Friday, March 28, 2008

Summary : Takaful vs Conventional Insurance

Takaful Insurance (or insurance for Muslims basically) is designed to adhere to Islamic laws and is based on the principles of fairness and equity among the participants (policyholders). Modern religious scholars have declared that traditional insurance is unacceptable by majority of scholars due to the type of investment traditional insurance companies' use as well as the uncertainty involved in traditional insurance contracts. In Takaful insurance there is no transfer of risk to a third party (i.e. stockholders) but a sharing of risk among participants.

Takaful insurance companies avoid investing in interest bearing securities as well as investing in unethical and immoral business (such as alcohol manufacturers, gambling casinos). The rewards in an Islamic investment should be profit or fee based. Typical investments include lease and rental instruments, real estate financing contracts, and venture capital funds. These investment types are largely untapped at the present moment.

Contract Uncertainty
Islamic law forbids the use of contracts that contain uncertainty. Thus it is not possible to have an insurance contract as that which exists between a conventional insurance company and a policyholder as that contract contains elements of uncertainty.

For example in a term insurance policy, not only is the timing of the payment of the death benefit not known, but whether any payment will be made (as the policyholder can survive the duration of the policy). However, it is acceptable in Islam to go into arrangements for mutual assistance. Based on this concept, Takaful insurance exists mainly as a cooperative or mutual arrangement.

Inherent Guarantees
From the Islamic perspective, traditional proprietary insurance companies contain elements of gambling in that the profit of shareholders depend on the misfortunes of the policyholders, for example annuities. With Islamic insurance there are joint guarantees among members, with risk sharing and mutual cooperation. The focus is on the community, not shareholders. Reinsurance is needed as in traditional companies, although preferably with the Islamic companies (re-Takaful).