Sunday, March 14, 2010



The restriction in Shariah regarding commercial conventional insurance has led to the establishment of a number of Takaful (Islamic insurance) company worldwide providing insurance coverage for the general public. In the majority of cases the companies are run as limited companies owned by shareholders. Some Takaful companies are also listed on the stock exchange, where their shares are actively traded, and thereby going public.

Generally, many Takaful companies (especially those using the Mudaraba principle) claim that their operations are based on the concept of mutual or co-operative insurance as approved by the Muslim jurists. This claim is on the basis that:
i) They receive the premium or contribution from the insured on the basis of the Mudaraba principle, whereby the company becomes the entrepreneur (Mudarib) and the insured party the capital provider (Rab al-Mal).
ii) The insured party agrees to donate a certain percentage (or in some cases as in General Takaful the whole of the amount paid) of the premium/contribution to a special fund used to pay compensation or benefits to contributors.
iii) Any surplus left in the fund after settlement of all claims is shared by the company and the insured as profit in a ratio as agreed in the contract. An insured party who has received compensation, the amount of which is greater than what he could have received as a share of the surplus had he made no claim, is not entitled to share such a surplus.
iv) The company uses normal actuarial principles to calculate risk and premium. Since this Takaful company operation is claimed to be based on the Mudaraba principle, the question arises as to whether such an operation can be considered to be Shariah-compliant.

In this case, the parties to the contract are the company (which is owned in most cases by the shareholders) on the one hand and the group of the insured parties on the other hand. In other words, the company does not belong to either the insured parties or the contributors. In fact, the company is a separate legal entity distinct from the shareholders. Since the operation of the Takaful company is based on the Mudaraba principle (as claimed), the insured parties are considered capital providers (arbab al-amwal), and the company as an entrepreneur (Mudarib). Therefore, both the insured parties (Arbab al-amwal) and the company (Mudarib) according to the scheme are entitled to share the surplus (or profit) in line with the contract, based on an agreed ratio or percentage.

Compensation or benefits to the insured parties are paid from the amount in the Takaful fund, receiving the money from the premium or contribution paid by the insured, which agree to pay the whole amount (or part thereof) as a donation (Tabarru’). This Takaful operation up to this point, is Shariah-compliant, but the Mudaraba contract should be examined in greater detail. Under the Takaful operation, the money in the Takaful compensation fund belongs legally to the company and not to the insured-cum-investors (as in the case of A Family takaful fund), and it is claimed (in line with the tabarru’ principle) that by making the donation (Tabarru’), that is when the insured pay the premium or contribution, an individual insured party is considered to waive his/her right to the money paid. However, if a general view of Shariah is to be relied upon with regard to all the insured parties as a group, the whole amount collected by the Takaful fund (particularly in the case of the general takaful i.e. the compensation fund) must be considered either as trust money or as a trust fund for the benefit of all the contributors. It can in no way be treated as funds belonging to the Takaful companies.
Furthermore it is not lawful in Mudaraba to stipulate that either or both parties to the contract should be entitled to a certain amount of guaranteed proceeds or benefits in kind or money other than a share of the profit in an agreed ratio or percentage. If, for instance, the investor / Mudarib should stipulate that he is to be guaranteed an amount of money or benefit other than the share of profit, the contract becomes void, because of the possibility that the venture might not yield a profit. This would badly affect the interest of the party who is not entitled to such favourable treatment due to the existence of the said unfair terms.

In a Takaful operation, there is seemingly a favourable stipulation for the benefit of the investors/insured parties that in the case of certain events, they are entitled to an agreed amount of compensation/benefits, or alternatively they may be helped to discharge the specified civil monetary liabilities as listed in the contract. Technically and legally this term in itself will render the Mudaraba contract void on the grounds of unfair terms in the contract. In practice, however, the Takaful company agrees to the insertion of such ‘unfair terms’ because the company’s actuaries have already calculated (as is usual in conventional insurance) that under normal circumstances there will be a surplus in the Takaful fund.

Thus such seemingly unfair terms are arguably not unfair to the Takaful Company which is fully aware of the truth behind the matter. But the matter is not fully known to the insured parties as individuals who will still hope to receive the benefits stated in the contract. The Takaful Company knows from the very beginning that only a small proportion of the insured will in the end claim benefits. There seems to be a manipulation, some would argue, by the Takaful Company against the insured parties, both as individuals and as a group.

In the case of the group, the accumulated contributions, which in fact belong to the group (or at least held in trust for their benefit), will be shared in the end by the company after all claims are paid. As for an individual insured, there is uncertainty as to whether he will receive the stipulated Takaful benefits. In the end, what is shared by the Takaful Company is nothing other than the proportion of the group’s money left in the Takaful account. It is therefore like paying the Mudaraba profit from the capital provided by the investors, a practice which is not acceptable according to the rules of the Mudaraba contract. On top of that according to mudaraba principles, in case of loss, the remaining capital of the mudaraba should be returned back to the mudaraba investors, and not to be shared with the mudarib since what is supposed to be shared is profit if there is any. This because in such a contract, the profit needs to be paid or shared out of the actual profit (ribh) of the business. In the case of Takaful, what is shared is a part of the capital left (after deduction made for payment of claims) provided by all the insured as a group of investors (Arbab al-amwal). After paying all the necessary claims, what normally happens is that the Takaful fund’s account would register a loss not a profit i.e. total amount of premium / contribution paid (capital of the Mudaraba) minus total claims paid. This means that there is no Mudaraba profit to be shared bearing in mind that profit is defined in Sharia law as any amount in excess of the original amount of capital in Mudaraba.

In accordance with Mudaraba principles and rules, there is thus no profit to be shared as the business registers a loss. This clearly shows that the Takaful Company shares what it is not entitled to share according to the principle of the Mudaraba contract. It seems that there is no real difference between a conventional insurance operation and its Mudaraba-based Takaful counterpart in this particular aspect. Above all, both are owned by a certain group of people who are there to make a profit from the business based on contingencies.
This fact alone makes the mudaraba-based Takaful Company and its operations doubtful if the test adopted for mutual or co-operative insurance is to be faithfully applied. According to Abu Jayb in his book “al-Ta’min bayn al-hazar wa’l ibahah”, mutual or co-operative insurance is principally valid under the Shariah according to nearly all modern Islamic jurists.
One major ground for the validity of truly mutual or co-operative insurance is based on the Shariah principle that says uncertainty (Gharar) can be tolerated in Tabarru’at contracts (contracts without consideration) whereby the parties concerned do not basically seek to gain from the arrangement as they do in normal commercial contracts (Mu’awadat).
Since mutual or co-operative insurance / Takaful is entered into on the basis of a voluntary donation (Tabarru’), as opposed to a contractual price or premium as in conventional insurance, the rule of certainty can be relaxed because in agreeing to the Tabarru’, the parties are not really concerned about who gets what and at the expense of whom since the core idea is to help one another in times of need, a true spirit of solidarity and mutuality, which is generally absent in commercial dealings where the prime motive is to make profit. The situation is akin, for instance, to when one makes a donation or contribution to the tsunami relief fund. One does not expect any particular return from one’s donation. The intention is to help the victims of the tsunami.
Additionally, in mutual insurance or Takaful, all contributors are partners in the relevant entity having equal rights and obligations. The prime objective of the arrangement is to provide help and assistance to all participating members. Management of the entity is normally put in the hands of some of the members acting on behalf on the rest. Salaried staffs, if any, are paid by the entity to run the same for the benefit of all the members. Members of mutual or co-operative insurance companies are owners of the entities, while at the same time receivers of benefits of the coverage. It is thus unlikely that the entity will act in ways prejudicial to the interest of its members.
In commercial insurance/ Takaful, the situation is different. When the insurance or Takaful companies sell their products to the insured parties (who do not own the company), the companies’ main concerns are to safeguard the interest of the shareholders (who are in the business to make profit), and not, as a general rule, that of the premium prayers or contributors or at least there is a conflict of interest situation.
Although the commercial Takaful operation as is practiced today seems to be the only viable Islamic alternative to conventional insurance, it is not fully conforming to the rule or concept of al-Ta'min al-Ta’awuni, or mutual or co-operative insurance. Modern commercial Takaful companies are more akin to normal business ventures whose prime objectives are to make profit based on contingencies. It is undeniable that they have provided the society with an alternative, which is closer to the spirit of the Shariah, compared with those products available under conventional insurance.
However, there remain some dubious elements in the Mudaraba-based Takaful operation which needs to be tackled to make it fully Shariah-compliant. The emergence of new Takaful models in some parts of the world, based on the true concept of Takaful Ta’awuni or mutual Takaful is something that must be welcomed by all of us. The establishment of such mutual or co-operative societies providing insurance or Takaful coverage to their members must be supported, primarily to remedy the shortcomings of current Takaful operations, many of which are run on the Mudaraba model.
Another alternative would be to run the Takaful operation on a basis similar to the method applied in the running of Islamic unit trust companies, whereby the managers of the fund are paid professional fees for the services rendered. The advantage of this method is that it will make it clear that all funds collected belong to the contributors/investors/insured as a group, and are held in trust for their benefit.


  1. Salaam prof.
    Thank you for shading light on the shariah issues bedeviling takaful, i would like to ask a question, suppose that a Takaful company adopts the mudaraba model and in order to be shariah compliant they refrain from sharing the underwriting surplus and only participate in the sharing of the profit from the participant's investment accounts(PIA) would that be in line with Shariah? can the Takaful operator charge a fee for distribution of the underwriting surplus back to the participants? Suppose the company applies wakalah for the initial underwriting and applies mudaraba on the investment side is this still within the confines of the shariah?

  2. Dear Hassan,
    As per the established shariah rule the capital of the Mudarabah belongs at all times to the Capital provider as the Mudarib will only act as his trading agent, and hence should there be a loss in the trading, the remaining part of the capital must be returned back to the capital provider. The mudarib in such a case will suffer losses in term of his efforts: he can not share the balance of the fund as per the mudarabah rule. In the wakalah model, the issue of the company receiving fees in return for service rendered in the management of the fund is less problematic. However the rights to be paid such fees need to be handled within the established rules governing "wakalah bi'l ujur" or contract for services where both the nature of the services to be provided and the fees to be paid need to be fully stated and agreed by the parties.

  3. Dear Prof

    Al salam Alaikoum

    Kindly elaborate on riders benefit and its related shariah and legal issues.

  4. Salam Prof
    Could you share further on the wakalah model for takaful. If the wakalah model is adopted, what is it advantages and disadvantages to both parties, i.e the participant and the takaful operator? And in terms of profitability, would the wakalah model be more superior than other models to the takaful operator? Thank you.

  5. Dear Zarina,
    In any business, to be profitable it is a must that the cost is less than the selling price, and most importantly from Shariah perspective to know exactly what is being sold or purchased@ the subject matter. In Family Takaful, which is essentially more of saving/investment plan, the takaful operator operating under the wakalah model is to be considered a party employed by the takaful participants to manage their investment by getting fees from them as a return. This can be justified on the basis of al-Wakalah bi'l ujur ( contract for services) provided the amount of fees payable is fixed and made certain, so also the period of the contract. As to how much is the fees to be charged by the operator, it is up to the business consideration of the operator. However the participants must agree to the same, and the contract needs to clearly lay down the terms and conditions of the engagement, failing which shariah compliance will be at risk. As to the application of wakalah in General Takaful, the operator is tasked to manage the risk/compensation fund created by pool of the participant donation/tabarru' contribution, and fees are charged/agreed for the provision of such a service. Again this is subject to the business consideration of the operator and agreement by the contributors. The important point to remember with regard to the above structure is that, profit/incomes gained by the operator do not come from selling risk or contingencies but realized as a result of selling usufruct/services based on Ijarah contract.

  6. Salam prof,

    Can you please elaborate more on the issues of underwriting in takaful ?

  7. Assalamu aleikum Prof!

    Please can you share your opinion on how to overcome the legal issues in takaful vs Insurance. How to avoid the conflicts of Shariah Law and Laws of jurisdiction?