Islamic law strictly prohibits followers of Islam to engage in traditional insurance as it does not comply with Shariah. Traditional insurance businesses are run for profit and incorporate the three forbidden rules of Islamic business, namely Riba (interest); Maisic (gambling); and Gharar (uncertainty). Yet it is only natural that Muslims wish to safeguard themselves against risk and loss, and of course in many Western countries insurance is an essential and often compulsory business requirement.
Traditional insurance depends on individuals paying premiums to guarantee against future uncertain risks. The insured will lose their premium if no claim is made and the insurer will profit from this. This is unacceptable under Shariah as it incorporates uncertainty, and gambles on human life in life insurance. It is also speculative which is considered gambling. Interest is strictly forbidden under Islamic law and traditional insurance includes interest.
Under Islam it is an acceptable practice to share risk as long as it is done in compliance with Islamic law. In order to provide ‘insurance cover’ Takaful insurance has been introduced which complies with Shariah. Takaful originates from the Arabic word kafalah and means “guaranteeing each other.”
The principle which Takaful operates under is that a group of donors or contributors pay subscriptions into a community fund which is established to guarantee the collective well-being of the group. The group makes a mutual agreement to indemnify each other against loss or damage, and any claim is paid from the collective donated fund.
The insurer stands as custodian and manager of the fund, and any profits and surplus are distributed between the group and the insurer on a pre-arranged basis. Companies which deal with Takaful insurance invest the funds held in strictly Shariah compliant investments. These invested funds are returned with profits to the group of contributors and the insurer.
Takaful insurance is a fair way of giving joint responsibility to the group of contributors for the collective well-being and security of the whole group. As the contributions made are not lost if the claims made do not exceed the collective fund, and any resultant profits are redistributed, it has appeal for non Muslims too. It is not necessary to follow Islam to be insured under the Takaful system.
There are two models under which Takaful operates, Mudharabah and Wakalah. It is usual to find that a specific country will adopt one model. All providers of Takaful insurance must be certified as Shariah complaint to operate under Islamic law.
Although the concept of Takaful is not new as it was originally practiced by communities, it is relatively new to the business world and is predicted to expand greatly in the next several decades, following the growth trend of Islamic banking.