What is 'Takaful'

Takaful is a type of Islamic insurance, where members contribute money into a pool system in order to guarantee each other against loss or damage. Takaful-branded insurance is based on sharia, Islamic religious law, and explains how it is the responsibility of individuals to cooperate and protect each other.

BREAKING DOWN 'Takaful'

Takaful insurance companies were introduced as an alternative to commercial insurance companies, which are seen as violating Islamic restrictions on riba (interest), al-maisir (gambling), and al-gharar (uncertainty) principles, and outlawed in sharia.

How Takaful Works

All parties (policyholders) in a takaful arrangement agree to guarantee each other and make contributions to a mutual fund, or pool, instead of paying premiums. The pool of collected contributions creates the takaful fund. The amount of contribution that each participant makes is based on the type of coverage they require and their personal circumstances. As in conventional insurance, a takaful contract specifies the nature of the risk and time period of coverage.

The takaful fund is managed and administered on behalf of the participants by a takaful operator, who charges an agreed-upon fee to cover costs. Much like a conventional insurance company, costs include sales and marketing, underwriting, and claims management.

Any claims made by participants are paid out of the takaful fund and any remaining surpluses, after making provisions for the likely cost of future claims and other reserves, belong to the participants in the fund, not the takaful operator. Those funds may be distributed to the participants in the form of cash dividends or distributions or via a reduction in future contributions. 

Takaful Operating Principles

An Islamic insurance company operating a takaful fund must operate under the following principles:

  • It must operate according to Islamic co-operative principles.
  • A reinsurance commission may be paid out to, or received from, only Islamic insurance and reinsurance companies.
  • The insurance company must maintain two separate funds: a participants/policyholders' fund and a shareholders' fund.

Differences Between Takaful and Conventional Insurance 

Most Islamic jurists have concluded that conventional insurance is unacceptable in Islam because it does not conform with sharia for the following reasons:

  • Conventional insurance includes an element of al-gharar (uncertainty)
  • Conventional insurance is based on the concept and practice of charging interest. Islamic insurance, on the other hand, is based on tabarru, where a portion of the contributions made by participants is treated as a donation. For this reason, policyholders in takaful are usually referred to as participants.
  • Conventional insurance is considered a form of gambling.
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