Six key areas of differences between Takaful and conventional insurance
Takaful and Conventional Insurance
The major points of difference between conventional and Islamic insurance may be enumerated in brief as under (Mohammed Obaidullah, Associate Professor, Islamic Economics Research Center, King Abdulaziz University, Jeddah, Saudi Arabia):
1) Conventional Insurance is based on profit-motive and aims to maximize returns to shareholders. The business of insurance is, in essence, “owned” by shareholders of the insurer company. Islamic insurance, on the other hand, is based on the motive of community welfare and protection. The business of insurance itself is non-profit.
The insurer is now called the takaful operator who receives a fair compensation, either through a share in returns on investment of funds or through agency fees. The business of insurance is, in essence, “owned” by policyholders and the operator company acts as the agent/manager.
2) In case of conventional insurance, insurer’s profits include underwriting surplus, which is the difference between total premiums received from and total claims and benefits paid to policyholders. Essentially, profit comprises underwriting surplus plus investment income. The distribution of profits or surplus is a managerial decision taken by the management of the insurer. As a result there is a conflict of interest between shareholders of the insurer company and the policyholders. In case of Islamic insurance, on the other hand, the operator has no claims in underwriting surplus. Further, it is the takaful contract, not the management of the operator company that specifies in advance how and when profit will be distributed. There is little room for conflict between interests of shareholders of the operator company and the policyholders.
3) In case of conventional insurance, the sources of laws and regulations are set by state and are man-made. In case of Islamic insurance, the laws and regulations are based on divine revelations. A manifestation of this is in the right of insurable interest that is vested in the Nominee absolutely in conventional life insurance. The same, however, is determined by Islamic principles of inheritance (faraid – a method of division of inheritance) in case of Islamic insurance.
4) Just as in case of the insurer, the insured or policyholders may or may not be governed by the profit motive. For instance, in conventional insurance, the insured or policyholder may decide between original costs or replacement cost as the basis of valuation and claim accordingly – whether or not they chose to rebuild property. In Islamic insurance, however, the insured may not “profit” from insurance and are entitled to compensation only for repair or rebuild or replacement.
5) In conventional insurance the investment of premiums is entirely at the discretion of the insurer with no involvement by policyholders. As such, investment usually involves prohibited elements of riba and maysir. In Islamic insurance, on the other hand, the takaful contract specifies how and where the premiums would be invested. By definition such investment would exclude prohibited areas.
6) In case of dissolution of the former (conventional insurer), reserves and excess/surplus belong to the shareholders. In case of dissolution of the latter (takaful operator) however, reserves and excess/surplus could be returned to participants, or donated to charity. Most scholars would prefer the latter course of action.
7) The Islamic insurance company has an additional obligation of annual payment of zakat.