Comparison between Takaful and Conventional Insurance
The following are some basic differences distinguish conventional insurance and takaful (Islamic insurance):
1) Riba exists in conventional insurance in two forms: Direct riba where the excess on one side in the exchange between the amount of premium and the insured sum. Insurance is the sale of money for money, of a greater or lesser amount, with a delay in one of the payments.
Indirect riba where the interest earned on interest-based investments- Riba exists in commercial insurance from the profits earned through investments of the premiums in interest-bearing financial instruments such as stocks, bonds, and savings accounts, an unknown part of which is then used for the payment of claims to policy holders. In Islamic insurance (takaful) the involvement of riba is prohibited in any activity is forbidden.
2) It is argued that through the mechanism of conventional insurance, the insured substitute’s certainty for a high degree of uncertainty. In return for a predetermined payment, the premium, and the transfers to the insurer the possible economic losses from stipulated risks. In Islamic insurance, the members share all risks mutually and no transfer of risk is involved. Participants pooling their contributions essentially own the takaful fund and the Takaful Operator acts like a trustee of that pool to manage the business professionally with insurance know-how and provide the resources for doing so. The participants are the insured and the insurers in the first instance. The risk is therefore borne by the participants collectively and they share in any surplus or loss from the pool. To ensure that the Takaful Operator can compete in marketplace, any losses are first absorbed by contingency reserves (also known as Participants’ Equity) built up by the Takaful Operator, then by transfer of a requisite amount from the shareholders taken as an interest-free loan (qardhasan), and lastly the Takaful Operator would resort to correcting the position by a general increase in pricing that would apply to the loss making classes of business.
3) Conventional insurance companies are motivated by the desire for profit. Islamic insurance companies, by the virtue of their adherence to the Shari’ah, are required to commit to a system that is fair to all parties to the transaction, i.e., the participants and the shareholders (of the Takaful Operator). The Shari’ah upholds profit incentives from business ventures provided these are achieved by ethical ways and means for the overall benefit of society and the environment without undue excesses and exploitations.
There are few Takaful Operators that have been set up as non-profit making organisations by their shareholders. The capital supports development of the operations, whilst business expenses are met out of insurance revenue (participants contributions and investment income).
4) Conventional system of insurance is subject to exploitation. For example it is possible to charge a high premium (especially in monopolistic situations) and full benefit of such over-pricing goes to the company. The takaful system has a built in mechanism to counter such over-pricing through its feature of profit sharing.
No matter what premium is charged, if the overall results are good, any surplus goes back to the participants in proportion to their contributions. Besides the elements of gharar associated with a high degree of uncertainty, maysir (gambling), and riba (interest) dealt with separately, there are a number of other areas where the two systems differ. Some of these are stated below and others are dealt later in this course.
(a) The system of takaful is regulated at two levels. Firstly by the country’s insurance regulatory body to ensure that the company is technically sound. Secondly, by the company’s Shari’ah Supervisory Board to ensure that its operations are conducted in line with the Shari’ah principles. As the Shari’ah objectives are for social benefit and protection of rights of individuals, it also serves as an additional protection for consumer.
(b) There are no contractual guarantees implicit in a takaful contract.
(c) The Articles and Memorandum of Association of a Takaful Operator must state that the operational aspects are based on Shari’ah principles. This is to signify that the prime motivation for insurance is its social obligation.
(d) The conventional insurance companies may invest their funds not only in interest-bearing assets and instruments, but also without any regard for the concept of halal (permissible) and haram (non-permissible) laid down in Islam. On the other hand, Takaful Operators must undertake business and investments, as well as distribute profits and share losses in accordance with the Shari’ah.
(e) Takaful system has a built-in mechanism to counter any over-pricing policies of the insurance companies because whatever may be the premium charged, the surplus would normally go back to the participants in proportion to their contributions.