Apr 15

Mudharabah in Takaful

Mudharabah is a commercial contract in Shariah which is being used broadly in Islamic Finance nowadays.

Mudharabah is an investment contract in which the capital (Ra’s al-mal) is contributed by one party (Sohibul mal) to another party (Mudharib) to run a business and if there any profit will be shared between them.

All Muslim Jurist acknowledge and accept the validity of the contract from Shariah perspective.

Mudharabah Contract
Any Islamic contract comprises of specific rules and provisions referred to as essential elements with necessary condition that must be met for the contract to be valid. For a Mudharabah contract, jurist had set essential element namely capital contributor (Sohibul mal), entrepreneur (Mudharib), capital (Ra’s al-mal), sharing of profit and contract (aqad). These shariah rules must be fulfilled at any point of time, otherwise the contract will be void.

In Mudharabah context, Mudharib is the trustee, agent and partner who will manage the capital without any intervention from the capital contributor (Sohibul Mal). In the event that the business being carried out makes a profit, the profit shall be shared. However if the business suffers losses then it will be borne by the capital contributor. On the other hand, the entrepreneur (Mudharib) also has to bear losses due to the cost incurred in carrying out the business without getting any income. This is due to the requirement that the entitled portion of income that is payable to Mudharib depends on the profit sharing with Sohibul Mal.

The basic principle of Mudharabah is that the capital contributor takes up the risk for investing the capital and Mudharib takes up the risk for time and energy put into managing the Mudharabah business. As such both parties deserve to share the profit gained from the so-called cooperation. In the event that there is no profit, Sohibul Mal will not get any share meanwhile Mudharib will not get any income for the effort put into managing the business.
Profit sharing will be based on common agreement on a certain fix ratio. Any loss will be borne by Sohibul Mal with the condition that the loss is not contributed by negligence of Mudharib.

Mudharabah in Takaful Operation
In a Mudharabah contract, Takaful operator acts as Mudharib (Entrepreneur) and participant as Sohibul Mal (Capital contributor). Takaful operator will be the administrator for the pool of Takaful contributions (funds) and as trustee on behalf of participant.
Takaful operator as a business entity which possesses the expertise will use the funds to conduct Takaful business as per agreed terms, and also manage the investment of the funds and benefit payment to the participants.
The contract determines how the profits from Takaful business are to be shared between Takaful operator and participant. Although Mudharabah principal decided that any loss shall be borne by capital contributor, yet, to protect participants’ interest, Takaful operator is required to comply with economic rule including by way of providing interest-free loans (Qardh Hassan) in the event that there is a deficit in the risk fund causing inability to make claim payments.

Hence, Takaful operator should not only provide interest-free loans (Qardh Hassan) when necessary, but also to bear the burden by not getting any income in carrying out the business. This is due to the concept of Mudharabah whereby income to Takaful operator is dependent on the profit or surplus gained from carrying out the business.

Certainly, based on Mudharabah contract, Takaful operator should carry out its business diligently, professionally, with transparency and accountability. Moreover, Takaful operator has established appropriate risk management and taken various actions to minimize possibility of risk that can be detrimental to them and also the participants. However, all businesses or investments, are exposed to risks that are due to unavoidable factors.

The main factor determining the profit is the claim payments made to the participants in the event of calamities. Claim amounts vary from one takaful period to another. There will be a period where the claims are low which lead to surplus in the funds that is translated into high profit that can be shared while in another period, claims could be high which lead to smaller balance in the fund or nil balance that is translated to lower profit or no profit at all.

The conclusion is profit sharing entitlement depends on the position of the pool of funds instead of the position of the individual participants. This means that, even though individual participants do not suffer calamities and has not make any claims, the participants are not entitled to a larger share of profit. This is because of the surplus calculation of the funds are based on the overall total of claims that need to be paid in a certain takaful period.

Hence, in accordance with the rules of Mudharabah profit sharing, profit is not guaranteed. As explained, profit sharing depends on the factors mentioned above. This is stated clearly in the Mudharabah contract (aqad) in the takaful certificate or policy as below:
“ and in the consideration thereof, I am/ We are entitled to share the net profit of the fund, if any, in a proportion 40% to Me / Us and 60% to the Company ”
For eligible participants, the share of profits will only be paid when the certificates have matured with the condition that no claims have been made or benefits received during the effective period of the certificate.

For this purpose, all finance and accounting transactions shall close at the end of a business period.
Therefore any percentage of profit sharing in Mudharabah that is being contracted is does not guarantee the participants of getting certain absolute amount of money in benefit. The Mudharabah percentage will be used to calculate the absolute amount of money that the participant will get from the profit. If the profit in high they will get large profit, and if there in loss they will get nothing.

Note: Thanks to Miss Karina for editing my article (22/8/2008)

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