Conventional insurance is a contract whereby the insurance company, for a price called the premium, promises to indemnify (guarantee) the persons who is insured (the policy holder) against certain perils such as fire, theft or loss of life. In the case where the peril occurs during the period of the insurance policy, the insurer will compensate the insured person or beneficiaries. *

GhararBoth subject matter-goods and price are uncertain because the actual value/amount of both is conditional upon the occurrence of the peril/hazard which is uncertain. The participant loses the money paid for the premium when the insured event does not occur is Gharar.The company will be in deficit if the claims are higher than the amount contributed by the participants is Gharar.RibaThe element of Riba (Interest) exists in lending or borrowing funds/investments at fixed interest, and other related practices in the investment activities of the conventional insurance companies *

MaysirMaysir is gambling. Conventional insurance is a zero-sum game or a game of chance when one party wins or gains, the other party must lose. It is as though the insurance premium, which is normally very low compared to the financial compensation claim, is paid win the protection amount.

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Takaful is an Arabic word that means "guaranteeing each other". It is a system of Islamic insurance based on the principle of Taawun (mutual assistance) and Tabarru (Voluntarily) where the risk is shared collectively by the group voluntarily. This is a formal agreement among a group of members or participants who agree to jointly guarantee among themselves against loss or damage to any of them as defined in the agreementIn Takaful, there is no selling or buying policy, rather, it is a contribution by way of donation by the participants to the pool of fund for the purpose of mutual indemnity.

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The Quran enjoins human beings to help one another in good things and virtue and avoid cooperating with people to cause injury or damage or corruption of virtues (Quran 5:2). Therefore, Islamic scholars have taken this verse as a solid foundation for establishing the Takaful industry. Takaful is a form of mutual help to those in need when peril strikes. It is a cooperative fund to help members of the fund.In addition the Hadith of the Prophet (saw) also advices Muslims to take precautions before relying on Allah. Other Islamic legal principles encourage steps to be taken to remove or mitigate injury and risk. *

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The transactional aspect of the commercial activity of Takaful must be subject to the Islamic contractual laws in order to ensure its compliance with the Shariah . The Company involved in takaful business, as the operator, will accept payment of the takaful installments or takaful contributions (premium) from the participants (clients) for the takaful plan or takaful scheme they wish to participate.

In order to eliminate the element of uncertainty in the Takaful contract, the concept of tabarru (to donate, to contribute, to give away) is incorporated in it. In relation to this a participant shall agree to relinquish as gift certain portion of his Takaful installments . For the service rendered as manager of the Takaful Operations the company will charge a management fee.

The Takaful Fund, consisting of the contributions paid as Tabarru, will be further invested by the Company based on the principle of Al Mudarabah, through which the element of interest (riba) will be replaced. All premium holders will participate in pofit and loss.Profit will be shared on agreed ratio.

Initially insurance was not successful in the Muslim community, not only due to the haram nature of conventional insurance but also a misconception of the concept of Tawakkul or surrendering to God and the concept of pre-ordainment and predestination (Qada and Qadar). God had pre-ordained a calamity, it is not thought appropriate by the pious to prevent Gods pre-ordainment through buying insurance. Takaful does not go against the belief in the pre-destination (Qada & Qadar) of God, as whether a person buys Takaful or not, Gods pre-ordained events will occur. It is only that financially compensating a victim of perils that takes place by Takaful and this is encouraged.

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Takaful can be used to coverProperty like house, factory, mosque, officesVehicles (car, motorcycle etc..)Goods ( like during import or export )Valuables Health, accidents and Life

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A pooling risk mechanismThe takaful operator has to share any surplus or deficit arising in the poolWidening the spectrum of the principle of solidarity or mutual helpWithout retakaful, takaful operator has limited implementation of principle of tabarru within the boundary of single takaful poolTakaful operators provide Qard (interest-free loan) to cover deficits in participants funds.*

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InsuranceTakafulFinancial Statement of Takaful CompaniesPremiumContributionsRevenue in the Policy Holders Revenue AccountAgency Commission(paid to agents)Wakalah Fees (paid to Takaful operator) Expense in the Policy Holders Revenue Account and income in the Income statement of the Takaful OperatorReinsurance expensesReTakaful contribution Expense in the Policy Holders Revenue AccountTechnical reservesTechnical reserves Increase: Expense in the Policy Holders Revenue Account; Accumulated reserve is a liability in the fund balance sheet.No equivalentProfit share from investments to operator Expense in the Policy Holders Revenue Account and income in the Income statement of the Takaful OperatorNo equivalentSurplus share to operatorDistribution in the Policy Holders Revenue Account and income in the Income statement of the Takaful OperatorNo equivalentJualah share to operatorDistribution in and income in the Income statement of the Takaful OperatorUnearned Premium ReserveUnearned Contribution reserveLiability in the Fund Balance Sheet; increase in the reserve is an expense in the Policy Holders Revenue AccountProvision for outstanding claims and claims incurred but Not Reported Provision for outstanding claims and claims incurred but Not ReportedLiability in the fund balance sheet. Increase in provision is an expense in the Policy Holders Revenue Account

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AAOIFI Takaful Accounting StandardsFAS 12 Presentation and DisclosureFAS 13 Disclosure of bases for determining and Allocating Surplus or Deficit in TakafulFAS 15 Provisions and Reserves in Islamic Insurance CompaniesFAS 19 Contributions in Islamic Insurance Companies

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For a Takaful company which is on-going for a few years, there will be unearned contribution reserve at the beginning (contribution received in the previous years) and would be recognised as revenue in the current financial year.And end of the financial year (contribution received during the current year) but will only be earned in the next or future financial years.

*Contribution earned for the financial year =The contribution received in the current year + contribution received in previous years for this year (i.e. beginning of the year unearned contribution reserve). - contribution received this financial year for future years (i.e. end of the year unearned contribution reserve).

Suppose, a Takaful Companys unearned contribution reserve at the beginning of 2012 was RM1,000 and it received contributions during the financial year of RM5,000. Further, if at the end of the year, the unearned contribution reserve (i.e. amount of contributions not earned in the year) was RM2,000; How much contribution earned in 2012? *

Definitions under IFRS relating to insurance contracts and insurers do not reflect the risk sharing nature of Takaful contracts: IFRS assume a transfer of risk.In order to present comparable financial information, IFRS largely ignores actual Takaful structuresContributions from participants are treated as revenue, when it would be more accurate to record them as liabilities.Claims and other expenditure paid out of Takaful funds are recorded as expenses, when in fact they are a reduction of liability.Some Sharia scholars argue that funds received by Takaful operators are fiduciary in nature and therefore should not even be shown on the operators Statement of Financial Position

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The IFRS accounting treatment of agency fees earned by the Takaful operator and charged to the fund can result in a confusing mismatch within the financial statement.This is because fees are deferred in the Takaful fund as an acquisition cost, but recognized upfront in the operators income statement as service revenue.

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*PHRA= Policy Holders Revenue Account

TransactionsDr.Cr.Contributions receivedCashPHRAUnearned contributions at end of year;Increase in unearned contribution reserveDecrease in unearned contribution reserve PHRAPHRAUCRUnearned contribution reserve(UCR)Unearned contribution reserve(UCR)PHRAWakalah fee to operator PHRAP/LInvestment returns to fundCashPHRAInvestments return : Operators sharePHRAP/LReTakaful contribution to ReTakaful companyPHRACashClaims paidPHRACashClaims incurred but not ReportedPHRAProvision for CIBNR (liability in BS)Claims incurred but not paidPHRAProvision for outstanding claimsOperating expenses charged to fundPHRACash/ or Deduct from PL operating expenseDistribution of surplus rebate to participantPHRACash/ accounts payableDistribution of surplus to operatorPHRAP/L

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The following data is from the records of ABC Takaful Ltd. for the year ended 31st December 2008: $000sGross Contributions received during the year1 1,500 Gross Contributions received last year for this year 300ReTakaful contribution ceded 700Claims incurred but not reported 100Claims incurred and paid this year 200Claims incurred last year and paid this year 80ReTakaful claims reimbursable on 2008 claims 150Operating expenses directly chargeable to Takaful fund 300Surplus of participants brought forward from 2007 100Profit from investment of shareholders funds 250Profit from investment of participants funds (gross) 500

Notes to the above data:This amount includes contributions amounting to RM200,000 which relates to the year 2009The operator charges Wakalah fee of RM100,000 a year and also charges operating expenses which are directly attributable to the Takaful fund.The operator has a Mudaraba contract and shares 40% of the profits for investment of the participants funds.The operator charges Jualah commission of 10% of the fund surplus of over RM200,000 The directors decide to distribute RM300,000 to participantsYou are required to prepare a Takaful Participants Revenue Account from the following data and notes, as well as an extract of Income statement of the Takaful operator

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ABC Motor Takaful Ltd.Participants' Revenue Account for the year ended 31st December 2008

Contributions received1500Add decrease in contribution reserve (300-200)100Gross Contributions earned1600Less ReTakaful Contributions ceded(700)Net Contributions earned900Less ExpensesClaims incurred but not reported 100Claims incurred and paid this year 200total gross claims300Less ReTakaful claims reimbursable on 2008 claims (150)net claims payable150 Operating expenses chargeable to fund300Wakalah Fee for operator100total fund expenses550 Underwriting fund surplus350 Less Ju'alah commission (10% of (350-200)(15)Surplus attributable to the participants335

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Add profit from investments of participants funds (gross)500Less operators' share (40%)(200)Profit attributable to participants300 Surplus for the year 635 Less distribution to participants(300)Surplus after distribution335 Balance of surplus brought forward100Balance carried forward435

Extract of Income statement of operator

Wakalah fee100Mudaribshare of investment profits 200 Jualah commission15 Total earnings from Takaful and investment operations315Profits from investment of shareholders' funds250Total income.565

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