In The Name of Allah, The Beneficent, The Merciful
All Praise is due to Allah and may Peace and Salutations be upon the last and final messenger Muhammad Sallallahu Alaihi Wa Sallam.
Over the past few years, a general awareness seems to have been created with regards to the impermissibility of dealing in interest, and therefore dealing with conventional banks. Many people seem to have understood why most of the dealings of conventional Banks are prohibited from a Sharia point of view. People have understood that their transactions are by and large interest based and are thus not acceptable. People have also understood that the transactions of an Islamic Banks are asset backed, and not interest based which is the key factor that makes the profits that they earn acceptable in terms of the Sharia. However, the question as to why conventional insurance is impermissible and as to what the basis for the permissibility of Takaful is, is a question that is still not clear to many. The present short article aims at briefly addressing this question.
It is my hope and prayer that Allah accepts this insignificant effort and makes it a means for people to carry out all their transactions in a manner that will please our Creator, Allah.
At the outset, it should be clearly understood that Islam does not condemn the basic concept of insurance which is to protect oneself from potential loss or in other words to manage one risk (risk management). Infact, Islam has promoted assisting one another in cases of loss. This is a concept has been endorsed by the Sharia at the highest of levels. The Holy Quran promotes mutual assistance and protection of one another. Similarly The Holy Prophet Sallallahu Alaihi Wasallam has endorsed the paying of blood money by the “Aaqila”, a third party, to the family of the injured which serves as a form of compensation for them. There are also other traditions of the Holy Prophet Sallallahu Alaihi Wa Sallam that indicate towards the acceptance of the concept of risk management. One such example is the incident in which Rasulullah Sallallahu Alaihi Wa Sallam restricted Hazrat Sa’ad ibn Abi Waqqas (R.A.) to giving only one third of his wealth to charity saying that leaving your heirs in a wealthy condition is better than leaving them poor and thus compelling them to stretch their hands out before others. This Hadith clearly depicts that the Sharia condones the concept of risk management. Sharia scholars also use this particular Hadith as a hadith that supports the concept of risk management in the case of life insurance. Another tradition that supports the concept of risk management is the Hadith that has been reported in Bukhari which explains that Rasulullah Sallallahu Alaihi Wa Sallam gave his wives the provisions of the entire year to come.
Hence, the concept of protecting oneself from potential loss and the concept of risk management is one that is well within the framework of the Sharia. However, it is the method in which this concept is implemented that would either make the system permissible or impermissible.
Why conventional insurance is not Sharia Compliant
Conventional insurance has certain features that are not consistent with some of the essential values of an Islamic financial contract. Ulama (Shariah Scholars) have highlighted three of these features as being the main reasons for conventional insurance being unacceptable from a Sharia point of view.
Riba or Interest
The first aspect that renders conventional insurance prohibited is the fact that conventional insurance entails interest-based dealings. The funds that the insurance company receives in the form of insurance premiums are generally invested in interest bearing accounts or interest bearing securities. Interest has been forbidden in the Sharia in no uncertain terms and is an extremely grave sin. The investments and operations in conventional insurance are all based on debt and equity, debt being interest based.
The conventional insurance system entails involvement in interest based transactions in other ways as well. The fact that conventional insurance schemes are in reality bilateral commercial transactions, i.e. there is an exchange of money from both parties to the transaction in the case of a claim, and this exchange of monies is generally unequal, would amount to clear interest. Further, in the case of life insurance policies that mature, the policy holder becomes entitled to receive the premiums that they have paid over the years plus an element of interest. Hence, interest based transactions appear in different forms in the conventional insurance system.
Gharar or Uncertainty
The second element that is a cause of conventional insurance being impermissible from the Sharia point of view is the aspect of Gharar or uncertainty. Gharar or uncertainty in commercial transactions has been prohibited by the Sharia and thus commercial transactions, in which an essential element of the transaction remains uncertain, and could thus be the cause of dispute in the future, are rendered impermissible transactions by the Sharia. Hence if the selling price, the item being sold or the payment/delivery dates are ambiguous the transaction would have an element of Gharar and thus be impermissible. It is for this reason that sale transactions that are contingent on an event that is to occur in the future are impermissible.
Conventional insurance also entails uncertainty. Sharia scholars explain that there are four types of uncertainty. These are;
- Al-Gharar fil wujood. This refers to the uncertainty that arises with regards to the existence of the subject of the transaction. The example that is normally quoted by the jurists for this type of gharar is the example of the impermissibility of selling a slave that has run away as the existence of the slave at the time of the sale is uncertain. This form of gharar is found in conventional insurance as the contract entails a bilateral deal in which the insured sells his risk to the insurer, which may or may not arise.
- Al-Garar fil husool. This refers to the uncertainty that arises with regards to the acquisition of the subject of the contract. For example a person is not allowed to sell a fish that has not yet been caught as there is an element of uncertainty with regards to his acquisition of the fish. This form of uncertainty is found in conventional insurance, as the insured is actually “selling” his loss to the insurer and is unaware of whether he will “acquire” the loss or not.
- Al-Gharar fil miqdar. This refers to the element of uncertainty that arises with regards to the amount of the subject of the contract. This form of uncertainty is also found in conventional insurance as the insured is uncertain at the time of concluding the contract of the amount that the insurer will pay him in the event of a particular loss, as the insurer will only pay him in accordance to the loss he has suffered. This would only be known after the infliction of such a loss.
- Al-Gharar fil ajal. This type of gharar refers to the element of uncertainty that would with regards to the time frame of the delivery of the subject of the contract. Hence the selling of the child that is to be born to the foetus of an animal is impermissible as there is uncertainty as to when this child would be born. This form of uncertainty is also found in conventional insurance, as the insured is uncertain as to when the loss would occur so that he could receive an amount of money as his claim.
Hence in conventional insurance, the insured person enters into a bilateral contract with the insurance company and thus pays a monthly premium. His benefiting from this premium is contingent on a misfortune or loss that may or may not occur in the future. Such uncertainty in financial transactions is not allowed in the Sharia. The policy holder looses his or her rights over the premium for a promise of benefits payable under certain circumstances in the future. The company owns the premium and any profit accruing from these premiums accrue to the income of the company. Hence, any bilateral transaction in which the liability of a party to the transaction is either uncertain or contingent on a future event is not allowed in the Sharia. It may be argued that this element of uncertainty is also found in Islamic Insurance, however we shall discuss later how this aspect of uncertainty does not arise in the case of takaful.
Maysir or gambling
Gambling refers to a contract in which payment from one of the parties to the contract is definite whereas the liability/payment of the other party to the contract is indefinite.
The third major aspect that renders conventional insurance impermissible is the aspect of Maysir or gambling. Insurance is definitely not a form of gambling. However, the structures of conventional insurance policies make them akin to gambling. This is because; the insured may never have any claims and therefore never receive any "consideration" for payments made. This is akin to gambling wherein any of the two parties involved may win a sum of money from the other, but one of them is destined for total loss depending on the happening of an uncertain future event. Although, insurance does not entail winning a sum of money, it certainly entails indemnifying a loss which is uncertain. Thus, it has a very strong semblance to gambling. The insured may have only paid a single premium and has now become worthy of huge amounts to compensate him for the loss that has occurred. On the other hand he may pay premiums everlastingly without having the “opportunity” to make a claim. Hence, just as how in gambling the benefits or liabilities of either party are uncertain, so is the case in conventional insurance. This uncertainty and semblance to gambling would only arise if the transaction entails an exchange of monies from both sides under a commercial transaction. i.e. the transaction is a bilateral commercial transaction. However, if money is not involved from both sides, i.e. one party voluntarily (without any compensation) declares that they shall compensate you on a particular event of loss, it would not amount to Maysir. Apparently, it may seem that this concern also arises in Islamic insurance, however when we discuss Takaful, this doubt will Inshallah be cleared.
How Takaful is Sharia Compliant
Takaful, which is the term that is generally used for Islamic Insurance nowadays, is actually co-operative insurance. It is based on the principle of a group of people pooling money together and agreeing to help participants of the pool in cases of need or loss. It is an insurance system through which the participants donate their contributions, which are used to pay claims for damages suffered by some of the participants. It is not a bilateral monetary transaction as is the case with conventional insurance. This is the most vital difference. The company’s role is to manage the insurance operations and invest insurance contributions in line with Islamic principles.
From the above it could be understood, that takaful or Islamic insurance is not a bilateral commercial transaction. Rather, it entails a voluntary contribution by a policy holder to a certain fund that has its own legal personality. The policy holder may thereafter be given compensation, from the fund that he has contributed to, for certain losses that could have occurred, as per the rules of the fund. Hence, due to takaful not being a bilateral commercial transaction, and in essence, being only a voluntary contribution, the concerns of uncertainty, maysir and the interest element (that arises due to the policy being a bilateral commercial transaction/contract in which there is an unequal exchange of money that entails interest) do not arise in takaful. This is because uncertainty is only prohibited in transactions that involve the exchange of money from both sides. A situation resembling maysir/gambling, would also only arise where there is monetary payment from both sides of the transaction wherein the benefit or liability of one of the partners is uncertain. In the case of takaful, the policy holder voluntarily gifts a certain amount of money to a pool. His being compensated from the pool for loss is as per the rules of the pool or fund which are recognized by the Sharia, and this compensation is not based on his contribution, although, the rules of the fund may also state that only those who pay their voluntary contribution would remain members of the fund and thus could be compensated by the fund in the case of loss or damage.
Similarly, the concerns of involvement in interest bearing investments are also dismissed as the Takaful Company is obliged to invest contributions in Sharia compliant forms of investment. As such, the excess that is given in the cases of maturity of a life insurance policy in a takaful company is the result of the Sharia compliant investment that the takaful company has made using the contributions of the policy holder and does by no means entail any interest component.
There are different models of takaful that are being used throughout the world. I shall discuss the model of takaful that is structured on the basis of a waqf, which, Mufti Taqi Usmani Saheb discusses in an article that he has written on this subject as well as the wakala model that is being used by many companies including Amana Takaful Limited, Sri Lanka and that has also been vetted by Sharia Scholars.
Mufti Taqi Uthmani Sb explains that a waqf fund for the purposes of Islamic Insurance may be formed as follows:
- The shareholders of a takaful company form a waqf or trust by endowing a certain amount of money, which should preferably not be negligible. Hence they would segregate a certain amount from their capital which would be waqf/endowed to the participants of the fund and would be directed towards a charitable cause at the end, or in the case of liquidation of the company. As per the rules of the Sharia this amount of endowment would be invested by way of Mudharaba in stable markets or businesses, and the profits accruing therefrom would gather in the fund for the benefit of the beneficiaries and to fulfill the objectives of the endowment as per the rules of the fund.
- The waqf fund would not be owned by any particular person or institution. Rather the fund would have it own legal recognition and thus be a separate legal entity. Waqf is recognized as a juristic person or legal entity both in the Sharia as well as in many contemporary legal constitutions. The Legal recognition of the Waqf concept may be achieved by using the mechanism of a trust to form the Waqf. Based on this, the waqf is able to own, invest and benefit others according to the rules of the fund.
- Those wishing to acquire insurance policies would participate in the membership of the fund by contributing voluntarily to the fund as per the rules of the fund.
- The contributions made by the participants (policy holders) come out of their ownership once they have made the contribution to the fund. These funds would now be owned by the waqf. From a juristic point of view, these funds would not be waqf. Rather they would be owned by the waqf and hence may be invested for the benefit of the fund and claims may also be paid directly from these funds. (note: Claims may not be paid directly from the principle amount that was initially endowed by the shareholders. This amount should be invested and only the fruits/profits accruing from these funds could be used for the beneficiaries.)
- The rules of the fund would stipulate the conditions under which a participant (policy holder) would become worthy of receiving compensation for a claim. Similarly the rules of the fund would stipulate the different amounts of money that would need to be contributed for different covers in order for one to become/remain a member/participant of the fund. These rules may be formulated by the trustees (shareholders/company) as per the normal actuarial practices.
- The money that participants would receive from the fund as a result of claims would not be in lieu of what they had contributed to the fund. Rather these are considered as a separate grant from the fund because of them becoming beneficiaries of the pool in accordance with the rules of the fund.
- As the waqf owns all the funds that are lying to its credit, the waqf may spend the funds as it pleases in accordance to the rules of the fund. Hence the waqf may decide that in the case of a surplus the funds would be transferred to a reserve for potential loss in the future or may distribute the funds among the participants depending on the rules of the fund. The surplus may also be divided into three categories and spent accordingly.
- A portion may be kept as reserve.
- A portion may be distributed to participant in order to highlight the difference between conventional and Islamic Insurance. This method has proved to be a very beneficial marketing technique as Islamic Insurance companies are seen to be the only insurance companies that distribute a surplus to their customers.
- A portion to be distributed to charitable causes which is the actual objective of a waqf or endowment.
Distribution in the above manner has been preferred and suggested my Honorable Teacher Mufti Muhammad Taqi Uthmani Saheb.
It is necessary that a rule be incorporated to the effect that in the case of liquidation the surplus amount lying to the credit of the fund after fulfilling its obligations would be directed towards an avenue that generally does not end. E.g. the poor, the destitute etc.
- The takaful company/shareholders that had made the initial endowment would manage the administration of the fund as well as invest money lying in the fund in Sharia Compliant avenues. As for the administration and management of the fund, the shareholders would be like the trustees of the fund and would, in this capacity gather the contributions of participants, pay any claims that may arise and would administer the surplus as per the rules of the fund. Similarly they would totally segregate the accounts of the waqf and those of the company. In lieu of these services to the waqf fund, the company may receive a management fee payable by the fund to the shareholders. With regards to investing the money lying in the funds, the shareholders may invest the funds as agents to invest, for which they could be given a fixed fee from the fund. Alternatively they may invest the funds as the mudharib and receive a share of the profits earned according to a pre-agreed profit sharing ratio. The profit sharing percentage in favor of the shareholders/mudharib should be slightly less than the market rate so as to conform to Sharia regulations.
- Based on the above, the company may acquire income for three sources;
- Investing their capital. (That besides what was endowed. As the amount endowed is no longer theirs.)
- A management fee for managing the fund.
- A fee for investing the monies of the fund or a share of the profits as a mudharib.
Amana Takaful Limited manages the takaful operation based on the wakala model which has also been vetted by Sharia Scholars around the world. This model entails the insured persons contributing a certain some of money to a fund which is said to be having the status of a separate legal entity. The takaful company invests these funds in various Sharia compliant investments whilst segregating part of these funds for the purposes of assisting participants that are inflicted with some type of loss through the payment of claims as per the rules of the fund. The Takaful Company manages the fund and makes their profit through a management fee that is charged from the contributors of the fund. The company also invests the monies lying in the fund on the basis of Mudharaba and thereby becomes entitled to a pre agreed share of the actual profits that are earned as a result of the investment. The wakala model is very similar to the waqf model explained above, except that it does not entail the formation of a waqf.
It is clear from the discussion above that the concept of takaful, does not contain the prohibited aspects that are found in conventional insurance.
I hope and pray that this short article be a means of creating awareness regarding the concepts involved in Islamic Insurance. I pray that Allah give us the ability to abstain from indulging in the prohibited contracts in general and specifically from entering into conventional insurance contracts. I also pray that Muslims establish such institutions with the intention of protecting Muslims from haraam and assisting Muslims that are inflicted with loss.
And Allah Knows Best
11 May 2006