Comparative Studies of Takaful and Convention Insurance - Essay Example

Name) (Instructors’ name) (Course) (Date) Comparative Studies of Takaful and Convention Insurance Everyone is exposed to possibilities of being affected by different perils such as fire, death, theft, etc. (Tahira and Arshad 2). As an organization, there is need to accept any accident that occur as the will of God. However, putting proper mitigation in place ensures that the effects of the unfortunate perils is reduced. Everyone should struggle to minimize the financial losses associated with unforeseen events. One way of reducing the impacts of catastrophes is to acquire an insurance cover (Tahira and Arshad 2). Insurance gives people an opportunity to transfer the financial losses incurred to the insurer through payment of premiums. When an individual agrees to pay the premiums, the insurer in exchange, will offer that individual a compensation for the financial damages incurred due to unforeseen risk. Insurance provides an assurance and opportunity for organizations and individuals to venture into high risk businesses (Tahira and Arshad 2). Hence, insurance contributes towards economic, social and technological realization of man. Takaful Insurance In Arabic, the word Takaful means to assure each other (Tahira and Arshad 3). The word Takaful is originating from another Arabic word, takafala, which means to provide guarantee or protection. Basically, the principle of Takaful is based on a pool of donation that is used to support each other. Takaful is a mutual agreement to provide protection for those who are in great risk by large number of donors (Tahira and Arshad 3). An example of takaful insurance company is Methaq Insurance Company. Conventional Insurance The main perspective of conventional insurance is to minimize risks (Tahira and Arshad 3). The funds from the policy holders is reinvested to finance generating activities. The conventional insurance is abolished in Islamic states because it contains some elements of interests (Tahira and Arshad 3). The interests are accrued from investment activities of the insurer. Al Wathba National Insurance Company is one example of conventional insurance company. Principles and Terminology Differences Between Takaful and Convention Insurance In Takaful insurance, provision of possible indemnity is under the Islamic financial protection of joint guarantee scheme (Tahira and Arshad 32). Whereas in conventional insurance, the insured compensates for the loss in exchange for paid premiums. and tabarru are the basic principles guiding Islamic insurance system (Tahira and Arshad 32). The donors agree to mutual assist each other for the sake of cooperation in case of a catastrophe. This insurance is not motivated by the profits but by sharing of profits among suffered participants. For the convention insurance, the main goal is to maximize profits (Tahira and Arshad 32). Social Solidarity Takaful is inspired by the idea of social responsibility, joint indemnification and mutual cooperation in the losses incurred by the members (Tahira and Arshad 33). The members formulate an agreement that ensures mutual fund contribution to assist any member affected by losses. On the other hand, Convention insurance has no religious boundary and their duty is to averse the risk from affected individual (Tahira and Arshad 33). Aaqilah Concept: Aaqilla is an arrangement of mutual help, according to some of the Muslim jurists (Tahira and Arshad 34). The concept was used in times of Holy prophet. In case of any peril, every individual used to donate some amount until the loss was indemnified (Tahira and Arshad 34). This principle of mutual help and joint liability was accepted by the Islam (Tahira and Arshad 34). Distribution of Risk The risk is not exchanged by a way of payment contribution made to operator, in a Takaful insurance system (Tahira and Arshad 36). The risk is distributed among the members and the operator does not undertake the risk. This is because he works under the role of fund manager, at the same time works on the behalf of participants (Tahira and Arshad 36). With the conventional insurance system, the insurer agrees to undertake the risk of the insured in exchange for premiums. If the risk occurs, the insurer will pay the insured fixed some of money to compensate for the loss (Tahira and Arshad 36). Man-made vs Sharia laws Most Muslim scholars agrees that the conventional insurance contracts contravene the Islam statutes. Specifically, life assurance applies certain elements that oppose the Sharia rules. The element includes, Gharar (uncertainty), Al-maisir (Gambling), and Riba (interests) (Khan 3). Al-maisir (Gambling) If the insured does not claim or incur losses, then the premium paid will be lost. Similarly, if the loses occurs, policyholder may receive more money in form of compensation which does not relate to what is entitled. In short, the insured agrees to pay premium and the insurance company agrees to indemnify the insured if the risk occurs (Khan 3). This is contrary with the Takaful insurance where the donations by policyholders is aimed at helping each other if anyone suffers a loss (Khan 3). Gharar (Uncertainty) Offering any agreement involving uncertainty and probability is against Sharia standards. Uncertainty is abolished in Islamic business contracts (Khan 3). The insurer and insured does not know when the risk insured against will occur in conventional insurance (Khan 3). However, in takaful insurance the insured enters in a mutual assistance contract that allows compensation of members who incur losses. In takaful insurance contracts, the uncertainty factor is not involved (Khan 3). Riba Riba is an Arabic word which means interest, and can be explained further as using money to make more money (Khan 3). Any investment activities involving interests contravenes Sharia laws. Conventional insurers invest in business activities such as purchase of company bonds which involves interests (Khan 3). Takaful insurance companies does not involve in such kind of transactions. At such is mandatory for takaful insurance companies to assure insured that the pool fund will not be invested in interests bearing ventures (Khan 3). Financial statements for Takaful and Convention Insurance Companies The proportion ratio analysis includes strategy for computing and translating money related ratios to survey the performance of an entity (Tahira and Arshad 44). These proportions are the indication of monetary performance of insurance agencies. Entrepreneurs can anticipate the future pattern of their business by doing the ratio analysis (Tahira and Arshad 44). To contrast the relative consequences of Islamic and convention insurance companies, the proportion analysis for the period between 2008 and 2011 have been performed. Profitability, risk solvency, and capital adequacy are examples of financial ratios used to determine financial performance of a business. (Tahira and Arshad 44). Profitability Proportions This ratio measure an organization's capacity to create income depending on sales, assets and value (Tahira and Arshad 44). These proportions highlight how successfully the profitability of an organization is being managed. Distinctive profitability proportions give diverse valuable bits of knowledge into the monetary performance of a company (Tahira and Arshad 44). The higher profitability proportion shows better management of an organization. The two primary ratios used are; Return on equity and Return on average asset (Tahira and Arshad 44). Liquidity Proportions Liquidity proportion measure the capacity of an organization to meet its transient debt commitments (Tahira and Arshad 44). It is a noteworthy measure of financial position. On the off chance that the results of these proportions are more than 1 it shows that the companies short term debts are completely secured and the company is in a better position. To measure banking liquidity, the Current Asset and Loan Deposit Ratios are applied (Tahira and Arshad 44). Risk and solvency ratios Risk and solvency proportions are utilized to quantify the level of budgetary risk that a business faces (Tahira and Arshad 44). These are the instruments that are utilized to gauge the capacity of an organization to meet its long term monetary commitments. Solvency proportion is measured by the relationship between the assets, liabilities and value of a business at guaranteed point in time. By utilizing this proportion, it is possible to evaluate the level of obligation and choose whether this level is suitable for a given organization (Tahira and Arshad 44). Capital Adequacy Ratios Capital adequacy proportion is the proportion which is intended to gauge the limit of a bank with regards to meeting the time, liabilities and other risks such as market risks. It measures the position of a bank in terms of capital. The ratio is also known as weighted asset proportion (Tahira and Arshad 44). Balance Sheet Difference Between Al Wathba and Methaq Insurance Companies Al Wathba National Insurance Company Balance Sheet Date: 31st Dec,2015 Assets 2015 2014 Current Assets     Cash 85,000 99,454 Investments carried at fair value 190,544 246,249 Investments carried at fair value-profit/loss 295,105 292,360 Investments at amortized cost 96,379 75,664 Insurance Receivables 162,926 184,979 Total Short-term assets 829,954 898,706 Fixed (Long-Term) Assets     Reinsurance contract assets 162,926 184,979 Properties for investments 338,017 326,279 Associates investments 131,918 147,978 Property and equipment 7,305 7,005 Total Long-Term assets 640,166 666,241 Other Assets     - - Total Assets 1,470,120 1,564,947 Liabilities and Owner's Equity       EQUITY AND LIABILITIES     Capital and reserve     Share capital 207,000 207,000 Legal reserve 76,146 74,330 Statutory reserve 51,750 51,750 General reserve 23,323 23,323 Capital reserve 9,959 9,959 Invest revaluation reserve 2,236 89,887 Retained earnings 404,420 416,366 Total equity 774,834 872,615 Liabilities       Employees' end of service benefits 9,147 7,986 Insurance contract liabilities 296,877 317,325 Bank overdrafts 124,059 88,262 Trade and other payables 107,819 103,551 Total liabilities 528,755 509,138         - Total Liabilities and Equity 1,303,589 1,381,753 {42} Basic Financial Ratios     Debt Ratio 0.89 0.88 Current Ratio 1.07 1.03 Working Capital 55,120 26,091       (Al Wathba National Insurance Company 5-7) Methaq Takaful Insurance Company Balance Sheet Date: 31st Dec,2015 Assets 2015 2014 Current Assets     Cash 10,538,465 49,468,200 Statutory deposit 5,999,999 5,999,999 Compressive Income investments carried at fair value 25,800,000 34,100,000 Investments carried at fair value (Profit/Loss) 7,235,641 32,554,094 Receivables and Takaful 119,566,823 92,337,518 Assets from Takaful Contracts 12,372,311 9,032,388 Total current assets 181,513,239 223,492,199 -Fixed (Long-Term) Assets     Advance on land purchase 55,400,000 Deffered acquisition costs 10,686,841 326,279 Investments in properties 144,140,000 22,000,000 Loan to policyholder, net 13,521,231 42,218,925 Furniture and equipment 2,281,911 2,120,540 Total fixed assets 170,629,983 122,065,744 Other Assets     Total Other Assets - - Total Assets 352,143,222 345,557,943 Liabilities and Owner's Equity       EQUITY, POLICYHOLDERS' FUND AND LIABILITIES Capital and reserve     Share capital 151,000,000 151,000,000 Legal reserve 1,956,081 1,956,081 Statutory reserve 41,740 41,740 General reserve 1,700,806 1,700,806 Capital reserve 9,959 9,959 Invest fair value reserve 8,080,000 16,381,000 Accumulated losses (70,112,748) (66,995,207) Total equity 92,675,838 104,094,379 Liabilities       Employees' end of service provision 1,132,343 614,616 Takaful contract liabilities 173,322,260 197,203,931 Retakaful and other liabilities 70,570,430 51,670,632 Unearned retakaful commission 947,304 313,500 Retakaful deposits and retained 3,652,884 102,012,017 Islamic financing arrangements 8,570,429 102,265,700 Total Liabilities 257,063,307 453,465,780         - Total Equity and Liabilities 349,739,145 557,560,159 {42} Basic Financial Ratios     Debt Proportion 0.99 1.61 Current Proportion 1.96 2.15 Working Capital 88,837,401 119,397,820     (Methaq Takaful Insurance Company 8-13) Table of Comparison Between Conventional and Takaful Enrollment in local colleges, 2005 Takaful Insurance Convention Insurance Benefits Paid from the related members’ mutual fund for common financial assistance Paid from the organization’s reserves Investments The funds are required to be invested in Riba-free assets, approved by Sharia laws and meet national insurance regulations. As long as the national insurance regulations’ requirements are met, the funds can be invested anywhere. Premiums Policyholder’s paid premiums are treated as donation and saving. Paid premiums establishes a relationship of sale and purchase is established between the insurer and insured. . Regulations The insurance’s mechanism of operation should comply with Sharia laws as well as the national regulations. The insurance’s mechanism of operation is only required to comply with the national regulations. Source: (Khan 4) Conclusion Based on provided profitability ratios, it is evident that takaful insurance companies performs better as compared to conventional insurance companies. Takaful insurance companies are not exposed to high risks as conventional insurance because of abolishment of interest bearing investments. For an investor, takaful insurance is the best because of its low risk involvements. However, the conventional insurance will give an opportunity to trade in various interest generating activities that may result in huge profits. Bibliography Al Wathba National Insurance Company,. Board Of Directors' Report And Financial Statements. 2015. Web. 6 Dec. 2016. Khan, Mohammed. 2.13 Takaful Vs. Conventional Insurance. 1st ed. Web. 6 Dec. 2016. Methaq Takaful Insurance Company,. Report Of The Board Of Directors And Financial Statements. Methaq Takaful Insurance Company, 2015. Web. 6 Dec. 2016. Tahira, Hafiza and Zeeshan Arshad. "Comparative Performance Of Islamic And Conventional Insurance Companies In Pakistan". IOSR Journal of Business and Management 16.6 (2014): 33-45. Web. Read More