Takaful is an Arabic word meaning solidarity or mutual guarantee. Takaful is the name attributed by many practitioners to Islamic insurance. Insurance as defined by the Oxford dictionary is: “an arrangement by which a company or the state undertakes to provide a guarantee of compensation for specified loss, damage, illness, or death in return for payment of a specified premium”. This definition can generally be applied to Takaful even though the Oxford dictionary has also defined Takaful as: a type of insurance system devised to comply with the sharia laws, in which money is pooled and invested.
even though there structural variations between Takaful and insurance and this is will
How does Takaful work?
Takaful works apparently like mainstream insurance but it structurally differs from it.
In Takaful, clients insure each other not the takaful company which implies that fund collected by Takaful company belong to the clients, therefore, they should decide what to do with any excess money left at the end of the period if not predetermined.
The price paid for the insurance policy is qualified as an obligation to give on demand and because of the mutual gifts, all the riba and Gharar ( excess if uncertainty) are avoided.
A Takaful company is an agent for the insurance policy holders and it is paid fees for managing the claims and customer’s portfolio either on a fixed cost agency (Wakala) basis or venture ( Mudarabah) basis.
To illustrate this more, let’s see this example. We only have two people for sake of simplification, a brother called Ameer and a sister called Ameera. They both wanted car insurance and paid £500 each. The Takaful company has now pooled £1000 and it is responsible to manage the fund by paying the claims and investing the money. Let assume that the management fee of the Takaful firm is 20% for claim and 30% of any investment gain.
Now the Takaful company has to manage £800 for both Ameer and Ameera. Let assume again that during the insurance period, it makes £500 from investment and the company will retain £150 for the investment management fee. Let assume that during the insurance period, Ameer filed a claim worth of £200. Now at the end of period an excess amount of £800 will remain which belongs to Ameer and Ameera. Normally, one of the clauses in the insurance policy will state how the excess amount is dealt with. It can be redirected to the next period, distributed among people who did not claim or paid it toward their next insurance period, or given it to a charity.
If during the insurance period, the claim exceeded the money in the fund, the takaful firm is only obliged to pay up to what the fund can afford and there is no liability on the Takaful firm. Note that Islamic finance is based on fairness.
What are the causes of prohibition of insurance?
Insurance as defined above has some problematic practices in shariah perspective. The two main issue with insurance is riba and gharar ( excess uncertainty). First, riba occurs as a client purchases an insurance policy at a fixed price and in case of the occurrence of the potential risk, the insurance company pays for the claim. This means that at the end of the insurance period, the potential risks may occur or not. When it does occur, the client may receive more than what was paid which is unfair to the insurance company, or nothing occurs and the insurance company keeps the money which is unfair to the client. Riba happens when the customer may get more than the cost of the insurance policy, and when this does accurs, it becomes riba because they get more money than they paid for. Secondly, when the potential hazard does not occur and the customer get nothing that is gharar ( excessif uncertainty) because they have not receive anything in return, therefore, it is unfair to the customer. Lastly, the big question is that : What service does the insurance companies sell? In reality, customer mutually pay for the claims and not the insurance companies. This is why the vast majority of insurance companies make profits. If they were paying for claims, how could they make profit?