Islamic Insurance (Takaful)

In Response to the Formal Interdiction of Conventional Insurance

‘Fiqh Council of the World Muslim League and the Islamic Conference resolved in 1978 and 1985 respectively that conventional insurance in its existing form is haram, but takaful, that is, cooperative or mutual insurance, was declared permissible.’ Takafala means mutually guarantee and protect one another […] Insurance premiums are not seen as payments made to reduce insecurity, but as tabarru, voluntary contributions made of the good of group members that suffer mishaps. Payments of claims to the policy holders may also be tagged as tabarru. […]‘The basic idea of takaful is the sharing of losses, in contract to the transfer of losses against a fee as in conventional insurance’[1]

Comparison of Conventional Insurance (in blue) and Takaful (in red)

A combination of tabarru’ contract and  agency and or profit sharing contract 

Contract of exchange (sale and  purchase) insurer-insured

Participant’s duty to make contributions to the scheme and are expected to mutually share the surplus

Policyholder’s duty to pay premium to the insurer

Takaful operator earns a return for rendering a service of managing the takaful program and from the mudarabah profit sharing scheme as mudarib

Insurance company makes a profit when there is an underwriting surplus

Counter value (‘iwad) is effort and/or undertaking of risk

No clear valid counter value. Source of profit is anticipating (hoping) that the uncertain future will be in their favour (that total premiums will exceed total claims)

Takaful operator acts as administrator of takaful fund and pays benefits from it. If there is any insufficiency in the fund, takaful operator must provide interest-free loan to rectify the deficiency

Insurer is liable to pay the benefits as promised from insurance funds or/and shareholder’s fund

Indemnification component is based on mutual contribution, reciprocal donation (tabarru’)

Indemnification component is a commercial relationship between insurance company and the insured

There is not insurer-insured relationship between takaful operator and participants. Participants act as both the insured and the insurer simultaneously

There is a clear insurer-insured relationship

Takaful funds must be invested in Shari’a compliant instruments

There is no restriction in investment of funds [2]

Types of Takaful Structures

Tabarru takaful. This is a non-profit model. It is a mutual insurance club run by the participants. Contributions come from the participants in the form of tabarru, though benefactors from outside may also make donations. If at the end of the financial year there is an underwriting surplus, which means that the sum of the premiums exceeds the sum of the claims paid, it should be returned to the participants. Shortfalls mean that benefits have to be reduced, but participants may instead make good the deficit or provide ward hasan[interest free] loans. The non-profit tabarru model perhaps comes closest to the ideal, but does not lend itself to large-scale operations. These call for other models.

Mudaraba takaful. In this model, a takaful operator, a commercial firm, will manage and invest the takaful fund fed by the premiums that the participants pay. The participants or policy holders collectively are the rabb al-mal and the takaful operator acts as the mudarib. Profits from the investments are shared between the takaful operator and the participants’ takaful fund according to an agreed ratio, but losses are exclusively charged to the takaful fund. The operator, as mudarib, is not obliged to shoulder any part of a loss. Policyholders should have the right to a full return of any underwriting surplus at the end of the fiscal year, though they may decide to use part of it to build up reserves. If there is a shortfall, participants will have to make up the difference, though the operator may provide a qard hasan loan. The AAOIFI is adamant that the underwriting surplus cannot be shared with the takaful operator, though it may be used for building reserves, reduction of premiums or donations to charities (sources). In practice, however, often not only investment surpluses but also underwriting surpluses are shared between participants and the operator, in particular in Malaysia. The operator’s share is seen as an incentive fee. Premiums are based on urf or custom, that is, on the premiums charged by conventional insurance companies and not on expected damages. This mutuality sits uncomfortably with the ideal of mutuality in takaful insurance.

Wakala  [agency] takaful. In a mudaraba-based takaful, the takaful operator receives no payment for their activity as manager of the takaful fund. Their income comes from profits. The takaful operator may instead work under a wakala, an agency contract. As the agent, wakil, for the policy holders the operator has the right to a remuneration or fee. This may be a fixed amount or money or a percentage of premium income. Unlike in a mudaraba-based takaful, all operating expenses are charged to the takaful fund but profits on takaful fund investments remain in the fund. In the event of a loss, the operator may again provide a qard hasan loan. Like the mudaraba model, however, the wakala model is not always applied in its pure form. It is not unusual for the operator to receive a share of the underwriting surplus as a performance incentive. This is allowed by the rules of the(IFSB).

A combination of wakala and mudaraba is the wakala-mudaraba model, where the operator is wakil for management and mudaraba for investment. The operator receives a fee, shares in investment profits and may also receive part of the underwriting surplus as an incentive fee.

Wakala-waqf Another variant of the wakala-based takaful is the wakala-waqf model. In general, takaful participants remain the owners of the takaful fund. The wakala-waqf model, however, converts the takaful fund into a waqf , a charitable trust. The tabarru character of the policy holders’ contributions or premiums is here taken to its logical conclusion: tabarru is a gift and the participants give up their right to any claim on their contribution. The takaful operator acts as the trustee of the waqf. The operator starts the waqf fund and pays the seed money. The waqf fund is used to pay claims and wakala fees and the investment income may be shared between the operator and the participants or added to reserves. [3]

[1] Hans Visser, Islamic Finance: Principles and Practice (second edition Ed Elgar Cheltenham 2013, pp 130-131. Paranthetical sources in the quotation omitted.

[2] Asyraf Wajdi Dusuki and Nurdianawati Irwani Abdullah, ‘Takaful: Philosophy, Legitimacy and Operation’ in Humayon A. Dar and Umar F. Moghul, eds, The Chancellor Guide to the Legal and Shari’a Aspects of Islamic Finance (London 2009), 285-314 at 297 (Table 13.2)

[3] Hans Visser, Islamic Finance: Principles and Practice, 132-133. Paranthetical sources in the quotation omitted.