Proceedings of 9th Asian Business Research Conference
20-21 December, 2013, BIAM Foundation, Dhaka, Bangladesh ISBN: 978-1-922069-39-9
Providing Insurance Products by Issuing Sukuk with Joint
Ownership and Risk Sharing
Dr. Mohammad Selim*
Insurance products are designed to cover against unexpected losses resulting
from fire, accidents or any unforeseen calamities that may strike on one’s
property and life at any moment. In conventional insurance system (CIS), there
is almost always a one way transfer of wealth from Insurance buyers to the
Insurance Providers. If a person is an expert and careful driver, he or she may
never make any accident in his approximately 50 years of driving life span, yet
he has to make on average $1000 annuity payment, a total of
50x$1000=$50,000. With an average of 8 percent rate of return, the future
value of 50 years $1000 annuity is 573.7702x$1000 =$573,770.2.This is
perhaps one of the most important parts of one’s life time potential savings
which will eventually end up in Insurance Company’s coffer. This paper
attempts to explore how in joint ownership, risk sharing Sukuk based ShariaCompliant Insurance System (SBSIS), both wealth and risks will be shared,
and transfer of wealth and exploitation will be eliminated and the person will
not only be fully covered but will also be provided with preventive measures
and huge savings which will eventually reduce the risk of losses of property,
and life, and thus will build a healthy, happy, relatively less risky, and
exploitation free society where all people will enjoy a relatively safe and
secured life style and high standard of living and will definitely be better off,
and the nation is expected to shift on a higher indifference curve.
Keywords: Sukuk based Insurance System, Risk sharing, Conventional Insurance System, Risk
Shifting, Exploitation Free, Potential Savings, Life time Savings, Safe and Secured Society, Higher
Indifference Curve
1. Introduction
Conventional insurance system (CIS )often can be a blend of Riba (Interest), Gharar
(Uncertainity), and Maysir((Gambling) – all of which are prohibited in Islam. No wonder, Muslims
on average, have a tendency to avoid insurance altogether and perhaps have relatively lower
participation rate in buying insurance policies unless it is compulsory. However, there are
alternatives to CIS, and Sharia-compliant Insurance System has been evolved over the years. So
far, there are Takaful Insurance based on Mudaraba and Wakala Systems. However, the Sharia
Scholars have reservations and disagreements over many issues on both the above systems.
Consequently a third variant of Wakala system with Waqf Fund has been introduced in order to
_______________________________________________________________
*Dr. Mohammad Selim, Assistant Professor, Department of Banking and Finance, Faculty of Business & Financial
Sciences, Royal University for Women, Riffa, Kingdom of Bahrain; Telephone: 973 39 573 782. E-mail:
msalim@ruw.edu.bh
1
Proceedings of 9th Asian Business Research Conference
20-21 December, 2013, BIAM Foundation, Dhaka, Bangladesh ISBN: 978-1-922069-39-9
address many of the issues raised by the Sharia Scholars. This paper proposes a fourth variant
but neither based on Mudarabah nor Wakala, rather a joint ownership and joint risk sharing Sukuk
based Sharia-Compliant Insurance System (SBSIS) in which most of the problems of Mudaraba
and Wakala systems can be minimized and the policy holders will be able to find a potential
savings vehicle where their life time savings will never be thrown away rather will be accumulated
and the policy holders will find it ready when they will need them most-during their old age when
they can no longer drive nor earn a living but still need to survive with high expenses on medicare
and on other amenities of life.
It is important to note that Sukuk is an important mode of Sharia-compliant financing. Accounting
and Auditing Organization for Islamic Financial Institutions (AAOIFI) defines sukuk as being:
“Certificates of equal value representing after closing subscription, receipt of the value of the
certificates and putting it to use as planned, common title to shares and rights in tangible assets,
usufructs and services, or equity of a given project or equity of a special investment activity”. In
this paper we will explore how Sukuk can be used as an alternative to conventional Insurance
system. This paper is organized as follows: Literature review and previous works are briefly
analyzed in section 2. The Sukuk based Insurance model is developed in section 3. Section 4
analyzes the potential savings and life time accumulated income for the Policy and Sukuk holders.
Section 5 explores and examines the Risk Shifting versus Risk Sharing Hypothesis. Concluding
remarks appear in section. 6
2. Literature Review
Islamic Insurance often called Takaful first introduced in Sudan in 1979 and later in Saudi Arabia
(Wahab, Lewis, Hassan; 2007). The word takaful is derived from the word Kafala, and thefore,
Takaful means “taken care of”.
There are so called 2 models of Takaful Insurance:
1. Mudarabah system, developed by the Malaysians, and
2. Wakala (Agency) System which is widely used, especially, in Gulf countries.
Furthermore, Wahab, Lewis, Hassan (2007) proposed a refinement of Wakala system, and new
version, called Wakala with Waqf fund for meeting the demand from claims from the proposed
Waqf Fund which will be derived mainly from the donations of the policy holders. However, Sharia
Scholars have major reservations and disagreements about the first two approaches. As
mentioned above, for addressing some of the concerns and questions of Sharia Scholars, Wahab,
Lewis and Hassan came up with the third model: Wakala with Waqf Fund in order to make it more
Sharia Compliant.
Conventional Insurance is based on Riba, Gharar and Maysir. Sheik Al Azher declared all life
Insurance to be prohibited under Sharia (Billah 2001; Wahib 1999).
Takaful Insurance is based on unique brotherhood and willingness to help in case of damage or
losses resulting from accidents and mishaps (Anwar 1994, Siddiqi 1985). Takaful Insurance is
based on Tabarru or donating to those who faced losses or injuries. Tabarru is an element
designed to minimize the incidents of Gharar and Maysir. But in reality most insurance claimants
may not necessarily eligible for receiving donations.
2
Proceedings of 9th Asian Business Research Conference
20-21 December, 2013, BIAM Foundation, Dhaka, Bangladesh ISBN: 978-1-922069-39-9
Yaquby (2000) emphasized that any insurance model must be approved by Sharia Scholars for
appropriateness, clarification, guidance and implementation. In Mudaraba model, as mentioned
above, Lewis (2005) emphasized that it is similar to investment linked insurance policy. In Takaful,
the operators, also called Mudarib should be the custodians of the funds of the participants
(Rabbul Mal) but in reality, they may be the owners of funds (Billah 2007). Many of the policy
holders who pay premiums are not aware that the premiums are for mutual help (Al-Qaradawi
1989). Furthermore, Tabarru and Profit-loss sharing cannot be combined (Abdul Rahim 2003).
Wakala model is widely used in Gulf countries. Takaful operator acts as Wakil for the participants
(Rabbul Mal and Policy holders). Wakil manage the affairs for fees. Under the Wakala, the
participants remain the actual owner of Takaful funds. The surplus will be invested in Shariacompliant ventures and investment vehicles. As mentioned above, Wakala with Waqf fund was
proposed by Wahab, Lewis and Hassan. Waqf funds and their rules are well known in Muslim
countries (Cizakca 1998), and therefore, operation and implementation of such funds will be rather
easy. However, in such approach, how one can meet the demands for claims with just one time
donations? Claims for insurance are recurring almost in every hour, in everyday and there should
be a continuous flow of funds to meet such claims. One time donations will hardly be enough to
meet daily demands for funds for the settling the on-going claims.
3. The Model
Suppose we have N number of policy holders, representing N1, N2,…..Nn number of individual
policy holders. Therefore, we can write:
……………………(1)
Total number of policy holder will be N. Now we can sum up as follows:
The Model is based on the following assumptions:
1. There are N number of total Policy Holders at a given period of time.
2. Each policy holder will buy ki number of Sukuk. In other words, each Sukuk holder is required to
purchase Ki number of sukuk in each year instead of buying policy.
3. Sukuk holders are the owners of the Sukuk based Sharia-compliant Insurance Company.
4. Each Sukuk holder instead of shifting the risk to somewhere else, they jointly share the risks and
periodic income from Sukuk.
5. Total Sukuk income is divided in each period, 50% goes to sukuk holders and 50% is retained to
pay for the insurance claims for the policy holders.
6. Among the policy holders, those who are responsible for accidents and accidents are caused
because of their own faults will be required to pay a onetime deductible.
Total funds collected from the sale of Sukuk or Sukuk Fund (SF) in each year can be written as:
3
Proceedings of 9th Asian Business Research Conference
20-21 December, 2013, BIAM Foundation, Dhaka, Bangladesh ISBN: 978-1-922069-39-9
In Equation 3, is the average number of Sukuk bought by each policy holder, and the face
value of each Sukuk is $1000. Sukuk income (y) is paid semi-annually. The Sukuk income (y) is
divided into two:
(4)
In Equation 4, y1 is 50% and y1 will be distributed to Sukuk holders while the remaining 50% will
be retained for settling Insurance claims. The drivers among the Policy holders who are
responsible for the accidents will pay a lump sum amount as deductibles, denoted as d to partly
cover the insurance claims. Therefore, for settling the Insurance claims, the following cash flow of
funds (CFF) will be available:
(5)
The expenses (E) for the Sharia-compliant Insurance Company will include Insurance Claims (IC),
Operating Expenses (OE) and expenses for drivers‟ education (EDE). Any driver who is fault will
automatically be enrolled for further driving training including learning about driving and traffic
laws, rules, regulations, traffic signs and how to be defensive driver. All such education and
training will significantly drop the accidents rates and therefore, IC will decline. Therefore, the
expense (E) equation for the sharia-compliant company can be written as:
(6)
The annual income and expense account of the Sharia-Compliant Insurance Company must
balance and therefore, Equation 5 equals Equation 6 and it can be written as follows:
In Equation 7, net insurance claims, denoted by
will continue to decline as the company
spends more on EDE. Often drivers‟ education services may be obtained from public services at a
very low prices or often at no extra cost and as such, drivers can improve their driving skills as
well as driving knowledge significantly and it will create welfare effect in the economy and less
destructions of vehicles, property and life. As a result, GDP will continue to rise and the society
will be better off with Sharia-compliant Insurance services. The policy holders who are also drivers
will see such benefits as added income to their cash flow from Sukuk. If the above argument
holds, then Equation 7, can be written as follows:
From Equation 8, if combined expenses decrease and as a result,
is greater than total
expenses, the surplus income will be returned to the Policy holders who are also the owners of the
4
Proceedings of 9th Asian Business Research Conference
20-21 December, 2013, BIAM Foundation, Dhaka, Bangladesh ISBN: 978-1-922069-39-9
Sukuk and they will find that the semi-annually sukuk income paid out to them will increase. Such
built-in incentives will encourage drivers to take driving seriously, pay more attention and learn life
savings driving skills. All such incentives driven behavior of the drivers will have positive effect and
the country will be safer because traffic accidents will decline, death and destruction of property
on daily horror scale will come to an end or will at least show a downward declining trend. In
conventional Insurance system such incentives of increase in income in every six months are
absent and in every year, the policy holders of conventional insurance system will continue to pay
higher and higher premiums, especially those who will be involved in accidents and accidents are
caused because of their faults. Such policy holders will never dream of getting back the premiums
they paid in each year for 50 years neither 50% of the income.
However in Equation 8, if overall costs are greater than , the Sharia-compliant Policy holders
will realize that their Sukuk income is falling because the drivers are not careful. Therefore, it is
the time of intervention, time of reckoning and time to take action. Such preventive measures are
absent in conventional Insurance systems except for collecting higher premiums and more and
more outflow of funds will take place from conventional policy holders to the Coffers of the big
Insurance companies.
Most insurance claims (IC) include repairs of the vehicles (R), medical expenditures for injured
(MEI) and disability allowances (DA), and IC equation can be written as follows:
Funds from the sale of Sukuk in Sharia –compliant Insurance system will be invested in Auto
repairing and auto parts sale facilities such as Canadian Tire chain stores in Canada. In addition,
funds will also be invested in Medical and Disability facilities with state of the Art facilities and
amenities. Such facilities will not only treat injured drivers and passengers but will also treat others
and will therefore earn income for the Sukuk holders. Such state of the art medical facilities will be
equipped with physiotherapy and other disability treatments and in most cases the facilities will be
used to treat the victims of accidents until fully recover. Such opportunities are absent in
conventional Insurance system where surplus funds are usually invested for earning riba or
interest income. Such practices of earning interest or riba income are not allowed in Shariacompliant insurance system.
An individual policy holder will accumulate Sukuk from each year up to about 50 years plus the
income generated in each period for each Sukuk. Since the Sharia-compliant policy holder is
buying Sukuk in each year of approximately 50 years of driving life span, the accumulated Sukuk
(AS) and income from Sukuk (ys) equations can be written as follows:
In Equation 10, total insured driving life span (T) is 50 years. However, for some countries,
especially for developed countries T may be higher than 50 years compared to developing or Less
Developed countries. T can be relatively higher for female drivers compared to their male
counterparts because of relatively higher longevity for females compared to the males.
5
Proceedings of 9th Asian Business Research Conference
20-21 December, 2013, BIAM Foundation, Dhaka, Bangladesh ISBN: 978-1-922069-39-9
And the income from the Sukuk (ys) can be written as:
(11)
In Equation 11, only 50% of Sukuk incomewill go to Sukuk owners or Policy holders. As
mentioned above if the drivers who are also policy holders respond to incentives then definitely
more than 50% of Sukuk income will be given as ys. In addition, the Sukuk owners will receive
100 payments of Sukuk income in 50 years because Sukuk income is paid semi-annually. Now
combing Equations 10 and 11, accumulated Sukuk (AS) and Sukuk income (ys) can be written as:
4. Potential Savings and Life time Accumulated Income for the Policy and
Sukuk holders
In Section 3, from equation 12, consider as annuity, T=50 years, and
) as Annuity
Future Value (AFV) and suppose the rate of return for 50% of the income paid out to the Sukuk
and policy holders will be approximately 3%, 4%, 5%, 6%, 7%, and 8%. Of course the return
depends on how SBSIS invests its funds for its growing business and industries. The following
Table 1 shows accumulated income at only 3% rate of return when annuity amount ranges from
$500 to $2500.
Table 1: Annuity Future Value for 3% Rate of Return
$500
$1000
$1500
$2000
$2500
3% Rate of
Return
3.0
3.0
3.0
3.0
3.0
T=Number of
years
50
50
50
50
50
Annuity Future
Value Factor
112.80
112.80
112.80
112.80
112.80
Annuity Future
Value
$56,400
$112,800
$169,200
$225,600
$282,000
The following Table 2 shows annuity future value for 4% rate of return.
Table 2: Annuity Future Value for 4% Rate of Return
$500
$1000
$1500
$2000
$2500
4% Rate of
Return
4.0
4.0
4.0
4.0
4.0
T=Number of
years
50
50
50
50
50
Annuity Future
Value Factor
152.67
152.67
152.67
152.67
152.67
Annuity Future
Value
$76,335
$152,670
$229,005
$305,340
$381,675
6
Proceedings of 9th Asian Business Research Conference
20-21 December, 2013, BIAM Foundation, Dhaka, Bangladesh ISBN: 978-1-922069-39-9
The following Table 3 shows annuity future value for 5% rate of return.
Table 3: Annuity Future Value for 5% Rate of Return
$500
$1000
$1500
$2000
$2500
5% Rate of
Return
5.0
5.0
5.0
5.0
5.0
T=Number of
years
50
50
50
50
50
Annuity Future
Value Factor
209.36
209.36
209.36
209.36
209.36
Annuity Future
Value
$104,680
$209,360
$314,040
$418,727
$523,400
The following Table 4 shows annuity future value for 6% rate of return.
Table 4: Annuity Future Value for 6% Rate of Return
$500
$1000
$1500
$2000
$2500
6%Rate of
Return
6.0
6.0
6.0
6.0
6.0
T=Number of
years
50
50
50
50
50
Annuity Future
Value Factor
290.34
290.34
290.34
290.34
290.34
Annuity Future
Value
$145,170
$290,340
$435,510
$580,680
$725,850
The following Table 5 shows annuity future value for 7% rate of return.
Table 5: Annuity Future Value for 7% Rate of Return
$500
$1000
$1500
$2000
$2500
7% Rate of
Return
7.0
7.0
7.0
7.0
7.0
T=Number of
years
50
50
50
50
50
Annuity Future
Value Factor
406.53
406.53
406.53
406.53
406.53
Annuity Future
Value
$203,265
$406,530
$609,795
$813,060
$1016,325
The following Table 6 shows annuity future value for 8% rate of return.
Table6: Annuity Future Value for 8% Rate of Return
$500
$1000
$1500
$2000
$2500
8% Rate of
Return
8.0
8.0
8.0
8.0
8.0
T=Number of
years
50
50
50
50
50
Annuity Future
Value Factor
573.77
573.77
573.77
573.77
573.77
Annuity Future
Value
$286,885
$573,770
$860,655
$1147,540
$1434,425
7
Proceedings of 9th Asian Business Research Conference
20-21 December, 2013, BIAM Foundation, Dhaka, Bangladesh ISBN: 978-1-922069-39-9
From the above tables, it is evident that the policy holders can turn themselves to Sukuk holders
and can jointly own, manage and share risks and eventually can realize extremely large savings
potential up to or over million dollars instead of throwing their money year after year with
conventional insurance system.
5. Risk Shifting versus Risk Sharing
In conventional insurance system when drivers are fully insured with zero deductibles, the drivers
become reckless, irresponsible for their action and hardly pay any attention to driving. Because
they have started to think that they have shifted the risks to the Insurance company and as such,
anything they do, the risk will be shifted to the insurance provider. In Sukuk based ShariaCompliant Insurance system risks are not shifted to a third party rather risks will be minimized by
quality driving education. Still whatever risks will remain, will be shared by the group of Policy and
Sukuk holders. In return, the Policy holders, who are also the Sukuk holders will be rewarded by
the income derived from the Sukuk. To pay for the risks, a portion of income, approximately 50%
as mentioned above will be allocated as Sadaqat-El-Jaria (Recurrent Charity) out of which all
claims will be settled . It is a continuous flow of funds, designed and dedicated solely to settle the
insurance claims on daily basis as well as spending on charity which will foster the safety and
security of life, property, Roads and Highways for all the people at all times.
6. Conclusion
It is evident that Sukuk based Sharia-Compliant Insurance System (SBSIS) will create business
focusing on supplying Insurance Claims support services and products including repair services,
high standard hospital and Medicare services. This business will continue to grow because there
is almost nearly infinite supply of funds injecting each day when a driver or individual buys SBSIS
policy. With such nearly infinite supply of funds, SBSIS will grow, its affiliated business will also
grow or even SBSIS finance industries which will also grow at a rapid rate and thousands of
people will find employment. With business in focus, SBSIS will avoid all objections of Sharia
Scholars because business is highly encouraged both in Quran and in Sunnah. Therefore, SBSIS
will be an ideal model for supplying insurance products and services in the days to come and it
may hold a bright future for Islamic Insurance.
References
Abdul Rahim, A. W. (2003, September). International Conference on Takaful, London.
Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), 2009,
Overview. Available at: http://www.aaoifi.com/overview.html
Al-Qaradawi, Y. (1989). The lawful and the prohibited in Islam. Kuwait: International Islamic
Federation of Student Organizations
8
Proceedings of 9th Asian Business Research Conference
20-21 December, 2013, BIAM Foundation, Dhaka, Bangladesh ISBN: 978-1-922069-39-9
Anwar, M. (1994, Winter). Comparative study of insurance and takafol (Islamic insurance).
Pakistan Development Review, 33, 1315–1330.
Billah, M. M. (2001). Principles & practices of takaful and insurance compared. Malaysia: GECD
Printing Sdn. Bhd.
Billah, M. M. (2007). Islamic banking and the growth of takaful. In M. Kabir Hassan & M. K. Lewis
(Eds.), The handbook of Islamic banking, pp. 401–418. Cheltenham, UK: Edward Elgar.
Cizakca, M. (1998). Awqaf in history and its implications for modern Islamic economics. Islamic
Economic Studies, 6(1), 43–70.
Lewis, M. K. (2003, August/September). Challenges to the takaful industry. New Horizon, 132 , pp.
10–14.
Lewis, M. K. (2005). Wealth creation through takaful (Islamic insurance). In M. Iqbal & R. Wilson
(Eds.), Islamic perspectives on wealth creation (pp. 167–187). Edinburgh: Edinburgh University
Press.
Selim, M 2013, „The Relative Effectiveness of Anti-Recessionary Monetary Policy in
Conventional and Sharia-Compliant Systems‟, Journal of Islamic Finance and Business
Research, Vol. 1, Number 2, (forthcoming).
Selim, M 2013, „Eliminating Interest Costs in Financing Trade Deficits by Pursuing and
Maintaining Fully Convertible Domestic Currency‟, Journal of Islamic Economics, Banking and
Finance, Volume 9, Number 2, (forthcoming
Siddiqi, M. N. (1985). Insurance in an Islamic economy. Leicester: Islamic Foundation.
Wahab, A.R.A., Lewis, M.K., Hassan, M.K., Islamic Takaful:Business Models, Sharia Cooncerns
and Proposed Solutions, Thunderbird International Business Review, Vol 49(3) 371-396 May-June
2007
Wahib, R. B. (1999). Islamic Takafol Insurance. New Horizon, Part 1, 86, 10–12; Part 2, 87, 16 –
17; Part 3, 88, 10–12.
Yaquby, N. (2000). Between Shari‟a scholars and takaful practitioners: Bridging the gap.
International Conference on Takaful/Islamic Insurance.
9