Comparing Conventional and Takaful Insurance Companies

Takaful insurance is a relatively new formalization of a practice that has been prevalent in Arabic culture for a very long time. In Arabic, takaful refers to a joint guarantee, a concept that predates modern financial systems. Takaful insurance is a pact among a group of participants who agree on a combined guarantee among themselves. Any damage or loss incurred by a party in the agreement is settled by the mutual fund defined in the deal. An Islamic insurance policy that is takaful derives basis from Islamic religious scripture and Shariah guidelines and is based on the concept of mutual help and cooperation among participating parties on how to provide material security against any unexpected events (Archer, Abdel Karim & Nienhaus, 2009). The fundamental differences between the policies of takaful and conventional insurance influence the performance and profitability of insurance companies.

The main difference between the two insurance policies is the fundamental basis that defines them. Conventionally, insurance has a purely commercial basis while takaful insuranceis cooperation based. Where takaful insurance is free from riba or interest, maysir or gambling, and gharar or uncertainty, conventional insurance includes all these elements (Jaffer, 2007). In conventional insurance, if the events that a party is insured against occur, he is covered and incurs fewer costs as a result, hence attaining an overall gain. If on the other hand the events do not come to pass, the insurance company incurs no costs on his account, hence results in a net loss in his part. For the purposes of this comparison, an analysis of two insurance companies, the Abu Dhabi National Takaful Company PSC, which applies takaful policies and Abu Dhabi National Insurance Company PSC which applies conventional policies. The first demonstration of this difference lies in the profit and loss statements for the two companies. The Abu Dhabi National Takaful Insurance made a net profit of AED 35.8 million, compared to the figures for Abu Dhabi National Insurance, which were a net loss of AED 280 million. The profits and loss statements of the two companies reflect the differences in the two policies towards risk and uncertainty, interests, and premium refunds.

The takaful insurance companies enjoy greater certainty in annual fiscal figures. The first indicator of the differences between takaful and conventional insurance is gharar or uncertainty. Conventional companies have no idea when a loss will occur and how much they will incur as compensation to the insured party. Takaful insurance agencies exercise more stringent control, and donations for a good cause are used to insure against any risks to which the contributing parties may be exposed. In the previous year, Abu Dhabi National Takaful Insurance made AED 35.2 million in net profits. In the same period, Abu Dhabi National Insurance had a net profit of AED 156 million. Looking at the relevant data, it becomes readily apparent that takaful insurance companies benefit from less uncertainty than conventional insurance companies. Abu Dhabi National Takaful Insurance has more predictable profitability figures as compared to those of rival Abu Dhabi National Insurance. The certainty translates to easier policy formulation and planning. All or part of the contributions paid by the participants in takaful insurance companies are mudareb or donations to the Takaful Fund (Othman & Abdul, 2009), and they mitigate any uncertainties. The donations help other members by providing wakalah or insurance protection against potential risks. Conventional insurance agencies ask for payment of a premium and in exchange they bear all expected risks. As a consequence, especially in cases where underwriters make calculations that are below the potential risk margins, it is upon the insurance company to bear the risks.

Takaful insurance companies undertake fewer risks than their conventional counterparts. The comparative profit and loss statements across the last two fiscal years are also indicative of the varying levels of risks the two policies derive. While Abu Dhabi National Insurance is profit driven, they suffered substantial losses because they take on more risks than Abu Dhabi National Takaful. Due to their policies in the preceding year, Abu Dhabi National experienced a Net Underwriting Loss of AED 157 million, compared to a Net Underwriting Profit of AED 266m in 2013. The performance indicators for Abu Dhabi National Takaful were a consistent Net Underwriting Profit of AED 265 million which is comparative to the preceding year’s 235 million. The levels of risk in conventional insurance result in greater chances of making losses in a financial year as compared to those of the previous year. The shared risk model that takaful insurance employs would also mean that the losses are shared among the participants. Further, in the case of takaful insurance there are fewer cases of maisir or gambling (Maysami & Kwon, 1999). The participant contribution serves as security against potential risks. With conventional insurance policies, there are speculative assessments of risks coupled with a premium payment that is non-refundable. Premiums prices cover the costs of the potential risk, although cases in which the payments fail to cover the risk are rampant. In such cases, the conventional insurance companies bear the risks, and sometimes, the net losses.

Takaful insurance has considerably more surplus than their conventional counterparts. As a result, they outperform conventional insurance on the surplus to premium ratio. Abu Dhabi National Takaful had an excess of AED 3,239,698 compared to the previous year’s (20,372.712). On the other hand, Abu Dhabi National had no surpluses as they suffered a net loss. Another primary difference lies in how these values are perpetuated. For Abu Dhabi National Takaful, the surpluses belong to the contributing members and are distributed accordingly to them. In the case of Abu Dhabi National, shareholders bear the costs of surpluses if any. Surpluses in conventional insurance translate into dividends that are shared by the shareholders, and the lack of any declared dividends testifies to the lack of surpluses in the 2014 fiscal year. Deficits are managed in a similar manner. In the case of a deficit in a participant’s takaful fund, the operator, who is in charge of the running of the fund provides an interest-free loan (Qard Hasan) to the Participants. In conventional insurance companies, however, any deficits are covered by the insurance company. Funds in takaful insurance are not primarily for returning an interests as is the case in conventional insurance. The arrangements between the insurance firm and the insured party in the instance of conventional insurance are enforced through contracts, unlike in takaful insurance where the agreements are based on mutual understanding (Wahab, Lweis & Hassan, 2007). The financial statements for a conventional insurance company include figures for insurance contract liabilities which demonstrates this fact.

To conclude, the differences in performance between conventional and takaful insurance companies results from the differences in policies that each maintains. The fact that takaful insurance does not rely on interest-driven mutual funds means that they generate significantly lower interests as compared to conventional insurance. At the same time, their reliance on policies that are free from gambling and uncertainty ensure they are always in the green. The differences are reflected in the financial performance, with each exact regulation demonstrating policies that are consistent with the practices they adopt.

References

Archer, S., Abdel Karim, R., & Nienhaus, V. (2009). Takaful Islamic insurance. Singapore: John Wiley & Sons (Asia) Ltd.

Jaffer, S. (2007). Islamic insurance. London: Euromoney.

Maysami, R. C., & Kwon, W. J. (1999). An analysis of Islamic Takaful insurance: A cooperative insurance mechanism. Journal of Insurance Regulation, 18(1), 109.

Othman, M. S., & Abdul Hamid, M. (2009). A study on the level of knowledge and understanding among muslims towards the concepts, arabic and shariah terms in Islamic insurance (Takaful). European Journal of social sciences, 10(3), 468-478.

Wahab, A. R. A., Lewis, M. K., & Hassan, M. K. (2007). Islamic takaful: Business models, Shariah concerns, and proposed solutions. Thunderbird International Business Review, 49(3), 371-396.