TAKAFUL ISLAMIC ALTERNATIVE TO CONVENTIONAL INSURANCE

ROHAIL ALIKHAN
General Manager, Takaful Pakistan Limited

Dec 11 - 17, 2006

Generally speaking conventional insurance is a way to provide security and/or compensation for what is valuable in the event of loss, damage, or destruction, based on the principle of risk-taking and speculation.

The Contract of Insurance: Insurance is born from the human need to find safeguards against the possible risk to one's self and one's property. A contract of insurance can be defined as:

"A contract whereby one person called the 'insurer' undertakes, in return for an agreed consideration called the 'premium', to pay to another person called the 'assured', a sum of money, on the happening of a specified event..."

Thus, it is a contract between two parties, the insurer and the insured. The former promises to compensate the latter on the happening of a defined event, in return for his/her contributions.

The aim of insurance is therefore to make provisions against danger.

Conventional insurance principles
Pooling of risk
Payment of fortuitous loss
Risk transfer
Indemnification

PROFIT FOR THE SHAREHOLDERS FROM UNDERWRITING RESULTS AND INVESTMENTS

Point of interest: The first mention of the notion of insurance in the traditional books of Islamic Fiqh (Science of Shariah) appears in the works of a famous scholar of the 18th century, Allama Ibn Aabideen who noted that:

"When merchants charter ships owned by belligerent states then along with the fees for the ship's charter, another amount is paid separately to the subject of that belligerent state. This payment is known as 'Sukra' (or insurance premium). Its payment ensures that in case of loss of the goods due to fire, sinking of the ship, or looting by pirates, the recipient of the Sukra is responsible to indemnify the merchant who incurred the loss. (Raddul Mukhtar, Vol. 3, p.345)

Abu Zahra, one of the well-known commentators of this particular work, stated:

"Even though the underlying motive was mutual co-operation, it ultimately met the same fate as did every other institution which came under the control of the Jews. A system based on the spirit of cooperation in what was good and pious, was mutilated by the Jews to a system which contains the elements of speculation and interest (Riba) - typical of the Jewish mentality".

WHY 'NO' TO CONVENTIONAL INSURANCE

The Islamic Fiqh Academy emanating from the Organization of Islamic conference, meeting in its Second Session in Jeddah, Saudi Arabia, from 10 to 16 Rabiul Thani, 1406 H (corresponding to 22-28 December, 1985) issued a resolution which in summary stated the following:

After reviewing the presentations made by participating scholars during the session on the subject of 'Insurance/Re-insurance';

And after discussing the same;

And after closely examining all types and forms of insurance and deeply examining the basic principles upon which they are founded and their goals and objectives;

And having looked into what has been issued by the Fiqh Academies and other institutions in this regard;

RESOLVES

The commercial insurance contract...is prohibited (Haram) according to the Shariah.

WHY?

Is there something wrong with the concept? I.e. Risk aversion, assuring others, risk sharing?

WHAT IS WRONG WITH THE PRACTICE?

There is nothing wrong with the concept of insurance but rather its practice.

The contract between the insurer and the insured is technically wrong from the Shariah point of view because it contains at least one of the following 3 elements:

Gharar
Maysir
Riba
Gharar

LEXICALLY GHARAR MAY BE DEFINED AS 'UNCERTAINTY'.

Technically, gharar is the uncertainty of the consideration or the subject matter or the period in a commutative contract.

According to the scholars therefore, Gharar arises in insurance out of the factor of 'trade'. Because conventional insurance works as a contract of exchange or a commercial transaction i.e. through the buying and selling of insurance, it must therefore conform to the rules of the Shariah governing sales.

Under Islamic law, if a subject is involved in trade it must satisfy the basic principles of trade. These principles relate to:

The buyer and seller
Offer and acceptance
Object of trade

The uncertainty in the case of conventional insurance relates to the object/subject matter of trade. The object of trade must satisfy the following conditions:

The object must be something that can be given in trade i.e. something tangible ('peace of mind is not tangible')

The time of surrender/delivery must be known
The quantity of the object must be known
The place of surrender/delivery must be known

Insurance companies and those who sell insurance refuse to insure cases except where there is clear uncertainty in whether or not the condition being insured against will happen or not. In other words, the condition being insured against must have a possibility of happening or not happening (as opposed to, for example, someone who has a pre-existing condition, such as a person who is on death row applying for life insurance). Moreover, this transaction involves the uncertainty of when an accident will happen and the extent of the damage caused. Hence insurance combines three kinds of extreme uncertainty.

According to the past great scholars, gharar meant:

"The lack of information about a certain product (object); the existence of uncertainty in the presence of that object and, the lack in quantity and conciseness of information about the object" (Ibn Rushd)

Sheikh ul Islam Ibn Taimiyyah explained that gharar occurred "when one party obtained his rights or acquired his profits while the other party did not get what was rightfully his".

In the context of conventional insurance therefore, an insurance contract contains gharar because:

"When a claim is not made, one party (the insurance company) may acquire all the profits (premiums) gained whereas the other party (the insured) may never obtain any profit whatsoever".

This reason is in line with Ibn Taimiyyah's definition of Gharar.

Other reasons given for the existence of gharar in conventional insurance contracts are that:

The insurer does not know how much he will owe to the insured

The insured does not know how much he will ultimately have to pay to the insurer.

MAYSIR

Also known as Qimaar, maysir literally refers to gambling or games of chance, and is a consequence of gharar (uncertainty). The effect of maysir is very similar to gharar such that it involves the chance of total loss to one party. The basic difference between the two terms is that while one (gharar) is uncertainty the other (maysir) is based upon or the result of uncertainty (gharar).

E.g. the insured loses all the money paid by way of premiums when the uncertain event that has been insured against does not occur.

RIBA

Direct Riba - the excess on one side in the exchange between the amount of premium and the insured sum. Insurance is the sale of money for money, of a greater or lesser amount, with a delay in one of the payments.

Indirect Riba - the interest earned on interest-based investments.

Riba exists in commercial insurance from the profits earned through investments of the premiums/funds in interest-bearing financial instruments such as stocks, bonds, and savings accounts, an unknown part of which is then used for the payment of claims to policy holders.

Reference to the Quran regarding the basic prohibitions that exist within a conventional insurance contract

The system of takaful must avoid Riba, Maysir (the gambling element) and Gharar (uncertainty).

AVOIDING RIBA

The funds of a conventional insurance company are mainly in investment activities that contravene the rules of Shariah. They invest in companies that may be involved in unethical activities and build their business through participating in Riba. Also, loans may be granted on insurance policies and interest charged for that loan. This is not permitted in a takaful contract. Riba is prohibited in Islam and stated below are references in the Quran to this effect.

"Those who eat Riba (usury) will not stand (on the Day of Resurrection) except like the standing of a person beaten by Shaitan (Satan) leading him to insanity. That is because they say, "Trading is only like Riba or usury, whereas Allah has permitted trading and forbidden Riba. So whosoever receives an admonition from his Lord and stops eating Riba shall not be punished for the past; his case is for Allah (to judge): but whoever returns to Riba, are dwellers of the Fire - they will abide therein. Al-Quran, Al-Baqarah (2).- 275

"0 you who believe! Be afraid of Allah and give up what remains (due to you) from Riba (from now onward), if you are (really) believers. And if you do not do it, then take notice of war from Allah and His Messenger but if you repent, you shall have your capital sums. Deal not unjustly (by asking more than your capital sums), and you shall not be dealt with unjustly (by receiving less than your capital sums)" Al-Quran, Al-Baqarah (2): 278-279

AVOIDING MAISIR

Maisir refers to gambling and to any form of business activity where monetary gains are derived from mere chance, speculation and conjecture. For example uncertainty of the timing of benefits in a pure life insurance contract creates an element of maisir. The basis of compensation must be clearly pre-defined. In its absence, the proceeds of a life insurance policy may not relate to premiums paid up to the date of death.

The Hadith of Sahih Muslim narrates that the Prophet (pbuh) forbade the sale called "Habal-Ala Habala" which was a kind of sale where one would pay the price of a she-camel which was not yet born but would be born as the immediate offspring of the expectant she-camel.

Al-Maisir is referred to in the Quran as follows:

"O you who believe intoxicants (all kind of alcoholic drinks) and gambling, and Al-Ansab (ways for seeking luck) are an abomination of Shaitan (Satan). So avoid strictly all that (abomination) in order that you may be successful." Al-Quran, AI-Maidah (5):90

AVOIDING GHARAR

Transactions which involve uncertainty are forbidden according to many saheeh ahaadeeth, such as the hadeeth narrated by Abu Hurayrah (may Allaah be pleased with him):

"The Messenger of Allaah (peace and blessings of Allaah be upon him) forbade transactions determined by throwing a stone and transactions which involved some uncertainty." (Narrated by Muslim).

["Transactions determined by throwing a stone" - this was a type of transaction that was prevalent in the markets of pre-Islamic Arabia, whereby a stone was thrown by either the buyer or the seller, and whatever it touched, its transaction became binding. "Transactions which involved some uncertainty" - is a transaction in which there is no guarantee that the seller can deliver the goods for which he receives payment. Footnotes from the translation of Saheeh Muslim.]

An element of uncertainty or al-gharar may exist in both life and general insurance policies. One of the basic rules of a contract in Islam is that it must be clear (mu'ad'alaih). In a conventional contract the insured or the policyholder agrees to pay a certain sum of premium but it is never clear to him or her how the benefit of cover is derived.

According to Islamic jurisprudence, the element of gharar invalidates a contract if -

1. It is incorporated in a financial contract
2. Its contractual impact is very large and substantial
3. There is no genuine need for such contract

A contract is not invalidated due to al-gharar if the following conditions are upheld in the contract:

1. Insurance cover is genuinely required to safeguard insured's interests

2. Such protection cannot be provided other than through insurance. Insurance avoids uncertainty through contract of takaful based on cooperative principles

TAKAFUL

"An Islamic alternative to a conventional insurance program based upon a Shariah compliant, approved concept"

The Islamic Fiqh Academy emanating from the Organization of Islamic conference, meeting in its Second Session in Jeddah, Saudi Arabia, from 10 to 16 Rabiul Thani, 1406 H (corresponding to 22-28 December, 1985) issued a resolution which in summary stated the following:

After reviewing the presentations made by participating scholars during the session on the subject of 'Insurance/Re-insurance';

And after discussing the same;

And after closely examining all types and forms of insurance and deeply examining the basic principles upon which they are founded and their goals and objectives;

And having looked into what has been issued by the Fiqh Academies and other institutions in this regard;

RESOLVES

The commercial insurance contract...is prohibited (Haram) according to the Shariah.

The alternative contract which conforms to the principle of Islamic dealings is the contract of cooperative insurance, which is founded on the basis of charitable donation and Shariah compliant dealings.

Muslim jurists therefore concluded that:

Insurance should be based on the principles of mutuality and cooperation.

Insurance products should be founded on the basis of Tabarru, an Arabic noun meaning 'donation, gift, contribution'.

The insurance company must conduct all its affairs in line with the Shariah

The participants mutually contribute to the same fund for the purpose of mutual indemnity in case of risk and harm.

DEFINITION OF TAKAFUL

The word Takaful is derived from the Arabic verb Kafala, which means to guarantee; to help; to take care of one's needs.

Takaful is a system of Islamic insurance based on the principle of Ta'awun (mutual assistance) and Tabarru (voluntary contribution), where the risk is shared collectively by the group voluntarily. It is a pact among a group of members who agree to jointly guarantee themselves against loss or damage to any one of them as defined in the pact.

Takaful is operated on the basis of shared responsibility, brotherhood, solidarity and mutual cooperation or assistance, which provides for mutual financial security and assistance to safeguard participants against a defined risk.

Takaful operations must be within the spirit of the Shariah and there is no justification to involve therewith any element which contravenes Shariah principles.