Principles of Islamic banking and finance/PIBF203/Takaful/History and idea of insurance

In this session we will have a brief historical overview of insurance and then describe the basic idea of insurance.

Historical Overview
If we look back in the history, we will find that the idea of insurance existed since very long time. Mankind used the concept of cooperation and mutual help in order to manage the surrounding risks. There are many historical examples some of them goes back to the Roman Empire when it arranged burial clubs to pay for the costs of funerals. In the seventeenth century, the same principle was adopted in England to provide medical aid. In the same century, special funds were collectively raised to help those who were affected by the great fire of London which was later called “the Phoenix”. These early arrangements led to the birth of insurance institutions especially in the nineteenth century. The new transportation means and the industrial revolution increased number of accidents and deaths. As a result industrial assurance companies were established in England.

As the time passed, more insurance institutions were developed. Some were designed for social benefit, while others were set up primarily for personal profit. Unfortunately, the private insurance firms that were profit based grew fast in size and membership, while the social cooperative insurance institutions were somehow slow in growth. Greedy capitalists quickly noticed the potential gains they can make through the insurance industry. Because the industry was new, there were no regulations to control the activities of insurance institutions. Therefore, for more than 150 years the greedy entrepreneurs neglected the social benefits of insurance by subjecting the society to extremely high premiums, thereby making huge profit. Because of the negative effects of the exploiting insurance in the 18th and 19th centuries, a wave of regulations had been introduced. As the time passed, the regulations of commercial insurance institutions have become increasingly tighter.

The insurance idea was not only found in the West, it was also known and practiced in the Arab societies and reflected through the mutual help and assistance for a person whenever he faces a calamity or misfortune. For example, the merchants in Makka had formed a fund to help victims of natural hazards and disasters during their trading journeys. Therefore, the concept of insurance was practiced as a voluntary basis. Later on, under the Ottoman Empire, marine insurance known as sowkrah, and then non-life insurance were practiced at that era.

The current insurance has been developed in the west and it was introduced to Arab and Muslim countries in the 19th century with the colonization. After getting their freedom, Islamic scholars made effort to understand and analyze the insurance contract. Some issues violate the Shariah principles were founded in the conventional insurance contracts such as; uncertainty, gambling, and interest. To solve these issues, the concept of Takaful was introduced as an alternative for the conventional insurance.

The idea of insurance
The idea of current insurance comes from the "law of large numbers". The principle of this law states that while it is not possible to predict the exact outcome of a given situation at a given point of time, it is possible to some extent to determine the outcomes of incidents for a large sample over a period of time. For example, all people know that days are numbered, but none of them knows whether death will strike this year. However, at the level of society, people can predict how many individuals in a given group will die this year. The same principle is used to form the basis of general insurance business. For instant, when an insurance company sells car insurance policies, it finds out the predicted number of accidents per year multiplied by the average cost per accident, the insurance company can determine the predicted cost of claims each year. Accordingly, the insurance company determines the total premiums required to cover the expected claims, the administration costs, and the desired profit.

Commercial vs Cooperative insurance
Insurance can be classified into two types; commercial and cooperative. The main difference between the two is their goals. The priority of commercial insurance companies is making profit. While, the cooperative insurance companies are somehow voluntary seek to benefit the society. Most of the current insurance companies are commercial and their working procedure can be summarized as follow:


 * The clients pay a specific amount of premiums determined by the company after using probability to estimate the amount of claims. According to their calculations, the premiums will be sufficient to cover all claims, expenses, and the profit they seek for. By paying the premiums, the clients sell the risk to the company and it is obliged to cover the loss of any one of them if the insured risk occurred.
 * The company own the premiums and invest them in banks, bonds, and any other business activities. Any profits or losses are made go back to the company.


 * The company cover the claims at that period of time and any extra money is owned by the company.

On the other hand, few cooperative insurance companies are operating in all over the world. Most of these cooperative companies are operating in the West, more specifically; the Scandinavian countries. The procedure of the current cooperation insurance companies can be summarized as follow:


 * The participants pay a specific amount of money as contributions to form an insurance pool and they have agreement between them to use this money to cover the loss of any one of them in case one of the insured risks occurred to him.


 * The pool is managed by a cooperation institution where the participants are the owners (shareholders). The managers of the institutions are selected through voting where each participant has one vote.


 * Through statistical studies, the amount of contributions are determined to cover all the expected claims and any surplus is retained to the participants (policyholders).

After going through the concept and different organizational forms of insurance, different views of Muslim jurist will be discussed in the next section.