It is undoubtedly in human beings’ nature to be exposed to some form of risk throughout their daily lives. Risk, the possibility of loss in an event, is inevitable and in many cases, unforeseen such as theft, accidents, natural disasters and ultimately, death. Major losses, damage and financial dilemmas result from risk-induced situations, leading to the need for effective risk-management tools. One such tool is insurance.

A Few Examples

Islamic insurance, namely Takaful, is a modern and innovative approach to managing the demand for an instrument that can mitigate an individual’s exposure to specific types of risk. Literally translating to ‘solidarity’, Takaful is a Shariah-compliant arrangement whereby policyholders, as a collective enterprise, pool together their resources in order to aid other members against losses. As opposed to transferring losses to an insurance company which is practiced by conventional insurance, Takaful policyholders distribute said losses amongst themselves.

AAOIFI’s definition of Takaful

Takaful is a process of agreement among a group of persons to handle the injuries resulting from specific risks to which all of them are vulnerable. A process is thus initiated, involving payment of contributions as donations, and leading to the establishment of an insurance fund that enjoys the status of a legal entity and has independent financial liability. The resources of this fund are used to indemnify any participant who encounters injury, subject to a specific set of rules and a given process of documentation. The fund is managed by either a selected group of policyholders, or a joint stock company that manages the insurance operations and invests the assets of the fund, against a specific fee.

Takaful vs Conventional Insurance: A brief comparison

Conventional insurance, as mentioned in the table, consists of elements such as interest, gambling, uncertainty and contracts of indemnity. These concepts are explained below.

  1. Instead of paying premiums to the insurance company, policyholders make donations to the Takaful fund. This is a unilateral transaction and not a financial exchange contract.
  2. Any surplus belongs to policyholders, which is therefore distributed amongst themselves or donated to charity.
  3. Return on investments are distributed amongst policyholders and shareholders via Wakala or Mudaraba models.
  4. Capital is invested in Shariah-compliant investment funds.
  5. Purpose of the arrangement is to share and distribute losses, hence promoting mutual cooperation.
  6. The Takaful company abides by the Shariah, as well as the governing laws.
  7. Takaful eliminates Riba (interest), Maysir (gambling) and Gharar (uncertainty).
  1. Premiums paid to the insurance company are considered as income in exchange for bearing the risks. This is a financial exchange contract.
  2. Insurance companies treat surplus as profit.
  3. Return on investments belong to insurance companies and not shared with policyholders.
  4. Capital of premiums are not necessarily invested in Shariah-compliant channels.
  5. The sole purpose is profit-making.
  6. The insurance company is only required to obey governing laws.
  7. Conventional insurance comprises of all three elements.
Interest (Riba)

Riba translates to ‘increase’, ‘addition’, ‘expansion’ or ‘growth’. In this case, it is relevant to an expansion of usurious items and upon debt, according to the deferred payment term. It is divided into two categories:

  • Riba Al-Fadl: It is the exchange of usurious items on spot-payment basis with a difference in values of the items. Example: the sale of 10 grams of gold for 20 grams of gold on the spot
  • Riba Al-Nasi’a: It is the increase on the principle as a result of deferments by the individuals. Example: trading with 50 kgs of sugar now against 100 kgs of sugar in one years’ time
  • Pertaining to conventional insurance, Riba is practiced in two forms:
    • Paying and/or receiving interest, which are related to both, the investment and liability sides
    • Discrepancies are evident between the premiums paid by the policyholders and the claims benefit received by them.
Gambling (Maysir)

Maysir is a zero-sum game and constitutes a substantial amount of uncertainty, where no additional value is created. The policyholder makes a bet on loss occurrences, which is also applied in reverse to the conventional insurance company.

Uncertainty (Gharar)

One way of defining Gharar is “that whose nature and consequences are hidden”. It is prohibited to ensure the full consent and satisfaction of parties involved in a contractual agreement. This is accomplished through certainty, full disclosure and transparency. Although uncertainty cannot be fully eliminated, excessive uncertainty needs to be removed.

Contract of Indemnity

It is referred to the underlying contract between the policyholder and the conventional insurance company, where the latter promises to indemnify the losses in the event of a crisis, for a premium. It is a bilateral contract through which premiums are the income and claims are the expenditure. The difference between the total premiums received and total claims paid results in a surplus, which is held by the company as profit.

Takaful implements the principles of Ta’awun (mutual assistance) and Tabbarru’ (donation). Ta’awun is a basic principle of economic enterprise in Islam which promotes mutual cooperation among individuals to deal with arising problems. A contract based on Tabbarru’ is unilateral, where the consent and consideration from the recipient are not required to make the contract valid and it is normally meant for gratuitous purposes. This contract is perceived to be the best possible one to replace conventional insurance due to the latter’s application of sale and purchase.

Shariah Guidelines

Contractual Reltionships
Relationship between the Takaful Fund Manager and the Policyholders for managing the Takaful Fund
Relationship between the Takaful Fund Manager and the Investment Manager, relating to the investment of the donation surplus

Takaful Accounts
An account for its own right and liabilities
An account for the rights and liabilities of policyholders

Takaful Participants
Apart from Muslims, non-Muslims can also participate in a Takaful arrangement

Commitments of Participants
They must submit all required information regarding the risks to be insured against.
They must make payments as per the agreed time.
They must inform about the occurrences of the risks they are insured against.

Commitments of Takaful Companies
The company should bear the responsibilities of preparing policies, collecting contributions, paying indemnities, among other tasks. Pre-operating and other expenses incurred from conducting business and investing funds should also be borne by the company. It must claim indemnity from the party that causes the injury regardless of whether it is a breach of contract or misbehaviour. The company’s Takaful account should cater to all of the fees and expenses resulting from Takaful activities and reconciliation between parties should be in the participant’s interest, aligning with the Shariah rules.

Condition in Takaful Policies
As long as they do not clash with the Shariah principles, conditions stipulate in Takaful policies remain binding. It is also allowed to make mention of stipulations relating to extraordinary cases that lead to the scarcity of indemnity, provided that justice and the preservation of rights are maintained.

Takaful Indemnity
The participant is obligated to receive either the loss incurred due to an injury or the Takaful amount, whichever is less.
The participant cannot receive both the indemnity and compensation from other parties for the injury.
In the case of properties, indemnity should be restricted to what has been provided for in the regulations.

Takaful Surplus
It is a part of the assets belonging to the Takaful account and should be utilised in a way that serves the best interest of participants, such as the following:
Distributing the surplus to the policyholders according to their respective contributions regardless of whether they have been indemnified during the financial period or not.
Distributing the surplus to the policyholders who have not been indemnified during the financial period.
Distributing the surplus to the policyholders following the deductions of the indemnity they are to receive.
Distributing the surplus via any other Shariah-compliant method.

Expiry of Takaful Policies
It will expire when:
The period agreed upon in the policy ceases.
The insured property is completely damaged, without nullifying the participant’s entitlement to the indemnity.
The insured person dies, without nullifying the entitlement of the beneficiary to the Takaful’s benefits.

Takaful Models and How They Work
Mudaraba Model

Mudaraba is a partnership-in-profit arrangement where one party (Rab-Al-Maal) supplies the capital and other (Mudarib) provides skill/labour.

In the case of Takaful, the Takaful Operator (fund manager) acts as the Mudarib, whereas the participants in the Takaful fund are the Rab-Al-Maal (capital providers).

Any profit/surplus derived from the Takaful fund investments are distributed between the Operator and the participants according to a predetermined ratio.

Any losses/deficits resulting from operations are borne solely by the participants.

The Takaful Operator is not entitled to receiving a salary except for the predetermined profit share. As an agent (Wakil), the Operator is responsible in allocating profits to the participants on the basis of their respective contributions to the fund, in accordance to the Takaful contract.

Wakala Model

Wakala is the assigning of one party (agent) on behalf of another (principal), in a known and permissible dealing.

In the case of Takaful, the Takaful Operator acts as the agent (Wakil) on behalf of the participants to set up the Takaful fund.

Contrary to the Mudaraba model, the Operator in this arrangement will act as the agent (Wakil) for investing the fund and so is also paid a fee for its services.

Any profits or losses resulting from the Takaful Fund operations are borne by the participants only.

Being the agent (Wakil), the Operator is responsible in allocating profits to the participants on the basis of their respective contributions to the fund.

Waqf Model

Waqf translates to “as if it were owned by God”. In the case of Takaful, the Takaful Waqf Fund is considered to be owned by God and so the participants do not possess ownership to the contributed amount to the fund.

The participants subscribe and make donations to the Waqf Fund in order to become members.

The Takaful Operator is designated either as a Wakil or Mudarib to manage the fund and is granted a fee or a predetermined profit share.

The participants are only entitled to the damages of loss claims from the fund and will not receive any surplus.

Any profit/surplus resulting from the Takaful operations or investment will be retained by the fund.

Hybrid Model

As the name suggests, it is a mixture of both, Mudaraba and Wakala models.

The participants and Takaful Operator sign two contracts: Mudaraba and Wakala contracts.

The Takaful Operator receives a Wakala fee from the participants’ contributions, as well as a predetermined profit share from investing in Shariah-compliant channels. However, it is not entitled to any amount that remains after paying out the claims.


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