Introduction
Insurance refers to the risk-sharing arrangement between the insurer and the insured regarding losses and obligations in case of situation as warranted and specified in the contract (Obaidullah, 2005). Essvale Corporation Ltd. (2009, p. 3) defines insurance as the "protection against possible hazard that can be bought against an event which or which may not happen, such as burglary, an illness, loss of property or a legal liability." It is a legal and binding contract entered by individuals or entity, wherein a party receives "financial protection, or reimbursement, against losses from an insurance company, which pools clients' risks to make payments more affordable, in exchange for a premium (Essvale Corporation Ltd, 2009, p. 3)."
With the demand for products that are in direct agreement and compliance with Islamic values and laws, Takaful becomes an alternative to conventional insurance. Takaful is strictly an Islamic insurance concept that follows the Islamic banking system within the rules and merits of the Islamic law (Kettell, 2011). This concept of insurance has been adopted and practiced by Muslims since in the 6th century, but it is not embedded in the modern insurance and banking system in most Muslims countries. Takaful is a direct breakaway from the traditional insurance system adopted by most Western organizations. In this paper, I will be reviewing these two types of insurance models to see the basic features that add value to each and to help organizations weigh the two for their own benefits.
Risk Consideration
Conventional insurance follows the traditional definition of insurance: transfer of risk from one party to another. The conventional insurance model holds that the risk or obligations in situations such as “burglary, an illness, loss of property or legal liability (Essvale Corporation Ltd., 2009, p. 3)” of a party, the insured, is transferred to the insurance company, the insurer (Beema, 2011). In this process, the insured pays the premium for the policy with the agreement with the insurer that at any event the risk of obligations are all transferred to the insurer, rather than the insured. This is the common idea behind insurance, which had been adopted by most countries globally.
However, within the Middle East region and other Muslim countries, conventional insurance is not too appealing because it has conflicts with the ideas and principles of Shari'ah. As a result, Islamic banking and insurance system promotes Takaful as an alternative to the conventional insurance system. Takaful, according to Beema (2011), is based on mutuality and not on the transfer of risk. This means that the insurance company does not have to shoulder the obligation of the risk when situations happen. Rather, the insurance company serves as the manager and executor of takaful.
Takaful is the sharing of risks between members of the common pool. This means that the insurance company forms a common pool with a certain number of participants. At the event of obligation of a member of the common pool, all members will have to share that obligation. This is the traditional convention behind takaful. Yet, it must also be noted that for takaful to take a contemporary face or modern standard, it is necessary to set a limit of obligations that should be shared by participants of the common pool, which is the same with conventional insurance which maintains a certain limitation. In the same manner, contemporary takaful takes a turn of value by categorizing what obligations are covered in this insurance system.
Simply, conventional insurance works on the value of commercialization. Although insurance companies receive the risk and obligations of the insured, they also earn in the process when that obligation does not arise. However, takaful is not about commercial or business consideration, but on the value of mutual cooperation (T'azur Company, 2010).
Element of Uncertainty
Generally, insurance has an element of uncertainty and risk, but conventional insurance and Takaful have different take considering the matter. As Johnson (1983, as qtd. in Hussain & Pasha, 2011) puts it, "risk is an element of uncertainty, as to whether an event occurs nor not." This means that in insurance system, uncertainty is what the insurer and the insured are agreeing on. It could be that the event being covered by the insured's policy does not occur and the insurer gets the advantage or it could be that the insured gets the benefit of the policy when the covered event occurs. In essence, insurance is all about uncertainty and risks, in general.
Conventional insurance works on two uncertainties. First, as I have noted in general terms of insurance, there is an uncertainty as to whether the covered event will occur (Kettell, 2011). A car insurance can only be effectively disbursed to the insured when an obligation of the insured happens during car accidents or such. However, if the insured does not encounter car accidents [as it is always the goal of a driver], the insurance policy will not be enforced and utilized, at the some extent. Second, in conventional insurance the element of uncertainty on how much will be covered becomes another issue. There is a certain level of convention as to the contention of how much is payable to the insured or how much is the obligation of the insurer to the insured. This is why there are insurances lawsuits that are filed to determine the cost of the situation and obligation of the insurance company.
This is what the Islamic Shari'ah is against to – the element of uncertainty or 'gharar'. Of course, the uncertainty of event is impossible to eliminate, but the uncertainty of the amount that should be payable to the insured as the obligations incurred is reduced. As noted by Kettell (2012) and Beema (2010), takaful is a synonymous to mutual help, as defined in the first section as mutual cooperation. Because of the essence of sharing the obligation or the burden of the obligation, the insured's obligation does not have to be debated on, but the obligation is shared by members of the common pool.
If we look closely, the principle behind takaful is a mutual fund. Participants contribute to the fund and at the event of unexpected claim, the insured of takaful can use the mutual fund. This means that members should only pay what was taken from the mutual fund, provided that the mutual fund does not earn from its non-interest bearing investments. They should share among each other to ensure that the mutual fund cap is reached.
Element of Gambling
Obaidullah (2005, p. 122) states that conventional insurance is "inadmissible in the Islamic framework" because it involves "maisir and qimar" or gambling. Gambling is out-rightly forbidden to Muslims by Qu'ran. To understand this, Beema (2010) said in conventional insurance "the insured pays an amount (premium) in the expectation of gain (compensation/payment against claim)." This can further stated that at the event the loss through accidents and other covered by the policy does not occur, the insured losses his money in form of premium. This is the same with the insurance company – they are betting on the uncertainty of the claim. This can be categorized as a clear testament of gambling. Two parties are betting on a certain event's occurrence to gain or lose something.
Although, we need to understand that conventional insurance is working to eliminate the value of gambling associated with the circumstance above, the idea of “maisir and qimar” expands widely that it extends to all. The concept of “maisir and qimar” works on a simple convention that when someone gets more at the expense of another, gambling occurs. This means that conventional insurance is really “inadmissible in the Islamic framework.”
The concept of Tabarru' or Conditional Donations is what prevails in takaful. Tabarru', according to Kettell (2012, p. 128) is "the agreement by a participant to relinquish, as a donation, a certain proportion of the Takaful contribution that he agrees or undertakes to pay, thereby enabling him to fulfill his obligation of mutual help and join guarantee, should any of his fellow participants suffer a defined loss." This means that a person donates or contributes to the mutual fund without consideration for future loss or gain. The brotherhood or mutual cooperation concept eliminates the meaning of “maisir and qimar” out of the takaful insurance model.
Instead of making the insurance system a model of commercial gain, the insurance system under the takaful model is within the bounds of social responsibility. A person donates or contributes to the fund because it is his responsibility to help others within the community, rather than out of the motive that one day the investment will return bigger gains. By devaluing the commercialization of insurance, takaful becomes free from the element of gambling.
Interest Consideration
Another problem that makes conventional insurance inadmissible in the Islamic framework is the issue of "riba". According to Obaidullah (2005, p. 124), "an insurance agreement in which the policyholder expects to receive a predetermined amount that is greater than that invested clearly contravenes with the prohibition of riba." By traditional view, “riba” is the prohibition made on the receipt or payment of interest on loans or money (Thomas, 2006). In conventional insurance, the insured is anticipating to receive more than the premium, which can be considered as an investment. This means that the investment, in form of insurance premium, receives interest after a certain period of time, or at the event of situation as covered in the policy. Simply, the conventional insurance model works on interest that is against the prohibition of “riba”.
The problem of conventional insurance is not just about the interest of the premium, as form of investment, but also on the methods used by insurance companies to raise the invested premium at the event of claims. Most insurance companies would invest the insurance premium fund on various fixed interest bearing instruments such as bonds, securities, TFCs, and other financial instruments. It is just imperative and necessary for insurance companies to invest on interest-bearing instruments and other forms of investments that bear interest within specific period of time because the insured person is also expected interest on the invested insurance premium (Beema, 2011). If the insurance company won't invest in interest-bearing investments, the claims of the insured won't be satisfied.
Because insurance should be a social and communal responsibility shared by members of the common pool, it is not Shari'ah compliant to insurance to earn profits, which makes it a commercial industry. Instead, takaful insurance model warrants investments on non-interest bearing concerns, but the model allows profit-sharing. This means that the fund can only be invested on investments or concerns that will ensure profit-sharing. In the same manner, the members of the common pool can only expect that they get equal share of the profit made by the fund on profit-sharing investments, provided that the mutual fund has already met the demand and obligations of members of the pool, which will be discussed in the next section.
Profit Distribution
It is necessary to understand that in takaful insurance model, risk- and profit-sharing are foundation concepts (Eyler, 2009). Better than gambling on who should pay more and who should receive much, takaful shares the risk and profit to eliminate the gambling element, as discussed earlier. This means that whenever the mutual fund gets profit or loss, the entire participants of the common pool must equally share the burden or benefit. By creating a certain level of equality, gambling does not happen within the insurance system; and the sharing system creates a level of responsibility to each other, thereby building strength of the society or the community. Members of the pool believe that they are interdependent on each other and this makes them responsible over each other.
In contrast, the conventional insurance system provides that the profit of the interest-bearing investments is shared by shareholders according to their stake on the company (Beema, 2011). This means that the insured policyholders (in takaful sense, members of the pool) are not part of the profit sharing. Instead, shareholders of the company would do everything to gain much from the premium of policyholders, as opposed to the convention of mutual interest. When the insured does not renew the policy, the company also has no interest and responsibility on him. This means that whatever the company earns, the policyholder can't ask for a share. The policyholder is confined only to the merit of the policy coverage.
By model, conventional insurance is just true to the idea of commercialization. The goal of business is to earn profit – that's it. There is no need for the business to take responsibility of the policyholder who quits even if the company earns from the premium of the policyholder. Furthermore, the policyholder cannot also ask the company to return the premium if he quits.
Takaful, as a Shari'ah compliant insurance model, works on that surplus of the mutual fund of the common pool is returned to the participants (Ayub, 2009). The company or the takaful operator does not earn from the fund, rather as noted above, the company is just the executor of the fund. [However, provided that operator of the takaful can earn by placing money on the investments of the mutual fund. This is not deemed as using others to gain for the takaful operator uses his money to gain.]This provides that the members of the pool get whatever they deserve from the fund, rather than giving the profit or surplus to a certain few, which is against the Shari'ah.
Other Important Comparative Elements Between Takaful and Conventional Insurance
Aside from these things mentioned above, takaful and conventional also differs in some important respect. First, Hussain & Pasha (2011) notes that in conventional insurance policyholders have no right to ask the company where their premiums are invested. This means that if the company invests on securities and instruments that are risky and may soon fail, policyholders don't have the right to know. This is why most policyholders would be shocked that their insurance coverage suddenly collapses due to the losses of the company's value or the changes of the instruments values. Not so in the takaful model wherein members or participants have the right to know where their contributions are invested and how the surrender value is calculated. This is a very important aspect of insurance system – the right of accountability and transparency.
Second, takaful insurance is governed by two laws – the governing laws and the Shari'ah regulations. This means that participants are assured that they get what they invested and they get what they deserve. In the conventional insurance, the management is only subject to governing laws. This is why there are several lapses that can be explored, especially in determining how much is payable and how much is insured. In fact, we can find so much injustice in the conventional insurance model. Through technicalities, insurance coverage can be forfeited. The insured who paid insurance premium receives nothing from the coverage due to the governing laws that may do so. This is what the takaful is avoiding – to create injustice among individuals. By putting the Shari'ah laws into action, the insurance system becomes of religious value rather than just pure commercial value.
Third, we need to understand that all takaful insurance policies are insured by another takaful company. This means that at the event that investment of the takaful company fails, participants are assured that any claim can still be met by the re-insurer. But this is not present in the conventional insurance. Only a few conventional insurance companies are re-insured. This is the reason why when the insurance company hits rock bottom with its investments, insured policyholders don't have the take to ask the company for payment of its claims. Rather, policyholders are left disenfranchised without the capability to meet obligations. This is common among pre-need insurance policies wherein the coverage is focused on the ability of the investments to make money. In fact, in series of financial crisis across the world, insurance companies are at the top of the meltdown and those who are insured with the companies faced battles of financial losses.
Fourth, with regards to social responsibility, conventional insurance companies still need to define theirs, but takaful insurance companies already defined theirs. As much as the value of the conventional insurance is resting on creation of wealth, it is necessary to safeguard the finances of the organization, and most of the times, insurance companies under the conventional model don't have well-defined CSR. But for the takaful insurance company, wherein the focus is the welfare of the people, the final corporate social responsibility is always patterned after the model's principles.
The vital problem behind conventional insurance is its being commercial in nature. Instead of looking at the welfare of policyholders, the conventional insurance company looks after its own interest. It has no responsibility, whatsoever, on the policyholders, save the obligation of the coverage. Stockholders of the organization are only looking forward in creating wealth for themselves. While for takaful, the responsibility is broaden to include the welfare of all. As a result, it becomes more engaging and appealing to members.
Conclusion
Both conventional insurance and takaful insurance models have their own advantages and disadvantages. For most Western countries, the conventional insurance model makes the insurance industry alive and ready to create new programs to benefit policyholders. But takaful insurance model works best for Muslim countries, where Shari'ah compliance is an important value. The simply analysis is that conventional insurance is a direct contrast of takaful. And Obaidullah (2005) is right to assert that it is impossible for conventional insurance to be accepted in Islamic banking and insurance system.
Takaful works best for Muslim countries because it follows the embraced idea of brotherhood and mutual responsibility. Instead of promoting value of gaining money, the insurance concept works on the value of the community and the society as a whole. This is the basic and fundamental benefit of takaful. It works within the concept that people are valuable and money comes secondary only. And it is works within the concept of Islamic principles and ways of life.
Just like other Islamic nations in the Middle East or across regions where Muslim communities are found, the United Arab Emirates financial institutions, including banks, insurance companies, and such other relative organizations, apply the takaful insurance model as part of their Shari'ah compliance. It is important to note that in UAE, Shari'ah compliance is an important elements of the banking system. Almost all banks including the Abu Dhabi Commercial Banks, the Sharjah Islamic Bank, and the National Bank of Abu Dhabi adopt a takaful insurance model as part of their personal finance and wealth management offerings. Other financial institutions such as those focusing on insurance such as Dar Al Takaful, Noor Takaful, and Watania also follow the takaful insurance model as the primary and standard insurance model within the emirate and the region.
References:
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