According to law and economics insurance is a form of risk management used to protect oneself against the risk of a future loss. When one subscribes to an insurance policy there is a transfer of risk from one entity (the insured party or policy holder) to another (the insurance company called insurer) in exchange for a premium. When insured parties experience a loss for a specified peril, the coverage entitles the policyholder to make a ‘claim’ against the insurer for the covered amount of loss as specified by the policy.
HOW DO INSURANCE COMPANIES MAKE MONEY?
The insurance company makes a profit by ensuring that their income accrued through collection of premiums and subsequent investments of the huge funds they hold exceeds the amount to be paid as compensation against claims made by policy holders. The most difficult part for insurance companies is to calculate the premium to be charged for different risks, called underwriting of different policies. Data is computed using principles of statistics and probability to accurately project the rate of future claims based on a given risk. Upon termination of a given policy, the amount of premium collected and the investment gains thereon minus the amount paid out in claims is the insurer’s underwriting profit on that policy.
TWO ISLAMIC POSITIONS ON INSURANCE
One opinion about insurance is that it is completely prohibited (haraam) as it involves the elements of usury (Al Riba), uncertainty (Al-Gharar) and gambling (Al-Maiysir) in its terms of contract.
GHARAR
– “UNCERTAINTY”
The insurance contract contains uncertainty due to:
Uncertainty whether the payment will be accepted as promised;
The amount to be paid is not known; and
The time it will occur is not known.
Any form of contract which is lopsided in favour of one party at the expense and unjust loss to the other is classified as Gharar.
When a claim is not made, the insurance company may acquire all the profits whilst the participant may not obtain any profit whatsoever. The loss of premiums on cancellation of a life insurance policy by the policyholder, or the “double standard” condition of charging a customary short period in general insurance, whilst only a proportional refund is made if the insurance company terminates the cover is also considered as unjust.
MAIYSIR
– GAMBLING
The participant contributes a small amount of premium in hope to gain a large sum.
The participant 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 contributions.
When a life insurance policyholder dies after only paying part of the premium his dependants receive a certain some of money which the policyholder has not been informed of and has no knowledge as to how and from where it has been derived.
RIBA
– INTEREST
An element of interest exists in conventional life insurance products – as the insured, on his death, is entitled to get much more than he has paid.
Insurance funds invested in financial instruments such as bonds and stocks contain element of Riba
Another opinion is that there is no Gharar (element of uncertainty) as it is a contract based on overwhelming statistical knowledge and the application of the theory of probability and is permissible provided it contains no Riba clause and that its subject (insured thing) should be ‘halal’. Even if the second opinion is accepted, conventional life insurance etc is still ruled out because the fixed value of the policy is the outcome of investment premiums at a compounded rate of interest, whereas a variable-return life insurance is permissible if the funds are invested in Shariah compliant stocks or mutual funds.
Another possibility is that the insurance cover is imposed by the employer and it is not optional for the employee to bypass it. Thus if the insurance provided by the employer is paid completely from the employer, i.e. given as a fringe benefit without deducting any part of the premium from the pay checks, then it is a kind of grant from the employer and if a hazard occurs then the paid policy amount is ‘halal’ because it is an outcome of the employers grant.
TAKAFUL
– THE ISLAMIC INSURANCE
The word takaful is derived from the Arabic word Kafalah which means guaranteeing each other or joint guarantee The proponents of Takaful claim that it is not a new concept and a system of aquila was in fact established by the Muhajireen of Makkah and the Ansar of Medina following the Hijrat (migration) of the Prophet over 1400 years ago. Islamic insurance was also practiced in the early second century of the Islamic era when Muslim Arabs expanding trade into Asia mutually agreed to contribute to a fund to cover anyone in the group that incurred mishaps or robberies along the numerous sea voyages (marine insurance). The Tabarru system is the main core of the Takaful system making it free from uncertainty and gambling. Tabarru’ means “donation; gift; contribution.” Each participant that needs protection must be present with the sincere intention to donate to other participants faced with difficulties. Therefore, Islamic insurance exists where each participant contributes into a fund that is used to support one another with each participant contributing sufficient amounts to cover expected claims. The objective of Takaful is to pay a defined loss from a defined fund.
PRINCIPLES OF TAKAFUL
The principles of Takaful perceived as cooperative insurance are as follows:
Policyholders co-operate among themselves for their common good.
Every policyholder pays his subscription 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 derive advantage at the cost of others.
MUDHARABAH
MODEL OF TAKAFUL
Here the entrepreneur or al-Mudharib (i.e. Takaful operator) will act as a Sahib-ul-Mal and accept payments of the Takaful installments or Takaful contributions (premium) termed as Ra’s-ul-Mal from investors or providers of capital or fund (Takaful participants). The contract specifies how the profit (surplus) from the operations of Takaful managed by the Takaful operator is to be shared, in accordance with the principle of al-Mudharabah or profit sharing, between the participants as the providers of capital and the Takaful operator as the entrepreneur. The sharing of such profit may be in a ratio 5:5, 6:4, 7:3, etc. as mutually agreed between the contracting parties.
In order to eliminate the element of uncertainty in the Takaful contract, the concept of Tabarru (to donate, to contribute, to give away) is incorporated. In relation to this a participant shall agree to relinquish as Tabarru, certain proportion of his Takaful installments or takaful contributions that he agrees or undertakes to pay thus enabling him to fulfill his obligation of mutual help and joint guarantee should any of his fellow participants suffer a defined loss.
In essence, Tabarru would enable the participants to perform their deeds in sincerely assisting fellow participants who might suffer a loss or damage due to a catastrophe or disaster. The sharing of profit or surplus that may emerge from the operations of Takaful, is made only after the obligation of assisting the fellow participants has been fulfilled. It is imperative, therefore, for a Takaful operator to maintain adequate assets of the defined funds under its care whilst simultaneously striving prudently to ensure the funds are sufficiently protected against undue over-exposure. The provision of insurance cover as a form of business in conformity with Shariah is thus achieved by combining the Islamic principles of al-Takaful and al-Mudharabah.
Al-Takaful
is the pact among a group of people, called participants, reciprocally guaranteeing each other; while Al-Mudharabah is the commercial profit-sharing contract between the provider or providers of funds for a business venture and the entrepreneur who actually conducts the business. The operation of Takaful may thus be envisaged as the profit-sharing business venture between the Takaful operator and the individual members of a group of participants who desire to reciprocally guarantee each other against a certain loss or damage that may be inflicted upon any one of them.
CAN MUSLIMS ENGAGE IN RISK CONTROL?
It is a Muslim’s belief that everything that happens in this world is by the will (Al Qadar) of Allah. Similarly any accident or misfortune that befalls us, that results in the loss of life or belongings, is by the will of Allah. One day the Prophet (pbuh) saw a Bedouin leaving a camel and he asked the Bedouin “why don’t you tie down your camel?” The Bedouin answered, “I put my trust in Allah.” The Prophet (pbuh) said, “tie your camel first, then put your trust in Allah”. Those who accept Takaful say they are merely tying to minimise risk as instructed by the Prophet (pbuh). Takaful or Tawakkal (putting your trust in Allah), the choice is yours.