Operating Framework of Tafakul and Conventional Insurance

Operating Framework of Tafakul and Conventional Insurance. The operational framework of conventional insurance is based on “risk assumption” but Takaful operate under mutual co-operation basis. The insurance system is based on following elements:

Gharar

Gharar means that a contract may be done in such a way that payment will be made on the occurrence of an uncertain event outcomes. One may think of “selling the fish in the water” or the fruits on the trees at the beginning of the season.

It may result in the unjustifiable loss of one party and equally undue enrichment of the other party. Gharar is forbidden to ensure full consent and satisfaction of the parties in a contractual agreement, because it is not showing the full knowledge, disclosure and transparency.

Other than riba, which makes any business transaction prohibited, it must be understood that uncertainty cannot be totally avoided in any business; it is excessive uncertainty that is prohibited.

The Islamic literature uses term “Gharar” to describe risk. It is generally described as risk of loss or promise to pay money upon the happening of specified event.

A transaction under Islamic law should be held invalid, if it involves the element of Gharar but conventional insurance system is totally based on the theory of risk taking and uncertainty.

Gharar can exist in insurance in four forms. Gharar in the out come, Gharar in the existence, Gharar in the results of the exchange and finally Gharar in the contract period.

Maisir

Maisir or gambling originates from Gharar and exists in insurance, since profit or loss to insurer very much depends on chances which is closely associated with claims level. Maisir, in insurance operation, resembles to a certain extent “risk taking” whereby insured got huge amount of money without an equivalent amount of input.

However the rule of “large number” also plays its role i.e., uncertain with regards to an individual and it is also uncertain with regards to a very large number of individuals. As Gharar is eliminated, so also, Maisir which is due to Gharar is also avoided under Takaful system.

But the conventional insurance is regarded as a kind of gambling as the insured makes a bet on the loss occurrence and the same applies vice versa for the insurer. It is also regarded as acquiring wealth on luck or by chance at the cost of others.

Riba

Payment and collection of interest is not permissible under Islamic philosophy. Riba is strongly condemned by the Quran and Sunnah, because reward of money is not permissible in Islamic economy.

Monetary capital is treated on par with production factors like land or labor, each being entitled to return regardless of profit or loss. But one has to understand that a key principle of the Islamic financial system is that any profit from trade and business has to come along with a liability or risk.

Money capital in Islamic finance is seen as on par with an enterprise which comes with both risks and rewards. Conventional insurance companies normally place insurance funds in Riba/interest bearing instruments such as bond and loans.

Investment of Funds

The distinction between conventional insurance and Takaful business is more visible with respect to investment of funds.

There is no hard and fast rule from investment point of view in insurance setup. Conventional insurers may invest in such type of assets that are strictly forbidden by the Shariah such as alcohol, gambling or pork are haram.

While Takaful companies invest funds in interest free avenues and with the concept of Halal-o- Haram.

Nature of Contract

By their nature, Takaful companies face additional risks as compared to conventional insurance. Conventional insurance companies invest large amount in fixed income securities on their balance sheet in order to minimize the risks and the variability associated with the equity.

But in Takaful under Shariah law, interest is forbidden, which rules out the investment in fixed income securities.

In conventional insurance the contract is based on the principles of exchange of interest. The relationship is designed in such a way that the insured buys protection by payment of premium, and insurer provides protection against the insured risk.

Under Islamic law insurance transaction can not be concluded on this basis of buy and sale contract.

Under Takaful contract every policyholder has the right to know how their money is used, how the surrender value is calculated, and Takaful policyholders must be certain that neither returns nor funds paid out in claim settlements, originate from unlawful means such as investments in stocks of companies producing non-halal goods but in conventional insurance policyholder have no right to know about this.

If the holder of an Islamic insurance policy decides to terminate a policy in a manner that is not provided under terms of the contract, premiums are refundable along with any corresponding surrender value less administrative fees, but in conventional insurance insured forfeited his/her premiums on termination of a policy.

Profit Distribution

Under Takaful contract every policyholder has the right to know how profits from different investments are divided among the participants but under conventional system there is no hard and fast rule for profit distribution, it is totally depends on company management.