Takaful

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Takaful Meaning

Takaful is a type of co-operative insurance based on the ideals of risk sharing and shared responsibility to ensure that the insurance practices are carried out as per the Islamic Sharia laws. Like conventional insurance schemes, takaful plans also ensure protection against different uncertain events depending on the nature of the plan. However, takaful companies work with certain rules especially in relation to fund management and risk-bearing aspects to adhere to the ethics of the Sharia laws.

Takaful Meaning

Takaful, also called Islamic insurance, operates as an alternative to traditional insurance. It works as a risk-sharing model as opposed to the risk-transfer model of the traditional kind.
Policyholders in takaful pool money together in the form of donations which is directed to a special fund. Every participant is responsible for the damages that could occur due to an uncertain event to the policyholders, who are given the insurance cover using the donations.
The funds are invested in investments that adhere to Sharia principles without a profit guarantee, unlike traditional insurance. This is because Islamic insurance focuses more on helping each other bear the burden of losses and uncertainties—however, the profits made are distributed amongst the participants.
A takaful operator, or administrator, runs the general account.

How Does Takaful Work?

Takaful was created to overcome the drawbacks of traditional insurance. In most insurance types, premiums are paid to an insurance company in exchange for coverage in the event of an emergency. If that emergency never occurs, a policyholder incurs a loss by losing all the money contributed as premiums.

The amount earned in premiums belongs to the insurance company that invests and does as it pleases with the customer’s premium. Policyholders rarely ever have a say in how their premiums get invested, nor are they privy to the investments taken.

Those who participate in takaful feel that traditional insurance does not work to ensure against uncertainty, gambling, and financial exploitation – all of which are not allowed under Sharia law. Traditional insurance is thought to contain Riba (lending money at high-interest rates), Maysir (gambling) and Gharar (uncertainty).

For instance, when a policyholder invests a small amount as premiums. He/she hopes to earn a huge insurance cover in the future based on the insurance company's high-interest investment schemes. The above process is seen more like a lottery win and hence qualifies as Maysir or gambling under Islamic insurance.

Let us understand the meaning and characteristics of takaful in detail.

Those who contribute to takaful contribute to the overall pool of money and, in turn, receive help from that pool when uncertainty occurs. Members are to cooperate for the common good.

Mutual Responsibility

Each member of the contract has the responsibility for alleviating the risk events of others. For example, if two participants have their homes burned down, they are responsible for helping the other, regardless of being in the same situation. Hence, the loss is shared amongst the policyholders and is not transferred to the insurance company. In addition, it ensures mutual protection and solidarity amongst participants.

Fund management

Tabarru, which is translated as donations or contributions, prevents instances of gambling and uncertainty as the donated amount is pooled and invested in investments schemes that adhere to Sharia laws. Suppose a policyholder or participant of donations faces an emergency that is covered under the insurance plan. The insurance cover for the same is paid through the pool of donations. While the funds' loss will be shared amongst the policyholders, the profit-sharing will work as per the Al-Mudharabah model.

Al-Mudharabah model

At the end of the year, any surplus earned from the investment will be distributed amongst the participants as per the ratio agreed upon by the insurance company and the participants. The profit calculation will involve subtracting the utilized insurance cover for the year and expenses earned.

It is an implicit part of the contract that profit earning is not guaranteed, or else it would violate the rules involving Riba, Maysir. and Gharar. This is because any guarantee of profit will require not providing funds if uncertainty does not happen. In case no one faces uncertainty, or when a dissolution happens, the money is usually distributed amongst the members.

Insurance agreement and operator

The Islamic insurance agreement carries out each members' consent to share the losses of the group. It also contains the ratio of the division of profits amongst the company and the policyholders. Just like an insurer, the task of the operator is to undertake all the administrative tasks.

Industry Statistics

As of 2019, the Islamic insurance industry grew to $ 23.7 billion, as per a recent report. Some of the leading areas were the Gulf Cooperation Council (GCC), with the highest share. While other regions were Southeast Asia and Africa. Islamic Insurance Company, JamaPunji, and Takaful IKHLAS are some popular insurance companies in the industry. Also, general, health and family plans were some popular insurance plans.

Takaful vs Insurance

There are a few points to understand whenever the takaful vs traditional insurance debate crops us. Traditional western insurance is based around a risk-transfer contract, whereas takaful bases itself on risk-sharing principles. Risk-transfer is the basis for all traditional insurance. It means that a series of payments are made to a third party to assume all of the risks. You pay your insurance company x amount each month for that insurance company to take responsibility for x amount of your property in the event of damage.

For example, let’s assume a property worth $500,000 needs repair. The insurance company pays out the entire liability at $500,000. They are responsible for all of the $500,000, and they bore that risk from the moment the contract began. In Islamic insurance, the policyholders and not the insurance company bear this risk.

An important distinction here is not the payout but what the insurance company did with its money. Insurance companies take policy payments and invest them. In other words, they gamble your premiums whilst still holding the responsibility of the risk. Once you have signed the contract, you do not have control over where the money goes or is invested.

As with any traditional insurance policy, it can always fail. This means that technically, even the largest insurance company, can go bankrupt. Insurance companies are generally thought of as being very safe as there are more contributions than there are depletions per year. This does not eliminate the risk entirely. Investments made by insurance companies have failed in the past.

Takaful eliminates a portion of, but not all of the same risk. Pooled contributions and shared ownership make things overall safer, but there is no full level of transparency. Takaful funds are still invested, but may only be invested in a system where both the profit and the loss is shared. In traditional insurance, one may be indemnified their entire life by the premiums paid without ever receiving anything back in return.