Financial planning has gained increased importance in a modern world characterised by volatile lifecycle patterns and uncertain income streams. The fast pace of modern life has also increased the risks that individuals face, as well as the cost of living and competing effectively.

Financial planning as a whole has moved away from pure product selling to focusing on advisory and structuring work. Modern financial planning experts are required to take a holistic view of a client and put in place the correct financial measures to protect against possible future events, and to provide for possible future events.

With regard to risk management, the primary means of achieving adequate risk protection in conventional finance is through paper-based risk transfer mechanisms, such as insurance policies, dread disease cover, medical aid, etc.

With regard to investment, again it is primarily a paper-based system of asset accumulation. Fixed income components are usually achieved through interest-bearing instruments.

Estate planning is largely discretionary and is achieved through the use of juristic entities with tax structuring being of utmost importance, in addition to giving force to the personal distribution wishes of the testator.

Future lifecycle needs are accommodated through specific savings products such as endowment policies, funeral policies, education savings plans, etc. where such funds so invested are grown through investment in the capital markets, both debt and equity.

Retirement is catered for through retirement annuity plans and pension funds. An overwhelming feature of these strategies is that they fail to satisfy the requirements of Shariah Law in a number of ways.

Underlying principles

In order to understand why conventional financial planning techniques are unacceptable to individuals seeking to arrange their affairs strictly in accordance with Islamic Law, a few examples will be looked at to illustrate the underlying principles of impermissibility.

The most obvious place to start is in the realm of estate planning. Under Shariah law, the manner in which the funds of the deceased need to be distributed is absolute and binding, regardless of the specific wishes of the deceased.

Thus, once a person passes away, there is an irrefutable manner of distributing his assets, and the possible list of heirs is defined and their respective distributions already determined. It then follows, that setting out a will is for the most part useless under a system of Islamic finance.

Every Muslim has a pre-ordained will dictated for them by divine law, and as such personal preference does not come into play. Furthermore, the use of juristic entities to achieve tax structuring will also pose a problem. Juristic entities enjoy very limited acceptance amongst Shariah scholars, and when accepted, it is not for any use or purpose loosely defined.

So, how does an adherent to Islamic finance give force and effect to his wishes as to the distribution of his wealth, if he wants it distributed in a manner that would not be possible under Shariah law?

The most obvious answer is that he must give the asset or cash away to the person of his choice, while he is alive. Thus, he may want to donate the asset to his prospective heir.

This raises a number of different possibilities: the spectre of donations tax looms large on such a scenario as well as the question of affordability. Can the person afford to give the asset away while he is alive?

One possible solution is to give the money away in tranches, or to give it to another family member who will lend him the sum if he needs it, and also is trustworthy enough to give the asset to the chosen person upon the death of the person leaving the legacy. There are possibly a myriad ways of structuring such transactions, as long as they are within the letter and spirit of Shariah law. Cheating and smuggling to get around divine limits on financial activity are futile and morally reprehensible.

Risk management

Risk management provides a fertile example for illustrating points of impermissibility.

Firstly, conventional insurance products are not permissible in Islamic finance, primarily due to the nature of the transaction, with there being consideration paid for nothing tangible in return, and due to the investment of the funds in assets that are not allowed in Islamic finance, such as interest-bearing bonds and certain equities.

In fact, a growing school of influential scholars believes that no investments on the stock market may be made at all. So, how does an individual mitigate risk under an Islamic finance system?

A major distinction between conventional risk measures and Islamic risk measures is that while conventional insurance in most cases seeks to restore the sufferer of the loss to the position that he was in prior to the loss, in Islamic finance, emphasis is placed on actively taking steps to prevent or minimise the loss.

Thus, rather than taking out life insurance, a person must endeavour to be debt free and live a prudent life so as to leave sufficient assets for his heirs. Thus, a person concerned about providing for his family after his death would curb his expenses, avoid large debt, and invest in income-producing assets, of which immovable property is a particularly well suited asset class.

A proper understanding of the Islamic philosophy behind risk is also very important in understanding how to approach risk management in Islamic finance. A great deal of emphasis is placed upon reliance in the providence of the Almighty, and an attitude of resilience in the face of adversity is encouraged.

In addition, the most important safety net in an Islamic financial system can well be argued to be the support and strength of the community.

Lifecycle needs can be catered for by investing in assets that are both acceptable in Islamic finance and that provide the required cashflow at the right time. Interest-bearing bonds are not acceptable, and a proxy for a fixed income portfolio would need to be created.

The solution would be to invest in a property fund run in accordance with Shariah principles with the desired investment horizon. Ultimately, the objective of financial planning under Islamic Finance is the same as under conventional finance – it is the method and underlying philosophy that differs.

Ebrahim Patel, BSc,BScHons, MPhil(Ethics), MIFM

(Ebrahim is a director of the An Nakheel Group, consisting of a Shariah Property Fund,a Corporate Shariah Advisory company and Media company. Ebrahim also serves on the editorial board of At Tijaarah,SA’s only Islamic finance magazine.)