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Basis of Insurance
Insurance is a process through which losses suffered by a few is spread to and borne by many.
In modern practice, insurance is a medium through which the financial burden of a misfortune
is transferred from the Insured to Insurer.
The concept behind insurance is that a group of people exposed to similar risk come together
and make contributions towards formation of a pool of funds. In case a person actually suffers
a loss on account of such risk, he is compensated out of the same pool of funds. Contribution
to the pool is made by a group of people sharing common risks and collected by the insurance
companies in the form of premiums.
In general, any person who has a legal right in financial interest in a property may insure
under a contract of insurance if as a result of loss or damage he will suffer financial loss. An
insurance contract is an agreement or promise that is legally enforceable between two parties,
i.e., the Insurer and Insured whereby the Insurer in return for a consideration (premium)
agrees to undertake for a stated length of time (period of insurance) to indemnity the Insured
up to an agreed amount (sum insured) for the value of such defined property (property
insured) if damaged by an insured peril.
A contract of insurance is a contract of indemnity (excluding Life and Personal Accident
Insurance) and this principle is to put the Insured in the same financial position as he was in
before the misfortune occurs.
The sum insured must be fixed at a level, which will provide an adequate compensation at the
time of loss. For insurance in real property, depreciation must always be taken into account.
The cost of insurance would depend on the scope of cover as additional cover requires
additional premium. Generally speaking, only unforeseen and fortuitous losses are insurable.
Therefore, foreseeable misfortune or losses are generally not insurable (except in Life
Insurance).

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Shariah Resolution on Insurance

The concept of conventional insurance has not achieved full agreement from scholars whether
it is permissible (halal) or prohibited (haram). Since conventional insurance as it is being
practiced now did not exist during the Prophets time, ijtihad is used to determine whether it
is permissible or otherwise.
4.4.1 Fatwas on Prohibition of Insurance

The National Fatwa Committee

Fatwa Committee of the National Council for Islamic Religious Affairs Malaysia, at its
meeting on 15 June 1972 discussed and deliberated on the issue of Life Insurance.

Resolved:
That Life Insurance provided by present-day insurance companies is a business transaction
which is voidable because it contradicts the Islamic business principles in view that the
contract contains the elements of Gharar, Maisir and Riba.

As such from the Shariah point of view, insurance is haram. A committee known as
Badan Petugas Khas was set up by the government in 1982 to study the feasibility of setting
up Islamic Insurance in Malaysia. The Badan Petugas Khas concluded that conventional
insurance contract is fasid, however, the objection is not against the concept of insurance per
se but against the existence of certain weaknesses in the insurance contract. The Takaful Act
1984 was enacted and subsequently the first takaful company namely Syarikat Takaful
Malaysia Bhd was formed in 1984.

The Islamic Fiqh Academy, OIC

The Islamic Fiqh Academy, emanating from the Organisation of Islamic Conference, meeting
in its Second Session in Jeddah, Kingdom of Saudi Arabia, from 10 to 16 Rabiul Thani, 1406
H. (corresponding to 22 - 28 December 1985). And after reviewing the presentations made by
the participating scholars during the Session on the subject of `Insurance and re-insurance,
and after discussing the same, and after closely examining all types and forms of insurance
and deeply examining the basic principles upon which they are founded and their goal and
objectives, and having looked into what has been issued by the Fiqh Academies and other
edifying institutions in this regard;

Resolved:
The Commercial Insurance Contract, with a fixed periodical premium, which is commonly
used by commercial insurance companies, is a contract which contains major element of risks,
which voids the contract and therefore, is prohibited (Haram) according to the Shariah.
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The alternative contract which conforms to the principles of Islamic dealings is the contract of
co-operative insurance, which is founded on the basis of charity and co-operation. Similarly is
the case of re-insurance based on the principles of co-operative insurance.
The Academy invites the Muslims countries to work on establishing co-operative insurance
institutions and co-operative entities for the re-insurance, in order to liberate the Islamic
economy from the exploitation and violation of the system which Allah has chosen for this
Ummah.

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DIFFERENCES BETWEEN TAKAFUL AND INSURANCE

Items

Pertinent Issues

Takaful

Insurance

01.

Essence of Intention

Intention is to create both Intention is to create legal

spiritual and legal relationship
relation only.
.

02.

Formalities

Unilateral contract.

Bilateral contract.

03.

Accounts Treatment
For General Takaful the account
is Tabarru, means donation. For
Family Takaful, there are two
accounts, PA treated in line with
principles of Mudharabah, while
PSA treated in in line with the
basis of Tabarru.

For General insurance the

paid premium is credited into
the
General
Insurance
Account. In life the premium
is credited into the Life
Insurance Account.

04.

Subject matter.

Subject Matter must be Shariah Subject matter must

Justified.
Common Law justified.

be

05.

Guarantee.

The Takaful Operator is only the The company provides the

Fund Manager. The Participant guarantee.
mutually guarantees each other.

06.

Fund.

The fund belongs to the

Participant and managed by the
Takaful Operator for a legitimate
consideration for the services
rendered.

07.

Payment of contribution/ Paid contribution is treated as Paid premium creates an

premium
donation (Tabarru).
obligation against the insurer
on a sale and purchase

The fund belongs to the

Company though separation
of assets is maintained
between the Shareholders
and the policy holders.

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contract.
08.

Forbidden Elements.

Islamic model is based on Insurance policy evolves

Islamic principles and free from around the element of
any of the forbidden elements.
Gharar, Riba and Maisir.

09.

Religious Supervisory

Religious Supervisory is made There is no Religious

mandatory by the Takaful Act Supervisory in Insurance.
1984.

10.

Profits.

The profit is shared between the In insurance the profit is at

Participant and the Company.
the
discretion
of
the
Company.

11.

Contract.

A combination of tabarru An exchange contract (sale

contract (donation) and agency and
purchase)
between
or profit sharing contract.
insurer and insured.

12.

Indemnity.

The indemnity is provided by The Company provides

the Takaful Fund.
indemnity
from
the
Companys fund.

13.

Operational Principle.

Operational
principle
in Operational principle in
Insurance is Shariah compliance. Insurance is not Shariah
compliance.

14.

Risks Treatment

Risks sharing concept among Concept of risks transfer.

Participants.

15.

Taxation.

Taxation and Zakat

16.

Benefits

Paid from the defined funds Paid from the fund legally
under joint indemnity borne by owned by the company.
the participants.

Tax.

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17.

Profits /Bonus

Specifies from the outset how

the profits are to be shared
between the participant and the
company.

May offer bonus or profit in

general terms only especially
with profit participating
policies.

18.

Responsibility
of Participants make contributions Policyholders pay premium
Policyholders / Participant to
the
scheme. to the insurer.
Participants mutually guarantee
each other under the scheme.

19.

Liability of the insurer / Takaful operator acts as the

operator
administrator of the scheme and
pays the takaful benefits from
the
takaful
funds.

Insurer is liable to pay the

insurance
benefits
as
promised from its assets
(insurance
funds
and
shareholders fund).

In the events of deficiency in the

takaful funds, operator will
provide interest free loan to
rectify the deficiency.

20.

Investment of Fund

Assets of the takaful funds are There is no restriction apart

invested in Shariah-compliant from those imposed for
instruments.
prudential reasons.

DPN1023: PRINCIPLES AND PRACTICES OF TAKAFUL