Introduction of Islamic Insurance

Islamic insurance is a term used for takaful that is a form of insurance based on principles of mutuality and
co-operation, encompassing the elements of shared responsibility, joint indemnity, common interest and solidarity.

All human activities are subject to risk of loss from unforeseen events. To alleviate this burden to
individuals, what we now call insurance has existed since at least 215 BC. This concept has been practiced in
various forms for over 1400 years. It originates from the Arabic word Kafalah, which means "guaranteeing each
other" or "joint guarantee". The concept is in line with the principles of compensation and shared responsibilities
among the community.

Takaful originated within the ancient Arab tribes as a pooled liability that obliged those who committed
offences against members of a different tribe to pay compensation to the victims or their heirs. This principle later
extended to many walks of life, including sea trade, in which participants contributed to a fund to cover anyone in a
group who suffered mishaps on sea voyages.

In modern-day conventional insurance, the insurance vendor (the insurance company) sells policies and
invests the proceeds for the profit of its shareholders, who are not necessarily policyholders. There is therefore a
clear disjunction between policyholders and shareholders. Payouts to policyholders may vary depending on
financial performance, but a minimum positive return is always contractually guaranteed.

Takaful is commonly referred to as Islamic insurance; this is due to the apparent similarity between the
contract of kafalah (guarantee) and that of insurance.

However, takaful is founded on the cooperative principle and on the principle of separation between the
funds and operations of shareholders, thus passing the ownership of the Takaful (Insurance) fund and operations to
the policyholders. Muslim jurists conclude that insurance in Islam should be based on principles of mutuality and
co-operation, encompassing the elements of shared responsibility, joint indemnity, common interest and solidarity.

In takaful, the policyholders are joint investors with the insurance vendor (the takaful operator), who acts as
a mudarib – a manager or an entrepreneurial agent for the policyholders. The policyholders share in the investment
pool's profits as well as its losses. A positive return on policies is not legally guaranteed, as any fixed profit
guarantee would be akin to receiving interest and offend the prohibition against riba.

For some time conventional insurance was considered to be incompatible with the Shari’ah that prohibit
excessive uncertainty in dealings and investment in interest-bearing assets; both are inherent factors in
conventional insurance business.
 However, takaful complies with the Shari’ah (which outlines the principles of compensation and shared
responsibilities among the community) and has been approved by Muslim scholars. There is now general, health
and family (life) takaful plans available for the Muslim communities.

Basis and Principles of Takaful

Islamic insurance requires each participant to contribute into a fund that is used to support one another with
each participant contributing sufficient amounts to cover expected claims.

The underlying principles of Takaful may be summarised as follows:

1. Policyholders co-operate among themselves for their common good.

2. Every policyholder pays a part of the contribution as a donation to help those that need assistance.
3. Losses are divided and liabilities spread according to the community pooling system.
4. Uncertainty is eliminated in respect of subscription and compensation.
5. It does not seek to derive advantage at the cost of others.

Theoretically, Takaful is perceived as cooperative insurance, where members contribute a certain sum of
money to a common pool. The purpose of this system is not profits but to uphold the principle of "bear ye one
another's burden."

In modern business, one of the ways to reduce the risk of loss due to misfortunes is through insurance. The
concept of insurance where resources are pooled to help the needy does not necessarily contradict Islamic
principles.

Three important differences distinguish conventional insurance from Takaful:

1. Conventional insurance involves the elements of excessive uncertainty (gharar) in the contract of insurance;
2. Gambling (maysir) as the consequences of the presence of excessive uncertainty that rely on future
outcomes
3. Interest (riba) in the investment activities of the conventional insurance companies;
4. Conventional insurance companies are motivated by the desire for profit for the shareholders;
5. Conventional system of insurance can be subject to exploitation. For example, it is possible to charge high
premium (especially in monopolistic situations) with the full benefit of such over-pricing going to the
company.

The key difference between Takaful and conventional insurance rests in the way the risk is assessed and
handled, as well as how the Takaful fund is managed. Further differences are also present in the relationship
between the operator (under conventional insurance using the term: insurer) and the participants (under
conventional it is the insured or the assured). Takaful business is also different from the conventional insurance in
which the policyholders, rather than the shareholders, solely benefit from the profits generated from the Takaful
and Investment assets.

Operation of Tafakul

All participants (policyholders) agree to guarantee each other and, instead of paying premiums, they make
contributions to a mutual fund, or pool. The pool of collected contributions creates the Takaful fund.

The amount of contribution that each participant makes is based on the type of cover they require, and on
their personal circumstances. As in conventional insurance, the policy (Takaful Contract) specifies the nature of the
risk and period of cover.

The Takaful fund is managed and administered on behalf of the participants by a Takaful Operator who
charges an agreed fee to cover costs. These costs include the costs of sales and marketing, underwriting, and claims
management.

Any claims made by participants are paid out of the Takaful fund and any remaining surpluses, after
making provisions for likely cost of future claims and other reserves, belong to the participants in the fund, and not
the Takaful Operator, and may be distributed to the participants in the form of cash dividends or distributions,
alternatively in reduction in future contributions.

Operating Principles

An Islamic insurance company must have the following operating principles:

1. It must operate according to Islamic co-operative principles.

2. Reinsurance commission may be paid to, or received from, only Islamic insurance and reinsurance
companies.
3. The insurance company must maintain two funds: a participants/policyholders' fund and a shareholders'
fund.

THE POLICYHOLDERS' FUND

1. The assets of the policyholders' fund consist of:

1. Insurance premiums received
 2. Claims received from re-insurers
3. Such proportion of the investment profits attributable to policyholders as may be allocated to them by
the Board of Directors.
4. Salvages and recoveries
5. Consultancy and other receipts.
2. All the claims payable to the policyholders, reinsurance costs, technical reserves, administrative expenses,
etc., excluding the expenses of the investment department, shall be met out of the policyholders' fund.
3. The balance standing to the credit of the policyholders' fund at the end of the year represents their surplus.
The General Assembly may allocate the whole or part of the surplus to the policyholders' special reserves.
If a part, the balance will be distributed among the policyholders.
4. When the policyholders' funds are insufficient to meet their expenses, the deficit is funded from the
shareholders' fund.
5. The shareholders undertake to discharge all the contractual liabilities of the policyholders' fund, but this
liability does not exceed their equity in the company.

THE SHAREHOLDERS' FUND

1. The assets of the shareholders' fund consist of:

1. Paid-up capital and reserves attributable to shareholders
2. Profit on the investment of capital and shareholders' reserves
3. Such proportion of the investment profit generated by the investment of the policyholders' fund and
technical and other reserves as is attributable to them
4. Miscellaneous receipts
2. All the administrative expenses of the investment department are deducted from the Shareholders' Fund.
3. The balance of the shareholders' surplus, if any, is distributed among them.

INVESTMENT OF FUNDS

The company may invest its funds only on a profit-and-loss-sharing basis, as approved by the Shari'ah.

Products and Services Offered by Islamic Insurance Companies

Islamic insurance companies may offer competitively priced products, without curtailing the scope and
benefit of insurance coverage made traditionally available to the public by conventional insurance companies.
 As regards life insurance facilities, Islamic insurance companies have developed Islamic Trust Funds for
social sol idarity, mortgage protection, student protection and employers' protection.

MODELS OF TAKAFUL

There are various models of takaful according to the nature of the relationship between the company and
the participants. There are wakalah (agency), mudarabah and a combination of the two. In the Sudanese takaful
model, every policyholder is a shareholder in it. An Operator runs the business on behalf of the participants and no
separate entity manages the business. Shari'ah experts consider this preferable. In other Islamic countries, the legal
framework does not allow this arrangement and takaful companies work as separate entities on the basis of
mudarabah (in Malaysia) and wakalah (in the Middle East).

In the mudarabah model practised mainly in the Asia Pacific region, the policyholders receive any available
profit on their part of the funds only. The Shari'ah committee of a takaful company approves the sharing ratio for
each year in advance, most of the expenses being charged to the shareholders.

In the wakalah model, the surplus of policyholders' investments – net of the management fee or expenses -
goes to the policyholders. The shareholders charge the wakalah fee from contributions and this covers most of the
expenses of the business. The fee is fixed annually in advance in consultation with the company's Shari'ah
Supervisory Board. The management fee is related to performance.

Differences between Takaful and Conventional Insurance

The overwhelming majority of Islamic jurists have concluded that the conventional insurance contract is
unacceptable to Islam, not being in conformity with the Shari'ah for the following main reasons:

1. it includes an element of al-gharar (uncertainty)

2. it is based on the theory and practice of interest; a conventional life insurance policy is based on interest,
while an Islamic model is based on tabarru where a part of the contributions by participants are treated as
donation. For this reason, policy holders in takaful are usually referred to as participants.
3. it is a form of gambling.

First and foremost, Islamic insurance, in conformance with the Islamic Shari'ah, is a form of social solidarity
(takaful), based on the principles of trusteeship and co-operation.
 1. In conventional insurance, the insured substitutes certainty for uncertainty. In return for a predetermined
payment, the premium, he/she transfers to the insurer the possible economic losses from stipulated risks. In
Islamic insurance, the participants share all risks mutually and no transfer of risk is involved.
2. Conventional insurance companies are motivated by the desire for profit, while Islamic insurance
companies are non-profit making, the shareholders not being entitled to share in the profits of the business
although they are entitled to charge fees for their services and share in the investment returns of funds
managed by them
3. The policy-holders in a conventional insurance company have no right to vote in the elections of the
directors of the company or to see the annual accounts of the company, while in Islamic companies; these
facilities are available to all participants who pay a certain stipulated amount of premiums (contributions).
4. In the takaful system, if the assured dies before the policy matures, the beneficiary is entitled to the whole
amount of the premiums, the bonus and dividend and a share of the profits made over the paid premiums,
plus a donation from the company out of the participants/policy-holder's contributions given on the basis of
tabarru. Such a transaction is seen as a mutual contribution towards the welfare of the helpless in society.
Where the insured is still alive on the maturing of the policy, he/she is entitled to the whole amount of the
premiums, a share of the profit made over the premiums, a bonus and dividends according to the company
policy.
5. In a conventional life insurance policy, the agent's payments are paid out of the insured's paid premiums,
whereas in the Islamic model, the agents work for the company and thus are paid by the company.
6. The insurable interest in the conventional system is usually paid to the policyholder, if he/she is alive at the
expiry of the policy. If he/she dies before that date, the insurable interest is paid to the beneficiaries, who
may include including family, servants, company, trustee, partners, mortgagor, etc. But under the Islamic
model, the insurable interest goes to the assured or his/her heirs, according to the principles of Mirth or
Wasiyyah.

Co-operative Insurance

The concept of co-operative insurance is acceptable in Islam because:

1. The policyholders co-operate actively for their common good;

2. Every policyholder pays his subscription in order to help those who need it;
3. It spreads liability in the community by a pooling system;
4. It does not aim at deriving undue advantage for one at the cost of other individuals;
5. The element of uncertainty is eliminated as far as determination of the premiums is concerned.
An Islamic co-operative insurance contract should embody the following conditions:

1. The company functions according to Islamic co-operative principles.

2. The policyholders have the right to participate in surplus profits and are liable to contribute additional
amounts if their subscriptions are not sufficient to meet all the losses. However, it is preferable for such
losses to be written off against future surpluses. Shareholders are not entitled to any of the underwriting
profits generated by the insurance operations. But, as mudarib (agents), they are entitled to receive a
proportion of the profits from the investment of insurance funds, plus, of course, all the profits on the
investment of their own capital and any other funds and reserves attributable to them.
3. The company will strictly follow Islamic laws in the matter of investment and will not indulge in the
practice of usury.
4. Policyholders are represented on the Board of Directors and have a right to scrutinise its accounts.

Gambling and Insurance

There are three main differences between a gambling contract and an insurance contract.

1. In a gambling contract, neither party has any other interest than winning a sum of money. The gambler is
not being indemnified against any loss. But, in an insurance contract, the insured's right to be paid depends
on his suffering loss from the insured peril. In other words, an insurance contract is a contract of indemnity,
which is non-existent in a gambling contract.
2. In the case of gambling, one party must win and the other loses. In insurance, on the other hand, the event
entitling the insured to compensation may or may not happen during the period of the policy, but he pays a
premium for being protected during that time.
3. If a gambler wins, he gets back not only his original stake but also an additional amount without suffering
any loss, whereas an insured person never gets back his premium and is only indemnified to the extent that
he has suffered damage.

Status of Takaful

As Islamic finance continues to expand, there is likely to be a huge takeoff of other products such as
pensions, education, marriage and health Takaful plans. There is also a huge scope for mortgage Takaful.

Islamic principles strong emphasis in Takaful on the economic, ethical, moral and social dimensions, to
enhance equality and fairness for the good of society as a whole should also have appeal for the ethically
minded.
 In modern society, insurance has become a necessity to trade and industry. Life insurance has become the
most effective vehicle for mobilising savings, for capital formation and for long-term investment, as well as for
making provision for old age and bereavement in the case of individuals.

In the west, the insurance sector is the largest single contributor to the capital market. Banks and insurance
companies now form international alliances for mutual benefit.

There is an increasing demand for a Shari'ah-compliant insurance system. Until recently, there has been a
low demand for insurance in Islamic countries, because Muslims believe that insurance is un-Islamic. The
development of Islamic insurance, therefore, requires extensive education of the Muslim public, besides
development of resources and expertise, a legal framework for it, the harmonization of practices, development
of new Shari'ah-compliant instruments, accounting standards, and arrangements for retakaful. (Institute of
Islamic Banking and Insurance (IIBI) 2016).

Critique

Islamic insurance throughout the world has been facing a lot of problems (Bekkin 2007). Similarly, Islamic
insurance in Bangladesh has been facing numerous problems (ARTIIL 2012, p. 14). The following are some issues,
among others, that can be found in Islamic Insurance.

Lack of separate regulation, shariah-based deposit and Islamic capital market for Islamic insurance

In 2000, Bangladesh Islamic insurance companies were licensed under the Insurance Act 1938 which was
not equipped to deal with Islamic insurance (Khan 2010). This is because, Islamic insurance is based on shariah
rules and regulations (Foster 2007), while conventional insurance is based on conventional regulations (Schwarcz
and Schwarcz 2014). Although a committee was formed by the government of Bangladesh to draft separate
insurance laws for Islamic and conventional insurance in 2007, the outcome of the effort has yet to materialise. In
2008, the caretaker government of Bangladesh promulgated the Insurance Ordinance 2008 and the Insurance
Regulatory Ordinance 2008. These were ignored by the present government (Ali 2012). Furthermore, two
insurance laws were passed in the parliament of Bangladesh on March 3, 2010 which came into effect as an
Insurance Act on March 18, 2010. However, it only mentioned rules for investment assets of Islamic insurance
(IDRAB: Insurance Development and Regulatory Authority Bangladesh 2013). The lack of a legal and regulatory
framework has stifled the Islamic insurance industry.

Islamic insurance has to deposit a large amount of money with the Central Bank of Bangladesh as security
to operate whereas the Bangladesh Bank operates based on interest (Riba). Bangladesh Bank provides interest
against this deposit, but Islamic insurance cannot receive this kind of money as a profit (Kalil 2011, pp. 218–220).
Another obstacle of Islamic insurance is lack of Islamic capital market (Azad et al. 2013). Islamic insurance
companies do not have any alternative for investment as without Islamic banks all bonds and certificates are based
on interest. Islamic insurance companies cannot participate in this kind of investment or capital market. As a result,
Islamic insurance companies lag behind conventional insurance (Kalil 2011, pp. 218–220).

Unexpected competitions, lack of skilled people, qualified field workers and desk officers

Conventional non-government insurance companies gain illegal business through discounting or returning
the premium to the policy holder. Policy holders are encouraged to dealing with conventional non-government
insurance companies expecting profit or bonus at the end of the year while Islamic insurance companies do not
offer any discount or return the premium to the policy holder. This is why they are less interested in an Islamic
insurance policy. This kind of competition is considered a big challenge not only for Islamic insurance but also for
conventional government insurance companies. Some conventional non-government insurance companies accept
cheques on credit to sell policies in debt (Kalil 2011, p. 218–220). Moreover, there is a lack for skilful and
experienced people in conventional insurance in Bangladesh (Reza and Iqbal 2007). In Islamic insurance, this
number is even more shocking. Although 90 % of the total Bangladesh population are Muslim, there is a lack of
qualified human resource in Islamic insurance (Bhuiyan et al. 2012). Furthermore, field workers and most desk
officers in Islamic insurance do not enough training and Islamic education required to serve Islamic banking and
insurance. This inhibits their ability to work professionally and inform the public of the benefits of their products
and services (Khalid 2007, pp. 27–28).

Lack of Islamic re-insurance and training institutions

There is no Islamic re-insurance company in Bangladesh (TJCSCIIB 2012, p. 5). Islamic insurance
companies are forced to re-insure their money through conventional re-insurance. From the premium derived from
these re-insurance companies at the end of the year, the conventional insurance companies distribute one part of
this profit to the policy holders of the different companies as an original profit, while Islamic insurance companies
cannot accept interest-based profit (Kalil 2011, pp. 218–220).

Insurance companies in Bangladesh lack training institutions for their employees. There are seven fully
fledged Islamic Banks in Bangladesh. Among them only Islami Bank Bangladesh Ltd. has a training institute and
opportunities to provide its employees training services. Employees are provided little training insurance (Ullah
2013). General Islamic insurance companies (general takaful companies) do not have any training institutions,
although the Bangladesh Insurance Academy trains how to conduct Islamic insurance without interest but there is
no opportunities for one-to-one teach training or to research the Islamic insurance system (Khalid 2007, pp. 27–
28).

Lack of public interest in Islamic insurance and consensus among muslim scholars (Ulamah)

Most of the people are not interested in Islamic insurance due to lack of Islamic knowledge and
understanding: absence of people’s awareness, propaganda, and misinterpretation about Islamic insurance among
the general people in Bangladesh (Reza and Iqbal 2007). The lack of financial solvency further reduces
subscriptions to Islamic insurance. Although Bangladesh is a Muslim country, the governor is unaware of Islamic
studies, especially Islamic finance (Huqe 2002, pp. 164–165). In addition, many question Islamic insurance and its
operating system (Rahman 2006, p. 273) particularly in Bangladesh. Some Muslim scholars say that Islamic
insurance and its operations are like conventional insurance and should be prohibited. Others argue that it is
legalised by shariah through some operations remain conventional. Others encourage avoiding it completely as it is
unclear whether it is truly Islamic in spirit and content (Khan 2015, p. 219). Such debates confuse the public
causing them to doubt Islamic insurance. (Issa Khan, et.al., 2016)