DIFFERENCE BETWEEN

THE CONVENTIONAL
INSURANCE & TAKAFUL

Master Islamic Finance

Presented by:
Saliha Zerban
Azbida Imane Under supervision:
Oumayma Kachaf Dr.A.AKHRIF
Omkelthoum Ben Jeloul
Ayoub Tourdi
Ilyass El HarrarAmrani

30/12/2017
ABSTRACT

Insurance in Islam is essentially a concept of mutual help. Insurance business under

conventional system is based on uncertainty, which is prohibited in Islamic society
under Islamic principles. So there is need to clear the difference between the
conventional insurance and the Islamic insurance. A rich literature also describes such
differences but the present article addresses the differences based on conceptual and
operational framework.

Keywords: Aqilah; Maisir; Mudarabah; Mudarabah Model; Tabarru; Takaful; Wakalah

Model; WakalahWaqf Model.

INTRODUCTION
In this world, everyone is exposed to the possibility of risk and disasters such as death,
losses and damages through fire, accident, and business etc. Despite this, all the Muslims
believe in Qadha-o-Qadr, but Islam requires that one must find ways and means to keep
away from such troubles and adversities whenever such things occur, and one should
try to minimize his/her or his/her family financial losses. One possible way out is to buy
an insurance cover. Dictionaries define the risk in different meaning like possibility of
facing loss or threat. It is a common element of life. Risk can be defined as the variability
or volatility in unexpected outcomes (Jorion and Khoury, 1995, p.2). It can be defined as
the chance of events happening that could put an impact on the outcomes of the event.
Johnson (1983) defines risk in insurance context and says, “risk is an element of
uncertainty, as to whether an event occurs or not”.

The basic idea of an insurance agreement is that it is a mutual co-operation between two
parties to protect one of them from unexpected future financial loss. Under conventional
setup the main viewpoint of insurance is to minimize the risk. Pfeiffer (1956) defines as
“insurance is a device for the reduction of risk of one party, called the insured, through
the transfer of particular risks to another party, called the insurer, who offers a
restoration, at least in part, of economic losses suffered by the insured”.

An insurance contract minimizes the risk of loss due to accident or ill-fated situation. In
conventional setup, this agreement is unproblematic; but, its acceptance to Islamic law,
or Sharia, is debatable (Bilhah, 1993, 1996). Sharia scholars have different opinions
about the status of conventional insurance from sharia point of view. One group of
scholars has a perception that the actual lawful position of any matter is permissibility
until there is a proof of its prohibition. They emphasize that there is no injunction
against mutual insurance and it should be allowed (Billah, 1996, comments on Sheikh
Al-Azhar’s Fatwa). Muslims have to accept any catastrophe that befalls, as the will of
Allah but they are also insisted to take positive steps to reduce unfortunate events.
Other school of thought argues that insurance must be illegal due to the view that, each
contract or agreement whose consequences are unknown is illegal. The result of an
insurance contract is, by its nature, unknown, so it is illegal. The majority of the Sharia
scholars believe that it is unlawful due to involvement of Maisir (gambling) and Gharar
(uncertainty) (Ayub, 2003). Moreover, when a person is purchasing an insurance policy,
the policy holder is assured of promised fixed returns at the end of the insurance

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contract if premium installment payments are made. Once again, the outcome may
contravene with the spirit of Islam, which prohibit a predetermined return or Riba (El-
Gamal, 2000).

All the above discussions invite a question of clear differentiation between the Islamic
Insurance and the Conventional Insurance. The present article addresses the same
question. Many authors have already explained such difference, e.g., see Bt. Esman
(2008) and Shahzad (2009) but we present here conceptual and operational difference
between these two types of insurances; the Islamic Insurance and the Conventional
Insurance.

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 Table of contents

S.NO. DISCRIPTION PAGE NO

Abstract 1
introduction 1
I. What is Insurance? 4
1. Types of insurance 4
Life insurance 4

General insurance 5
2. Insurance: is it acceptable
in Islam? 6

II. Takaful 7
1. Definition 7
Reference- Al 7
Quran/Hadith
2. Origins of Takaful 7
3. Takaful worldwide 8
4. ReTakaful 8
5. Models of Takaful 9
Mudarabah model 9
Wakalah model 10
Hybrid model 11
III. Difference between the 13
conventional insurance and
Takaful

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I. What is Insurance?

Pfeiffer and Klock [1974] offer a definition of the term: ‘Insurance is a device for the
reduction of uncertainty of one party, called the insured, through the transfer of
particular risks to another party, called the insurer, who offers a restoration, at least in
part, of economic losses suffered by the insured.’ This characterization of insurance
stresses a major aspect which can be found implicitly or explicitly in most other
definitions, namely the reduction of risk through some transfer mechanism. In fact,
Trowbridge (1975) sees risk transfer to be ‘at the very heart of the typical insurance
arrangement’. This shows the key feature of risk transfer.

1. Types of insurance :

 LIFE INSURANCE:

“Life insurance is a protection against financial loss that would result from the
premature death of an insured”.

rLife insurance provides a monetary benefit to:

- A decedent's family or other designated beneficiary

- May specifically provide for income to an insured person's family, burial, funeral and
other final expenses.

Life insurance policies:

 Profits paid to the beneficiary either in a lump sum cash payment or an annuity.

 Annuities and pensions that pay a benefit for life are sometimes regarded as
insurance against the possibility that a retiree will outlive his or her financial
resources.
 Annuities and endowment policies are financial instruments to accumulate or
liquidate wealth when it is needed.

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  GENENRAL INSURANCE :
An insurance policy that protects you against losses and damages(unforeseen) other
than those covered by life insurance.

There are four types of general insurance:

a) Vehicle insurance
b) Health insurance
c) Home insurance
d) Property insurance

a) Vehicle insurance
“Auto insurance protects you against financial loss if you have an accident.”
Auto insurance provides:
- Property
- Liability
- Medical coverage

b) Health insurance
Medical and Health Insurance. (MHI), is an insurance policy which is designed to cover
the cost of private medical treatment, which can be very expensive, especially with
hospitalization and surgery.

c) Home insurance
“Home insurance provides compensation for damage or destruction of a home from
disasters.”
In some geographical areas, the standard insurances exclude certain types of disasters,
such as flood and earthquakes.

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 d) Property insurance
“Property insurance provides protection against risks to property, such as fire, theft or
weather damage.”
This includes specialized forms of insurance such as:
- Fire insurance
- Flood insurance
- Earthquake insurance
- Home insurance

2. The Concept of Insurance: is it acceptable in Islam?

Insurance has attracted many Muslim writers particularly in discussing the fact
whether it is permissible or not in Islam. This issue has been dealt with through Fiqh,
conferences and academies, and the result of the majority of Fuqaha (Muslim jurists)
consensus is that conventional insurance is not compliant with Islamic laws or Sharia.
Minority of Fuqaha who are not against conventional insurance, thought that there can
be no possible Islamic alternative to insurance besides its benefits to all modern
societies (Ahmed, 2009). Ahmed (2009: 29) states ‘Lots of confusion that had arisen
among a minority of Fuqaha who showed no objection to conventional insurance and
still raised from time to time, is due to mixing up between the practise of insurance, the
insurance business, and the concept of insurance in itself’.
According to the International Cooperative and Mutual Insurance Federation (ICMIF)
(2012) the elements that exist in conventional insurance contract is unlawful because of
involvement of prohibited elements like:

Uncertainty due to (Gharar): whether the payment will be accepted as promised, the
amount to be paid is not known as well as the time it will occur. In addition, when a
claim is not made, the insurance company may acquire all the profits whilst the
participant may not gain any profit at all. The loss of premiums on cancellation for
instance of a life insurance policy by the policyholder, or the condition of charging a
customary short period in general insurance, whereas only a proportional refund is
made if the insurance company terminates the cover30 .

 Gambling (Maisir): The participant contributes a small amount of premium expecting

to gain a large sum, the participant loses the money paid for the premium when the
insured incident does not occur and the company will be in debit if claims are higher
than contributions.

Usury /Interest (Riba): As the insured, on his death, is entitled to get much more than
he has paid. Furthermore, insurance funds invested in financial instruments such as
bonds and stocks contain an element of interest.

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II. Takaful(Islamic Insurance)

1. Definition
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 Kafala, 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.

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.

Reference - Al Quran:
‘Help (taawan) one another in furthering virtue (birr) and Allah consciousness (taqwa)
and do not help one another in furthering evil and enmity” al maidah: verse 2(5:2)

Reference – Hadith:
-“Tie the camel first, then submit (tawakkal) to the will of Allah”
The hadith implied a strategy to mitigate/reduce risk.

-Basis of Mutual Protection: By my life (which is in God's power), nobody will

enter Paradise if he does not protect his neighbour who is in distress. (Narrative of
Imam Ahmad bin Hanbal.)[17] The fundamentals underlying takaful are very similar to
co-operative and mutual principles, to the extent that the co-operative and mutual
model is one that is accepted under Islamic law.

- Basis of Responsibility: The place of relationships and feelings of people with faith,
between each other, is just like the body; when one of its parts is afflicted with pain, then
the rest of the body will be affected. (Narratives by Imam al-Bukhari and Imam Muslim)

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 2. Origins of Takaful :

Members of the first Islamic community 14 centuries ago practiced successful schemes
ofco-operative risk sharing.
Early precursors were developed in response to perils and risks associated with long
distance
trade via caravans or sea voyage and included:

Hilf (undertaking)
Aaqila (pooling of resources for arranging payment of blood money)
Damaankhatar al tarik(surety)In the first constitution in Madinah of 622 CE,
there were codified references to social insurance relying upon practices like:
Al – diyah and Al – aqila(wergild or blood money to rescue accused in
accidental killing).
Fidyah(ransom for prisoners of war)
Cooperative schemes to aid the needy, ill and poor.
Dawania – Mutual indemnification amongst officers working in the same
department during the rule of the 2nd Caliph Umar Ibn Al Khattab.
Cooperative schemes to aid the needy, ill and poor.

3. Takaful Worldwide

Currently few ReTakaful companies worldwide offering a relatively small capacity:

 Sudan (1979) National Reinsurance.
 Sudan (1983) Sheikhan Takaful Company.
 Bahamas (1983) Saudi Islamic Takaful and ReTakaful Company.
 Bahrain/Saudi Arabia (1985) Islamic Insurance and Reinsurance Company.
 Tunisia (1985) B.E.S.T. Re
 Malaysia (1997) ASEAN ReTakaful International.
 Dubai (2005) TakafulRe by ARIG.
 Lloyds of London to form a ReTakaful Syndicate.
 SwissRe to form a separate ReTakaful Pool
 MunichRe to form a separate ReTakaful Pool
 Provision in Takaful Rules – 2005

4. ReTakaful
Takaful operators may transfer risks to larger operators. This is generically called
reinsurance, or retakaful in Islamic Finance. Reinsurance is defined as: “Insurance
bought by insurers. A reinsurer assumes part of the risk and part of the premium
originally taken by the insurer, known as the primary company. Reinsurance effectively
increases an insurer's capital and therefore its capacity to sell more coverage. It also
allows Takaful funds to shift or transfer their larger risks to these companies, who
accept these risks from a diversified list of primary companies; thus, spreading the risk
through their auspices, which could not otherwise be intermediated by a single Takaful
operator. The retakaful is global and some of the largest reinsurers are based abroad.
However, Malaysia is home to 2 of these large retakaful operator’s subsidiaries, i.e.
Munich Retakaful and Swiss Re. Reinsurers have their own reinsurers, called

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retrocessionaires. Reinsurers don’t pay policyholder claims. Instead, they reimburse
insurers for claims paid. They do so under 2 methods:

• Facultative. A reinsurance policy that provides an insurer with coverage for specific
individual risks that are unusual or so large that they aren’t covered in the insurance
company’s reinsurance treaties. Examples are coverage for jumbo jets or oil rigs.
• Treaty reinsurance. A reinsurer agrees to assume a certain percentage of an entire
classes of business, e.g. as various kinds of general Takaful, up to preset limits. Retakful
operations are structured on the tabarru’ basis. They take contributions from
participating Takaful operators, who share in the risk pools. Retakaful operators
primarily use the wakalah and mudharabah models. The wakalah fee is usually paid up
front and runs approximately 5% for acting as wakil over the pooled fund. The
mudharabah shares in the profit from managing the investments of the pooled fund as
the mudharib partner. The profit percentage may vary but ARC, for example, charges
407%.

5. Models of takaful

MUDHARABAH-BASED TAKAFUL:
Mudharabah is an Arabic term that comes from darb fil-ard, meaning to journey through
the earth seeking the Bounty of Almighty Allah. Under this model, the participants make
contributions that are credited to a participants’ fund, while the shareholders of the
Takaful operator company contribute to a shareholders’ fund which is different from the
participants’ fund. The Takaful operator, as mudharib, invests the participants’ fund in
Shari’ah-compliant instruments. Profits generated from the investment are shared
between the participants and Takaful operator in the agreed ratio. Any losses are
charged to the participants’ fund. In a mudharabah concept, operational expenses
relating to investment are charged to the shareholders’ fund. In managing the
operations, general and administrative expenses other than relating to investments are
charged to the participants’ fund. As valid claims are made, Takaful benefits are paid to
beneficiaries depending upon occurrence of actual losses and damages. In case of
surplus, the participants receive full refund, but have to make additional contributions if
a deficit exists.

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Source : LE MONDE DE TAKAFUL PAR SHINASH BHAGALOO

CM₌ (RC ₊F)/ { 1₋(AQ₊EX₊Q₊PF}

Where:
CM: contribution amount (mudarabah model)
RC: risk contribution
F : fix cost
AQ: acquisition cost
EX: management expenses
PF: profit margin target

WAKALAH-BASED TAKAFUL:
Under the wakalah-based model, the Takaful operator performs as the wakil or agent of
the participants and is consequently entitled to a fee
for the services provided. In theory, the participants’ contributions are credited to a
participants’ fund. As an agent, the shareholders of the Takaful operator company
donate to a shareholders’ fund which is maintained separately from the participants’
fund. The Takaful operator invests the participants’ fund in Shari’ah-compliant
instruments in its capacity as wakil or agent. All operational general and administrative
expenses are charged to the participants’ fund. The Takaful operator receives an agency
fee from a percentage of the gross contributions received. As valid claims are occurred,
the benefits are paid to the participants depending upon occurrence of actual losses and
damages. Any underwriting surplus is given back to the participants. And the
participants are required to make additional payment of deficit if any (Ibid). Waqf
Model. Under this model, a waqf can be established by the Takaful operator through the
contribution of a “ceding amount” (part of the capital) to compensate the beneficiaries
or participants of a Takaful scheme. The ceding amount of the waqf will remain invested.
The Takaful fund, consisting of the contributions paid as tabarru’, will be further
invested by the operator in accordance with Shari’ah. Any person by signing the
proposal for, contributing to the waqf and subscribing to the Takaful documents, shall
become a member of the waqf. The waqf will become owner of all contributions and has
the right to act as a legal.

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Source : LE MONDE DE TAKAFUL PAR SHINASH BHAGALOO
CW₌ (RC ₊ F) / {1₋ (V₊ Q}
Where :
CW: contribution amount( wakalah model)
RC: risk contribution
F: fix cost
V: variable cost (Wakalah Fee for operator and for intermediaries
Q: provision of XOL cost

HYBRID MODEL:
The hybrid model combines elements of the wakalah and mudharabah models and is set
so that the Takaful operator has two funds; one for the shareholders and the other for
participants. In this model, a wakalah contract is used for underwriting activities while
mudharabah contract is used for investment activities. With regard to underwriting
activities, the Takaful operator acts as wakil or agent on behalf of participants to manage
their funds. In exchange for managing the funds, the Takaful operator received a fee
known a wakalah fee of agency fee which is normally a percentage of the contributions
by participants. An incentive fee is provided to the Takaful operator if there is a surplus
in the participants fund as a result of managing the fund effectively. Generally, any
surplus contributions will be invested in different Islamic instrument based on
mudharabah contract, which the Takaful operator acts as mudharib on behalf of
participants (capital provider). Like other mudharabah contract, the ratio of profit is
fixed and agreed upon between the two contracting parties.

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Source : LE MONDE DE TAKAFUL PAR SHINASH BHAGALOO

III. Difference between Takaful and Conventional

Insurance

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Source: the-relationship-between-insurance-and-finance.doc

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Source : DAWOOD FAMILY TAKAFUL (LTD)

Source: Takafulemarat.com

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 Conclusion

We have shown that Takaful insurance is a new kind of insurance, combining

the principles of conventional insurance, Islam and ethical values. It thus
constitutes an attractive alternative to conventional insurance. Indeed, Takaful
insurance avoids the main wrongs of the conventional insurance prohibited by
the Moslem right like the alea, the speculation, the interest, and the investments
in the forbidden sectors. Takaful insurance has, therefore, succeeded in
combining a modern, religion-compatible product, while the old insurance
systems were all secular.

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