Takaful: Understanding Shariah Compliant Insurance
In Malaysia, we live in a multiracial and multicultural community. Therefore, you can expect that our insurance products will be varied too.
Very often, we come across conventional insurance products like life insurance, home insurance and medical cards. However, there is also another type of insurance known as Takaful.
Takaful is a Shariah compliant insurance plan that conforms with Islamic teachings and values. It is available to both Muslims and non-Muslims in Malaysia. In order to know whether Takaful is suitable for you, we should understand it more and know its main differences with conventional insurance.
What is Takaful?
Takaful is a type of insurance which conforms to Muamalat, which are the principles of Islamic transactions. The concept of what we know today as insurance, has existed among the Arabic speaking communities since about 200 BC.
The original concept is rooted in the principle that compensation must be paid to a wronged party or their heirs by the wrongdoer. This is a form of shared responsibility in a community, and was later extended to various other forms.
For example, sailors or traders who were going on a sea voyage would pool their resources together to cover anyone in their group who suffered an unfortunate event, such an injury or theft.
In these modern times, Takaful takes on various forms of products too. There is motor Takaful for vehicles, medical Takaful and life Takaful.
Source: Unsplash
How Does Takaful Work?
There are several aspects of modern insurance that go against Islamic principles. This includes
Having elements of al-gharar or uncertainty.
It also includes the concept of riba (usury) whereby interests are charged to policy-holdres. The practice of charging interest is actually forbidden in Islam.
Many Muslim scholars consider modern conventional insurance to be a form of gambling, also known as the forbidden element of al-maisir.
Therefore, shariah compliant insurance is based on the concept of all members contributing money to a pool in order to guarantee each other. Therefore, any claims made by one member is paid out from this fund.
The fund pool is known as Tabarru’ and everyone who purchases a Takaful policy will have their funds end up in the same pool. In Malaysia, the Takaful industry is regulated by the Islamic Financial Services Act 2013, and the governing or reference body for all things related to shariah compliant insurance is the Malaysian Takaful Association (MTA).
As mentioned earlier, you don’t have to be a Muslim in Malaysia to purchase a Takaful policy, and agents can come from any background too.
Source: Unsplash
How is Takaful Different From Conventional Insurance?
To answer this question, it is important to know how conventional insurance works. In conventional insurance, the insurance company sells insurance policies to policyholders or individuals.
These policyholders will be required to pay a premium to the insurance company, either monthly or annually. The company will make payouts to these policyholders as coverage for unfortunate incidents. There is a minimum rate of payout as stated in the policy, but payouts also depend on the severity of the incident, the losses experienced and market conditions.
First, we have to see how both Takaful and Conventional insurance are similar. Both are meant to provide financial support for various untoward incidents in the policyholders life. However, here is where the similarities end and the differences begin:
Types of Investments
In conventional insurance policies, the company will usually take the premiums paid and invest them in order to generate additional income. They are not limited in what type of industries they invest in and have flexibility to determine what businesses to invest in.
On the other hand, Takaful investments are tightly controlled, so they can only invest in approved businesses. These businesses cannot have any elements of gambling, unreasonable interest rates and uncertainty.
Distribution of Returns
With conventional insurance companies, any profits from investments and any surplus premiums will only benefit the company shareholders ( i.e. the owners of the company). The policyholders do not actually get to benefit, except whatever they obtain from their insurance claims and/or investment linked policies.
However, when it comes to Takaful, any leftover Tabarru’ funds from low claims are distributed among the policyholders and belong to the policyholder, not the insurance providers/operators. In some cases, excess Tabarru’ funds are also distributed to company shareholders, under the condition that the shareholders cannot gain more than what is received by the policyholders.
Takaful operators mainly earn from charging a fee to policyholders for administration, marketing, accounting, management operations and so on. This is often referred to as the performance fee.
Risk Distribution
Under the shariah financial conditions, including for Takaful, both profit and losses are borne equally by all policyholders as well as the company shareholders. This means that in the event of an investment loss, that liability will be equally distributed among the policyholders. In short, any risks are shared among Takaful participants who agree to this shared risk.
In conventional insurance policies, any losses will only be borne by the company shareholders and not affect policyholders. Policyholders will be guaranteed a minimum payout upon making their claims, as long as they fulfill all the necessary conditions. In brief, all the risk is borne solely by the insurance provider, and policyholders have their risks transferred away from them.
Summarizing Shariah Compliant Insurance
In a shariah compliant insurance plan or Takaful, the insurance provider exists outside of the plan and only plays the role of a fund manager ( known by the term Mudarib). They are paid a fee to administer and manage, but do not profit from it, nor bear risks. They are in effect only a ‘moderator’. Any losses, profits, risks and benefits are shared among all the policyholders or participants.
In conventional insurance, the insurance provider is the vendor that sells their insurance policies as products. Policy holders can claim coverage as promised by their policy, and benefit from any investment linked policies they buy. However, they don’t share any losses or profits from the company’s operations.
Source: Unsplash
In Malaysia, Takaful policies are available to anyone, but agents have to be registered with the Malaysian Takaful Association before they can sell or promote Takaful products. Takaful is definitely an interesting form of insurance to consider.
Do feel free to contact us if you’re interested in Takaful products, or would like us to explain and clarify it further. Our consultants will be able to make things clearer in no time.
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