Can Takaful Insurance Improve Western-Style Insurance Schemes?

Given that Islamic financial institutions had weathered better than their Western counterparts, can Takaful insurance concepts help improve Western-style insurance schemes?


By: Ringo Bones


Just recently, many financial analysts based in London and New York City’s Wall Street were somewhat amazed to find out that financial institutions that practiced Shariah Banking Laws weathered better during our current global credit crunch in comparison to their credit derivatives obsessed Western counterparts. If this is true, then are there any benefits if Western-style insurance underwriters learn and adapt concepts of Takaful Insurance?

Believe it or not, many concepts behind our contemporary Western insurance underwriting schemes have their origins in the ancient civilizations that flourished in the Middle East. Ancient Babylonian artifacts had been found portraying King Hammurabi receiving the Code of Laws from the Sun God in 1800 BC. These laws contained early references to various types of insurance – namely marine, robbery, crop, and adoption. Back then it is declared by law that an adopted child reared by a family would in return provide for the family in his or her adulthood. Otherwise, the penalties for the failure to care for his or her foster parents are execution or slavery.

Takaful – the idea behind Islamic insurance – is based on the concept of social solidarity, cooperation, and mutual indemnification of the losses of members. The Takaful contract so agreed usually involves the concepts of Mudarabah, Tabarru’ (to donate for the benefit of others) and mutual sharing of losses with the overall objective of eliminating the element of uncertainty. Takaful is by no means a new concept in Islamic Commercial Law. It has been practiced by the Muhajrin (émigrés) of Mecca and the Ansar (supporters or followers) of Medina following the Hijra 2 of the Prophet Muhammad over 1400 years ago as an early form of risk management. Even though it is already been a very profitable business reality for years now, Takaful Insurance – as a profitable business entity – is almost became stillborn.

An overwhelming majority of Shariah Law scholars believe that conventional Western-style insurance – especially life insurance – is unlawful or Haram. Even as recently – relatively speaking - as 1903, some prominent Shariah Law scholars of most Arab countries declared that Western-style conventional life insurance were unacceptable. In 1974, the National Religious Council issued a legal opinion that conventional life insurance is not permissible because it contains elements of risk and uncertainty or Gharar, gambling or Maisir, and interest or Riba. In 1985, the Grand Counsel of Islamic Scholars in Saudi Arabia called the Majma al-Fiqh eventually approved the Takaful system as the alternative form of insurance written and structured in compliance with Islamic Shariah Law. The rational being that the Takaful system is a concept of protection for the good of society, thus approved as a means of co-operation and mutual help by the Grand Counsel.

The first formally established Takaful Insurance company was the Islamic Insurance Company of Sudan that opened its doors for business back in 1979 – six years before the Grand Counsel in Saudi Arabia deemed it okey. Given that the crude oil business is already a very lucrative post World War II industry in the Middle East plus the need of capital to process the “black gold”. The inevitability of Shariah Law compliant insurance industry is too good to pass up – Grand Counsel approval or not – because it represents a good source of much needed revenue for infrastructure development.

The establishment and eventual success of the Takaful Insurance system took quite a long and hard road indeed. Despite of some criticisms of Western financial analysts over the Takaful system like Moody's Investor Service's concerns over unused surplus liquidity. Not to mention still gray area of Shariah Law compliance of the reinsurance version of Takaful – which has still been an area of much debate. It did managed to avoid much – if not all – of its Western counterparts risky financial behavior and excesses. Not to mention the Takaful systems concerns over the sustainability of investment banking, which many see as nothing more than making money out of thin air. In short, Takaful Insurance system could teach its Western counterpart to remember prudent financial practices and risk management .