Mubbsher Munawar Khan - International Journal of Business and ...

International Journal of Business and Social Science Vol. 2 No. 10; June 2011 

Abstract 

Comparative Analysis of Islamic and Prevailing Insurance Practices 

Mubbsher Munawar Khan 

Hassan Mobeen Alam (Corresponding Author)* 

Assistant Professor 

Hailey College of Commerce, University of the Punjab, Lahore, Pakistan. 

E-mail: hassanmobeen.hcc.pu.edu.pk@gmail.com* 

Naveed Ahmad 

Muhammad Sabeeh Iqbal 

Salmat Ali 

M.Com Scholars (2009-11) 

Hailey College of Commerce, University of the Punjab, Lahore, Pakistan. 

Purpose – Islam is believed to provide guidance in every sphere of life. This guidance is not limited to the 

social aspects but also covers economic dimension of human life. Islamic economic system supports interest 

free financial system. This paper addresses insurance, a part and parcel of modern financial and economic 

system. We have compared prevailing insurance system with Islamic alternative, Takaful. We have attempted 

to highlight its main features and discussed its suitability. 

Methodology - Sources of Sharia (Islamic way of life) are sought to trace the roots of Takaful. A brief 

comparison between Islamic insurance and prevalent system is given to find out whether Islamic insurance 

can take over prevailing insurance system. 

Findings – After comparing Takaful with conventional insurance, it is indicated that Takaful is more suitable 

than insurance especially to the vast Muslim community of the world. 

Value – This article gives a comparative analysis of Islamic and conventional insurance system. In this way it 

is an addition to the scarce literature on the subject. It has a managerial implication in the shape of guidance 

to the potential buyer of the insurance. 

Keywords: Takaful, Islamic insurance, Islamicity of insurance, Difference between takaful and conventional 

insurance 

Paper type Conceptual paper 

1. Introduction 

Islam is one of the greatest religions of the world, second largest in terms of number of believers. Nearly 1.3 

billion of Muslims live in this planet. Islam deals with every social and non-social issue. For financial and 

economic systems it has given broader outlines. Takaful an Arabic word means “assuring each other” 

(Takaful, 2010). Takaful is the Islamic term used to denote Islamic insurance. Takaful is based on the 

principle that the pool of donations is created and is used to support each other. This is the principle of 

Tabarru. To fully understand Takaful one can see principles of waqf, Kafalah, Tabarru etc… (Usmani, 2007). 

Conventional insurance is Haram (forbidden) in Islam because it contains the element of Riba, Maisir and 

Gharar. The funds pooled from large no of policy holders are reinvested in interest bearing instruments etc…. 

As the translation of the verse of the Quran S-ii, 274 says "God hath permitted trade and forbidden usury”. 

Usury means giving loan at high interest. 

Similarly in Sura 2 verse 219, the Gharar is prohibited. Takaful is free from Riba and Gharar. So, it confirms 

to the Islamic principles. Moreover Takaful is a mutual agreement by large no of donors to protect those who 

are in great risk. The amount is distributed in accordance with the principles of Wasiah (Mirath) if the assured 

dies. It is given in Fatwa (Verdict by Islamic Scholars) by the National Council for Muslim Religious Affairs 

in Malaysia. This can be a solid ground for making distinction between Islamic and conventional insurance. 

Concept of Takaful in Sharia 

Takaful principles have their roots in Sharia. Sacred Orders of Allah in Quran, religious, social and 

commercial practices of The Holy Prophet (SAW), Qiyas (comparative arguments), and Ijma (the agreement 

of whole Islamic world on an issue) form the basis of Sharia. Sharia is the constitution of Islamic world. The 

basic principles of Sharia are necessary to be discussed before further discussion on Islamic insurance. 

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Takaful is an Islamic contract therefore requires acceptance of offer (Mohammad, 1988). The contract of 

Mudarabah (Islamic way of partnership) forms the basis of Takaful. In ancient Arab takaful was found in 

system of “Aaqilah” involve mutual assistance arrangement. As in takaful loss is covered by many people so 

this system is allowed in Islam. In Takaful policy holders share a specific percentage of profit and also pay a 

sum of money to assist or indemnify each other. Basis of takafal can be traced down in Sunnah of The Holy 

Prophet (SAW) and Sunnah of Companions. Then we find operational improvements in fourteenth to 

seventeenth century; in nineteenth century; and twentieth century (Billah, 1998). Takaful is originated from 

the Sharia principles especially those of Muamlatt (transactions between men) and purely is in compliance 

with the teachings of Islamic Sharia (Mohammad, 1988). 

Models Governing Takaful 

There are Mudarabah, Waqalah, and Waqf models of takaful. In Mudarabah model one person invests money 

seeking efforts from mudaharib. The profit sharing is based on the rate at which Sharia committee agrees. The 

participants are the money investors and takaful operators are mudaharibs (Takaful, 2007). In Waqalah model 

there is a distinction between effort making company and the participants. The efforts maker gets their salaries 

from the contribution of the participant and profits made by investing funds of takaful. The fees provided to 

operators for their efforts are set by Sharia committee which ensures compliance of company’s policies with 

Sharia (Takaful, 2007). On the other hand in Waqf model the donors donate money to the assured in need. In 

this way company works as a Governmental foundation not for profit. Unlike in Mudarabah and Waqalah 

models the funds in this model are not in the ownership of anybody. Mufti Mohammad Taqi Usmani (famous 

Islamic scholar) likes Waqf model the most and believes it as purely Islamic (Takaful, 2007). 

2. Why Islamic Sharia Prohibits Conventional Insurance? 

An opinion was sought from a religious scholar Syed Ibn-Abdin about insurance related to sea. In his opinion 

it is not according to Islamic Sharia that a trader pays amount of premium to insurance company so that he 

may be indemnified (Mankabady, 1989). Conventional insurance include Riba, Maisir, and Gharar which are 

against Islamic Sharia. Riba is used in Arabic language which means excess or addition in something. In Islam 

loan without interest is allowed and if interest is charged then it is Haram and against Sharia however service 

charges are allowed (Mahmood, 1991). It is narrated by Hazrat Jabir (R.A),”The Holy Prophet (SAW) cursed 

the devourer of usury, its payer, its scribe and its two witnesses and they were equal (in sin)” (Karim). 

Gharar is uncertainty in a contract in which one party is in benefit and loss is beard by other party. Gharar 

may be in case of any insurance contract in which there is no idea about payment as promised or there is no 

idea about how much amount should be paid at the time of its payment. Maisir in insurance is in which policy 

holders invest small amount premium with hope to gain large profit and some time due to losses they lose 

their premium invested and claims may be higher than contributions. Maisir refers to obtaining or acquiring 

something without any effort. This is done in gambling (Mohammad, 1988). In Holy Quran Allah has clearly 

declared Maisir (gambling) unlawful and there is no relaxation in it (Quran, 627 A.D). About 200 scholars 

participated in a conference in Makkah and concluded that insurance practiced in conventional insurance 

companies is against Sharia ( First international conference on Islamic economics, 1976). In this 

conference it was also concluded that Islamic insurance system is different from conventional insurance 

system and is according to Sharia. Council of Islamic Ideology of Pakistan in 1983 rejected all the models of 

commercial insurance. 

3. Differences in Takaful and Conventional Insurance 

Takaful operate in such a way that the participants contribute their money and formulate a pool of money. 

This money is then invested to earn Halal profit in sharia compliant investments. The amount of profit earned 

is then added in money pool and is then distributed among the participants after satisfying any claim as a 

renewal discount. The takaful operator only receives Wakala fee. 

Takaful Operations (Takaful and conventional insurance compared, 2009). 

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Conventional insurance operates in such a way that premium is paid by policy holders to insurance company 

and then this amount is invested by insurance company in interest bearing or non sharia compliant investing 

areas. Amount of interest and profit is received by insurance companies and then surplus is retained in the 

company without distributing it among policy holder and only claims are met with this surplus. 

Conventional Insurance operations (Takaful and conventional insurance compared, 2009) 

Islamic insurance companies invest in a number of Sharia compliant products. Governments of the countries 

in which Muslims are in majority have introduced a legal framework which helps in introduction of new 

Sharia compliant products. Mudaraba certificates are the instruments which are evolved from such legal 

framework. While a conventional insurance company invests in interest based instruments like treasury bills, 

certificates of deposits, interest bearing bonds etc....Table 3.0 shows some of the Islamic and non-Islamic 

instruments that attract the investments of Islamic insurance companies and conventional insurance companies 

(Hakim, 2007). 

The present form of conventional insurance is Haraam and Takaful is according to Islamic Sharia is fully 

permissible because conventional insurance has elements of interest, gharar and gambling and takaful has not 

such type of elements as explained above (Islamic conference in jeddah , 1985). Insurance includes pure risk 

and speculative risk. In pure risk loss may occur or not while in speculative risk there may be loss, profit or no 

loss. Takaful applies the indemnification principle and compensate the loss of Takaful client. Takaful is only 

related with pure risk and not with speculative risk. 

The goal of insurance is to maximize profit in favor of shareholders because they are stock companies and 

ignore client while in contrast takaful goal is well-being and self sustaining operation without earning high 

profit. In Takaful surplus is shared between shareholders and policy holder and also surplus is owned by 

participants and is reduced by performance fee for operators before dividing in to participant (Wakala model). 

Takaful helps people to accumulate their saving for goodness of whole community. An opportunity is 

provided by takaful scheme to people to practice Islamic way. The Holy Prophet (PBUH) saying is “whosever 

removes the hardship from believer, Allah will remove hardship from him one of the hardship of the Day of 

Judgment” (Sahih Muslim ). Insurance is vice versa. Al tabarue is account in takaful which involves donations 

and it also involves al Mudarabah principles. While in conventional insurance general insurance and life 

insurance accounts are involved. In Takaful profit is divided between different participants in specific ratios 

on the basis of Al-Mudarabah principles. While in conventional insurance profit is not shared between 

members in a specific ratio and in some year bonus is provided and some time not. 

Takaful fund is managed by operator but ownership is of participants. They have a complete right of 

contribution and benefits. In conventional insurance the policy holder purchase policy and there exist seller – 

purchaser relationship. Takaful company performs trustee and operator functions. In conventional insurance 

there exist one to one relationship between policy holder and company. Different elements like Riba, Gharar 

and Gambling are not involved in takaful and it is according to Islamic Sharia. Riba and Gharar are involved 

in conventional insurance system and do not fulfill sharia requirements and therefore it is not allowed 

(Haberbeck, 1987). Sharia Council determines where to invest funds so that interest factor may not involve 

while in conventional insurance funds are invested without guideline of Sharia Council usually in interest 

based businesses. Takaful operates on mutual assistance principle. Conventional insurance operate on 

business principle. 

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In insurance contract there is clause that insurer can forfeit the premium amount that is paid by the policy 

holders under certain circumstances. Islam does not allow the forfeiture of premium, wholly or partly, as the 

amount of premium is consider as loan by insured to insurer. In takaful there is no forfeiture of contributions 

and it is distributed among the participant in form of surplus (Mahmood D. N., 1991). Rules are made 

according to Holy Quran and Hadith in takaful system. In conventional insurance system rules are made 

according to human mind and thinking. All participants contribute fixed amount in Takaful .In conventional 

insurance amount of paid premium vary from one policy holder to others. In takaful the participant can 

receive all the benefit on the maturity of contract but if he died before maturity then amount is paid to the 

claimant without investigation and without letter of administration. The claimant is entitled to receive same 

benefits as it is to be paid to the participant on maturity and there is no deduction (Mahmood D. N., 1991). In 

conventional insurance if the policy holder is died then amount is not paid to the claimant without proper 

investigation of causes of death. 

In Islamic insurance the agent (wakil) gets the salary for his services while in conventional insurance agent 

gets specific percentage from the amount paid by policy taker. In Islamic insurance agent is considered as 

employee of the takaful operator and only gets salaries for his services. In conventional life insurance the 

persons (not necessarily the heirs) can have the insurable interest of the policy holder whereas in Islamic life 

insurance the insurable interest is vested according to wasiyah principle (Billah, 1997). 

Quran, Hadith and Fatwas Regarding Conventional Insurance 

All kinds of insurance according Islamic Sharia is Haram and prohibited by The Holy Quran because it 

includes gharar and gambling. No doubt interest factors are included in every type of insurance which are 

riba-ul-nasiah and riba-ul-fadl and are prohibited in Islam (Noorzoy, 1982). God has prohibited gambling 

saying “O ye who believe! Strong drink and game of chance and idols and divining arrows are only an infamy 

of Satan’s handiwork. Leave it a side in order to succeed” (Al-Ma'ida, 627 A.D). Gharar is included in all type 

of conventional insurance. Therefore Islam prohibits all type of conventional insurance as “O ye who believe! 

Eat not up your property among yourself in vanities” (Al Nisa). The Holy Prophet says, “Do not buy fish in 

the sea, for it is gharar” (Hanbal). 

Ulamas (religious scholars) gave fatwas related to insurance. Hanfi (a religious school of thought) scholars 

considered that co-operative insurance is legal while other types of insurance are illegal because it includes 

the elements of riba and gharar. According to Maliki’s (another school of thought) contract of life insurance is 

illegal while other insurance contracts are legal. Shafi’s agree with Maliki’s but in other contract of insurance 

they think are as well. According to the Hanbalis (a religious school of thought) contract of insurance is illegal 

(Mankabady, Insurance and Islamic Law, 1989). The contract of commercial insurance involves the element 

of risk which makes the contract void and therefore not allowed in Islam while the contract of mutual 

assistance (takaful) fulfill the sharia principles and is allowed. The pure Islamic nature of Takaful gets a solid 

support from Ulama’s Fatwa. In Feb. 16, 2006 takaful approval was signed by Justice Taqi Usmani and other 

religious Ulama of Pakistan. 

Conclusion 

Britain is a Muslim minority country. A nationwide study in Britain revealed that 74% of Muslim participants 

considered their religion were very important in living their lives, and 21% considered it fairly important. 

Moreover, around 80% declared to visit mosque once or more than once in a week (Modood, et al., 1997). 

Muslims represent a large portion of world population and are increasing at a greater pace than other religious 

communities. Muslims are 20% of the world population and are expected to be 30% by 2025 (Shafie & 

Othman, 2006). Fifty seven Islamic countries are regular members of the Organization of Islamic 

Conference’s (OIC). 

The Muslims all around the world wish to go side by side with modern commerce. They are not willing to 

follow non- Islamic practices. They are looking for Islamic alternatives to prevailing financial instruments and 

practices. Islamic banking is a great success not only in Muslim majority but also in Muslim minority 

countries. Major international banks are today offering Sharia compliant products. In the similar manner 

akafal presents an Islamic alternative to insurance. 

The Interpretations made by Scholars provide a complete framework governing Islamic Insurance. In this 

article the suitability of Islamic insurance over conventional one along with its applicability in Muslim world 

is discussed. Ahmed (2010) reported that the Islamic principles can prohibit the global crisis to occur. Islamic 

insurance funds are invested in interest free securities which reduce the chances of the crisis in this industry. 

Resultantly it provides a solid support for Islamic insurance. 

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To maintain his Homo-Islamicus behaviors a Muslim may adapt his practices to and comply with Sharia 

principles. The models of Takaful are helpful in categorizing it. Tawakal concept best deals with takaful 

because firm belief in the God is compulsory but taking due care is also necessary. Takaful and conventional 

insurance models are different because of their permissibility in Islam. Conventional mode is based on Riba 

which is prohibited in Islam. 

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286 

Table 3.0 Islamic and non-Islamic instruments 

Islamic instruments Non-Islamic instruments 

Mudaraba certificates Treasury bills 

Musharaka certificates Certificates of deposits 

Musharaka term finance certificates Call money market 

Sukuk Asset-backed securities 

Mudaraba inter-bank investment Negotiable certificates of deposits

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