 405.00

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Note that, at the end of year 3, which is also the first profitable year under this scenario, the surplus is shared
using a pre-defined ratio with the participants. Accumulated participants’ surplus at the end of the fifth year
amounts to CU 135.00, assuming no surplus has been distributed in the past two years.

4.7 COMPARISON – ILLUSTRATIVE EXAMPLES

PARTICIPANTS’ FUND

The comparison shown below under each scenario relates only to the Hybrid and the Wakala models. Segregation
of the participants’ fund and the shareholders’ fund is non-existent under the Cooperative Model. The difference
in profits or losses is only driven by the absence of the Mudarabah fee under the Wakala Model.

Note that, under the Hybrid Model, in all scenarios, profits/losses are lower/higher by CU 10.00.

Table 19
PARTICIPANTS’ FUND
SCENARIO MODEL YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5

Hybrid Model 140.00 140.00 140.00 140.00 140.00

Scenario 1
Wakala Model 150.00 150.00 150.00 150.00 150.00

Hybrid Model (210.00) (210.00) (210.00) (210.00) (210.00)

Scenario 2
Wakala Model (200.00) (200.00) (200.00) (200.00) (200.00)

Hybrid Model (210.00) (210.00) 290.00 290.00 290.00

Scenario 3
Wakala Model (200.00) (200.00) 300.00 300.00 300.00

SHAREHOLDERS’ FUND

Similarly, the difference in profits or losses within the shareholders’ fund is only due to the Mudarabah fee, which
is an additional income to the shareholders under the Hybrid Model. Note that under the Hybrid Model, in all
scenarios, profits/losses are higher/lower by CU 10.00.

Table 20
SHAREHOLDERS’ FUND
SCENARIO MODEL YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5

Hybrid Model 160.00 160.00 160.00 160.00 160.00

Scenario 1
Wakala Model 150.00 150.00 150.00 150.00 150.00

Hybrid Model 160.00 160.00 160.00 160.00 160.00

Scenario 2
Wakala Model 150.00 150.00 150.00 150.00 150.00

Hybrid Model (210.00) (210.00) 290.00 290.00 290.00

Scenario 3
Wakala Model (200.00) (200.00) 300.00 300.00 300.00

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ENTITY

As explained previously, the amalgamation of the two funds would result in the elimination of Takaful-specific
transactions and, therefore, entity-level profits or losses would be the same under each of the three Takaful
models. Aggregated statements under any Takaful model are also directly comparable with the statements for a
conventional insurer or a mutual.

Table 21
ENTITY
SCENARIO MODEL YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5

Hybrid Model 300.00 300.00 300.00 300.00 300.00

Scenario 1 Wakala Model 300.00 300.00 300.00 300.00 300.00

Cooperative Model 300.00 300.00 300.00 300.00 300.00

Hybrid Model (50.00) (50.00) (50.00) (50.00) (50.00)

Scenario 2 Wakala Model (50.00) (50.00) (50.00) (50.00) (50.00)

Cooperative Model (50.00) (50.00) (50.00) (50.00) (50.00)

Hybrid Model (50.00) (50.00) 450.00 450.00 450.00

Scenario 3 Wakala Model (50.00) (50.00) 450.00 450.00 450.00

Cooperative Model (50.00) (50.00) 450.00 450.00 450.00

The illustrative profit and loss statements provided above under various scenarios cover the three most common
models practiced across the Takaful industry; however, in practice, financial reporting framework as prescribed by
the regulatory authorities could deviate, but would still fit under one of the models discussed above.

Another variation in practice is the non-charging of a wakala fee if there’s Qard outstanding. This is usually
considered a healthier practice, however uncommon, but provides for the participants’ funds to quickly recover
from deficits.

In most of the markets where Takaful entities operate and are effectively regulated, the financial reporting
framework is usually prescribed by the regulatory authorities. As a best practice, participants’ funds should ideally
be reported under IFRS 4 (now IFRS 17) or U.S. GAAP, whereas the shareholders’ fund should be reported under
IFRS 15.

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4.8 ACTUARIAL CONSIDERATIONS

The role of actuaries has always been a prominent one in the insurance world with their expertise being utilized by
various functions, including product pricing, reserving, capital adequacy assessments, reinsurance optimization,
etc. However, this role is more pronounced under the Takaful framework where certain jurisdictions lay out
additional requirements for the Appointed Actuaries of the Takaful operators.

In this section, we will focus on the role of the actuarial function under the Takaful framework and how it differs
from the role of actuaries under the conventional form of insurance.

PRODUCT DESIGN AND PRICING

Product design under Takaful must be approved by the company’s Shari’ah Board ensuring that the design is in
compliance with the applicable Shari’ah standards.

As for the pricing of the products, the approach is similar to that of pricing any product under conventional
insurance where a risk premium is determined based on historical claims experience or reinsurer prescribed risk
premium rates are to be followed. Once cell-level risk premium rates are assessed, the key difference is with
respect to the loadings applied. Under conventional insurance, the risk premium rates are loaded up to reflect the
expenses, commissions, and profit margins; however, under the Takaful framework, the aggregate loading is in the
form of the wakala being levied on the participants’ fund. The two approaches can be formulaically expressed as
follows:

CONVENTIONAL

𝑁𝑒𝑡 𝑅𝑖𝑠𝑘 𝑃𝑟𝑒𝑚𝑖𝑢𝑚

𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑒𝑚𝑖𝑢𝑚 =
1 − 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 𝐿𝑜𝑎𝑑𝑖𝑛𝑔 (%) − 𝐴𝑐𝑡𝑢𝑎𝑙 𝐶𝑜𝑚𝑚𝑖𝑠𝑠𝑖𝑜𝑛 (%) − 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 (%)

TAKAFUL

𝑁𝑒𝑡 𝑅𝑖𝑠𝑘 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛

𝐺𝑟𝑜𝑠𝑠 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 =
1 − 𝑊𝑎𝑘𝑎𝑙𝑎 𝐿𝑜𝑎𝑑𝑖𝑛𝑔 (%)

The approach is similar when pricing long-term individual life products where wakala is treated as a charge to the
participants’ fund which, in turn, covers expenses and commissions borne by the shareholders’ fund. The excess of
wakala over and above the expenses and commissions paid is the profit to the shareholders.

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RESERVING

The table below presents a comparison of different reserves held within each fund under the Takaful framework
compared with those maintained in conventional insurance.
Table 22
COMPARISON OF RESERVES HELD UNDER CONVENTIONAL INSURANCE AND TAKAFUL
CONVENTIONAL INSURANCE4 PARTICIPANTS’ FUND SHAREHOLDERS’ FUND
Premium Reserve – Short- Unearned Premium Reserve Unearned Risk Contribution Unearned Wakala
term Reserve Reserve
Premium Reserve – Short- Premium Deficiency Reserve Risk Contribution Deficiency Not Applicable
term Reserve
Premium Reserve – Long- Mathematical Reserve5 Mathematical Reserve6 Unearned Wakala
term Reserve
Claims Reserve Reported Claims Reported Claims Not Applicable
Claims Reserve Unreported Claims Unreported Claims Not Applicable
Expense Reserve Expense Reserve Not Applicable Not Applicable7

The unearned wakala reserve held within the shareholders’ fund is not usually a prescribed requirement from the
regulatory authorities given the actual extent of expenses and commissions is well known in advance. However, as
a best practice, it is recommended that shareholders hold an unearned wakala reserve.
In essence, under the Takaful framework, specifically when operating under either the Wakala or Hybrid Model,
Unearned Premium Reserve is held in two parts – the portion of the gross contribution, which is expected to cover
future benefits within the participants’ fund held as an unearned risk contribution reserve, whereas the portion
expected to cover expenses and commissions within the shareholders’ fund is held as an unearned wakala reserve.
A similar approach is followed in the case of long-term Takaful contracts where the mathematical reserve under
the Takaful framework is assessed only for the participants’ fund taking the risk contribution (net of wakala fee) as
an inflow and benefits as an outflow. An alternative approach could be to take the gross contribution as an inflow
and wakala fee and benefits as an outflow.

4 Applies to Mutuals, as well as the Cooperative Model, under the Takaful framework
5 Held to cover future expected claims
6 Held to cover future expected benefits
7 Unearned Wakala serves as an expense reserve under the Shareholders’ Ffund

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The premium deficiency reserve under the Takaful framework is only assessed on the participants’ fund. The
following formulaic expressions are helpful for a clear understanding:
CONVENTIONAL
𝑃𝑟𝑒𝑚𝑖𝑢𝑚 𝐷𝑒𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦 𝑅𝑒𝑠𝑒𝑟𝑣𝑒 =
𝑃𝑟𝑜𝑗𝑒𝑐𝑡𝑒𝑑 𝑂𝑢𝑡𝑓𝑙𝑜𝑤𝑠 (𝐶𝑙𝑎𝑖𝑚𝑠 + 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 + 𝐶𝑜𝑚𝑚𝑖𝑠𝑠𝑖𝑜𝑛𝑠) − 𝑃𝑟𝑜𝑗𝑒𝑐𝑡𝑒𝑑 𝐼𝑛𝑓𝑙𝑜𝑤𝑠 (𝑈𝑛𝑒𝑎𝑟𝑛𝑒𝑑 𝑃𝑟𝑒𝑚𝑖𝑢𝑚𝑠)

TAKAFUL
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝐷𝑒𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦 𝑅𝑒𝑠𝑒𝑟𝑣𝑒 =
𝑃𝑟𝑜𝑗𝑒𝑐𝑡𝑒𝑑 𝑂𝑢𝑡𝑓𝑙𝑜𝑤𝑠 (𝐶𝑙𝑎𝑖𝑚𝑠) − 𝑃𝑟𝑜𝑗𝑒𝑐𝑡𝑒𝑑 𝐼𝑛𝑓𝑙𝑜𝑤𝑠 (𝑈𝑛𝑒𝑎𝑟𝑛𝑒𝑑 𝑅𝑖𝑠𝑘 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛𝑠)

Given the participants’ fund is only expected to cover benefits, a contribution deficiency reserve is recommended
when the held unearned risk contribution reserve is insufficient to cover future expected benefit payments.

Claim reserves, either reported or unreported, follow the same practice under all forms of insurance. There’s a
general concern for new Takaful operators with respect to the lack of historical data and challenges around
adequate pricing and reserving of Takaful contracts held. Given the lack of benchmarks, it is advisable to use
benchmarks from the conventional counterparts given the loss experience is largely the same and varies only with
the underwriting practices being followed, assuming both the Takaful operator and its conventional counterpart
are operating in the same jurisdiction.

ENHANCED ROLE OF ACTUARIES UNDER THE TAKAFUL FRAMEWORK

Apart from the traditional role of actuaries in the insurance industry, in certain jurisdictions, Appointed Actuaries
for Takaful operators are also required to advise on the following aspects:

• Reviewing Investment Policy of the Participants’ fund – including carrying out an asset-liability matching
exercise.
• Advise on the basis of surplus distribution.
• Review and advise on the operators’ policy of determining the wakala and mudaraba charges.

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Section 5: Retakaful
Retakaful serves as a Shari’ah-compliant reinsurance framework, mirroring conventional reinsurance practices, but
rooted in the principles of collective support and voluntary contributions. In this cooperative system, participants
unite to collectively shoulder risks. There are two primary forms of Retakaful: treaty and facultative. Treaty
Retakaful involves a formal agreement between a Takaful operator and a Retakaful operator to cover specific
business categories, while Facultative Retakaful focuses on covering specific risks through an arrangement
between the two operators.

Apart from risk-sharing, Retakaful operators provide various services, including underwriting, claims management,
training, product innovation, and risk control. This comprehensive support helps Takaful operators establish and
maintain their operations, similar to conventional reinsurance counterparts.

The prominence of Retakaful is on the rise in the insurance sector, with an increasing number of enterprises
offering comprehensive solutions to Takaful operators globally. This trend highlights the growing recognition of
Retakaful's value within Shari’ah-compliant practices.

By adhering to ethical principles and avoiding interest-based transactions, Retakaful demonstrates a commitment
to ethical conduct that aligns with the well-being of society. In essence, it serves as a cornerstone in Islamic
finance, strengthening Takaful operators against risks and safeguarding the entire industry's stability (Salman et al.,
2014).

Figure 7
RISK CIRCULATION (GÖNÜLAL, 2012)

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5.1 THE NEED FOR RETAKAFUL

Retakaful is imperative for Takaful operators as it serves as a fundamental risk management strategy. By sharing a
portion of risk with external entities, Takaful operators can diversify their risk exposure, ensuring that they are not
overly concentrated in specific types of risks.
In essence, Retakaful serves as a strategic tool for Takaful operators, offering them financial stability, risk
management support, and the ability to navigate a dynamic and challenging insurance landscape. Discussed below
are some of the objectives Takaful operators seek to achieve from Retakaful arrangements:

• Diversification of Risks: Allows operators to spread risk across a broader spectrum, reducing exposure to
concentrated risks.
• Capacity Enhancement: Access to additional capacity beyond the operator’s own financial resources. This
is particularly beneficial for operators when dealing with large and complex risks.
• Financial Stability: Provides an additional layer of financial security, ensuring the operator’s ability to meet
its obligations and maintain solvency.
• Technical Expertise and Support: Access to valuable insights into risk management, underwriting
practices, and claims handling from experienced Retakaful partners.
• Facilitating Expansion: Provision of support and risk-sharing mechanisms to operators for expansion into
newer markets, enabling them to enter regions with diverse risk profiles.
• Regulatory Compliance: Helps Takaful operators meet regulatory requirements, as some jurisdictions
mandate a certain level of risk-sharing through Retakaful arrangements.
• Catastrophe Coverage: Offers a crucial layer of protection against large-scale catastrophes, ensuring that
the Takaful operator can effectively manage and cover losses arising from such events.
• Shari’ah Compliant: Ensures that the risk-sharing practices align with Shari’ah principles, providing a
framework for ethical and Shari’ah-compliant risk management.

5.2 RETAKAFUL WINDOW

Well-capitalized conventional reinsurers can diversify their services by offering Retakaful services in addition to
their primary reinsurance operations. This expansion is facilitated through a dedicated channel known as a
Retakaful Window. To ensure compliance with Shari’ah Law, it is imperative for conventional reinsurers to
maintain a clear segregation of operational activities between their conventional and Retakaful segments. The
Retakaful window must strictly adhere to the prerequisites of Islamic finance. A notable example is ZEP Re (PTA
Reinsurance Company), which extends Retakaful services into Africa through its specialized Retakaful window
located in Sudan.

5.3 RETAKAFUL COMPANIES

Prominent providers of Shari’ah-compliant Retakaful services include Swiss Re Retakaful, Munich Re Retakaful
(MRR), and RGA Retakaful. Swiss Re Retakaful adopted a risk-sharing model, distributing risks among participants
to offer a comprehensive range of services. Operating globally from Kuala Lumpur, Munich Re Retakaful, a
subsidiary of Munich Re, specializes in innovative and Shari’ah-compliant Retakaful solutions for both general and
family segments. Based in the USA, RGA Retakaful provides diverse Retakaful solutions worldwide, emphasizing
mutual assistance and voluntary contributions. These companies, equipped with expertise in risk management,
underwriting, and claims services, play pivotal roles in supporting the global Takaful and Retakaful markets.

The Retakaful industry faces distinctive challenges compared to traditional reinsurance, attributed to its relatively
smaller size and ongoing efforts to expand globally. Challenges include enhancing capacity for large risks and new
products, navigating complexities in surplus distribution, addressing ownership concerns of the Retakaful

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contribution fund, ensuring the availability of Retakaful alternatives, and defining the nature of risk-sharing versus
risk transfer. Overcoming these obstacles necessitates innovation, regulatory clarity, and collaborative efforts to
fortify the Retakaful sector, ensuring sustained and meaningful growth (Gönülal, 2012).

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Section 6: Rationalizing Takaful’s Global Adoption

Adopting Takaful in its truest form, and overcoming the obstacles posed by policymakers and regulators, may
present challenges. The Takaful industry confronts various well-known hurdles that could impede its expansion
and hinder its widespread acceptance in the global market. Nevertheless, a meticulous examination of the
untapped Muslim population segment on the international stage and the opportunities inherent within the Takaful
framework might outweigh the risks linked to fully embracing this framework.

6.1 UNTAPPED MUSLIM POPULATION

The worldwide Muslim population, representing about 23.4% of the global populace in 2010, is projected to reach
2.2 billion by 2030, accounting for approximately 26.4% of the world's population. As the second-largest global
religion, Islam has a significant presence, with 44.1 million Muslims in Europe and 5.2 million in the Americas as of
2010. It's worth noting that roughly 58% of the Muslim population in the Americas consists of immigrants who,
despite having easy access to Islamic financial products in their native countries, may encounter challenges in
accessing such products or services post-immigration to Western countries. This creates a substantial demand for
ethical insurance solutions (Pew Research Centre).

Figure 8
MUSLIMS AS A SHARE OF WORLD POPULATION

Muslims as a Share of World Population, 1990-2030

10

6
Billions

6.1
5.8
4 5.3
4.8
4.2
2
1.6 1.9 2.2
1.1 1.3
0
1990 (A) 2000 (A) 2010 (A) 2020 (P) 2030 (P)

Muslims Non-Muslims

(Source: The Future of the Global Muslim Population, January 2011, Pew Research Centre)

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Table 23
MUSLIM POPULATION BY REGION
2010 2030
Estimated Estimated Percentage Projected Muslim Projected Percentage of
Muslim of Global Muslim Population Global Muslim
Population Population Population

World 1,619,314,000 100.00% 2,190,154,000 100.00%

Asia-Pacific 1,005,507,000 62.09% 1,295,625,000 59.16%
Middle East-North Africa 321,869,000 19.88% 439,453,000 20.06%
Sub-Saharan Africa 242,544,000 14.98% 385,939,000 17.62%
Europe 44,138,000 2.73% 58,209,000 2.66%
Americas 5,256,000 0.32% 10,927,000 0.50%
(Source: The Future of the Global Muslim Population, January 2011, Pew Research Centre)

In the quest for a more inclusive and socially responsible insurance landscape, the adoption of Shari’ah-compliant
products holds significant promise. Insurers, by steering clear of interest-based transactions and unethical
investments, can cultivate trust and establish enduring connections with customers, securing a competitive edge in
a specialized market. Drawing inspiration from the Takaful framework, insurance companies in the Western world
may find avenues for enhanced market penetration, offering ethical insurance products to a vast Muslim customer
base. A notable practice, Window Takaful, involves traditional insurers diversifying services by providing Takaful
products alongside conventional offerings, catering to customers seeking Shari’ah-compliant insurance (Hassan &
Abbas, 2019).

6.2 INCLUSIVITY AND SOCIAL SOLIDARITY

In a world grappling with economic inequality and environmental challenges, Takaful fosters a sense of social
solidarity and mutual support. By integrating these principles into business models, insurance companies in the
western markets can reinforce their corporate social responsibility efforts and demonstrate a commitment to
ethical practices that extend beyond mere profit-making motives. Based on the concept of cooperation and shared
responsibility, Takaful tends to foster a sense of social solidarity amongst investing members who contribute to a
common pool to support those in need. This can promote a more inclusive insurance system, especially in
communities where traditional insurance might be inaccessible or less prevalent (Hassan & Abbas, 2019).

6.3 DIVERSIFIED INVESTMENT PORTFOLIOS WITH ETHICAL ASSETS

One of the major concerns associated with conventional insurance amongst the Muslim population in the Western
markets is the risk of their investments being made into unethical ventures. The Takaful framework addresses this
by encouraging insurers to diversify investment portfolios with ethical assets, contributing to a more sustainable
and socially responsible world. This not only mitigates risks associated with traditional investments, but also taps
into untapped markets in the Islamic financial sector, attracting socially conscious investors (Qian & Darman,
2023).

6.4 CROSS-CULTURAL UNDERSTANDING AND COLLABORATION

The cross-pollination of ideas between Islamic and conventional finance can foster relationships between
companies and potential customers, leading to the development of hybrid models that combine the best aspects
of both systems, and ultimately result in penetration of an untapped population segment. Such innovation may

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foster financial products that not only adhere to Islamic principles, but also cater to broader ethical and social
responsibility considerations. This creative synthesis can bring about financial solutions that benefit individuals and
businesses alike, irrespective of their cultural or religious backgrounds (Qian & Darman, 2023).

6.5 RISK-SHARING AND FAIRNESS

The Takaful framework's essence lies in risk-sharing, promoting equality and fairness among policyholders. When
participants share the costs of claims, the system reinforces the principles of equality. Adopting the Takaful
framework can help conventional insurers attract individuals and businesses actively seeking Islamic financial
solutions, achieving better market diversification (Hassan & Abbas, 2019).

6.6 REGULATION AND CONSUMER PROTECTION

Regulation plays a crucial role in formalizing the Takaful industry, ensuring adherence to strict standards for
consumer protection and market confidence. While the Takaful framework offers advantages, its adoption
requires careful consideration of regulatory requirements and a thorough understanding of Islamic financial
principles for a harmonious business process between providers and consumers (Hassan & Abbas, 2019).

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Section 7: Shari’ah Supervisory Board

A Shari’ah Supervisory Board (SSB) is a vital component in an Islamic financial institution comprising distinguished
religious scholars well-versed in Islamic jurisprudence, specifically regarding financial transactions. The primary
role of the board is to assess and affirm the alignment of activities conducted by an Islamic financial institution
with the principles of Shari’ah law.

Moreover, the board's responsibility extends to ensuring that the Islamic financial institution under its purview
conducts financial operations in accordance with the ethical guidelines outlined by Shari’ah principles (Abdul
Rahman et al., 2004).

As per the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), the SSB is an
independent body consisting of jurists with specialized religious knowledge. This body is entrusted with the task of
directing, guiding, checking, reviewing, and overseeing the financial operations of Islamic Financial Institutions (IFI)
to ensure Shari’ah compliance.

7.1 ROLES AND RESPONSIBILITIES OF THE SHARI’AH SUPERVISORY BOARD

The Shari'ah Supervisory Board (SSB) plays a crucial role in the context of Takaful, ensuring that the operations and
practices of Takaful operators adhere to Islamic principles and Shari'ah law. The responsibilities of the SSB are
multifaceted, encompassing both pre-auditing and post-auditing functions to guarantee compliance (Briston & El-
Ashker, 1986).

In the pre-auditing phase, the SSB is responsible for formulating review procedures tailored for adoption by
Takaful operators. These procedures are designed to assess and evaluate the Shari'ah compliance of various
aspects of Takaful operations, including product structures, investment activities, and underwriting practices. The
aim is to establish a robust framework that aligns with Islamic finance principles and safeguards the interests of
participants. This pre-emptive role ensures that Takaful products and processes are developed in accordance with
Shari'ah guidelines from their inception.

In the post-auditing phase, the SSB performs rigorous review procedures, involving a thorough examination of
working documents related to Takaful operations. This includes scrutinizing financial transactions, investment
portfolios, and underwriting practices to ensure that they remain in compliance with Shari'ah principles. The SSB
records its findings and generates comprehensive reports detailing the outcomes of the review process. These
reports serve as a transparent mechanism to communicate the Shari'ah compliance status of the Takaful
operations to stakeholders, including participants and regulatory authorities.

This oversight by the SSB provides a robust framework for ethical and Shari'ah-compliant Takaful operations (Billah
& Daud, 2015).

7.2 SSB AND CORPORATE GOVERNANCE ISSUES

While the Shari’ah Supervisory Board (SSB) plays a crucial role in aligning the operations of financial institutions
with Islamic finance principles, it introduces five significant corporate governance issues: independence,
transparency, confidentiality, consistency, and disclosure.

The foremost concern centers around the independence of SSB members regarding the institution's management.
As these members are appointed by shareholders and report to the Board of Directors, a potential conflict arises
due to their dual role as evaluators and employees. This dual relationship can compromise their impartiality,
especially when their judgment opposes financially beneficial yet non-compliant transactions. Management might
exert influence to sway the opinion of SSB members in such cases.

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The issue of confidentiality emerges when Shari’ah scholars sit on multiple financial organizations' boards. While
this might enhance their independence, it poses a risk of breaching confidentiality. Consistency of judgment across
institutions and jurisdictions is another crucial matter. Although jurisprudence is used to interpret the law, any
conflict in opinions among jurists questions the acceptability and authenticity of financial matters. Notably, global
surveys show a high level of concordance among jurists.

The final concern is the disclosure of information about Shari’ah advisories. While complete transparency
enhances stakeholders' confidence, it also brings potential issues to light. However, if concerns regarding
independence, confidentiality, and consistency are addressed, transparency becomes a valuable tool for educating
the public, positively impacting cost implications, credibility assessment, and building confidence in Shari’ah
compliance (Grais and Pellegrini, 2006).

Transitioning from these challenges, the Accounting and Auditing Organization for Islamic Financial Institutions
(AAOIFI) plays a pivotal role in establishing comprehensive standards that govern various aspects of Islamic
finance, including Shari'ah compliance, accounting, auditing, and governance. AAOIFI has diligently developed and
published a total of 59 Shari'ah standards, 33 accounting standards, 8 auditing standards, 14 governance
standards, and 3 standards on ethics. These standards collectively form a framework to ensure the adherence of
Islamic financial institutions (IFIs) to Shari'ah principles, while promoting transparency, accountability, and sound
governance practices.

Among the plethora of standards, those pertaining to governance hold particular significance in enhancing
corporate governance within Islamic financial institutions. The governance standards set by the AAOIFI encompass
crucial aspects, such as the appointment and composition of Shari'ah Supervisory Boards (SSBs), review
procedures, and the independence of SSBs. These standards are instrumental in addressing corporate governance
issues by providing clear guidelines on the establishment and functioning of SSBs, which play a pivotal role in
ensuring Shari'ah compliance.

7.3 ENHANCING SSB PROFICIENCY AND SHARI’AH COMPLIANCE

Ensuring the effectiveness of Shari’ah Supervisory Board (SSB) members and Shari’ah reviewers demands a
comprehensive strategy. Immediate actions to elevate the expertise of Shari’ah advisors may involve
implementing targeted training initiatives focused on Islamic transactions and commercial law within the Islamic
financial institutions. Collaborations with specialized training institutions and partnerships with government-
authorized bodies, such as central banks, could be instrumental in this effort.

The development and promotion of academic programs concentrating on Islamic transactions and commercial law,
supported by funding and official university endorsements, would further strengthen proficiency. Simultaneously,
a certification process would formally acknowledge the skills of Shari’ah advisors and reviewers.

To ensure transparency and accountability, the professional backgrounds of SSB members should be readily
accessible to the public through platforms like websites and annual reports. Consistent prerequisites at a national
level could be enforced by self-regulatory bodies or national authorities, fortifying the overall certification process.

Similarly, a nationwide registration system, modeled after Malaysia’s Association of Shari’ah Advisors in Islamic
Finance (ASAS), could be established. This approach not only ensures competency, but also fosters increased
independence in Shari’ah audit processes (Grais and Pellegrini, 2006).

Recognizing the pivotal role of Shari’ah Supervisory Boards (SSB) in fostering good governance within the Islamic
financial institutions, it is imperative to grant them maximum independence in their supervisory capacity to

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eliminate perceived differences between Islamic Financial Institutions (IFIs) and SSB members. Despite these
efforts, variations in interpretation and conclusions may still arise among scholars sitting on different SSBs
appointed by IFIs within a country.

To ensure a unified interpretation, it is recommended that SSBs be centralized at the national level. This
centralized approach has proven effective in countries like Iran, where the Council of Guardians oversees and
guarantees Shari’ah compliance of the entire financial sector. In a similar vein, Indonesia’s National Shari’ah
Council (NSC), an extension of the National Ulama Council, possesses the authority to issue clarifications on various
financial matters.

By consolidating the functions of SSBs at the national level, a standardized framework for Shari’ah compliance can
be established, mitigating the risk of divergent interpretations. This model, already successfully implemented in
certain jurisdictions, ensures consistency and oversight, contributing to the overall effectiveness and credibility of
Shari’ah governance within the financial sector.

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Section 8: Global Expansion and Barriers: Takaful Growth in Key Markets and
Challenges Ahead
The Takaful market has been developing steadily in recent years, especially in Muslim-majority countries and
regions. According to various sources, the global Takaful market exhibited remarkable growth, reaching
approximately USD 30 billion in 2022 (USD 19 billion in 2017). This expansion is attributed to several factors:
escalating demand for Shari’ah-compliant financial services among the world’s substantial Muslim population,
especially in the GCC and Southeast Asia; untapped opportunities due to the limited presence of traditional
insurance in many Muslim nations; appealing ethical aspects resonating with both Muslim and non-Muslim
clientele, such as fairness and transparency; and innovative, diversified Takaful offerings addressing various
customer needs like family, general, health, and education takaful.

Forecasts predict a continuous upward trajectory with a projected 10.2% compound annual growth rate during
2023-2028, potentially reaching USD 54.9 billion by 2028. This growth will be driven by factors such as increasing
awareness in emerging markets, supportive regulatory measures, collaborative efforts within the industry, and the
integration of digital solutions for operational efficiency, customer service enhancement, and product innovation
(Raj & Kumar, 2021).

Figure 9
HISTORICAL AND FORECASTED VALUES OF THE GLOBAL TAKAFUL MARKET FROM 2018 -2030

World Takaful Market Size

70

60

50
USD Billions

40

30

20

10

0
2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030

8.1 TAKAFUL IN SELECT GCC AND ASIAN COUNTRIES

This subsection offers insights into the dynamics of the insurance industry across selected GCC and Asian countries
from 2020 to 2022, paralleling the regulatory discourse highlighted in Section 3. It delves into the number of listed
insurers and Takaful operators, as well as examining the proportion of Takaful contributions against traditional
insurance premiums for each selected country.

The tabulated data presents the landscape of conventional and Takaful companies in Bahrain, the KSA, Malaysia,
Pakistan, and the UAE. Notably, the KSA dominates the Takaful market, with Pakistan following closely behind in
terms of the listed Takaful operators.

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Table 24
CONVENTIONAL & TAKAFUL COMPANIES IN SELECT GCC AND ASIAN COUNTRIES – 2022
COUNTRY CONVENTIONAL TAKAFUL TOTAL
Bahrain 3 2 5
KSA - 27 27
Malaysia 34 16 50
Pakistan 21 19 40
UAE 21 7 28
Total 79 71 150

The table illustrates the count of listed reinsurers and Retakaful operators across the five chosen countries. Among
the 150 listed companies, 71 are designated as either Takaful or Retakaful operators. Notably, in the Kingdom of
Saudi Arabia, insurers adhere to the cooperative model mandated by the regulatory authority, rendering
conventional insurers absent in the Kingdom. This highlights the KSA's prominence, boasting the highest number of
Takaful operators, with Pakistan following closely as the second-largest hub.

Analyzing revenue trends over the three-year span reveals Malaysia's robust performance, leading in annual
insurance/Takaful revenues. The KSA emerges as the most prominent Takaful market in the GCC and globally,
showcasing substantial growth.

Figure 10
CONVENTIONAL & TAKAFUL REVENUES IN BAHRAIN – 2020-2022

Bahrain
0.700
0.600
0.500
USD Billions

0.400
0.300
0.200
0.100
-
2020 2021 2022
Conventional 0.344 0.351 0.389
Takaful 0.142 0.151 0.189
Grand Total 0.485 0.501 0.578

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Figure 11
CONVENTIONAL & TAKAFUL REVENUES IN THE KINGDOM OF SAUDI ARABIA (KSA) – 2020-2022

Kingdom of Saudi Arabia (KSA)

16.000
14.000
12.000
USD Billions

10.000
8.000
6.000
4.000
2.000
-
2020 2021 2022
Conventional - - -
Takaful 10.083 11.055 14.228
Grand Total 10.083 11.055 14.228

Figure 12
CONVENTIONAL & TAKAFUL REVENUES IN MALAYSIA – 2020-2022

Malaysia
20.000
18.000
16.000
14.000
USD Billions

12.000
10.000
8.000
6.000
4.000
2.000
-
2020 2021 2022
Conventional 14.350 14.647 14.161
Takaful 3.256 3.824 4.282
Grand Total 17.606 18.471 18.443

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Figure 13
CONVENTIONAL & TAKAFUL REVENUES IN PAKISTAN – 2020-2022

Pakistan
1.400
1.200
1.000
USD Billions

0.800
0.600
0.400
0.200
-
2020 2021 2022
Conventional 0.994 1.011 0.921
Takaful 0.191 0.213 0.182
Grand Total 1.186 1.223 1.103

Figure 14
CONVENTIONAL & TAKAFUL REVENUES IN THE UNITED ARAB EMIRATES (UAE) – 2020-2022

United Arab Emirates (UAE)

9.000
8.000
7.000
6.000
USD Billions

5.000
4.000
3.000
2.000
1.000
-
2020 2021 2022
Conventional 5.691 6.051 6.926
Takaful 0.966 1.037 0.963
Grand Total 6.657 7.088 7.889

Across the examined countries, Malaysia leads in annual insurance/Takaful revenues. Notably, the KSA emerges as
the largest Takaful market globally. In 2021, the growth in Takaful contributions outpaced the growth in
conventional premiums, with significant growth observed in Malaysia and Pakistan. In 2022, while the KSA
experienced remarkable growth, Malaysia saw substantial growth in Takaful contributions despite a negative
growth in conventional premiums.

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Table 25
GROWTH IN CONVENTIONAL & TAKAFUL REVENUES IN SELECTED GCC AND ASIAN COUNTRIES
GROWTH – 2021/2020
COUNTRY CONVENTIONAL TAKAFUL TOTAL
Bahrain 2.09% 6.41% 3.35%
KSA 0.00% 9.65% 9.65%
Malaysia 2.07% 17.44% 4.91%
Pakistan 1.68% 11.01% 3.18%
UAE 6.32% 7.36% 6.47%
Total 3.18% 11.22% 6.45%

GROWTH – 2022/2021
COUNTRY CONVENTIONAL TAKAFUL TOTAL
Bahrain 10.87% 25.05% 15.13%
KSA 0.00% 28.86% 28.86%
Malaysia -2.92% 12.42% 0.26%
Pakistan 0.70% -5.22% -0.33%
UAE 14.33% -7.27% 11.17%
Total 2.20% 22.22% 10.70%

In 2021, aggregate Takaful contributions for the selected countries surged by 11.22%, outpacing the modest 3.18%
increase in conventional revenues. Notably, the Kingdom of Saudi Arabia (KSA) experienced significant growth,
with Takaful contributions soaring by 9.65%. Across all selected countries, Takaful contributions exhibited robust
growth, surpassing that of conventional premiums. Malaysia and Pakistan stood out with remarkable growth rates
of 17.44% and 11.01%, respectively, while conventional premiums lagged behind at 2.07% and 1.68%, respectively.

In 2022, aggregate revenues across the five countries surged by 10.70%, driven by substantial growth in the KSA at
28.86%. Malaysia saw nominal growth in insurance revenues, yet Takaful contributions surged by 12.42%, while
conventional premiums plummeted by 2.92%. Pakistan experienced a nominal decline of 0.33% in overall
revenues, largely due to currency devaluation. However, in local currency terms, Pakistan's insurance/Takaful
revenues witnessed an approximate 15% annual growth from 2020 to 2022.

Takaful contributions in 2022 showcased remarkable growth of 22.22%, compared to conventional premiums'
modest 2.20% increase. Notably, the UAE and Pakistan experienced negative growth in Takaful contributions,
contrasting with positive growth in conventional premiums. This downturn in Takaful contributions can be
attributed to a combination of factors, including insolvencies among the UAE Takaful operators and regulatory
pressure to consolidate. In response to financial strains and regulatory scrutiny, several Takaful operators faced
challenges and were compelled to consider consolidation strategies, such as selling or merging with larger players
in the industry. These developments underscore the complexity and competitive landscape of the Takaful sector,
prompting a reassessment of business models and regulatory frameworks to ensure long-term sustainability and
resilience.

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8.2 IMPEDIMENTS TO TAKAFUL PENETRATION

While Takaful is gaining a respectable momentum in the GCC and other Asian regions, it’s awareness, penetration
and potential adoption in the Western markets remain uncertain. Frequently mistaken for mutual funds, Takaful,
as a form of ethical insurance, is still an anomalous concept for many Western insurance companies, impeding its
worldwide expansion. Several barriers obstruct its progress:

8.2.1 LACK OF KNOWLEDGE AND COMPREHENSION OF TAKAFUL

The concept of Takaful and its principles remain unfamiliar to many individuals, including both Western consumers
and insurance companies. This lack of familiarity may lead to limited promotion on suitable platforms,
misunderstandings regarding Takaful's concepts, or a general reluctance to engage with Islamic finance products.
Some perceive Takaful merely as a variation of conventional insurance within an Islamic framework and question
its adherence to Shari’ah principles. Others underestimate its financial security, relying instead on traditional social
security systems. Overcoming these challenges necessitates educational initiatives aimed at enhancing
comprehension of Takaful and promoting individual risk management practices within Muslim and non-Muslim
communities alike. Presently, Takaful education predominantly targets practitioners and investors, with minimal
efforts directed towards broader awareness campaigns among the intended audience (Unwin et al., 2010).

8.2.2 REGULATORY CHALLENGES AND LACK OF STANDARDIZATION

The regulatory framework presents significant challenges for Takaful operations, particularly in Western
jurisdictions where regulations are primarily designed for conventional insurance models. Integrating Takaful
concepts into Western financial reporting frameworks is intricate and time-consuming, often yielding unreliable
outcomes. This complexity not only impedes cross-border business endeavors and product innovation, but also
complicates compliance efforts. The lack of standardized regulations further constrains market expansion and
hampers the overall advancement of the Takaful industry. Takaful entities must navigate a plethora of regulatory
requirements, eroding consumer trust and hindering the potential for operational efficiency and uniformity
(Saeed, M., 2019).

To address these issues, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) has
developed and issued 117 standards and technical pronouncements. These aim to harmonize and standardize
financial reporting for Takaful and Retakaful operators, ensuring compliance with Shari’ah principles.

8.2.3 CHALLENGES FROM CULTURAL AND REGIONAL DISCREPANCIES

Negative perceptions surrounding Takaful have emerged due to limited awareness and misunderstandings about
Islamic Finance. Variations in the interpretation of Islamic principles influence how potential clients perceive
Takaful's adherence to them. Misconceptions arising from a lack of understanding of cultural nuances can breed
distrust. To address these challenges effectively, it is imperative to implement strategies, such as refining product
offerings, employing robust communication methods, and fostering a culture of transparency. Enhancing
awareness of how the Takaful framework aligns with principles of ethical finance is crucial for removing barriers
associated with cultural and religious perceptions (Nabi & Rahman, 2019).

8.2.4 THE LACK OF SHARI’AH EXPERTS WITH THE NECESSARY QUALIFICATIONS

The establishment of a Shari’ah Supervisory Board, typically comprising three or more experts, is a prerequisite for
every Takaful operator. Preference is often given to board members with regional expertise when Takaful
companies seek expansion, enhancing their credibility. These scholars bear the responsibility of ensuring Shari’ah
compliance, necessitating a deep understanding of both Takaful operations and Islamic law. However, the scarcity
of experts proficient in both Islamic law and insurance leads to a situation where these scholars serve on multiple
boards, potentially resulting in conflicts of interest and diminished advisory quality. Moreover, the limited

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availability of such scholars elevates the cost of establishing a Shari’ah board, posing a temporary barrier for new
entrants into the Takaful market (Unwin et al., 2010).

8.2.5 WAKALA LEVIES AND COST OF CAPITAL

The challenges stemming from wakala levies and capital costs profoundly affect the financial sustainability and
operational efficiency of Takaful operators. Elevated wakala fees possess the potential to reduce participants'
contributions and undermine competitiveness in the market. Moreover, since commissions are deducted from the
shareholders' fund and wakala fees, in specific jurisdictions, may be subject to regulatory limits, Takaful operators
face constraints in competing with conventional insurers. Takaful operators must ensure that commissions fall
within the maximum wakala levied, ensuring surplus wakala remains to cover operating costs and yield profit
margins for the shareholders, a limitation not imposed on conventional insurers. Therefore, achieving a delicate
equilibrium between covering expenses and offering competitive returns to both participants and shareholders is
essential. Maintaining a competitive edge and ensuring operational efficiency are paramount, as high fees can
deplete the profitability of participants' funds. Given that the cost of capital profoundly influences investment
strategies and overall financial performance, a meticulous approach that prioritizes participants' interests,
complies with legal requirements, and ensures long-term sustainability is imperative (Ali & Nisar, 2017).

8.2.7 CHALLENGES IN RISK ACCEPTANCE

The acceptability of risk in Takaful presents multifaceted challenges that stem from differing scholarly perspectives
and interpretations, particularly evident in General Takaful. Scholars hold varying opinions on the permissible
extent of risks, especially concerning mutual guarantee concepts applied to large-scale risks involving limited
participants, such as government projects where government agencies are the primary contributors.

Discussions surrounding Takaful risk also grapple with distinguishing between permissible and impermissible risks,
emphasizing the need for rigorous risk assessment protocols for inclusion. The absence of standardization further
complicates matters, extending to defining insured events and exclusions. In the realm of Family Takaful,
disparities emerge in how sensitive issues like suicide, AIDS, and contestability are addressed.

These inconsistencies contribute to the complexity of pricing assumptions and experience pooling, hindering
efforts to achieve consistency across Takaful operations with varying underwriting practices and contractual terms.
Overcoming these challenges requires concerted efforts to establish standardized frameworks and protocols,
promoting transparency and coherence within the Takaful industry.

8.2.8 LACK OF PERMITTED INVESTMENT AVENUES

The challenge of limited investment avenues confronts Takaful operators, who frequently encounter restrictions
due to the dominance of interest-bearing instruments in the market. This dilemma is exacerbated by the need to
strike a balance between long-term sustainability and short-term profitability. The increasing pressure to mitigate
investment risks, driven by the concentration of investments in equity and real estate, presents Takaful companies
with an ethical dilemma. Shari’ah laws prohibit certain forms of investments, leading to a lack of available
investment avenues for Takaful companies.

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Section 9: The Solution - Window Takaful

Amidst the growth of Takaful in the GCC and other Asian countries, coupled with the challenges hindering its
expansion, it becomes imperative to devise solutions to the existing obstacles. Takaful's framework stands out for
its fairness, particularly evident in its principle of excess sharing among participants, fostering a sense of
community ownership. However, a significant hurdle lies in the absence of a standardized financial reporting
framework, especially prevalent in many Western countries. Despite this, the absence of such a framework
shouldn't preclude the consideration of Takaful operations.

For insurers worldwide, particularly those operating in regions with limited Takaful infrastructure, the concept of
Window Takaful presents a practical solution. According to the Islamic Financial Services Board (IFSB), Window
Takaful involves establishing a dedicated division within a conventional insurer, referred to as the ‘host,’ with its
own distinct assets and liabilities. This division is separate from the conventional operations and is specifically
designed to offer Takaful or Retakaful products.

Window Takaful, prevalent in various Muslim countries like Pakistan and Indonesia, serves as a conduit for
expanding into untapped markets. Window operations promote financial inclusion by extending Takaful products
to segments of the population previously underserved by conventional insurers. By leveraging the existing
infrastructure and market insights of conventional insurers, window operations can efficiently penetrate untapped
regions, thereby boosting growth and expansion within the insurance industry.

In Pakistan, for instance, prominent insurers have successfully reached a segment of the population seeking Islamic
insurance products by establishing window Takaful operations, facilitated by minimal licensing requirements and
lower capital thresholds set by the Security & Exchange Commission of Pakistan. In Indonesia and Turkey, most
window operations have evolved into full-fledged Takaful entities. This transition was primarily guided by
regulatory directives, as window operations were initially permitted for a limited duration. However, this
allowance significantly contributed to the growth of the Takaful industry in these countries and facilitated the
development of relevant regulatory frameworks.

Similarly, financial giants in the Middle East, such as Citi, Deutsche, and HSBC, have ventured into the Islamic
finance domain through dedicated “Islamic Windows," leveraging their market insights and financial expertise to
cater to the growing demand for Islamic products.

In countries where regulators do not provide a financial reporting framework for Takaful operators, such as Sri
Lanka, Takaful companies exist and operate with internal financial reporting carried out in line with the standards
established by the AAOIFI, while public reporting is carried out in compliance with local regulations. This approach
is operationally possible, as shown in Section 4 of this paper, where the amalgamation of Takaful funds produces
financial statements closely aligned with conventional financial reporting.

While the establishment of an independent Shari’ah Supervisory Board may come with its own inherent problems,
as discussed in Sections 7 and 8 of this paper, particularly due to the scarcity of Shari’ah experts well-versed in
Islamic finance principles, for window Takaful operations, there exists a viable avenue for navigating this challenge.

In the absence of a Shari’ah Supervisory Board, guidance and reference can be drawn from the comprehensive
Shari’ah standards established by the Accounting and Auditing Organization for Islamic Financial Institutions
(AAOIFI). These standards serve as a universally recognized framework for ensuring Shari’ah compliance within
Islamic financial institutions, offering a roadmap for Takaful operators, including those operating through Takaful
windows.

By leveraging the principles outlined by the AAOIFI, window Takaful operations can streamline their compliance
efforts and mitigate the complexities associated with establishing an independent Shari’ah Supervisory Board.
These standards offer a clear framework for interpreting Shari’ah principles, enhancing transparency and trust in
the Takaful sector. Despite the scarcity of Shari’ah experts posing a formidable challenge for Takaful operators, the

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utilization of standards established by the AAOIFI presents a practical solution for ensuring Shari’ah compliance,
especially within the realm of window Takaful operations in jurisdictions where regulatory guidance around
Takaful framework is non-existent. By following these guidelines, Takaful providers can effectively navigate Islamic
finance complexities confidently, building trust and promoting ethical insurance practices.

It is also important to note that the Takaful market is on a steady and impressive growth trajectory in recent years,
with a particularly strong presence in Muslim-majority countries and regions with market expansion surging from
written contributions of USD 19 billion in 2017 to approximately USD 30 billion in 2022. Owing to a significant
increase in demand for Shari’ah-compliant financial services, fertile ground waits for conventional insurers to
provide Shari’ah-compliant solutions, either through a window or a stand-alone Takaful entity.

Moreover, many underdeveloped nations still have limited traditional insurance offerings, leaving ample room for
Takaful to fill this void and tap into previously untapped opportunities. The ethical dimensions of Takaful, including
principles of fairness and transparency, have also resonated strongly with both Muslim and non-Muslim
customers, further fueling its growth. Takaful providers have innovatively diversified their offerings, catering to a
range of customer needs, including family, general, health, and education Takaful. This diversification has
contributed to the industry’s resilience and attractiveness.

In summary, Takaful goes beyond mere insurance; it signifies a substantial and ethical shift in the insurance
landscape. As we continue to prioritize moral and inclusive financial solutions, Takaful will undoubtedly remain a
prominent feature, contributing to our mission of fostering a financially secure and compassionate future for all. As
someone who values social responsibility, I perceive Takaful as a refreshing and compassionate insurance
alternative. Its emphasis on principles like avoiding interest and uncertainty aligns seamlessly with my core values,
ensuring that my insurance decisions reflect my convictions.

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Acknowledgments
The author extends heartfelt gratitude to individuals whose dedicated efforts were instrumental in the data
accumulation and analysis for this project: Ms. Sidra Mansoor, Ms. Fatima Khan, Ms. Hiba Ibad, and Ms. Rida Hanif,
whose diligent work ensured the accuracy and relevance of this paper.

A special acknowledgment to Mr. Syed Shiraz Anwar for his valuable review of the work, and sincere appreciation
to the General Insurance Research Committee (GIRC) of the Society of Actuaries Research Institute for providing
the opportunity to undertake this endeavor.

Project Oversight Group members:

R. Dale Hall, FSA, MAAA, CERA

Zain Ibrahim, ASA, ACIA

Andrew Peterson, FSA, MAAA, FCA

At the Society of Actuaries Research Institute:

Rob Montgomery, ASA, MAAA, Independent Consultant – Research Project Manager

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Appendix A: Definitions and Acronyms

AAOIFI: The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) stands as an
independent international nonprofit entity. It is dedicated to formulating standards for accounting, auditing,
governance, ethics, and adherence to Shari’ah principles within the Islamic financial sector.

Capital Adequacy: Capital Adequacy is to prescribe the capital requirement of a statutory fund to ensure that the
obligations to, and reasonable expectations of, policyholders and creditors are able to be met under a range of
adverse circumstances, in the context of a viable ongoing operation.

Conventional Insurance: Conventional companies are only subject to the governing laws. Premium paid by the
policyholder is considered as income to the company, belonging to the shareholders. All surpluses and profits
belong to the shareholders only.

Cooperative Model: The Cooperative Model is a type of Takaful Model and differs significantly from the Hybrid
and Wakala models. The financial reporting under this model is more closely aligned with that under mutual or
conventional insurance given there’s only one fund and Takaful-specific transactions, such as a Wakala fee,
Mudarabah fee, or Qard, are non-existent. The only key difference relates to the profit-sharing between the
participants and the shareholders, which does not exist in the case of conventional insurance.

Earned Contribution: Earned contribution refers to the portion of a Takaful contribution that corresponds to the
expired portion of the Takaful policy. In Takaful, contributions are typically paid in advance for a specific period of
coverage. As time progresses and the policy is in force, the operator "earns" the contribution by providing
coverage for that period.

Gharar: An Arabic term used in Islamic finance referring to uncertainty, hazard, or ambiguity in a contract.

Hibah: In Islamic finance, "hibah" refers to a unilateral gift given voluntarily by one party to another without any
expectation of reciprocity. In the context of Takaful operations, hibah may be utilized to address deficits within the
participants' funds, effectively transferring the ownership of assets without any consideration.

Hybrid (Wakala & Mudarabah) Model: Wakala represents a contract where one party acts as an agent to manage
another party's funds or assets for an agreed fee or commission. Meanwhile, Mudaraba is a partnership
arrangement where one party provides the capital and the other contributes expertise or labor (Mudarib), and
profits are shared according to a pre-agreed ratio while bearing potential losses.

IFSB: Islamic Financial Services Board

Islamic Commodity Funds: A finance vehicle in the realm of Islamic finance that focuses on investing in
commodities in accordance with Islamic principles.

Ijarah Fund: An Ijarah fund is a financial mechanism in Islamic finance that operates based on the principle of
Ijarah, which is akin to a leasing or rental agreement.

Kafalah: Kafalah is a concept in Islamic finance that refers to a guarantee or suretyship. It involves a contract
where a third party assumes responsibility or acts as a guarantor for the fulfillment of a contractual obligation or
debt owed by another party.

Maysir: An Arabic term in Islamic finance and ethics that refers to the concept of gambling or speculation.

Mudarabah: Mudarabah is a partnership-based contract in Islamic finance where one party provides the capital
and another party offers expertise or labor (known as Mudarib). In this arrangement, the investor provides the

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funds, while the entrepreneur or manager (Mudarib) contributes skills, effort, or expertise to undertake a business
venture or investment activity.

Murabaha: Murabaha is a transaction in Islamic finance that involves the sale of goods at a marked-up price. It's a
type of contract where the seller expressly mentions the cost incurred and the profit margin added to determine
the selling price. In essence, it's a cost-plus-profit arrangement which allows the buyer to defer payment through
installments.

Mudarabah Model: It is a type of Takaful Model where Mudarib, the Takaful operator, and the participants have a
profit-sharing agreement. Mudarib manages investments and claims payments, while the participants combine
their cash into a Takaful fund.

Mutual Insurance: A mutual insurance company is a privately-held insurance company that is owned by its
policyholders. Mutual insurers are established with the sole purpose of providing its members with insurance
coverage.

Muamalat: Muamalat refers to the transactions, contracts, and dealings involving monetary or economic activities
within Islamic jurisprudence.

Participants: In the context of Takaful, a participant refers to an individual or entity that joins a Takaful scheme.

Qard-e-Hasn: Qard-e-Hasn is an interest-free loan extended out of goodwill in Islamic finance. The term "Qard"
refers to a loan, and "Hasn" signifies "good" or "beneficial.” It's a form of loan where the lender provides funds to
the borrower without expecting any interest or profit in return.

Riba: It is an Arabic term that refers to the prohibition of interest or usury in Islamic finance.

Retakaful: Retakaful represents a Shari’ah-compliant reinsurance framework, serving as the Islamic counterpart to
conventional reinsurance practices. It operates similarly to conventional reinsurance, but aligns with Islamic
finance guidelines.

Retakaful Window: A Retakaful window refers to a specialized division or unit within a conventional reinsurance
company that offers Retakaful services alongside its primary reinsurance operations. This setup allows a
conventional reinsurance company to provide Retakaful services to Islamic insurance companies (Takaful
operators), while maintaining its traditional reinsurance activities.

Shari’ah: Shari'ah is the set of guidelines and rules that guide Muslims in how to live their lives. It covers
everything from daily routines like prayer and charity to how people should behave and do business. It's like a
moral compass for Muslims, guiding them to be fair, kind, and follow the teachings of Islam in all aspects of life.

Shari’ah Advisor: An expert in Islamic law and finance who provides guidance and oversight to ensure that
financial products, services, and business practices comply with Shari’ah principles.

Shari’ah Supervisory Board (SSB): A Shari’ah Supervisory Board (SSB) is an independent body that is composed of
high-standing religious scholars with in-depth knowledge of Islamic jurisprudence on the matters of financial
transactions. It's established by Islamic financial institutions, such as banks or insurance companies, to ensure that
their operations, products, and services comply with Shari'ah principles.

Sukuk: Sukuk, often referred to as Islamic bonds, are financial instruments structured to adhere to Islamic principles.
Unlike conventional bonds that involve interest payments, sukuk represent ownership or a share of an underlying
asset, project, or investment in compliance with Shari’ah law.

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Tabbaru: A concept in Islamic finance that refers to voluntary contributions made by participants in a Takaful
scheme.

Takaful: Takaful is an Islamic insurance system based on the principles of mutual cooperation, shared
responsibility, and solidarity. It operates as an alternative to conventional insurance while adhering to Shari’ah
guidelines.

Ta'awun: Ta’awun refers to the concept of mutual cooperation or assistance in Islam. It is one of the fundamentals
of Takaful on which the whole framework has been established, thereby upholding the values of cooperation,
solidarity, and social responsibility that are deep-rooted in the Islamic injunctions pertaining to financial matters.

Takaful Contribution: It refers to the amount paid by participants into the Takaful fund.

Takaful Operator: An entity that administers and manages a Takaful scheme. It can be an insurance company or a
specialized institution specifically set up to operate Takaful arrangements.

Takaful Funds: Takaful funds are owned by Takaful participants, and they are managed to preserve their interest.
The operator establishes policies and procedures for establishing Takaful funds, including the establishment of
participants’ risk or investment funds.

Ulema: Refers to scholars or learned individuals in Islamic knowledge and jurisprudence.

Wakala Fee: Wakala fee refers to the compensation payable to the Takaful operator in return for the services
rendered by the Takaful operator in managing the risk funds on behalf of the participants.

Wakala Model: The Wakala Model refers to a specific arrangement where the Takaful operator, responsible for
managing the Takaful fund, is appointed as an agent by the participants.

Zakat: Zakat is an obligatory charitable contribution in Islam. It's considered one of the five pillars of Islam and is
mandatory for eligible Muslims who possess wealth above a certain threshold to give a portion of their wealth to
those in need.

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Dikko & Ghani (2015), Maqasid Al Sharia and Takaful Operations: Issues and Challenges in an Emerging Industry,
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Gönülal (Ed.) (2012), Takaful and Mutual Insurance: Alternative Approaches to Managing Risks
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Hassan & Abbas (2019), Factors Influencing the Investors’ Intention to Adopt Takaful (Islamic Insurance) Products:
A Survey of Pakistan, Journal of Islamic Marketing

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