Understanding Insurance

12. Why is conventional insurance not in line with Shariah? (part 2)

Riba

Riba (usury) is divided into two groups, namely riba fadl and riba nasi’ah. Riba fadl is usury from an exchange between two objects (for example money with money, gold with gold, silver with silver, and so on). Whereas riba nasi’ah occurs due to a delay in delivery or payment. Thus, bank interest is clearly riba nasi’ah.

Conventional insurance contracts actually contain riba fadl. What is actually being exchanged in an insurance contract? As we have discussed in the previous article Why is conventional insurance not in line with Sharia? (part 1), in an insurance contract, premium is being exchanged for claim payment. In other words, it is an exchange of money for money. The rules are very clear in Shariah that if we exchange the things of same kind, including money, then the size or quantity, even the quality of both must be the same. If there is an additional (extra) given by one party and accepted by another party, that extra is usury.

The reality what happens in insurance is that the payment of claims is almost always greater than the premium. The difference of the two is what considered as usury. Once again, it becomes usury because there is an exchange of two things as a logical consequence of legally recognizing conventional insurance as a contract of exchange or buying and selling.

In addition, it is also worth mentioning that in conventional insurance operation, insurance companies collect premiums from the insured and then invest them in interest-bearing instruments either through banking or other markets. This is another source of usury in conventional insurance.

Maysir

Some explain maysir (gambling or speculation) from the insured point of views who buy insurance in the hope of getting compensation or claim payment greater than the premium. So, this mechanism is just like people gambling or placing lotteries, who place small bets, hoping to win big.

You can debate this logic because gambling and insurance are driven by completely different motivations. Insurance is driven by fears of a disaster that brings financial loss, while gambling is motivated by someone delusion of a big financial victory. However, when it is viewed from the mechanic of operation, one can indeed says that insurance is tantamount to gambling.

We may also view the presence of maysir in insurance from the insurance company point of views. Under insurance contracts, as a commercial institution, insurance companies certainly intend to make profit from the uncertainties inherent in the contract. The insurance company hopes that there will be no or less disaster so that the premiums it receives exceeds the number of claims it pays, so that it can make money from the difference. So, insurance companies can badically be seen as relying their welfare or faith on the occurrence or non-occurrence of something (uncertainty). Isn’t that the same as speculating or gambling? That is why insurance contracts are illegal in the eyes of the Sharia.

So…

From the discussion above and the previous article, the most important conclusion is that the main problem that makes conventional insurance unacceptable by Shariah is the risk transfer mechanism it uses in managing risk. Whereas, riba (usury), gharar and maysir are basically derivatives that exist because risk-transfer-based conventional insurance is legally recognized as a contract of exchange or buying & selling.

Therefore, to get insurance in line with Sharia, this fundamental problem must be resolved first, by removing risk transfer mechanism and replacing it with something else, i.e. risk sharing mechanism. Under risk sharing, risks are no longer transferred by the insured to the insurance company, but rather jointly borne by all risk owners (the insureds or participants). This risk sharing is not a contract of commercial nature (like buying and selling), it is a non-profit contract instead. With that, the trio of (riba) usury, gharar and maysir automatically disappear.

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