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When it comes to insurance, the differences between conventional insurance and takaful (Islamic insurance) aren’t commonly known. And that’s understandable, considering that both are in terms of function – and in many cases operational methodology – effectively the same. With so many similarities,
why is one considered haram and while the other is halal? The main differences between the two lies in intention, usage, distribution and the ultimate beneficiary.
Before we dive into what makes these forms of insurance different, let’s take a look at what makes them similar. Both forms of insurance are a type of shared risk management that relies on a pool funding from a large group in order to offer financial protections against the likelihood of an adverse event or loss taking place and offering payouts to contributors if those losses take place.
Both cover everything from healthcare, potential damage to automotive vehicles, property damage, and even life insurance. In both cases the insurance company or the takaful assesses the risks when assigning a price tag on contribution or premiums. And both invest the contributions of their respective pool to cover finance payouts and generate a profit from these investments.
Takaful is based on the principle of mutual cooperation and shared responsibility for the members of the pool. In other words, the purpose of the insurance structure in Islam is the common good and not primarily for profit.
Contributions by policyholders are considered donations into a mutual fund set up with the intention of mutual assistance. Think of it as a community pool, where everyone contributes, and everyone is eligible to receive equitable (but not equal) compensation should losses happen based on their contribution.
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In the spirit of mutual cooperation, takaful organizations are run collectively, plan collectively and are run transparently, with all members being informed of workings of the takaful. When it comes to structuring the pool, the risks, losses and liabilities are spread out among all contributors.
And most importantly, no one member of the system can derive and advantage over another. Meaning that the Takaful could in theory payout less to everyone should the health of the pool suffer.
Conventional for-profit insurance is (as the name suggests) violates that principle, with the ultimate intention of the insurance provider is obtain a profit. In principle, the insurer assumes the risks stated in the policy and charges the policyholder a premium for that risk to cover potential insurance payouts to customers as well as a profit margin to the insurer.
The risks in conventional insurance aren’t spread out, meaning that the insurance provider must payout an agreed upon claim regardless of the financial health of the pool.
Insurance providers are also structured as a company offering a service with the policyholders being customers. Unless they are publicly-listed, insurance companies aren’t obligated to disclose their internal workings and, in all cases, the customer doesn’t get a say in the internal workings of the company.
Both conventional and Islamic insurance must invest contributions and premiums to ensure sufficient funds to payout claims. However, as with everything in Shariah-compliant finance or commerce, investments by takaful organizations have to adhere to Shariah principles.
Takaful are prohibited from investing in activities that are haram, including alcohol, gambling, drugs (including tobacco), and interest-bearing finance (riba). They are also forbidden from investing in products or assets that are overly speculative (gharar). Conventional commercial insurance companies aren’t bound to these same restrictions.
Read more about: Halal Investment
Another major point of contention between the two is what to do with any surplus that is retained in the pool due to a lack of claims. In takaful, any surplus that is obtained must either be paid back to the policyholders after a certain amount of time or donated to charity.
This includes any profits made from the investments of the takaful, meaning that policyholders may in fact gain financially in a Shariah-compliant way. Takaful are in essence a profit-sharing participatory mechanism between the pool and the individual policyholder, making it a convenient savings tool.
In conventional commercial insurance, however, all profits from the premiums and the investments are retained solely by the insurance provider as it assumes all the risks. Any investment or savings offerings provided by a conventional insurance provider comes in the form of expensive add-ons.
Discalmer:
"Funding Souq Limited (DIFC) is regulated by DFSA. Funding Souq operates an Islamic Window. This content is not reviewed by the Firm's Shariah Supervisory Board, it is for educational purposes only, and the Firm does not directly or indirectly provide these services."
