ISLAMIC INSURANCE: TAKAFUL A majority of Shari'a scholars find conventional insurance inadmissible in the Islamic framework. They have several objections against conventional insurance because it practiced the Islamic prohibited maisir, gharar, and riba. Insurance is permissible in Islam when undertaken in the framework of takaful or mutual guarantee and ta awun or mutual cooperation.. Essentially, the concept of takaful is based on solidarity, responsibility and brotherhood among participants who have agreed to share defined losses to be paid out of defined assets. Takaful is a form of insurance that is based on the system of cooperation, mutuality and shared responsibility. Takaful involves each participant giving away as donation or tabarru a certain proportion of the full amount of his or her contribution. The financial assistance paid to a participant facing a loss or damage is from a fund that is contributed by all participants by way of donation. From the operational standpoint, takaful implies an agreement among a group of members, known as participants, who collectively agree to guarantee each member against potential loss or damage. The nature of such potential loss or damage is clearly defined in the agreement. Under the arrangement, any participant who suffers such loss is compensated in the form of financial assistance from a common fund established for this purpose. The fund is created with contributions from participants that are invested in Islamically acceptable avenues. When invested prudently and profitably, the fund generates income and grows. There are different structures depending upon who promotes and manages the fund and what constitutes income for various parties involved in the process. Before we move to discuss the alternative financial structures, it is pertinent to note several facts. The concept of takaful is based on the notion of mutual help and social solidarity. As
such, takaful is originally seen as a non-profit activity. However, there is no reason why takaful cannot be undertaken as a commercial venture. From the way takaful is being practiced currently, one can observe and delineate several alternative models and financial structures. These are discussed below. Tabarru -Based Takaful The first financial structure or model of takaful assumes a non-profit nature of takaful business. Originally used in Sudan, this is also called the tabarru model of takaful. Under this model, there are no returns for the promoters, and for the policyholders. The initial contribution to organize the venture may come from the promoters as qardhasan. Participants make donation or tabarru to the takaful fund, which is used to extend financial assistance to any member in the manner defined in the agreement. Temporary shortfalls are also met through qard hasan loans from promoters. In this arrangement, policyholders are the managers of the fund and the ones with ultimate control. It may be noted that such an arrangement is closer to the ideal as compared to profitoriented takaful business. However, this also precludes large-scale expansion of takaful business. In practice, such model can be seen in operation in social and government-owned enterprises and programs operated on a non-profit basis. The programs utilize a contribution that is 100% tabarru or donation from participants who willingly give to the less fortunate members of their community. Mudharaba-Based Takaful In this model, a clear distinction is made between the business of takaful or insurance and the business of investing funds mobilized from policyholders and/or the shareholders. The takaful operator seeks no returns from managing the takaful business in line with
the spirit of takaful. It seeks returns from the business of investing the takaful funds under a mudharaba agreement with the policyholders for managing their funds. The policyholders assume the role of fund provider or rabb-ul-mal. As a mudharib the takaful company receives its share of profits generated on investments The major steps in this arrangement 1. Policyholders pay premium that is credited to a policyholders fund. 2. The takaful operator company s shareholders contribute to a fund called shareholder s fund that is distinct from the policyholders fund. This activity is the same as formation of a takaful company. 3. The takaful operator invests the policyholders fund in Shari a compatible assets and investments in its capacity as mudharib. 4. Profits generated from investing the policyholders fund are shared between the policyholders (rabb-ul-mal) and the operator (mudharib) in an agreed ratio. The policyholders fund and the shareholders fund are credited with their respective profit shares from investments. Losses if any, are charged to the policyholders fund. 5. In line with the rules of mudharaba, operational expenses relating to the investments are charged to the mudharib, the takaful operator company, and hence to the shareholders fund. The expenses charged are the general and administrative expenses of the investment department only, as distinct from general and administrative expenses for the entire business. 6. General and administrative expenses in managing the operations other than relating to investments are charged to the policyholders fund. 7. Takaful benefits are paid to beneficiaries as and when valid claims are made depending upon occurrence of actual losses and damages. 8. At periodic intervals, the net insurance or takaful surplus, that is the difference between premium received and claims paid is computed; policyholders receive full refund of insurance surplus if any; and are required to make additional
payment of deficit if any. Thus, the above arrangement ensures that the business of takaful remains a non-profit one. The policyholders in a collective capacity receive what they pay for. There are no profits to be made due to overpricing of the takaful product. Profits are made out of investments only. Return for the takaful company comprises the profit share as mudharib. Wakala-Based Takaful In the wakala-based model, the takaful operator acts as the wakil or agent of the policyholders. As such, it is entitled to a known remuneration. It incurs all the operational expenses on behalf of its principal. The distinct features of this model are: 1. Policyholders pay premium that is credited to a policyholders fund. 2. The takaful operator company assumes the role of an agent or wakil of the policyholders; its shareholders contribute to a fund called shareholder s fund that is maintained separately from the policyholders fund. 3. The takaful operator invests the policyholders fund in Shari a compatible assets and investments in its capacity as agent or wakil. Profits generated from investing add to the policyholders fund. 4. All operational general and administrative expenses are charged to the policyholders fund, since the takaful operator incurs the expenditure on behalf of the policyholders in its capacity as agent or wakil; 5. The takaful operator receives a known remuneration that may be an absolute amount or a percentage of the gross premium received. 6. Takaful benefits are paid to beneficiaries as and when valid claims are made depending upon occurrence of actual losses and damages. 7. At periodic intervals, the insurance or takaful surplus, that is the difference between premium received and claims paid is computed; policyholders receive full refund of insurance surplus if any; and are required to make additional
payment of deficit if any. Major differences between conventional and Islamic insurance The major points of difference between conventional and Islamic insurance may be enumerated in brief as under: 1. Conventional insurance is based on profit-motive and aims to maximize returns to shareholders. The business of insurance is, in essence, owned by shareholders of the insurer company. Islamic insurance, on the other hand, is based on the motive of community welfare and protection. The business of insurance itself is non-profit. The insurer is now called the takaful operator who receives a fair compensation, either through a share in returns on investment of funds or through agency fees. The business of insurance is, in essence, owned by policyholders and the operator company acts as the agent manager. 2. In case of conventional insurance, insurer s profits include underwriting surplus, which is the difference between total premium received from and total claims and benefits paid to policyholders. Essentially, profit comprises underwriting surplus plus investment income. The distribution of profits or surplus is a managerial decision taken by the management of the insurer. As a result there is a conflict of interest between shareholders of the insurer company and the policyholders. In case of Islamic insurance, on the other hand, the operator has no claims in underwriting surplus. Further, it is the takaful contract, not the management of the operator company that specifies in advance how and when profit will be distributed. There is little room for conflict between interests of shareholders of the operator company and the policyholders. 3. In conventional insurance the investment of premiums is entirely at the discretion of the insurer with no involvement by policyholders. As such, investment usually involves prohibited elements of riba and maisir. In Islamic insurance, on the other hand, the takaful contract specifies how and where the premiums would be invested. By definition such investment would exclude prohibited areas.
4. In case of dissolution of the conventional insurance, reserves and excess/surplus belong to the shareholders. In case of dissolution of the Islamic insurance, however, reserves and excess/surplus could be returned to participants, or donated to charity. Most scholars would prefer the latter course of action. 5. The Islamic insurance company has an additional obligation of annual payment of zakat.