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Insurance has existed for many centuries. Humans have a natural desire for security and the need to be prepared for loss. Insurance is one of many means humans use to deal with the consequences of damages, risks and disasters. Insurance can be defined as the equitable transfer of a loss from one entity to another in exchange for payment. It is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. However, the commercial insurance, which is provided by companies, is this era doesnt fulfill the sharia conditions, which would make it valid and acceptable. For this reason Islamic insurance was established in the early second century of the Islamic era. In this paper, Ill discuss the sub ect of Islamic insurance as an alternative approach to managing risk, its principles and models, and last but not least Ill discuss the difference between commercial insurance and Islamic insurance.

The definition of Islamic insurance:

!he desire of "uslims to oin world markets in a controlled and acceptable manner led to the developments of Islamic insurance #takaful$ !akaful is an %rabic word that means guaranteeing each other. it is an Islamic insurance where members contribute money into a pooling system in order to guarantee each other against loss or damage. !akaful is based on sharia, Islamic religious law. It a system of Islamic insurance based on the principle of !a& %wun #mutual assistance$ and !abarru #'oluntarily$ where the group 'oluntarily shares the risk collectively. !heoretically, tankful is perceived as cooperative insurance.

Principles of Islamic insurance:

(nder Islamic insurance individuals are responsible to be cooperative and protect each other .!he following are the principles of Islamic insurance) *& policyholders cooperate among each other for their common good. +& the contributions to the fund pool by policyholders are considered a donation #tabarru$. ,& every policyholder pays his part to help those who need assistance. -& losses and liabilities are divided and spread according to the community pooling system. .& uncertainty is eliminated in respect of subscription and compensation. /& 0hariah approved investments and products. 1& Islamic insurance doesnt derive advantage at the cost of others.

Distinction between Islamic insurance (takaful) and commercial insurance: A- risk : 2ecause it is based on mutuality and cooperativeness of the participants, the risk in Islamic insurance #takaful$ is shared by the participants #policyholders$. !he company acts only as a manager of the takaful fund. 3here in commercial insurance the risk is transferred from the insured to the insurance company. B- uncertainty ( harrar): In Islamic insurance the element of uncertainty #gharrar$ is decreased to an acceptable level by making contribution as conditional donations for a good cause. 3here in commercial insurance the uncertainty lays in when the loss would occur and how much compensation would be paid. !- amblin : In commercial insurance the insured pays and amount # the premium$ expecting a again # the compensation$. However if the anticipated loss doesnt occur, the insured losses the amount he4she paid as a premium. "oreover, if the loss does occur the insurer loses a larger amount than the collected premium and the insured gains by the same. !his is considered gambling. !he fact that participants pay the contribution in the spirit of purity and brotherhood removes the element of gambling in Islamic insurance. 5articipants dont lose the benefit of takaful. D- "sury: In Islamic insurance funds are only invested in non&interest bearing instruments. 3here In commercial insurance the funds are invested in fixed interest bearing instruments, which contain riba.

#- profit: In Islamic insurance the profit is divided among the participants in proportion to their shares of contribution at the end of the accounting period. 3hile the profits in the commercial insurance belongs to the shareholders. !he insured is only covered during the policy period and he4she doesnt receive any return at the end of the policy period.

Islamic insurance models:

$- Tabarru%-based takaful: !his structure of takaful assumes non&profit nature of takaful business. It is based on the notion of social solidarity, responsibility, mutual help and brotherhood among the participants. (nder this model each participant makes a donation to the takaful fund with the intention to provide financial assistant to the other participants faced with difficulties. !his model doesnt provide a return to both the policyholders and the operator. (nder this model the policyholders are the managers of the fund. &- 'udaraba-Based Takaful: "udaraba is a partnership where one partner #rabu ul mal$gives money as an investment in a commercial enterprise to another party # mudarib$ who manages the enterprise. It is a profit&loss sharing contract. % mudaraba based takaful is a contract of profit sharing between the takaful participants #policyholders$ and the operator. (nder this model , policyholders assume the role of fun provider # 6abu ul mal$ while the takaful company assumes the role of mudarib. In this model the operator receives its shares of profit generated on investments. (teps in this model: %& the premium paid by the policyholders is credit to a policyholders fund. 2& the shareholders of the takaful company contribute to a different fund called the shareholders fund.

7& the takaful operator invests the policyholders fund in shariah compliant instruments. 8& the profits generated from the investments are shared between the policyholders and the operator in an agreed ration. F& the losses are charged to the policyholders fund. 9& general administrative expenses are charged to the policyholders fund. H& operational expenses related to the investments are charged to the shareholders fund. I& upon the occurrence of actual loss and damage, the takaful benefits are paid to the beneficiaries. :& in the case of surplus or deficit, the policyholders will either receive a full refund #surplus$ of make an additional payment #deficit$. )- *akala-Based Takaful: In this model of takaful the operator assumes the role of the agent of the policyholders and receives a fee for the service provided. !he policyholders premium is credit to the policyholders fund. !he shareholders of the takaful operator company contribute to another fund, which is maintained separately from the policyholders fund called the shareholders fund. %s the agent of the policyholders, the takaful operator invests their funds in shariah compliant investments. (nder this model, all operational general and administrative expenses are charged to the policyholders fund. "oreover, the takaful benefits are paid to beneficiaries upon the occurrence of actual loss and damage. In addition, the surplus will be given back to the policyholders and they are required to make an additional payment in the case of deficit.

+- 'i,ed model: !his model combines the elements of mudaraba models. !he wakala contract under this model is used for underwriting activities; the operator acts as the agent on behalf of policyholders and manages their funds and he4she receives an agency fee. in the case of surplus, the company is entitled to a surplus for managing the fun effectively. "oreover, the mudaraba contract is used for investing activities. (nder the mudaraba contract, the surplus is invested in Islamic instruments.

Types of takaful: !akaful products are divided into two categories) $- -amily takaful: It is a long&term saving and investing plan with a fixed maturity. It pools the effort to help the needy in times of need due to untimely death and other mishaps resulting in personal in ury or disablement. (nder this policy , the participants and the takaful company enter into a long&term mudaraba based takaful contract. !he following are the types of family takaful plans available in the market ) %& Family !akaful 5lan for <ducation. 2& Family !akaful "ortgage 5lan. 7& 9roup Family !akaful 5lan. 8& 9roup Hospitali=ation and "edical 2enefit.

&- .eneral takaful: !his policy is basically a short term contract of oint&guarantee between a group of participants to provide mutual compensation in the event of a defined loss.

!he schemes are designed to meet the needs for protection of individuals and corporate bodies in relation to material loss or damage resulting from a catastrophe or disaster inflicted upon properties, assets or belongings of participants. !he following are examples of general takaful policies) %& home takaful. 2& "otor takaful. 7& 5ersonal accident takaful.

6etakful is a derivative of the takaful. It mimics the concept of reinsurance. (nder reinsurance the insurer passes on specific risks to reinsurance companies. In other words reinsurance is viewed as insurance for insurance companies. >ike reinsurance the takaful operator uses retakaful to limit its liability on specific risks # it is takaful for takaful companies$. "oreover, retakaful is a contract between the takaful operators and retakaful operators where retakaful operators manage the contributions received from takaful operators and invest them in shariah compliant instruments and investments. 0tructurally retakaful principles are the same to the takaful principles. There are two methods of retakaful : $- -acultati0e: (nder this method the takaful operator offers the individual risk to the retakaful operator and it is in the retakaful operators right to accept to re ect it. &- Treaty: (nder this method the retakaful operator is bound by the contract to accept all the risks offered by the takaful operator.

Differences between retakaful and reinsurance:

*& retakaful separates shareholders fund from the risk fund. +& investments under retakaful are limited to sharia compliant instruments.

,& under retakaful the operator assumes the role as risk and fund manger. "oreover the operator is responsible for providing interest free loan to cover deficits or claims obligations.

!hallen es facin takaful insurance companies:

$- e,pense risk: !akaful companies like other businesses have fixed and variable expenses that it needs to load its costs of services to cover them. For example overhead can only recovered on a specified sales volume. If the sales volume in not met there will be expense overruns. !his risk is borne by shareholders. &- corporate o0ernance and re ulation: 5articipants in nearly all&takaful companies are not represented on the board of directors. "oreover, even when represented, conflicts between different board members representing stockholders and participants may arise because their interest may not be aligned. )- asset allocation policy: !akaful insurers focus on sharia compliant equities, real estate assets , sukuk # the Islamic equivalent of bonds$. %ll these sharia compliant instruments may increase the risk profile of the takaful fun when there is no credit enhancement by an international institution.

%s an industry, takaful is relatively new. "oreover the takaful industry is seeing significant expansion during the past two decades. !akaful is not another name for insurance .In order for takaful to succeed, there is a need to understand how risks in takaful are distributed and how they should be managed so as to align the interests of the various stakeholders as closely as possible. !he challenge in takaful is how best to work within the constraints imposed by sharing rather than transferring risk. "oreover, takaful works as an alternative for commercial insurance which are forbidden by the Islamic teaching

:affer #ed.$, 0ohail . Islamic Insurance) !rends, ?pportunities and the Future of !akaful . >ondon) <uromoney Institutional Investor 5>7, +@@1. 5rint. 9onulal, 0erap. !akaful and mutual insurance alternative approaches to managing risks. 3ashignton, 8.7.) 3orld 2ank, +@*+. 5rint.

"%0(" 2I>>%H, 86. "?H8.. Islamic Insurance #!akaful$. Auala >umpur, "alaysia.) Ilmiah 5ublishers, +@@,. 5rint.

Islamic Insurance