Ali Jiliow Page 1

IS ISLAMIC INSURANCE SUBSTITUTE TO

CONVENTIONAL INSURANCE?

BY

ALI IBRAHIM JILI'OW

MBA, OUM

April, 2016

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Introduction

Islamic insurance has captured the attention of Muslims and non -Muslims throughout the world,

due to its tough establishment of Islamic principles which are based on the idea of brotherhood,

mutual co-operation and solidarity.

The word Takaful is derived from Arabic verb„ Kafala‟, which means to guarantee, looking

after, to help and to take care of one's needs. Takaful is a system of Islamic insurance based on

the principles of mutual assistance and voluntary contribution (Mohd Shril Matsawali M. F.,

2012)

Modern takaful practice is comparable to conventional insurance in practice whereby the

contribution amount is calculated and is fixed for a typical normal person at a definite age for a

certain amount of advantage (Coetzer N. P., 2010)

However, this paper highlights, Takaful Insurance, Meaning , concepts, history and definitions of

Takaful, Takaful in modern times, difference between Takaful insurance and Conventional

insurance and finally the paper briefly focuses on how Takaful contracts are made

Takaful, Meaning, Concepts, History and Definition

The essential principle of the Islamic economic system is a reasonable distribution of wealth.

Takaful is a scheme where people are encouraged to contribute funds for common help in times

of need (Swartz, 2010)

Islamic insurance or takaful is a concept of mutual cooperation to guarantee mutual protection of

the members (Mortuza Ali, 2006). The appearance of Takaful method is very a great deal in line

with Islamic values regarding socioeconomic philosophy for the benefit of individuals and

society as a total.

History Of Takaful

Muslim jurists acknowledged that the bases of shared responsibility in the system of ''aquila'' as

practiced between the Muslims of Mecca and Madina in era of prophet Moh'ed ( PPH) and laid

down the foundation of mutual insurance.

The concept of Takaful

The Takaful concept developed from individual common interest during the industrial age of the

early 1900’s. Only eighty million of the world’s 2.5 billion poor are presently covered by some

form of micro insurance(Coetzer N. P., 2010)

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Takaful is the Islamic description of conventional insurance. It is foundation for the concept of

cooperation and mutual support, whereby a set of participants have the same opinion to support

one another jointly against a specified loss.

Islamic insurance or takaful is a concept of mutual cooperation to guarantee mutual protection of

the members (Mortuza Ali, 2006).

Essentially, the concept of takaful is based on solidarity, responsibility and brotherhood among

participants (Obaidullah, 2005).

The participants make voluntary contributions (Tabarru) to a finance (participants’ fund), which

in turn provides monetary aid to those that experienced a loss.(Chaibi H. M., 2014)

According to Abdul Rahim, Lewis & Kabir (2007) the acceptance of Takaful is based on co-

operation among policyholders for the common good. In fact, the key principle of Takaful

system is mutual Co-operation, taawun (brotherhood), and solidarity(Miniaoui, 2014)

Meaning of Takaful

Takaful is Arabic term meaning guaranteeing each other or joint grantee

The Arabic word of Takaful has derived from the verb “kafal”, which means to take care of one

another’s needs or “guaranteeing each other” (Stagg-Macey, 2007)

The term Takaful is derived from Arabic verb„Kafala‟, which means to guarantee, taking care

of, to assist and to pay attention of one's requirements. Takaful is a scheme of Islamic cover

based on mutual assistant and voluntary contribution)(Mohd Shril Matsawali, 2012)

Definition of Takaful

Type of Islamic insurance where members contribute money into a pooling system in oder to

grantee each other against loss or damage.

Section 2 of the takaful act of Malaysia 1984: “a system based on brotherhood, unity and mutual

support which offers for mutual financial aid and assistance to the participants in case of need

whereby the participants mutually agree to contribute for that purpose”(Yura Carissa, 2010)

Takaful in in modern time

In contemporary contexts, the first takaful company came to existence late in the twenty century,

it was Islamic Insurance Company of Sudan, and the company was founded in Sudan by the

Faisal Islamic Bank in January, 1979 (Anwar, 2008)

In the modern theory of Takaful is derived from Pak KuwaitTakaful Company Limited as the

operator of Takaful fund.

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Source: insurance and takaful.blogspot.com

The Beginning Of Takaful Insurance In Malaysia

According to Malysian Takaful Association, Takaful industry in Malysia comes to existent in

October 1982, when Malaysian government established special task force to explore the viability

of sitting up an Islamic insurance company.

The growth of takaful in present times was initially commenced in Sudan in 1979 and Malaysia

in 1984. As the result of the 1985 fiqh Academy ruling declaring that conventional insurance was

haram (forbidden), while insurance based on cooperative principles, sharia compliance, and

charitable donations are acceptable. The birth of takaful industry in Malaysia was shown by

takaful act 1984 in November 1984(Jacky Lim Y. C., 2010)

The takaful industry in Malaysia had experienced strong growth and revolution since its

beginning 25 years ago. The industry started with one Takaful operator known as Syarikat

Takaful Malaysia in 1984 and has currently increased to twelve after Bank Negara Malaysia

issued four new family takaful licenses(Chaibi H. M., 2014)

Sources: www.Wikinvestment.com

The first Islamic insurance in Malaysia was established in 1984. Followed by the 1985 Fiqh

Academy ruling declared that conventional commercial insurance was forbidden while insurance

based on the application of cooperative principles, Shari’ah compliance and charitable donations,

was acceptable(Jacky Lim M. F., 2010)

The fact that takaful insurance is available to both Muslims and non-Muslims is of chief

significance, Takaful has an explicit ethical structure which can be marketed to both Muslims

and non-Muslims. The economic recession is fast becoming a worldwide

Economic tragedy(Coetzer N. P., 2010)

Well know Takaful operators for family Takaful business in Malaysia include

AIA Public Takaful Bhd

AmMetLifeTakafuln Berhad

Great Eastern Takaful Berhad

However all insurance companies are regulated by Bank Nagara the central bank of Malaysia

Source: www.takafulMalysia.com

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According to Risco Consulting Sdn Bhn, Top Ten Insurance Companies in Malaysia

1. Allianz life insurance malysia

2. American International Assurance

3. Great Eastern life insurance

4. Hong leong Assurance Berhad

5. Manulife Asurance Berhad

6. Prudential Assurance Malysia

7. Tokio Marine life insurance Malysia

8. Zurich Insurance Malysia Berhad

General Insurance Firms In Malysia

Allianz General insurance company Malysia

AMG Insurance Berhad

AXA Affin Gerneral Insurance

Etiqa Insurance Berhad

Charts Malysian Insurance Berhad

Berjaya Sompo Insurance

Uni Asia General Insurance Berhad

Source: Www.ToptenMalysia.com/hot/index/news and events

How does Takaful works

In Islam, the basic standard of investment is that reward must be accompanied by risk. Takaful

industry cannot therefore invest in goods which are debt-based, have a guaranteed or minimum

return on the investment, or are based on haram practices (casinos and gambling companies)

(Anwar, 2008).Primarily, Takaful insurance is perceived as a non-profit oriented activity. It

based on solidarity, responsibility and brotherhood among participants

Takaful Methods

Tabarru (Donation) -Based Takaful

The most accepted model of takaful contract is tabarru. Tabarru means a donation, charity or gift

which cannot be taken back. In Takaful, a percentage of the participant's contribution will be

considered as tabarru ( donation) and therefore cannot be taken back.

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Donation takaful is based on cohesion, responsibility and brotherhood among participants. In this

model, each participant is willing to make donation to the takaful fund with sincere intention to

extend financial assistant to other participants faced with difficulties.

Mudaraba-Based Takaful ( Profit sharing)

Mudaraba means profit-sharing in Arabic. Under this form, the takaful worker asks for no returns

from managing the takaful business. It requires returns from the business of investing the

policyholder funds in agreed ratio such as 50:50, 60:40, 70:30, and etc. hypothetically, the

policyholders pay an amount of money (premium) that is credited to a policyholders’ fund

As mudarib, the takaful operator, invest the policyholders’ fund to the shari’ah compliant

instruments. Profits make from the investment are shared between the policyholder and takaful

operator in agreed ratio. If Any losses arise are charged to the policyholders’ fund. Policy

holders 'fund as valid claims are made, takaful benefits are paid to beneficiaries depending upon

occurrence of actual losses and damages. In case of surplus, the policyholders will receive full

refund and have to make additional payment of deficit if any.

Wakala-Based Takaful ( Agent)

Under wakala-based model, the takaful operator performs as the agent of the policyholders and

as a result entitled to a fee for the services offered. In theory, the policyholders pay premium that

is credited to a policyholders’ fund. As an agent, the shareholders of the takaful operator

company donate to a shareholders’ fund which is maintained separately from the policyholders’

fund.

Mixed Model

The mix model combines elements of the wakala and mudaraba models and is set so that the

takaful operator has two funds; one for the shareholders and the other for policyholders. In this

model, wakala contract is used for underwriting activities while mudaraba contract is used for

investment activities. With regard to underwriting activities, the takaful operator act as wakil or

agent on behalf of policyholders to manage their funds. In exchange for managing the funds, the

takaful operator received a fee known a wakala fee of agency fee which normally a percentage of

the contribution paid for the premium.

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An incentive fee is entitled to the takaful company if there is a surplus in the

policyholders fund as a result of managing the fund effectively. Generally, any surplus

contributions will be invested in different Islamic instrument based on mudaraba contract, which

the takaful operator acts as mudarib on behalf of policyholders (capital provider). Like other

mudaraba contract, the ratio of profit is fixed and agreed upon between the two contracting

parties(Carissa, 2010)

Conventional Insurance, Concept, History And Definition

Insurance scheme has existed for ages. Some historians trace the origin of insurance to 215 CE,

when the Roman government was required by military supplies to accept all risks arising from

enemy attacks, storms, and other natural disaster for supplies carried on their ships. (Omar

Fisher, 2009).

The Definition of Insurance

“A way to provide security / and compensation to what is valuable in the event of its loss,

damage or destruction based on the principle of risk taking and speculation”

Insurance is a risk-sharing arrangement between two parties. In this arrangement, one party (the

insurer) agrees to indemnify another party (the insured) against certain losses specified by a

contract (the policy). Insurance is an economic device by which individuals and organizations

can transfer pure risks (that is, uncertainty about financial losses) to others. (Obaidullah, 2005)

Conventional insurance can be defined as an agreement whereby an insurer agree to pay a

Policyholder an amount of money on the occurrence of a specified event(Coetzer N. P., 2010)

How insurance companies work?

Insurance Companies help consumers manage their risk in exchange for constant stream of

premium, insurance companies offer to pay consumers predetermined events such as natural

disasters as car crush.

More broadly , put insurance create value by pooling and redistribution various types of risk, it

does this by collecting liabilities from every one that is insured and then paying them out to the

few that actually need them.

How do insurance companies make money?

Insurance companies make the money into two different methods, first by charging enough

premiums to cover the expected payout that they will have to cover over the life of the policy,

and second by earning investment returns using the collected premiums.

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Actually, most insurance companies pay out almost all of their premiums in order to attract large

customer volume and liabilities, chief earning focus is thus placed on investment returns

Conventional Insurance drawbacks

Uncertainty (Gharrar)

Gambling (Maisir)

Interest (Riba)

Uncertainty: Conventional Insurance contract is basically a contract of exchange

(mu’awadat).Whether the insured will get the compensation promised? How much the insured

will get? When will the compensation be paid? Thus, it involves an element of uncertainty in the

subject matter of the insurance sales contract, which renders its void under the Islamic

law.Gambling: The insured loses the money paid for the premium when the insured event does

not occur. The company will be in deficit if claims are higher than premium

Interest ( Riba)“Allah has permitted trading and forbidden Riba” (Al-Baqarah2:275).Insurance

funds are invested in financial instrument which contain the element of Riba.

Difference between Takaful and Conventional Insurance contracts

1) The basic principles of conventional insurance companies is that all the profits are belong to

the share holders

2) At the basics, Conventional insurance they usually transfer the risk

3) when it comes to value proposition, Conventional insurance firms always intend to

maximize profits and reduce risks

4) Conventional insurance bylaw they follow is secular or local regulations

5) The ownership of the firm remains to the share holders not other parties

6) The form of the contract in Conventional insurance is for sale

7) When it comes to investment, the Conventional insurance companies is based on interest and

the surplus is belong to share holder's accounts.

Takaful insurance contract

1) The basic principles of Takaful insurance companies is that all the profits are belong to

mutually for participants

2) At the basics, Takaful insurance companies cooperate by sharing of risks

3) When it comes to value proposition ,Takaful insurance firms always tend to affordability and

spiritual satisfaction among the parties

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4) Takaful insurance by law, that they follow Slamic Sharia plus regulations

5) The ownership of the Takaful insurance firms remains the participants

6) The form of the contract in Takaful insurance is for cooperation, Islamic contract of Wakala

or Mudaraba with ''tabaru'' contribution

7) When it comes to investment, the Takaful insurance companies is Sharia compliant, Riba

free contract

Takaful contract

Takaful contract is an insurance contract base on islamic models of financing concepts where

participants pay contributions to takaful company. The takaful company to act as an operator to

manage risk and invest the contribution fund. Takaful is derived from an Arabic word that means

joint guarantee, the group of participants agrees among themselves to support one another jointly

for the losses arising from specified risks.

The premiums (contributions) paid by the participants are credited into the pooling fund, which

is then invested and the profits generated are paid back to the participants. Takaful company may

have three pooling fund namely takaful funds, investment funds and corporate funds.

Takaful contracts always have significant insurance risk and takaful fund as an accumulation of

contribution will allocated to pay claims only. This will form the contract of insurance assets and

liabilities of the company. Asset consists of pooling funds is calculated based on the accumulated

fund and asset valuation based on existing accounting standards.

Comarision between Syarika Takaful company and Great Eastern life insurance

Syarika Takaful Malysia Bernad

Syarika Takaful Malysia Berhad was incorporated on 29th of November 1984, but it commenced

on its operations on 22nd july in 1985, prior before it's launching on the second of August 1985,

by then, Prime minster of Malysia Tun Dr. Mahather Mohamed.

Takaful in Malaysia was transformed into public limited company on the 30th of July 1996

followed with listing of its shares on the main board now known as Main Market.

Comarision between two companies

Issue AMG Insurance Berhad Syarika Takaful

Company principle Profit for share holders Profit for participants

Basics of contract Risk transfer Cooperate risk sharing

Valu proposition Profit maximization Affordability & spritual satisfaction

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Laws to follow Secular and regulations Islamic sharia plus regulation

Company's ownership Shareholders Participants

Management Company management Operator

Form of contract Contract of sale Co-operation, islamic contract

Investment Interest based Sharia compliant, interest free

Surplus Share holders account Participant's account

Conclusion and recommendations

This paper highlighted different insurance schemes that exist across the world weather

conventional and Islamic insurance, the paper also discusses concepts, meaning, history and

definitions of Takaful insurance, how to form insurance and takaful insurance contracts are also

discussed, comparison between conventional insurance and takaful insurance have also

highlighted in this paper

Finally, the paper recommends the use of the Islamic takaful insurance as the conventional

insurance has many pitfalls that can not comply with the Islamic sharia as Uncertainty (Gharrar)

Gambling (Maisir) and Interest (Riba)

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Appendix One: Takaful Insurance scheme frame work

Source: (Obaidullah, 2005)

.

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