Takaful -Insurance- Part I (Definition)

What is Takaful?

This concept has been practiced in various forms for over 1400 years. It originates from the Arabic word Kafalah, which means "guaranteeing each other" or "joint guarantee". The concept is in line with the principles of compensation and shared responsibilities among the community.

Takaful originated within the ancient Arab tribes as a pooled liability that obliged those who committed offences against members of a different tribe to pay compensation to the victims or their heirs. This principle later extended to many walks of life, including sea trade, in which participants contributed to a fund to cover anyone in a group who suffered mishaps on sea voyages.

In modern-day conventional insurance, the insurance vendor (the insurance company) sells policies and invests the proceeds for the profit of its shareholders, who are not necessarily policyholders. There is therefore a clear disjunction between policyholders and shareholders. Payouts to policyholders may vary depending on financial performance, but a minimum positive return is always contractually guaranteed.

Takaful is commonly referred to as Islamic insurance; this is due to the apparent similarity between the contract of kafalah (guarantee) and that of insurance.

However, takaful is founded on the cooperative principle and on the principle of separation between the funds and operations of shareholders, thus passing the ownership of the Takaful (Insurance) fund and operations to the policyholders. Muslim jurists conclude that insurance in Islam should be based on principles of mutuality and co-operation, encompassing the elements of shared responsibility, joint indemnity, common interest and solidarity.

In takaful, the policyholders are joint investors with the insurance vendor (the takaful operator), who acts as a mudarib – a manager or an entrepreneurial agent for the policyholders. The policyholders share in the investment pool's profits as well as its losses. A positive return on policies is not legally guaranteed, as any fixed profit guarantee would be akin to receiving interest and offend the prohibition against riba.

For some time conventional insurance was considered to be incompatible with the Shari’ah that prohibit excessive uncertainty in dealings and investment in interest-bearing assets; both are inherent factors in conventional insurance business.

However, takaful complies with the Shari’ah (which outlines the principles of compensation and shared responsibilities among the community) and has been approved by Muslim scholars. There is now general, health and family (life) takaful plans available for the Muslim communities.

Prohibitions of Gharar, Maysir and Riba

Gharar: An insurance contract contains gharar because, when a claim is not made, one party (insurance company) may acquire all the profits (premium) gained whereas the other party (participant) may not obtain any profit whatsoever. Ibn Taimiyah, a leading Muslim scholar, further reasoned "Gharar found in the contract exists because one party acquired profit while the other party did not". The prohibition on gharar would require all investment gains and losses to eventually be apportioned in order to avoid excessive uncertainty with respect to a return on the policyholder's investment.

Maysir: Islamic scholars have stated that maysir (gambling) and gharar are inter-related. Where there are elements of gharar, elements of maysir is usually present. Maysir exists in an insurance contract when; the policy holder contributes a small amount of premium in the hope to gain a larger sum; the policy holder loses the money paid for the premium when the event that has been insured for does not occur; the company will be in deficit if the claims are higher that the amount contributed by the policy holders.

Riba: Conventional endowment insurance policies promising a contractually-guaranteed payment, hence offends the riba prohibition. The element of riba also exists in the profit of investments used for the payment of policyholders’ claims by the conventional insurance companies. This is because most of the insurance funds are invested by them in financial instruments such as bonds and stacks which may contain elements of Riba.

[source: Institute of Islamic banking and Insurance (IIBI)]