Principles of Islamic banking and finance/PIBF203/Takaful/Overview

It is in the nature of human beings to think about different kind of risks that he may face in the future and get prepared for any unwanted situation. A number of things people do at the individual or family level first to minimize the possibility of any bad occurrence, and then to have a plan to tackle the unwanted incident. However, from the ancient times, it was realized that if many people expect similar calamities in the future but unware about as to who actually would be the victim, a collective arrangement might be matter. A number of examples of such arrangements could be found in History of Insurance.

Although insurance contracts were written centuries earlier, the wide use of insurance did not exist before the eighteenth century when traders started insuring their cargoes against piracy and natural disasters or urban houses started to be insured against fire. Life insurance only became popular in the 19th century; in America after alleviating the reservations of opposition of religious entities.

While the basic idea of insurance is easily understandable, scholars of different religions questioned some aspects of modern insurance companies that were established as profit seeking entities. The situation of Muslim countries was more complicated where people were more skeptical about all modern financial institutions were developed during the colonial era and were based on concepts and procedures not acceptable ( and in some cases, un-understandable).

Takaful (التكافل) means in Arabic mutually insuring each other. Mutually underwriting each other’s interest at the time of hardship and difficulty is the underlying principle behind Takaful as a financial vehicle. In a general sense, this is the Islamic alternative to conventional insurance which is not acceptable by vast majority of Islamic religious scholars.

Shariah position on insurance
Opinion of Shariah scholars is divided on insurance. They can be classified into three major groups.

1) Those who consider both the concept and practice of commercial insurance un-Islamic.

2) Those who are in agreement with the present insurance and find nothing wrong in it.

3) Those who accept the concept of insurance, but find prohibited elements in its present  practice.

Major Arguments Against Insurance
According to different bodies of religious scholars, conventional insurance is unlawful because of involvement of prohibited elements like,


 * Riba (Interest)


 * Qimar (Gambling)


 * Gharar (Uncertainty, Doubt, Risk)


 * Unlawful appropriation of others’ property


 * Violation of law of inheritance in case of life insurance.

As you already know, in Islamic business dealings riba, gharar and mysir must be avoided. The income of conventional insurance companies largely comes from interest based assets. On the liability side as well the insurance companies guarantee fixed amount at future dates. This cannot be accepted under an Islamic financial system. The other objections to conventional insurance that mostly came from religious scholars, were that the return to different policy holders were uncertain; it was not known who will receive the benefits, if any, and what will be the amount paid under different circumstances. In case of life insurance, the heirs of the person insured could get a huge sum of money if he dies - something resembling gambling.

There was also a more fundamental question as to how someone else take the responsibility of insuring others - especially in the case of life insurance. Islamic economists and financial experts successfully answered many of these questions, in some cases by explaining how the conventional insurance companies actually operate. We will give a review of these arguments in following pages.

Background of Takaful
The word Takaful is derived from the Arabic verb “Kafal”, it means to aid or help out. This forms the basis of Takaful that is about shared responsibilities, solidarity and mutual cooperation. Takaful is not a new or modern phenomenon, this concept has been practiced in various forms for centuries ever since the days of Islam. In those days there were trade caravans that were exposed to the similar risks to those faced today in trading activities. Muslim scholars acknowledge that the basis of shared responsibility in the system of Al Aaqilah as practiced between Muslims of Makkah and Madinah laid the foundation of mutual insurance. It consisted on contributions from tribes’ members to share joint responsibility to indemnify the victim or the victim’s family and relatives against financial liability arising from defined events. That system was accepted by Prophet Muhammad (pbuh) under the principle of mutual protection and cooperation in virtue and good deeds.

Other early traditions practiced by Islamic and pre-Islamic Arab tribes also constitute the origins of Takaful; these include Diya, Kafalah, Aqd muwalat, Ju’hala, Daman Khatar Al-Tariq and Hilf.

Diya is the indemnity paid as “blood-money” to the next-of-kin or the injured party of a murder victim;

Kafalah is a suretyship whereby a third party guarantees the performance of another party involved in a contract, it was used to assist victims of hazards on trade routes;

Aqd muwalat is a contract to bring an end to mutual enmity or revenge; Ju’hala is a contract to be pay for a work that involves a significant part of uncertainty; Daman Khatar

Al-Tariq is a guarantee against travel hazards; and Hilf is an agreement for mutual assistance among people. In all these agreements, Arab tribes and traders covered the losses and liabilities of individuals in the form of solidarity and brotherhood, and provided mutual financial aid and assistance in case of need.

The underlying features of Takaful primarily lie on solidarity and mutual protection. From this joint benefit and shared responsibility culture, Takaful brings equity to all the parties involved in the operation. The purpose of this system is not profits or gains but to uphold the principle of mutual assistance and shared responsibilities to take precautions against risks and misfortunes for all individual constituting the group. And by mitigating the burden of individuals whose risks are divided among their fellow members of the society, Takaful brings a peace of mind to all the participants and improves their quality of life.

In addition, Funds collected through Takaful premiums are channelled into Shari’ah compliant investments that involve environmentally friendly and socially responsible business activities. Most of the profits from these funds are shared among the participants. Besides, Takaful involves each participant giving away as donation (Tabarru) a certain proportion of the full amount of the contributions required to be paid. Therefore, by joining Takaful, every participant is indirectly involved in charity and social welfare.

The term “Takaful” means undertakings towards shared guarantee, mutual protection and collective assurance of each other. Investing collective efforts towards social wellbeing and solidarity is among the common objectives of the Takaful fund. While setting up Takaful as an investment fund manager for profit, this original welfare nature of mutual protection should also be made as objectives and recorded in a memorandum of understanding. A platform within the fund may also be created to carry out the welfare activities among the members and beyond. In a general sense, Takaful bears many similarities to commercial co-operatives and mutual insurance funds in a conventional sense and application.

In modern times, to avoid the undesirable elements in conventional insurance, several models of Islamic insurance or takaful have been developed.

Business models of takaful
There are basically two different types of Takaful models for the management and investment of funds by a Takaful operator, namely, the Mudarabah model and the Wakalah model. Other business models such as Waqf model, Tabarru’ model and combination of models are also adopted by some Takaful operators on a slighter extent.