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Home > Insurance Markets Best Practice > Islamic Insurance Markets and the Structure of Takaful

Insurance Markets Best Practice

Islamic Insurance Markets and the Structure of Takaful

by Suzanne White

Executive Summary

  • Islamic scholars object to the concept of conventional insurance due to three key elements: riba (usury), gharar (uncertainty), and maysir (gambling).

  • Islamic insurance or takaful operators have therefore redesigned their management and accounting practices to comply with shariah law.

  • Takaful, and conventional or traditional insurance policy wordings, both operate in a similar way, with the protection that is provided to the client being exactly the same.

  • The differences between Islamic and conventional insurance lie in the ownership and financing of the company, in the management and accounting systems, and in the entities in which the premiums are invested.

  • Islamic insurance is a very close concept to that of “mutual insurers” in the West and, in particular, to those we call “ethical” insurers.

Introduction

Insurance plays a vital role in supporting both national and international economic development and growth. Islamic countries are no exception. The main issue for insurers in the Islamic world is that many Islamic scholars view conventional insurance as prohibited by Islam.

Muslim scholars are not against the concept of risk mitigation, risk sharing, or risk management, including risk financing, per se. In fact, they support the compensation of victims of misfortune. However, many scholars consider some aspects of conventional insurance contracts as being prohibited from a shariah (Islamic law) point of view. Shariah covers all aspects of a Muslim’s life, not just worship.

Prohibited Factors of Insurance

Several fatawa (the plural of fatwa, meaning an answer to a question related to an issue of shariah) have been issued by eminent Muslim scholars on the subject of insurance. The objections tend to relate to the insurance contract itself or to insurance market practice in general.

Objections relating to the insurance contract itself are those of riba (usury), gharar (uncertainty), and maysir (gambling). The other objections relating to market practice are usually concerned with two issues: The first is that insurance companies’ investment policies are generally interest-bearing (which is not acceptable in Islam), and the second issue is the fact that life assurance is considered to breach Islamic inheritance rules by distributing the sum assured among beneficiaries. These objections relating to market practice can be easily overcome by the insurer making changes to their company policy, as they do not affect the insurance contract itself.

The objections related to the contract itself, however, require the restructuring of insurance contracts to be in line with shariah.

Riba (Usury)

Under a conventional insurance contract, the insured pays the insurance company a premium (either as a lump sum in general insurance or as installments in life insurance), in exchange for financial compensation at the time of a claim, subject to the happening of an insured occurrence or event. Claims are generally larger amounts than the premium paid. Islamic law objects to this payment on the grounds that a small amount of money (premium) is being exchanged for a larger amount of money (claim). Scholars consider this an unjustified increase of money, and therefore riba. Islamic insurers therefore have to structure their operations and investments to avoid riba.

Gharar (Uncertainty)

Gharar can be defined as uncertainty or ambiguity. Islamic law seeks to avoid ambiguity in contracts, in order to prevent disputes and conflict between parties. This is a general Islamic principle that must be applied to all contracts, including insurance.

In the case of conventional insurance, neither the insurer nor the insured knows the outcome of the contract (i.e., whether a loss will occur or not). The insurer is entitled to get the premium in all cases, whereas the insured may not receive a claim because the payment of claims depends on the probability of loss occurrence (which is a random variable). Other uncertain elements are as to when the claim may be paid and how much the insured may receive.

In life assurance contracts, gharar can be seen to exist even in the premium, as the insured party does not know how much he will pay to the insurance company each year, or for how many years. The insured may know the monthly or yearly premium, but he does not know how much he will pay to the insurer before he dies. In general insurance (nonlife insurance), the premium is pre-agreed, but there is gharar in the claim amount. Therefore gharar exists in all insurance contracts, either in premiums or in claims. In Islamic insurance, scholars agree that engaging in takaful transactions, with a donation element as part of their contribution, offsets gharar.

Maysir (Gambling)

Some arguments against conventional insurance are based on the grounds that insurance contracts are basically gambling contracts. Islam rejects any contract where financial gain comes from chance or speculation. Insurance, however, needs to comply with the principle of insurable interest. This principle requires a financial and legal relationship between the insured and the subject matter of insurance. The insured is only entitled to get a claim if he proves his insurable interest, and this feature therefore nullifies the notion that insurance is a gamble.

The other difference between gambling and insurance is that the first is a speculative risk (which is uninsurable), while the latter consists of pure risk only (i.e., the insured should not make a gain but should be put back into the same financial position as before the loss occurred).

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Further reading

Books:

  • El-Gamal, M. A Basic Guide to Contemporary Islamic Banking and Finance. Houston, TX: Rice University, 2000.
  • Jaffer, S. (ed). Islamic Insurance: Trends, Opportunities and the Future of Takaful. London: Euromoney Books, 2007.
  • Kassar, Khaled, Omar Clark Fisher, et al.What’s Takaful—A Guide to Islamic Insurance. Beirut: BISC Group, 2008.
  • Ma’sum Billah, M. Islamic Insurance (Takaful). Kuala Lumpur: Ilmiah Publishers, 2003.

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