Takaful is a form of insurance based on the Islamic principle of mutual protection. Participants contribute to a shared fund, which is then used to pay eligible claims. A takaful operator manages the fund and provides the administration and other services needed to run the scheme.
That basic idea is quite simple. The differences from conventional insurance come from the way the fund is structured, how risk is shared and the rules governing how money can be invested.
What is takaful and how does it work?
In a takaful arrangement, participants contribute to a common fund rather than simply paying premiums to an insurer in exchange for a promise to cover their losses.
Part of each contribution is generally treated as Tabarru, an Arabic term meaning a contribution or donation made for the benefit of others. Claims are then paid from the fund when participants suffer a covered loss.
The operator manages the fund and may be paid in different ways. Under a Wakalah model, it receives an agreed fee for managing the arrangement. Under Mudarabah, the operator shares in investment profits. Some takaful products use a combination of the two.
What does the word takaful mean?
Takaful comes from the Arabic root kafala, associated with guaranteeing or taking responsibility for one another.
What Islamic principles shape takaful insurance?
Takaful follows Islamic rules governing financial transactions. Among other things, these require transparency and fairness and restrict certain types of financial activity and investment.
What are riba, gharar, and maysir?
Riba refers to interest. Gharar means excessive uncertainty or ambiguity in a contract, while maysir refers to gambling or games of chance.
These concepts are important when comparing takaful with conventional insurance. Some Islamic scholars have raised concerns about conventional insurance because the outcome of the contract is uncertain, and because insurers may invest premiums in interest-bearing assets. Takaful is structured differently. Contributions are made to a mutual fund, and the fund’s investments must comply with Shariah requirements.
How is takaful different from conventional insurance?
The biggest difference is the treatment of risk. Conventional insurance generally involves transferring risk from the customer to the insurer. Takaful is based on participants sharing that risk through a common fund.
There are differences in the ownership and management of the fund, too. The takaful operator manages the fund according to the terms of the arrangement rather than simply treating all contributions as its own insurance revenue.
Any investments must also comply with Shariah principles. And where there is a surplus in the takaful fund, it is dealt with according to the product’s rules and the requirements of the relevant regulator.
Takaful is not only for Muslims. People of any faith can take out takaful cover.
What are the main types of takaful products?
Takaful products generally fall into two broad categories: Family Takaful and General Takaful. Takaful operators may also use retakaful, which is the Islamic equivalent of reinsurance. It allows an operator to pass on some of its risks, particularly where a potential loss is large or difficult to predict.
What is Family Takaful?
Family Takaful provides cover for life-related and longer-term financial needs. Depending on the product, it can provide a benefit following death or disability and may also include a savings or investment component.
What is General Takaful?
General Takaful covers non-life risks such as motor, property, marine and liability cover.
Who oversees Shariah compliance in takaful products?
There’s no single worldwide body that approves every takaful product. Responsibility is shared between the takaful operator’s Shariah governance arrangements, national regulators and international Islamic finance standard-setting bodies.
Most takaful operators have a Shariah Supervisory Board or Shariah committee made up of Islamic scholars. Its role is to examine products, contracts, investments and other activities and determine whether they comply with the relevant Shariah requirements.
The exact arrangements differ from country to country. Organisations such as the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and the Islamic Financial Services Board (IFSB) provide international standards and guidance, while individual countries may impose additional requirements.
How are surpluses handled in a takaful fund?
A surplus is what remains in the takaful fund after claims, reserves and other permitted expenses have been taken into account.
What happens next depends on the particular product and the rules in the jurisdiction where it operates. A surplus may be distributed to eligible participants, retained in the fund or dealt with in another Shariah-compliant way.
The important point is that a takaful surplus is connected to the participants’ fund, rather than automatically becoming the operator’s profit.
How is takaful regulated and growing globally?
Takaful has developed into an established part of the Islamic finance industry, with markets across the Gulf, Southeast Asia, South Asia and parts of Africa. Each market has its own insurance regulations and approach to Shariah governance, while international bodies such as AAOIFI and the IFSB provide standards and guidance used across the industry.
About JENOA
JENOA provides specialist advice on Shariah-compliant insurance and reinsurance, including takaful product development, Shariah compliance and regulatory matters.
For businesses and individuals looking to understand Islamic finance and insurance products, JENOA offers expertise on how these principles work in today’s insurance markets.
Services and products are subject to change based on jurisdiction.
This article is for general information only and doesn’t constitute legal, financial or religious advice. To find out more about JENOA products and services per jurisdiction, please contact the JENOA team for more information.
