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Truth About Islamic Banking and Takaful - Part 2

By Shah Nawaz Khan


takaulEver since the insurance companies were established in India early in early 20th century a section of orthodox Muslims regarded insurance as forbidden by Islam as they thought that elements of interest, wager and avarice are involved in it.

However, enlightened Muslims like Sir Syed Ahmed Khan, Sir Sultan Muhammad shah- Aga Khan the Third and Allama Iqbal have regarded insurance as beneficial to the society. Hakeemul Ummat Allama Iqbal was among the founders of Muslim Insurance Company in Lahore before partition of India.

Fatwa of Jame Azhar of Cairo in favor of insurance was issued over 80 years ago. Quite a few ulema have given fatwas that Insurance is not prohibited. But there are fatwas declaring insurance as forbidden and all of them are based on faulty understanding of insurance.

Conventional Insurance

Under conventional insurance Interest Free operations are possible. In prescribing premium rates 3 basic assumptions are used for (1) administrative expenses, (2) likely yield on investments in permissible ventures like real estate, share capital of sugar, textile or other permissible industries or farming or as prescribed by law and (3) a provision for claims arising in future due to death/loss or maturity of the endowment policy based on actuarial mortality and survival tables i.e. averages or past experience. The factor used to calculate likely yield and savings is called interest in actuarial science but not in the sense of usury.

Actuarial Valuation takes place usually every two years or as prescribed by law of the land. If the yield is more than that assumed in premium rates, that goes to surplus fund. Similarly if the claims paid are less than those assumed than the excess goes to surplus and if the administrative expenses are less than assumed tha savings also go in surplus. A huge portion of surplus usually 90% is distributed among policyholders as dividend or bonuses and only 10% is distributed among Shareholders of the company. Laws of the country determine such limits and the period of valuation. Facility of policy loan may not be available in Interest Free life insurance but provision for policy surrender in full or part may be available before the maturity date selected originally. Conventional insurance is highly regulated business in Pakistan capturing a lion's share in the market.

Islamic Insurance

Takaful, is the term for the Islamic alternative to insurance. It is based on the same concept as the old mutual societies formed in England before Insurance business was developed. Its basic concept is pecuniary protection against fortuitous financial losses by mutual cooperation and the members undertake to indemnify the losses of members of their group and establish a pool by small contributions as well as donations when needed due to insufficiency of the money in the pool.

Some historians say that Arab traders used to practice Takaful since before the dawn of Islam and mutual societies in Europe were established on more or less on similar pattern. Some Islamic scholars misconstrue Takaful as shared responsibility that was called the system of -Aaqilah-, which was an arrangement of mutual help or indemnification in some tribes in 7th century. In case of any calamity, every able member of the tribe used to contribute something to meet the losses of the victims. Islam accepted this principle of pooling money for indemnifying the fortuitous losses in case of calamities or losses to trading caravans or ships by pirates.

 Many companies in different conservative Islamic countries have been writing Takaful business since 1970s.or so. To exploit the inclination of Muslims in interest free operations even in Non-Muslim countries Takaful as well as Interest Free Banking Companies have been established by Muslims as well as Non-Muslims.

Usually the contract of Takaful provides indemnity of agreed amount in respect of pecuniary losses arising due to death, disability and losses to the business or property due to perils like marine accidents, fire, theft, earthquakes etc. The policyholders (Takaful member ) pay subscription to a pool to assist and indemnify each other and share the profits earned from business conducted by the Company with the subscribed funds. But no universally accepted standards appear to have been evolved how the groups are formed based on varying values of the property or goods or earning capacities and living standards of individuals. In books and articles about Takaful, Arabic Terms are used instead of the English words. For instance Maisirmeans any forms of business in which monetary gains come from mere chance, speculation and conjecture and not from work or from genuine business. Gharar means any major uncertainty about the subject matter or rights.

How the Al-Mudharrabah Takafol Business is transacted?
The entrepreneur establishes a company as management of takaful operations and enrolls the participants (policyholder/investors). The contributions of the participants, which could be paid in installments or lump sum, consist of two elements: (1) tabarru (contribution for losses) and (2) investment part.
The contract between the management and participants specifies how the profit, or losses will be shared.

In many countries the generally accepted ration is 70% for policyholders and 30% for the management (entrepreneur) for the Family Business (life and health insurance) and 50%:50% for the General Business (non-life insurance). However the Insurance Act in Pakistan had provided much higher ratio of surplus for the policyholders and in case of State Life it has been 95% and only 5% as the Government’s share for its operations under conventional business. At present State Life and for that matter all the registered Insurance Companies are not allowed to enter takaful market.according to the Takaful Rules, 2005.

 The sharing of profit takes place after all the covered losses have been paid. The periods for which actuarial valuation of Takaful business is carried out differs from country to country. All commercial activities must adhere to Shariah and in most countries a Sharia advisory board is formed.

Generally the Islamic insurance companies engage in the following type of business:
 Family or Personal Takaful Business (life insurance)
General Takaful Business (non-life insurance)

The Personal Takafol Business includes various types of insurance policies –life insurance, accident insurance, health and disability insurance, mortgage life insurance and endowment insurance for college education, marriage, and capital for starting business or to provide provision for retirement. In most cases Whole life insurance is not favored and the coverage period or maturity period ranges from ten to forty years. The logic for excluding whole life insurance from Islamic view-point is not understood. Perhaps the Arab Shariah scholars did not understand the concept of periodic (usually biennial) actuarial valuations that could provide cash dividends periodically.

In most Islamic countries, conventional Term Insurance is considered Un-Islamic because the company does not pay anything to the insured policyholders at the end of the contract.

General Takaful (non-life insurance) are contracts of joint guarantee to provide property and liability coverage which include fire, automobile accidents, personal accidents, public liability, fidelity losses, machinery breakdowns, bonding, sprinkler leakage, workers compensation and marine insurance. Many companies do not cover theft, robbery and burglary losses.

 Generally Takafol installments paid by participants are deposited into two separate accounts: (1) Participant’s Account (PA) and (2) Participant’s Special Account (PSA)

PA is an investment account, and a substantial portion of the installment is deposited into a PA account solely for the purpose of savings and investment.The balance of the installments is credited onto PSA or tabarru account, which pays the covered losses. The proportions of installments to be credited to the two different accounts are determined by an actuary.

 In some cases Takfol companies operate in much the same way as the Mutual Insurance companies but interest is not employed in any operation or investments and the products and the investments need to be approved by Sharia ‘h Advisory Board. Despite lapse of several decades there is no standard book or manual about Sharia Compliant schemes for insurance business.

The first Islamic insurance company is stated to have started in Sudan in 1979. Since then, several other Muslim countries have started Islamic Insurance companies.However, the progress is slow.

In many countries with a very large Muslim population, the people are more enlightened than Sudanese and Saudis and do not regard conventional Insurance against Islamic values. But new Takaful Operators hope to exploit the Muslims sentiments and preference for the so- called Sharia’h compliant products and provide service and protection as comparatively higher cost than conventional insurance business. Group Life and Health Insurance Protection by Takaful operators appears to be in formative stage.

No standard practices appear to have been developed to deal with extra hazards and acceptance of sub-standard risks as member. Generally the same underwriting principles are adopted as in conventional business.

It is believed that the insurance market in Islamic countries is expanding at a rapid rate with the resurgence of Islam, higher literacy rate, rising income levels, and number of new insurance companies- both domestic and multi-national- have entered the market and are doing business on conventional pattern and the competition is stiff. The hype for buying ‘Halal’ or lawful insurance products may help the expansion of Takaful business in orthodox Muslim communities.


Islamic banking and Takaful are re-invention of wheels in 20th century due to bigotry but that can serve as tools to exploit the sentiments of Muslims for staying away from interest bearing products and speculation. The fact remains that Islamic moral standards can be applied to conventional banking and insurance businesses and interest-free and speculation-free operations are possible at comparative lower cost with better benefits and greater flexibility, simplicity and clarity than the so-called Sharia'h compliant financial products that are technically and operationally deficient in many respects.

Orthodox Sharia’h scholars say that insurance is forbidden because elements of wager and speculation are involved that promote avarice and mischief. They do not appreciate that the requirement of insurable interest eliminates the element of wagering. The possibilities of speculation, avarice and mischief exist in tafakul to greater extent than the conventional form of insurance. In conventional insurance those are checked out by appraisal of moral hazard in underwriting by the tested and proven methods. In order to protect the interests of policyholders in tafakul business underwriting and regulatory practices and laws would have to be kept under constant review. (End of the Article)

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Allama Iqbal was among the founders of Muslim Insurance Company, Lahore before partition of India. In those days Muslims of India and most of the world did not hear anything about takaful.