Unit I

Introduction
Contents
 Preview
 Insurance and Islam
 Stages of the growth of Islamic Insurance
 Introduction
 Takaful
 Prohibitions of Gharar, Maysir and Riba
 Gambling and Insurance
 Basis and Principles of Takaful
 Why No to Conventional Insurance
 How does Takaful Work
 Comparison of Takaful & Conventional Insurance
Preview
 To date, Takaful market is considered as one of the fastest growing
service industry.
 It needs to work on further improvements in:
 accounting,
 regulatory,
 jurisprudential
 operational.

 Nevertheless, due to its growing demand, the Takaful industry seems

to have a bright future.
Insurance and Islam
 It is not clear when insurance practices began in Islam.
 They had been practised since before the time of holy
prophet Mohammad (SAW).
 Since then it is gradually developed until the beginning of
nineteenth century.
 Hanafi lawyer Ibn Abidin (1784-1836) became the first
Islamic scholar who introduced the meaning, concept and
legal entity of the insurance contract.
Stages of the growth of Islamic Insurance
 1. Practice of the doctrine of Aqila among the ancient
Arab tribes as a tribal custom.
 2. Practices of the holy Prophet Mohammad.
 3. Practices of the companions.
 4. Developments in 14th to 17th century.
 5. Developments in 19th century.
 6. Development in the 20th century.
1. Doctrine of Aqila
 It is an ancient Arab Tribal custom.
 In this system, if any member of a tribe was killed by a member of another
tribe, the heir of the victim would be paid an amount of blood money as a
compensation by the close relatives of the killer.
 Those close relatives of the killer were addressed as ‘Aqila’ or ‘Ma’aqil’ in
Arabic terminology.
 So, it was a common practice among them to contribute on behalf of the
killer.
 Readiness of the ancient Arabs with individual contribution at that time to
pay compensation seemed to be a kind of financial protection for the heir of
the deceased against an unexpected death of the victim.
2. Practices of the holy Prophet (SAW)
 Numerous verdicts are found in the history whereby the
Prophet (SAW) ordered to pay the blood money.
 First constitution of Madinah is the greatest example how
the Prophet (SAW) had legislated the insurance concept.
 This appeared into three modules:
 Diyat (Blood money)
 Fidya (Ransom)
 Alms and charity
Three Modules
 Diyat (Blood money):
The immigrants among Quraish shall be responsible for their word and shall
pay their blood money in mutual collaboration relying on the doctrine of
‘Aqila’.
 Fidya (Ransom):
Prophet Mohammad declared that: The immigrants of Quraish shall be
responsible for releasing the prisoners by way of paying their ransom.
Likewise, all other tribes were obliged to follow this rule.
 Alms and charity:
Prophet Mohammad declared that the society will be responsible to establish
a joint venture (Baitul Maal) with a mutual understanding towards providing
necessary aid to the needy, sick and poor.
3. Practices of the companions

 Aqila system had further been developed in the period of

second Khalifah Omer Bin Khattab.
 He commanded that a Diwan of Mujahideen (A committee
of the collectors) be established in various districts who
would extend mutual cooperation to contribute the blood
money for murder of their own tribesman committed by
one of the same tribe.
4. Developments in 14th to 17th century:

 During this period a Sufi order was very active especially

in the port cities like Malabar, China, etc.
 This order served as a kind of marine insurance company.
 It had been associated with the tomb of Mohammad Ishaq
Ibrahim ibn Shahariyah (963-1035AD) whose blessings were
considered as a protection against peril during the sea
voyage.
5. Developments in 19th century
 The well known jurist, scholar and lawyer Ibn Abidin Hanafi (1784-
1836).
 He was the author of the well-known and one of the most authentic
books on Islamic jurisprudence “Raddul Mukhtar”.
 He became the first person to draft the methodology and the legal
entity of the insurance.
 Until now the insurance was continuing as a customary practice. He
introduced the insurance in the context of a legal constitution.
 He too faced opposition from the traditional conservative preachers
but his idea prevailed and prompted many to involve in the insurance
business.
 King Muller writes that the Muslims began to practice insurance
business and it tempted the Europeans to become the insurer
themselves.
6. Development in the 20th century
 The well known scholar, jurist and the strong follower of
Jamaluddin Afghani the hero of the Pan Islamism,
Mohammad Abdu issued two fatwas mentioning that
 The insurance transaction is like the transaction of
Mudarbah.
 A transaction which is similar to endowment or life insurance
is legal.
Introduction
 Schemes for mutual protection against losses have
traditionally existed in Islamic societies.
 The conventional insurance industry also faces major
regulatory issues, in which it may be thought to lag behind
banking with particular respect to international prudential
standards on solvency, capital adequacy and related
matters and financial reporting.
Introduction contd…
 The first modern takaful undertaking was founded in Sudan in 1979.
 Its foundation was due to the solution by a Sudanese Shari’ah scholar
of a juristic problem:
 How may the Shari’ah prohibition of trading in insurance be
overcome?
 Part of the solution lies in the adoption of a mutual structure for
underwriting insured risks: the participants mutually insure one
another, on a non-profit basis, according to the principle of takaful.
 Another aspect of the solution consists of characterizing the policy
contributions
 (premiums) to the risk fund as incorporating an element of conditional
and irrevocable donation (tabarru’), the donor making the
contribution to the risk fund subject to being entitled to benefit from
mutual protection against insured losses.
Introduction contd…
 The adoption of a mutual structure runs into two kinds of
institutional obstacles.
 First, the legal systems of many countries do not accept
mutual or cooperative forms of company without share
capital.
 Second, even if such forms of company are accepted for
insurance undertakings, they need to be able to raise
enough capital from policyholders to meet regulatory
capital adequacy and solvency requirements.
Introduction contd…
 To surmount these two obstacles, the vast majority of
Takaful undertakings have a two-tier, hybrid structure.
 In which the risk funds operate on a mutual basis but are
managed by a Takaful operator, which is a company with
shareholders.
 However, this hybrid structure involves complexities and
raises juristic and legal issues which are yet to be
satisfactorily resolved.
Introduction contd…
 In addition to the need to overcome juristic and
institutional problems,
 The development of Takaful is inevitably constrained by
the economic and social development of predominantly
Muslim countries.
 It affects the market for and the propensity (especially at
the retail level) to take up insurance cover.
 Takaful can contribute to economic development
 At the micro level by enabling more efficient risk
management by firms and households, and
 At the macro level (particularly in life or family takaful)
by mobilizing savings and providing funding for investment
in long-lived assets.
What is Takaful?
 All human activities are subject to risk of loss from
unforeseen events.
 To alleviate this burden to individuals, what we now call
insurance has existed since at least 215 BC.
 This concept has been practiced in various forms for over
1400 years.
 It originates from the Arabic word Kafalah, which means
"guaranteeing each other" or "joint guarantee".
 The concept is in line with the principles of compensation
and shared responsibilities among the community.
Takaful Contd…
 Takaful originated within the ancient Arab tribes as a
pooled liability that obliged those who committed
offences against members of a different tribe to pay
compensation to the victims or their heirs.
 This principle later extended to many walks of life,
including sea trade, in which participants contributed to a
fund to cover anyone in a group who suffered mishaps on
sea voyages.
 In modern-day conventional insurance, the insurance
vendor (the insurance company) sells policies and invests
the proceeds for the profit of its shareholders, who are
not necessarily policyholders.
Takaful Contd…
 Takaful is commonly referred to as Islamic insurance; this is due to
the apparent similarity between the contract of kafalah (guarantee)
and that of insurance.
 Muslim jurists conclude that insurance in Islam should be based on
principles of mutuality and co-operation.
 It should contains the elements of:
 shared responsibility,
 joint indemnity,
 common interest and
 solidarity.
Takaful Contd…
 In Takaful, the policyholders are joint investors with the
insurance vendor (the Takaful operator), who acts as a
mudarib – a manager or an entrepreneurial agent for the
policyholders.
 The policyholders share in the investment pool's profits as
well as its losses.
 A positive return on policies is not legally guaranteed, as
any fixed profit guarantee would be akin to receiving
interest and offend the prohibition against riba.
Takaful Contd…
 Conventional insurance is considered to be incompatible
with the Shari’ah that prohibits
 Excessive uncertainty in dealings and
 Investment in interest-bearing assets.
 However, Takaful complies with the Shari’ah and has been
approved by Muslim scholars.
 There is now general, health and family (life) Takaful
plans available for the Muslim communities.
Prohibitions of Gharar, Maysir and Riba
 Gharar (Uncertainty OR Risk):
 An insurance contract contains gharar because, when a claim is not
made, one party (insurance company) may acquire all the profits
(premium) gained whereas the other party (participant) may not
obtain any profit.
 Ibn Taimiyah, a leading Muslim scholar, further reasoned "Gharar exists
in the contract because one party acquired profit while the other
party did not".
 The prohibition on gharar would require all investment gains and
losses to be apportioned in order to avoid excessive uncertainty with
respect to a return on the policyholder's investment.
Prohibitions of Gharar, Maysir and Riba
 Maysir (Gambling):
 Islamic scholars have stated that maysir and gharar
are inter-related.
 Where there are elements of gharar, elements of
maysir is usually present.
 Maysir exists in an insurance contract when;
 The policy holder contributes a small amount of premium in
the hope to gain a larger sum;
 The policy holder loses the money paid for the premium
when the event that has been insured for does not occur;
 The company will be in deficit if the claims are higher that
the amount contributed by the policy holders.
Prohibitions of Gharar, Maysir and Riba
 Riba (Interest):
 Conventional endowment insurance policies promising a contractually-
guaranteed payment, hence offends the riba prohibition.
 The element of riba also exists in the profit of investments used for
the payment of policyholders’ claims by the conventional insurance
companies.
 This is because most of the insurance funds are invested by them in
financial instruments such as bonds and stacks which may contain
elements of Riba.
 Gambling and Insurance
Gambling
 Speculative in its risk assessment.
 One may win or lose by creating that
risk
 Promotes dissension, ruin and hatred
Insurance
 Pure risk and is non-speculative.
 The risk is already there and one is trying
to minimise the financial effects of that
risk.
 Shifts the impact of that risk to someone
else and relieves the person of risk
 The risk nevertheless still remains
 Based on cooperative principles, enables
the insured to lessen the financial
impact without which it could drive the
individual and his dependents to poverty,
thereby weakening their place in the
society.
 Strengthens the financial base of the
society.
Gambling and Insurance

 Islamic scholar, Yusuf Ali, in his translation of The Holy

Qur’an, comments on Sura (chapter) Al-Baqara, ayat
(verse) 219,
 “Insurance is not gambling, when conducted on business
principles.
 Here the basis for calculation is statistics on a large scale,
from which mere chance is eliminated.
 The insurers charge premium in proportion to the risks,
exactly and scientifically calculated".
Basis and Principles of Takaful
 Islamic insurance requires each participant to contribute into a fund that is
used to support one another with each participant contributing sufficient
amounts to cover expected claims.

The underlying principles of Takaful may be summarised as follows:

 Policyholders co-operate among themselves for their common good.
 Every policyholder pays a part of the contribution as a donation to help those
that need assistance.
 Losses are divided and liabilities spread according to the community pooling
system.
 Uncertainty is eliminated in respect of subscription and compensation.
 It does not seek to derive advantage at the cost of others.
 Theoretically, Takaful is perceived as cooperative insurance, where members
contribute a certain sum of money to a common pool. The purpose of this
system is not profits but to uphold the principle of "bear ye one another's
burden."
Why No to Conventional Insurance
 In modern business, one of the ways to reduce the risk of loss due to
misfortunes is through insurance.
 The concept of insurance where resources are pooled to help the
needy does not necessarily contradict Islamic principles.

Three important differences distinguish conventional insurance from

Takaful:
 Conventional insurance involves the elements of excessive uncertainty
(gharar) in the contract of insurance.
 Gambling (maysir) as the consequences of the presence of excessive
uncertainty that rely on future outcomes.
 Interest (riba) in the investment activities of the conventional
insurance companies.
 Why No to Conventional Insurance

 Conventional insurance companies are motivated by the desire

for profit for the shareholders;
 Conventional system of insurance can be subject to exploitation.
For example, it is possible to charge high premium (especially in
monopolistic situations) with the full benefit of such over-pricing
going to the company.
 The key difference between Takaful and conventional insurance
rests in the way the risk is assessed and handled, as well as how
the Takaful fund is managed.
 Further differences are also present in the relationship between
the operator (under conventional insurance using the term:
insurer) and the participants (under conventional it is the insured
or the assured).
 Takaful business is also different from the conventional insurance
in which the policyholders, rather than the shareholders, solely
benefit from the profits generated from the Takaful and
Investment assets.
How does Takaful Work
 All participants (policyholders) agree to guarantee each other and,
instead of paying premiums, they make contributions to a mutual fund,
or pool. The pool of collected contributions creates the Takaful fund.
 The amount of contribution that each participant makes is based on
the type of cover they require, and on their personal circumstances. As
in conventional insurance, the policy specifies the nature of the risk
and period of cover.
 The Takaful fund is managed and administered on behalf of the
participants by a Takaful Operator who charges an agreed fee to cover
costs. These costs include the costs of sales and marketing,
underwriting, and claims management.
 Any claims made by participants are paid out of the Takaful fund and
any remaining surpluses, after making provisions for likely cost of
future claims and other reserves, belong to the participants in the
fund, and not the Takaful Operator, and may be distributed to the
participants in the form of cash dividends or distributions, alternatively
in reduction in future contributions.
Comparison of Takaful & Conventional Insurance