UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Takaful in Islamic Finance

Difference between Conventional and Islamic Insurance

Islamic law prohibits speculation on risk where one can make a profit from speculating on the risk.  Basically, conventional insurance is based on this concept of making a profit off of speculating risk and transfer of loss.  A conventional insurance company speculates on the risk by making an assessment of the risk and then pre-determining profit based on the estimated pay-out versus the premium.  It is in a sense gambling. (AMANIE)

It results often times in conventional insurance companies making up excuses after the fact of why they cannot make a payout on the insurance policy based on a twisted but justified interpretation of the law and with the person with the insurance policy left uninsured or underinsured even though technically that person has purchased an insurance policy. Conventional insurance is more of a money-making scheme than a system to protect people from debt. (Me)

Conventional insurance is also based on the transfer of loss as conventional insurance imposes on the insurer the obligation to pay claims as the risk has been transferred from the insured to the insurer via the insurance policy.  (AMANIE)

Sharia’h Objection to Conventional Insurance

According to AMANIE, the Islamic Fiqh Academy or the Organization of the Islamic Conference in 1985 issued the following resolutions:

  • The commercial insurance contract with a fixed periodical premium, which is commonly used by commercial insurance companies, is a contract that contains a major element of uncertainty which voids the contract and therefore is prohibited (HARAM) according to the Sharia’h.
  • The alternative contract, which conforms to the principles of Islamic dealings, is the contract of cooperative insurance, founded on the basis of charity and cooperation.

‘In other words, conventional insurance is objectionable because the insurance company as the insurer sells the protection to the policyholders as the insured for a premium.  This involves the element of gharar (uncertainty), which is prohibited in Islamic Law.  Uncertainty is common to any insurance industry, therefore, the Scholars have advocated for the contract of tabarru/donation in Takaful to tolerate the presence of uncertainty.’ (AMANIE)

TAKAFUL التكافل

“Takaful is perceived as cooperative or mutual insurance where members contribute a certain sum of money to a common pool. The purpose of this system is not profits, but to uphold the principle of “bear ye one another’s burden.”  Each member should be able to draw upon the pool of funds when needed.

The principles of Takaful are as follows:

  • Policyholders cooperate among themselves for their common good.
  • Every policyholder pays her subscription to help those that need assistance.
  • Losses are divided and liabilities spread according to the community pooling system.
  • Uncertainty is eliminated in respect of subscription and compensation.
  • It does not derive advantage at the cost of others.

Commercial insurance is strictly not allowed for Muslims as agreed upon by most contemporary scholars because it contains the following elements:

  1. Al-Gharar (Uncertainty)
  2. Al-Maisir (Gambling)
  3. Riba (Interest)

There are three (3) models and several variations on how takaful can be implemented.

  1. Mudharabah Model
  2. Wakalah Model
  3. Combination of both”

‘Takaful is a mutual protection among the policyholders.  It is meant to provide a scheme of mutual protection and indemnity that one participant is helping the other participants in the case of loss, damage, or financial difficulty.’  In regards to transfer of loss or speculation on risk, there is neither in Takaful.  In Islamic Insurance, the loss and risk are essentially distributed amongst the policyholders.  ‘In Islam, the division of loss is motivated by humanitarianism and the principle of bearing one another’s burden.’ In Takaful, there is no commercial motive as there is no transfer of loss or speculation on risk.   ‘Overall, Takaful is a scheme of mutual protection that exists amongst the participants making them both the insurer and the insured.’  (AMANIE)

In Takaful, there is no insurance company speculating on the risk in order to pre-determine profit based on the pay-out/premium ratio.  It is a mutual assistance scheme whereby the members become both the insurer and the insured and are insured against hardship instead of belonging to a money-making racket where they may be partially or under-insured with insurance companies fighting them every step of the way to make any kind of payout as profit is the main motivation of the conventional insurance scheme. (Me)

‘The Takaful mutual assistance scheme is centered on the participants as one group putting their monies in one common pool to benefit one of the participants in the case of loss or damage.  However, to make it commercially viable, the participants need to engage a licensed Takaful operator to manage both the administrative and the investment activities of the Takaful business.  Contributions from the participants are invested according to Sharia’h principles.  The contract between the participants and the licensed Takaful operator could be based on Wakalah or Mudarabah or a hybrid of the two.  This contract refers to a management contract between the participants and the Takaful operator.’ (AMANIE)

Mudharabah Model

“By this principle, the entrepreneur or al-Mudharib (takaful operator) will accept payment of the takaful installments or takaful contributions (premium) termed as Ra’s-ul-Mal from investors or providers of capital or fund (takaful participants) acting as Sahib-ul-Mal. The contract specifies how the profit (surplus) from the operations of takaful managed by the takaful operator is to be shared, in accordance with the principle of al-Mudharabah, between the participants as the providers of capital and the takaful operator as the entrepreneur. The sharing of such profit may be in a ratio of 50:50, 60:40, 70:30, etc. as mutually agreed between the contracting parties.

In order to eliminate the element of uncertainty in the takaful contract, the concept of tabarru (to donate, to contribute, to give away) is incorporated. In relation to this concept, a participant shall agree to relinquish as tabarru, certain proportion of his takaful installments or takaful contributions that he agrees or undertakes to pay should any of his fellow participants suffer a defined loss. This agreement enables him to fulfill his obligation of mutual help and joint guarantee.

In essence, tabarru would enable the participants to perform their deeds in sincerely assisting fellow participants who might suffer a loss or damage due to a catastrophe or disaster. The sharing of profit or surplus that may emerge from the operations of takaful is made only after the obligation of assisting the fellow participants has been fulfilled. It is imperative, therefore, for a takaful operator to maintain adequate assets of the defined funds under its care whilst simultaneously striving prudently to ensure the funds are sufficiently protected against undue over-exposure. Therefore, the provision of insurance cover as a form of business in conformity with Sharia’h is based on the Islamic principles of al-Takaful and al-Mudharabah.

Al-Hari Raya is the pact among a group of people, called participants, reciprocally guaranteeing each other; while Al-Mudharabah is the commercial profit-sharing contract between the provider or providers of funds for a business venture and the entrepreneur who actually conducts the business. The operation of takaful may thus be envisaged as the profit-sharing business venture between the takaful operator and the individual members of a group of participants who desire to reciprocally guarantee each other against a certain loss or damage that may be inflicted upon any one of them.” (Wikipedia)

Wakalah Model

‘In Wakalah Model, the surplus of policyholders’ funds investments – net of the management fee or expenses – goes to the policyholders.  The shareholders charge a Wakalah fee from contributions that covers most of the expenses of business.  The fee rate is fixed annually in advance in consultation with the Sharia’h committee of the company. In order to give incentive for good governance,  the management fee is related to the level of performance.’

TAKAFUL is Based in the Qu’ran

“These fundamentals are based on the sayings of the Islamic Prophet Muhammad. Based on the hadith and Qu’ranic verses mentioned below, Islamic scholars had decided that there should be a concerted effort to implement the Takaful concept as the best way to resolve these needs. Some of the examples are:

  • Basis of Co-operation Help one another in al-Birr and in al-Taqwa (virtue, righteousness and piety): but do not help one another in sin and transgression. (Surah Al-Maidah, Verse 2)[2]
  • Allah will always help His servant for as long as he helps others. (Narrated by Imam Ahmad bin Hanbal and Imam Abu Daud)
  • Basis of Responsibility The place of relationships and feelings of people with faith, between each other, is just like the body; when one of its parts is afflicted with pain, then the rest of the body will be affected. (Narrated by Imam al-Bukhari and Imam Muslim)
  • One true Muslim (Mu’min) and another true Muslim (Mu’min) is just like a building whereby every part in it strengthens the other part. (Narrated by Imam al-Bukhari and Imam Muslim)
  • Basis of Mutual Protection By my life, which is in Allah’s Power, nobody will enter Paradise if he does not protect his neighbour who is in distress. (Narrated by Imam Ahmad bin Hanbal) The basic fundamentals underlying the Takaful concept are very similar to co-operative and mutual principles, to the extent that the co-operative and mutual model is one that is accepted under Islamic Law.”  (WIKIPEDIA)


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