Understanding Insurance

13. How to make Insurance in line with Shariah?

Discussions in the last two articles Why is conventional insurance not in line with Sharia? (part 1) and Why is conventional insurance not in line with Sharia? (part 2) have led us to the conclusion that the principal problem that makes conventional insurance unacceptable to Shariah is the mechanism of transferring risk from the insured to the insurer.  All other issues such as usury, gharar and maysir are derivatives of that main problem.

Source: BanyanRFP

Maximum effort before leaving it to God’s hand

But, Shariah does not deny managing risk as the main objective of insurance.  Shariah does not order a person to completely surrender everything to Allah, without doing anything about it beforehand.  In fact, trying to do maximum effort in avoiding danger is part of the teachings of Islam. 

One of the famous hadith narrated by Ibn Hibban says “Amr bin Umayah Radhiyallahu ‘anhu said,’ I asked, ‘O Messenger of Allah !!, Did I tie my camel then I put my trust in Allah, or I just let it go? then I put my trust? ‘He answered, tie your vehicle (camel) and then leave the rest to Allah”. 

The requirements of insurable risks and the basic principles of insurance, aiming to avoid insurance of being misused for gambling or speculation, also not in conflict with Shariah. 

Under the argument that insurance brings many benefits and has become an important part of modern life, it is certainly unwise to forbid it at all, just because there are a few elements in it are not in line with Shariah.  The best option is to continue having such a risk management system that functions like conventional insurance minus conflicting elements with Shariah.

From risk transfer to risk sharing

How to get such system?  There are two approaches.

First, create something completely new and different from existing conventional insurance.   It could be extracted from the treasury of Islamic science and civilization in the past.  The second approach, and this is probably the most practical, is to take a conventional insurance mechanism and replace the problematic elements with other alternatives that are in line with Shariah.

The latter approach produced what we know today as takaful or Shariah Insurance as it is called in Indonesia.  Takaful is a fairly young concept that was born in the 1970s.  After several rounds of discussion and resolution of scholars at global level, the first takaful company was founded in Sudan in 1979, the Islamic Insurance Company.

In other words, Shariah insurance or takaful is conventional insurance which problematic risk transfer element has been dismantled and replaced by risk sharing.

Under the concept of risk transfer, the risk that was initially held by the owner of the asset is transferred to another party, in this case the insurance company.  The Insurance company charges a price for services accepting the transferred risk, which we know as premium.

Therefore, the owner of a risk is referred to as the insured and the recipient of the transfer of the risk is called the insurer.  We have discussed in the previous article that the contract between the insured and the insurer is basically an exchange or sale and purchase, which lead to Shariah issues such as gharar, usury and maysir.

On the other hand, under the concept of risk sharing, risks are not transferred to insurance companies. The risk is instead collected and jointly carried by a group of risk owners. This mutual guarantee scheme is implemented in the form of a pool of fund, also known as tabarru fund.  Any legitimate claim will be paid out of the fund.  Thus, the role of insurance companies is no longer as a insurer, but rather the manager of risk sharing scheme. Risk owners are now called participants (instead of insured) and insurance companies are called operators (instead of insurer). Money paid by the participants to build tabarru fund is no longer called premium, but rather contribution. The term contribution is more appropriate because the money put into tabarru’ funds by participants is considered as their donation or contribution to the mutual assistance scheme (risk sharing). Meanwhile, the word premium has the connotation of the price of a contract of sale or exchange, which is suitable for conventional insurance but not for Islamic insurance (takaful).

Clearly this risk sharing mechanism is not a contract of sale or exchange, but a contract that is non-commercial. Gharar, which is prohibited under commercial contract if it exceeds certain level, is actually allowed to be the subject of a non-commercial contract and as such, there is no more element of usury and maysir.  

The following picture summarizes the mechanical differences between conventional insurance and Shariah insurance.

Source: unknown

Risk sharing is not a completely new idea. The concept has been known since the early days of Islamic civilization.  It even existed before the Prophet Muhammad preached Islam. There was something called Diyat. At that time humans lived in tribes. Inter-tribal interactions occured all the time, especially in trade. Sometimes, conflicts happened and brought casualties. If someone was found killing other from different tribe, the victim’s family has the right to ask for compensation called Diyat or blood money. Diyat was very big amount by standard of that time, the killer alone would not be able to bear it.  Then it had become a custom or tribal rule that the Diyat is jointly borne by all members of their tribe. This is clearly a risk sharing mechanism.

To conclude, we can say that takaful or Islamic insurance that we know today is actually a modified version of conventional insurance.  The modification made is actually quite major and fundamental, as what being replaced is the core component of a system, not just secondary or tertiary features. Like a car, we are replacing the engine, not just audio system or window tinting.  With such magnitude of the modification, it brings many consequences that make the difference between conventional and Shariah insurance to be quite fundamental from various aspects. We will discuss these in the next issues.

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