Takaful, is based on the concept of solidarity, which is different from the concept of risk underwriting in conventional insurance.
Islamic view on conventional insurance
Shari'ah scholars do not recognize commercial insurances to be lawful and ethically justified based on Ijtihad, the independent legal reasoning of qualified scholars. This could be considered as the majority opinion nowadays, although other views may persist to exist.
The main line of arguments given for this prohibitive view, were discussed by the Fatwa (legal opinion) of Ibn Abidin, which answered a question regarding permissibility of marine insurance. The main reasoning came from comparing the contract of commercial insurance with potential classical contracts, like a guarantee – which did not fit, and a silent partnership, which neither applied. Binding consequences could not be derived based on a commercial insurance contract for a Muslim and the compensation are not lawful inside the Islamic jurisdiction.
Zuhayli summarized the arguments against commercial insurance with five reasons:
• Riba – the insurance compensation is an increase above the installments paid and also the insurance company invests the premiums in Riba based financial activities;
• Gharar –the compensation may or may not occur; this is considered as a substantial uncertainty, leaving also open to receive no compensation
• Ghabn (Fraud) – the object of the contract remains unclear; Islamic jurists tend to see the monetary compensation as object and not the abstract “security” provided. “Knowing the object of the contract is a condition for its validity.” Zuhayli.
• Maisir/Qimar – Gambling is assumed for two reasons : the person and its property is exposed to unknown events and the insured pays small amounts of money in ancipation of collecting large sums – both are defining elements of gambling
• Jahala (Ignorance and uncertainty) – Both parties do not know their proper financial obligations are, whether it is about profits or losses.
Forms of cooperative insurance
Cooperative Insurance, however, is considered to be different, following the classification as voluntarily contribution instead of a sales contract. It “encourages the type of cooperation that Islamic law requires Muslims to exhibit.” (Zuhayli). A number of major conferences of Muslim scholars approved cooperative insurance schemes for sharing responsibilities, with different models to perform them.
The risk in Islamically structured cooperative insurances, so-called Takaful Operators, is born by the participants (which are “insured”). The operators charge a fee for the management of the operations and for managing and investing the funds. Because their core business is non-profit oriented regarding the risk (underwriting business). Takaful is still different from conventional cooperative insurances, whereby the cooperative takes over the underwriting risk as an object of the contract.
Three different structures did evolve in regard to Takaful operations:
• Wakala Model – (takaful operator as agent) Participants joint for mutual risk sharing, the operator earns a fee for management of the operations and is allowed to receive a fee for fund management (asset management); example: Bank Al Jazira
• Non-Profit Model – Contributions are 100 % voluntary donation for others less fortunate society members (Tabarru); governmental schemes may fit into this category
• Mudaraba Model – (silent partnership, Malaysian model) Also the participants join for mutual risk sharing, however, the operator shares in any operating surplus as a reward for careful underwriting in behalf of the participants – this models is the closest to the commercial insurance. Example: Takaful Nasional, Malaysia
The Mudaraba Model of Malaysia allows the operator to benefit from the surplus of premiums versus covered insurance cases. It is elsewhere not fully accepted and criticised. Also the Wakala Model can show similar aspects if the agent fee paid is subject to the underwriting results. In both exceptions the profit derived from the underwriting results still remains primarily with the policyholders.
The pure Mudaraba Model does not allow the operator to benefit from the surplus of the underwriting business. The operator is only eligible to gain from a profit share of the invested funds.
The general guideline and recommendation for the Accounting and Audition Organisation for Islamic Financial Institutions (AAOIFI) is to use the Wakala Model for the underwriting activities and the Mudaraba Model, the silent partnership, for the investment side, in which is no harm to share the profits between manager and capital provider. This differentiation could be regarded as the safe, acceptable route to offer Takaful services in any Islamic market.