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INTRODUCING ISLAMIC INSURANCE (TAKAFUL)

Concept of Risk

Risk or uncertainty is regarded as one of the fundamental facts of life. All human

activities, be it financial, industrial or social are subject to risk and uncertainty, which

may lead to financial or physical losses arising from unexpected events.

Risk and Uncertainty are Two Different Concepts

Risk

A condition in which there is a

possibility of an adverse deviation

from a desired outcome that is

expected or hoped for.

Risk is something that can be

quantifiable by using probabilities

Uncertainty

Being uncertain to varying degrees

about everything in the future which

one does not have full information.

Uncertainty is something that cannot

be quantifiable.

Since time immemorial human society has adopted various measures and remedies for

overcoming or ameliorating the effect of risk or uncertainties. These measures are

broadly classified as Risk Avoidance, Risk Mitigation, Risk Retention, Risk Transfer and

Risk Sharing.

Type Approach

Risk

Avoidance

This is a negative approach to managing risk where the exposure to

risks is not permitted to come into existence. A relevant instance

would be abstaining from engaging in any action that may give rise

to risks. For example, to avoid risk associated with ownership to

property, an individual should only rent or lease such property,

instead of buying it. This may not be the practical option or the most

optimum way of averting possibility of risk, particularly in business,

where certain risk taking is required for the opportunities of profit.

Risk Retention Generally, certain risks that are negligible and are of little financial

value with minute and minimal negative impact can be retained. For

the same reason, insurance or takaful cover will not be provided for

these types of risk. Risks of loss of a pencil, common cough and

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cold are simple examples of negligible financial impact of which its

losses can be easily absorbed by the individual or organization

concerned.

Risk

Reduction

This may be undertaken by loss prevention and loss control

mechanisms such as by way of safety programs and loss prevention

measures of which some of its examples are the use of security

guards, burglar alarms, sprinkler systems, CCTV, use of better

building materials, work safety standards and etc. Additionally, risks

may also be reduced in the aggregate by the use of the law of large

numbers - by combining a large number of exposure units to

reasonably making accurate estimates of future losses. For example;

insurance or takaful cover warranted, or in some cases encouraged

risk reduction efforts in return for better pricing through discounts.

Risk Transfer/

Risk

Financing

Where risks are transferred to another party who is willing to bear

such risk, either for a price or voluntarily. This is a method of

providing funds to meet the pre and post cost of loss. Insurance is a

form of risk transfer/risk financing from an insured to an insurer.

Another method of risk financing is through hedging where a firm

transfers defined risks to another party (via standard agreements).

Other forms of risk transfer include hold-harmless agreements,

leases, and indemnity agreements.

Risk Sharing A mechanism under which risks are shared among two or more

parties who are willing to mutually share the consequences of the

risks either for a price or voluntarily. Takaful is a method of risk

sharing mechanism between various participants of a takaful scheme

managed by a takaful operator.

Costs of Risk

Costs of Loss

Costs of loss may be easily

identifiable such as loss or

destruction of asset.

Costs of Uncertainty

Costs of uncertainty are subjective in

nature such as fear, anxiety and worry

and most importantly, may cause

misallocation of resources, poor

decisions and unnecessary high cost of

capital/expenses.

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Concept of Risk in Islam

Fundamentally, in Islam the concept of risk and uncertainty is in the realms of the

unknown (al ghaib). It is absolutely in the knowledge of Allah (SWT) whose affairs of

the physical and metaphysical world and the world hereafter are entirely in His command

and control, as pronounced in the Holy Quran:

“…and with Him are the keys of the invisible. None but He knoweth

them. And He knoweth what is in the land and the sea. Not a leaf falleth

but He knoweth it. Not a grain amid the darkness of the earth, naught of

wet or dry but (it is noted) in a clear record (the Preserved Tablet or

Lohmahfuz)...” (Surah al An’am: Verse 59).

As a religion, Islam also seeks to free man from the shackles of ignorance (jahl) and

guides him in his fear and apprehension of the unknown to only rely on the will of Allah

(SWT) based on the principle of tawheed (unity) instead of practising polytheism (shirk)

through acts such as shamanism, astrology, superstitious beliefs, omens, beliefs in ghosts

and spirits, beliefs in oracles and soothsayers as described in the Holy Quran:

“…O you who believe, intoxicants, and gambling and sacrificing stones,

and divining arrows are an abomination… of Satan’s handiwork; eschew

this that you may prosper…” (Surah al Maidah: Verse 90).

Attitude towards risks and uncertainties is also closely related to the concept of al-

Qada’wa al-Qadar (Divine Ordainment and Predetermination) which is an article of faith

in Islam. However, many Muslims have the negative misconception of divine

ordainment and predetermination. Ibnu Qayyim Al Jawziyyah in his book “Shifā' al-alīl

fīmasā'il al-qadā' wa-al-qadar wa-al-hikma wa-al-talī” (Healing the Person with Wrong

Concept about Predetermination and Causality) indicates that in upholding the belief in

predetermination and divine ordainment, Muslims have the responsibility to exercise his

choice (ikhtiar) and will (irada), and then carries out his actions (fa’ala) accordingly.

This is in line with the concept of tawakkul (means to rely on Allah or to put complete

trust in Allah) in man’s endeavours towards fulfilling his role as khalifah and abd of

Allah (SWT) as declared in the Holy Quran:

“…I put my trust in Allah, my Lord and your Lord! There is not a moving

(living) creature but He has grasp of its forelock. Verily, my Lord is on the

Straight Path (Truth)…” (Surah Hud: Verse 56).

The concept and practice of ikhtiar, irada, fa’ala and tawakkul is evidenced in a Hadeeth

that one day the Prophet (pbuh), noticed a bedouin who left his camel untied (which

would expose the risk of the camel being stolen or getting strayed), advised the Bedouin:

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“…Why don't you tie down your camel?” The Bedouin answered, “I

placed my trust in Allah." At that, the Prophet said, “Hobble (tie) your

camel and place your trust in Allah…” (Jame Tirmidhi).

Al-Bukhari and Abu Dawud reported that Ibn `Abbas (ra) said,

“The people of Yemen used to go to Hajj without taking enough supplies

with them. They used to say, `We are those who have Tawakkul (reliance

on Allah)'. Allah (SWT) revealed in the Holy Quran: “…and take

provisions (with you) for the journey, but the best provision is At-Taqwa

(piety, righteousness)…” (Surah al Baqarah: Verse 197).

Abdul Hamid Abu Sulaiman in his book, “Crisis in the Muslim Mind” provides a lucid

distinction between the concepts of ‘tawakkul’ and ‘tawakul’. Tawakkul refers to one’s

trust in Allah after undertaking all the necessary effort ‘ikhtiar’ to avert or mitigate future

risks whilst tawakul refers to a state of inertia, carelessness, incompetence and refusal to

strive accordingly to avert or mitigate future risks and losses.

Sheikh El Gari in his definition of risk reaffirms the Shariah position that prohibits the act

of being ‘fatalistic’ without taking precautions to reduce the probability of loss or by

being reckless and ignore risks around them. It is a hallmark in Islam that a Muslim is

commanded to strive for good management which in essence calls for proper planning.

One of the dimensions to be effectively dealt with in order to attain good risk

management is through takaful.

Concept of Insurance

In its earliest form, insurance had been practiced in the various Babylonian, Greek,

Chinese, Phoenician, Indian, Egyptian, Arabs and Roman civilizations as tools of risk

management. It was primarily used to protect maritime and other trade activities at that

time, as well as for the provision of social safety net for the communities.

The history of insurance indicates that insurance mechanism germinated from financial

arrangements between bankers and merchants. This is a method involving risk transfer,

whereby the risks of sea trade are managed through loans with interest made by money

lenders to ship owners and merchants with the ship or cargo pledged as collateral. It was

further attached with an option (at a higher rate of interest) whereby the loan will be

cancelled if the ship or cargo were lost at sea. This mechanism is called bottomry.

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A classic definition of insurance is provided by Lord Ivamy as:

“…a contract of insurance in the widest sense of the term may be defined

as a contract whereby one person called the insurer undertakes in return

for the agreed consideration called the premium, to pay to the other person

called the assured, a sum of money or its equivalent on the happening of a

specified event…”

A pre-Roman-Dutch definition of an insurance contract was

“…an agreement by one person, having agreed with another on the price

of a risk, takes upon himself that other’s misfortune…”

Concept of Takaful

Islam is a religion that promotes solidarity, cooperation and joint-help among the

community with the objective of mitigating the burden of loss in the event of a mishap or

catastrophe. As these are universal virtues some forms of joint-help had been practiced

before Islam. This manner of joint-help took the structure of mutual help schemes among

its members.

Scholars and researchers have identified some of the practices as Al-Diyat, Al-Aqilah,

Ma’qil, Al-Qasamah, Al Tahanud, Al Diwan, Al Muwalah, Dhaman Khatar Al Tariq.

These were joint-indemnity or solidarity schemes, of which its virtues are pronounced by

Allah in the Holy Quran,

“…help one another in furthering virtue and God-consciousness, and do

not help one another in furthering evil and enmity…” (Surah al Maidah:

Verse 2).

Al-Aqilah (which literally means ‘slayer's paternal relative who undertakes to pay blood

money’) was introduced as a covenant of mutuality formed between the Meccan

immigrants (Muhajirin) and the Medinans (Ansars) whereby members paid their annual

contributions through a fund called ‘Al Kanz’. The fund then was used to pay

compensation on behalf of a member who was liable to pay a diyat.

Ma’qil’ was provided under the Constitution of the city-state of Medina. By this practice,

each member of a tribe had to contribute to a fund for the purpose of funding and settling

of ransom money in the event of any member of the tribe was made a prisoner of war by

an enemy. Other related or neighbouring tribes provided assistance for the ransom if the

fund were to be insufficient.

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‘Al-Qasamah’ was another pooling system under which a common community fund was

created. Contributions to the fund were made jointly by members of the community to

assist the family of murdered victims where the murderer could not be found.

‘Al-Muwalah’ was another scheme formed between two parties with the intention that

either one of the two will be responsible in the event of a mishap or misfortune inflicted

upon his counterpart.

‘Al-Tahanud’ was basically a food sharing and rationing programme among travelers in

view that the journey or time taken to travel from one point to another during those days

was ardous and long. All the travelling members agreed to contribute their foods to be

pooled so that it can be shared later during the journey.

‘Al-Diwan’ in essence was a register. Persons named or recorded in the ‘Diwan’ actually

owed one another mutual assistance and in consideration, were obliged to contribute to

the payment of compensation including financial aid akin to a retirement or pension

benefit, in particular those who had served for the cause of Islam and Allah. As a matter

of fact, conceptually the takaful product called ‘Maash’ (a form of annuity) was guided

by the practice of the Diwan. This system was institutionalised during the second Caliph

Umar Al Khattab.

‘Dhaman Khatar Al Tariq’ whereby the merchants of Mecca established a kind of

common fund by pooling the resources from all participating members. This form of

mutual fund was used to help the victims or survivors of natural hazards during their

journey plying their commercial ventures. It was reported that the Prophet (pbuh), who

traded with the capital provided by Khadijah (ra), contributed to such fund.

Milestones of Takaful

Prophet Muhammad (pbuh) validated a system of community

self help and financial assistance and later institutionalised

by Caliph Umar al Khattab

Early Islamic history

Seljuk Sultan Ghias al Din Kayhusraw introduced a form of

state insurance which reimburse traders if their merchandises

were stolen or robbed within the Seljuk state of Anatolia

12th Century

Ibn Abidin, a Hanafite jurist allowed a form of insurance for

marine venture

17th Century

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Fatwa of Sheikh Muhammad Abduh legalising insurance

18th Century

Fatwa issued by National Fatwa Council of Malaysia.

1972

Resolution by First International Conference on Islamic

Economics held in Makkah

1976

Incorporation of the first modern Takaful Company in

Sudan.

1979

Shariah Background of Takaful

Whilst fully appreciating the great service and importance of insurance as a risk

management tool to individuals, businesses and society, contemporary Islamic scholars

are not in agreement with the contractual nature of buying-and-selling transaction of

insurance which is not in line with the precepts of Shariah. They have identified a number

of traits of the insurance contract as well as its practices which they have concluded

contravening the Shariah principles and requirements namely, the presence of the

elements of gambling (maisir and qimar), uncertainty (gharar fahish), interest (riba). As

consequent, they further resolved the whole transaction is shrouded with fraud and

cheating (ghish wa ghabn), ignorance and uncertainty (al-jahala).

From the various fatawas and research works by scholars and jurists, the alternative form

of ‘insurance’ which is permissible under Shariah should be based on the concept of

takaful. In this manner its operation will be structured on the contract of donation (uqud

tabarruat), instead of the conventional commercial contract of exchange (uqud

muawadhah) as the latter contains major elements of riba, maisir and gharar which

invalidates the conventional insurance contract.

Gharar in Insurance

Gharar literally means risk. It is derived from the word tagheer which refers to

unknowingly exposing oneself or one’s property to jeopardy. Gharar may arise where:

(i) The parties are unaware whether such an event will take place or not

(ii) The subject matter is not within the knowledge of the parties

(iii) There is no certainty over the existence of the subject matter

(iv) Its acquisition is in doubt

(v) Its quantum is unknown.

This principle can be derived by the command of Allah (SWT) that in dealing with one

another or muamalah, it must be based on mutual acceptance, fairness and justice:

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…O ye who believe! Eat not up your property among yourselves in

vanities: but let there be amongst you traffic and trade by mutual good-

will: nor kill (or destroy) yourselves: for verily God hath been to you Most

Merciful... (Al Quran, Surah an-Nisa: Verse 29).

It is obvious that in an insurance arrangement, there are major elements of uncertainty

and lopsidedness in a contract known as ‘gharar fahish’. For example, both the insured

and insurer do not know:

(i) With any degree of certainty of the insured events which is integral to any insurance

transaction

(ii) Its liability and obligations as they relate to future, unknowable events.

(iii) When and how much the claim under the insurance agreement will be paid or

whether payable at all?

Riba in Insurance

Riba (usury) is forbidden in the Quran and the Hadith of the Prophet (pbuh). Riba

originally means “increase and growth” (see Al Quran, Surah Al Hajj verse 5). Increase

here means the hike over capital or nominal amount: irrespective of whether the increase

is large or small. Therefore, in Islamic jurisprudence the presence of riba in a contract

will render the contract invalid and void,

…those who devour usury cannot arise except as one whom Shaitan has

prostrated by (his) touch does rise. That is because they say, trading is

only like usury; and Allah has allowed trading and forbidden usury. To

whomsoever then the admonition has come from his Lord, then he desists,

he shall have what has already passed, and his affair is in the hands of

Allah; and whoever repeats (the offense) - these are the inmates of the fire;

they shall abide in it (forever). Allah will deprive usury of all blessings

and He will give increase for deeds of charity. For He loves not creatures

ungrateful and wicked. O ye who believe! Fear Allah, and give up what

remains of your demand for usury if ye are indeed believers. If ye do not

(give up usury), take notice of a war from Allah, and His Messenger, but if

ye turn back ye shall have your capital sums, without increase or

diminution… (Surah al Baqarah: Verse 275-279).

“…The Prophet (pbuh) said, “Gold is to be paid for by gold, silver by

silver, wheat by wheat, barley by barley, dates by dates, salt by salt, like

for like and equal for equal, payment being made hand to hand. If these

classes differ, then sell as you wish if payment is made hand to hand…”

(Sahih Muslim in Kitab al-Musaqah, Hadith No.1587).

There are basically four kinds of riba:

1) Riba al fadhl - an increase which occurs in exchanging riba goods not due to a

postponement

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2) Riba al nasiah - an increase which occurs in exchanging riba goods because of

postponement.

3) Riba al qard - a loan granted on condition that the borrower gives something

beneficial or useful to the lender.

4) Riba al yad - a deferment or postponement in the delivery or receipt of goods

which to be exchanged.

The nature of the insurance contract is such that money is exchanged for money (i.e.

insurance premiums for claims). Riba in insurance involves both riba al fadhl and riba al

nasiah:

(i) Riba al fadhl - since the amounts exchanged are not equal – insurance premiums

paid and the claims payout

(ii) Riba al nasiah - since the exchange is not spot – between paying the insurance

premium and receiving the insurance claim payout.

(iii) Investment - undertaken by insurance companies comprising of

elements/portfolios not compliant with Shariah.

Maisir in Insurance

Qimar and Maisir (Gambling and Wagering) which literally means ‘getting a profit

without working for it, or earning something too easily’ is clearly prohibited in Islam as

stipulated in the Holy Quran

“…They ask you about wine and gambling. Say, “In them is great sin and

(yet, some) benefit for people. But their sin is greater than their benefit”.

And they ask you what they should spend. Say, “The excess (beyond

needs)”. Thus Allah makes clear to you the verses (of revelation) that you

might give thought...” (Surah al Baqarah: Verse 219)

Essentially, Qimar and Maisir are acts involving the acquisition and distribution of

property based on a zero sum game whereby the winner takes all and the loser losses all,

contingent upon an uncertain event. Jurists also regard gambling as a form of gharar and

at the same time a form of qimar because the gambler is ignorant of the result of the

gamble he had undertaken.

Maisir in insurance contract happens where:

(i) as a consequence of excessive gharar upon receipt by the insurer of the insurance

premium although no claim is paid – no actual exchange took place.

(ii) insurer loses if the amount of claims paid to the insured is larger than the premium

collected

(iii) if the insurance premium collected exceeds the claims - the insurer makes profits.

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Takaful

Takaful is derived from the root word ‘kafala’. In Arabic it means responsibility,

guarantee, amenability or surety. In practice, takaful takes the meaning of joint guarantee,

shared responsibility, solidarity, mutual undertaking among its participants against

certain or defined financial loss as a result of being inflicted with specific or defined

misfortunes. In line with its meaning takaful participants agree to contribute to a defined

fund. Simply put, takaful is the creation of a common defined fund by way of defined

contributions from all its participants for the purpose of relieving their financial burden in

the event of a defined loss. Insurance in Islam according to Yusuf Al Qaradawi is:

“…in my view insurance against hazards can be modified in a manner

which would bring it closer to the Islamic principle by means of a contract

of donation with a condition of compensation…”

In that perspective takaful can be visualised as a pact among its participants to remove

damage or harm when it occurs on any of them, by way of the payment of compensation

from common takaful contributions, described in the Islamic legal maxim as ‘al darar

yuzal’ (damage or harm is removed). Therefore, takaful is a system that manifests a

sense of brotherhood and solidarity among participants. The Prophet (pbuh) in the

following Hadeeth declared the importance of this virtue:

Narrated by Abu Hurairah (r.a) from the Prophet (pbuh) “…Whosoever

removes a worldly hardship from a believer, Allah will remove from him

one of the hardships of the hereafter. Whosoever alleviates the needy

person, Allah will alleviate him in this world and the next…” (Sahih

Muslim, Kitab al-Birr).

AAOIFI Shariah Standard 26(2) of 2007 provides a comprehensive definition of takaful

business as:

“…Islamic Insurance is an agreement between persons who are exposed to

risks to protect themselves against harms arising from the risks by paying

contributions on the basis of ‘commitment to donate’ (iltizam bi al-

tabarru’). Following from that, the insurance fund is established and it is

treated as a separate legal entity (shaksiyyah i’tibariyyah) which has

independent financial liability. The fund will cover the compensation

against harms that befall any of the participants due to the occurrence of

the insured risks (perils) in accordance with the terms of the policy…”

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The practice of takaful can be summarised as follows:

1) A contract of donation between defined takaful participants to share their respective

takaful risks and liabilities based on solidarity and mutual assistance (taawun)

2) By voluntarily contributing defined takaful contributions into a defined takaful fund,

3) By jointly agreeing to cover defined takaful risks,

4) In a defined takaful period,

5) Under the trusteeship and management of a defined takaful operator based in

accordance with the selected business model – al-Mudharabah, al-Wakalah or

hybrid.

Differences between Insurance and Takaful

Points Insurance Takaful

Risk

Management

mechanism

Risk transfer from insured to

insurance company

Risk sharing among takaful

participants

Underlying

principles and

practices

Conventional principles and

practices

Shariah principles and practices

Essence of

intention

Intention to create legal

relationship only based on

individual needs

Intention to create both spiritual &

legal relations and as a form of

ibadah (worship to Allah) based on

solidarity and cooperation between

the takaful participants.

Contract Commercial (buying and

selling) contract or

Uqud al-Muawadhah

Donation contract or

Uqud al-Tabarruat as well as other

Shariah approved contracts such as

al-mudharabah, al-wakalah, al-

waqf

Company Guarantor of insurance fund Trustee and manager of takaful

fund based on Shariah approved

contracts of al-mudharabah, al-

wakalah or al-waqf

Guarantee Given by insurance company Takaful participants mutually

guarantee each other

Investment No restriction – as long as

sound investment in both riba or

Shariah based instruments

Strictly in Shariah compliant

instruments as well as sound

investment

Shariah Advisory

Council

Not required under the law Required under the law

Source of

regulatory

framework

Man-made laws:

statutes, legislation,

case laws, based on common

Divine justified principles : Quran,

Sunnah, juristic opinions,

legislation, based on Shariah

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law principles principles

Legitimacy of

Funds

Insurance funds belong to the

company though separation of

assets is maintained between

the shareholders and the

policyholders

Funds belong to the participants and

managed by the operator for a

legitimate consideration for the

services rendered. Shareholders

funds are accounted for separately

Justified risk Pure risk Defined pure risk

Subject matter Common law justified Shariah justified (mal

mutaqawwim)

Operating

expenses

From insurance fund (premium) Shareholders’ fund (mudharabah

model) / defined from contribution

as fixed up-front charges (wakalah

model)

Operating/

mortality

surplus/deficit

Surplus belongs to the

insurance company whilst the

deficit shall be the

responsibility of the insurance

company

Principally shared between

participants. Takaful operators may

share profit based on profit-sharing

principles of mudharabah or

jualah. Deficit on the other hand

shall in principle be the

responsibility of the takaful

participants

Reinsurance No restriction whether

conventional or retakaful

companies as long as sound

reinsurance basis.

Strictly with retakaful operators

unless insufficient retakaful

capacity as a temporary hajah as

well as sound retakaful basis

Reinsurance

contract

Based on risk transfer

mechanism from insurer to

reinsurer on commercial

(buying & selling) terms.

Based on risk sharing mechanism

between takaful operator and

retakaful operator on Shariah

approved contracts of tabarru’, al-

mudharabah or al-wakalah.

Reinsurance

Commission/Reta

kaful Service Fee

Treated as income to the

insurance company

Belongs to the takaful fund.

Damages (claims) The Courts of justice are in

some cases empowered to

award unlimited damages

There is no justification to award

unlimited or unreasonable damages,

but only justified one.

Payment of

premium/contribu

tion

Paid premium creates an

obligation against the insurer on

a sale and purchase relationship.

Paid contribution is treated as both

donation (tabarru’) and investment

(mudarabah).

Intermediary

(brokers and

agents)

Contract based on principal and

agent relationship where

commissions are paid from

insurance fund

Contract based on Shariah

approved contract of al-

mudharabah, al-wakalah and al-

jualah where commissions are paid

either from shareholders fund or

takaful fund.

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Zakat on business Not required Mandatory once the haul and nisb

criteria are met.

Historical Developed from contract of

Bottomry in Medieval Europe

based on interest/usury

Developed from system of al-

Aqilah in traditional Arab custom

(approved by the Prophet pbuh),

practiced on the basis of mutual

cooperation and brotherhood

Hukm (religious

edict) in Islam

Forbidden (Haram) Permissible (Halal) and

encouraged.

Capital No restriction, except through

legal sources

Preferably from Shariah compliant

sources and legal under the law.

Mr. IDRIS JIBRIN

ISLAMIC FINANCIAL ADVISORY UNIT,

AHMED ZAKARI & Co (Chartered Accountants),

5th FLOOR, AFRICAN ALLAINCE BUILDING,

SANI ABACHA WAY, KANO,

NIGERIA.

PHONE: +234-64-892449

E-Mail: info@ahmedzakari.com

Web Site: www.ahmedzakari.com