The conventional insurance is an arrangement whereby the insured pays premium to the insurer to gain financial compensation in return for a specified loss occur. It is a risk transfer mechanism that the insured and insurer exchange their uncertainty of financial loss for the certainty of the premium. It appeared due to the origin of human's social demand as human always will do anything to earn their safety. Since security is mainly a social demand before being a financial one, insurance is launched in the concept of targeting profit from securing operations.
Anyway, Islamic principles see insurance as non profitable and cooperative one. Also, it should not include prohibited effects in Islamic Shari'ah such as usury, deceit, ignorance and gambling. For those reasons, Takaful insurance has been introduced. Takaful is an Islamic insurance concept which is grounded in Islamic banking, observing the rules and regulations of Islamic law. The principles of Takaful include that policyholders cooperate among themselves for their common good, every policy holder pays his subscription to help those that need assistance, losses are divide and liabilities spread according to the community pooling system, uncertainty is eliminated in respect of subscription and compensation and Takaful does not derive advantage at the cost of others.
Since conventional insurance and Takaful present for different principles, our group is going to analyse, compare and discuss the differences between them in the aspects of nature, contract, premium, elements, investments, bonus, regulations and accounts.
NATURE
The entire operation of Takaful is based on the concept of group sharing, which is a simple community practice of coming together to help one another. It aims at promoting brotherhood, solidarity and mutual cooperation. In other words, it encourages us to take care of other people, to ensure the financial stability of our kin and to ensure that there is responsibility and bond with the society as a whole (Syed Moheeb Syed Kamarulzaman, 2010). According to Dr. Mohd. Ma'sum Billah, the nature of Takaful can be illustrated by a situation where anybody in the society who has the legal capacity may contribute a sum of money to mutual co-operative fund to ensure material security for one against a defined-risk probably encountered by another's life or property. The parties who involved in Takaful usually are participant, operator, insured, and beneficiary. Participants are those who contribute to the mutual fund while insured are those who among the participants face the risk and are assisted by the fund. Those who actually benefit from the fund are known as the beneficiaries while the monetary contribution made by the participants to the fund is known as mutual contribution. A registered or licensed body or corporation who known as Takaful operator is responsible to manage the fund according to Shari'ah principles and also to provide a reasonable financial security for those who really deserve it against the loss or damage suffered by them resulting from a defined-risk. The mutual contribution made by the participants is put into two funds; one of them is investment fund according to the principles of al-Mudharabah (profit and loss sharing) while the other is treated as charity according to the principles of al-Tabarru (donation). The mutual contribution does not belong to the Takaful operator who only responsible to manage the fund; it belongs to all of the participants in the scheme who share the risk.
We came out with an illustration to picture the nature of Takaful in a simple way:
Meanwhile, in conventional insurance, the values of brotherhood, solidarity and mutual cooperation are absent. The conventional insurance is just purely a mutual commercial transaction that carried out against unexpected risk that involved lives, property or business venture. It is a commodity that offered by the insurer to provide protection against several uncertainties while the risks are spread over a number of clients of the insurer. The parties involved in conventional insurance are insurer and insured. Insurer is usually referred to insurance companies while insured is referred to policyholder. The conventional insurance acts as a risk transfer mechanism whereby risk is transferred from the insured to the insurer in consideration of 'insurance premium' paid by the insured (Muhammad Asghar Shahzad, n.d.). After the process of risk transferring, the premiums that paid to the insurers will be belonged to the insurers and can be used by them to pay unfortunate and keep the balance.
CONTRACT
Takaful Contracts
Since the nature of risks are uncertain (or Gharar) and Islam prohibits sales or transaction that contain Gharar, consequently Takaful contracts cannot be sales contracts. Given that Gharar or uncertainty is prohibited within Takaful contracts, thus Gharar in price, method, terms of contract, and anything that is deemed to be uncertain or deceptive cannot be involved in the Takaful contract.
To make the concept of insurance applicable under Shari'ah law, the wording of the contract is changed, so that it is not a contract of exchange (i.e.: buy-sale contract), but a contract of donation. (Syed Moheeb Syed Kamarulzaman, 2010). In the proposal form, the policyholder declares that "I donate into this pool and appoint a Takaful operator as the managing agent to handle the funds according to the best practices". By making contributions as conditional donations, the element of uncertainty is brought down to acceptable levels under Shariah for a good cause i.e. to lessen the loss suffered by any one of the participants.
It is significant that Datuk Syed Moheeb Syed Kamarulzaman, chairman of the Malaysian Takaful Association uses the phrase "joining a Takaful scheme", instead of "buying Takaful". As he said, "We do not sell Takaful, but we invite people to participate in the scheme or the fund."This is to stress on the issue that Takaful contracts can never be sales contracts.
In addition, to avoid or eliminate the prohibited elements from Takaful contracts, the alternative contracts like Mudharabah Contract (Profit and Loss Sharing), Musarakah Contract (Joint-Venture), Wakalah Contract (Contract of Agency) can be used.
Conventional Insurance Contract
Conventional insurance is a buy-sale contract, in which policies are sold and policyholders are the purchaser. Uncertainty is an integral part of the contract since none of the insurer or insured will know how much they will have to pay or receive until the end of contract. The amount of uncertainties in insurance companies is substantial since the amount of uncertainties does not depend on the action of both contracting parties. Although the underwriting process can determine the probability of how much the insurer will pay or receive from each underwritten contract, the uncertainty that remained with each insured party is still substantial.
PREMIUM
In conventional insurance, premiums paid by the policyholder are various. Premiums paid depend on a specified risk for a specified time. For example, a man age 25 will pay less premiums compare to a man age 45 as a man age 45 will have higher risk in illness. The premiums paid by the policyholders depend on the age of policyholder first take out his policy. The higher risk policyholder face, the higher premiums that he has to pay. Risk level and the premium charged to the policyholder have positive relationship.
In Takaful, fixed minimum premium is imposed on all of the participants. All of the participants of all ages will have to pay the same amount of premium. Takaful disregards age and risk of their participants, as long as peoples want to participate in Takaful program, they will just need to donate the same amount as the other present participants donate in the program.
ELEMENTS
Our next point is about the element of conventional insurance and Takaful itself. Takaful practices are free from the elements of Riba (interest), Gharar (uncertainty), Maisir (gambling) and other unislamic elements. It involved the elements of al-Mudhrabah, al-Tabarru' and other Shari'ah that justified the elements. Here, we focus on two elements which are Tabarru' and Mudharabah. Tabarru' is an Arabic noun that means "donation, gift, or contribution". Each participant that needs protection from Takaful must be present with a sincere intention to donate in order to help other participants if they are faced with difficulties. In precise words, all participants agree to help one and each other. The emphasis on this issue can be observed from a fatwa by Dr. Yusuf Al-Qardhawi that insisted Islamic insurance may exist in condition that each participant contributes into a fund used to support one another.
Mudharabah means profit-sharing. Under this model, the Takaful operator asks for no returns from managing the Takaful business. It seeks returns from the business of investing the policyholder funds in an agreed ratio. Technically, the policyholders pay premium that is credited to a policyholders' fund, while the shareholders of the Takaful operator company contribute to a shareholders' fund which is different from the policyholders' fund. The Takaful operator, as a mudarib, invests the policyholders' fund to the Shari'ah compliant instruments. Then, profits generated from the investment are shared between the policyholder and Takaful operator in an agreed ratio.
On the contrary, the elements of conventional insurance is involved in Gharar (uncertainty), Maisir (gambling), and Riba (interest) which may not be justified by the Shari'ah principle. Gharar means "Uncertainty". The definition of uncertainty in the muamalah transaction is that when a matter is to be concealed by one party where it can raise a sense of inequality as well as tyranny to another party. In fact, Maisir and Gharar are closely related. When a transaction consists the element of Gharar there would be the existence of gambling element. (Why) Maisir can be illustrated in a condition when the participant contributes a small amount of premium in a hope to gain back a large sum. The last element is Riba which exists in the policy loan business offered to the participant in a life insurance product. This is because most of the insurance funds are invested in financial instruments such as bonds as well as stocks which contain the element of Riba.
INVESTMENT
Generally, there are two main objectives for the activities of fund investment. Firstly, it is about increasing and expanding the wealth and assets of both certificate holders and shareholders through the accumulation of profits and capital appreciation. Undoubtedly, expanding the wealth is consistent with Islamic obligation that it will create a balanced socio economic growth.
Secondly, it is to derive profits from all the investments made. In fact, profit maximization is always the main objective of any investment activity and it is not against Shari'ah. Also, under the principle of Mudharabah, certificate holders and shareholders have the right to share those profits.
The distinction between Takaful and conventional insurance is quite obvious in the aspect of investment. Takaful only invests in the business which is compliant with Shari'ah which means that the companies deal in interest, alcohol, gambling or uncertainty are not allowed to invest. This is exercised through statutory acts and it normally requires the setting up of a Shari'ah committee within the Takaful company. The committee is accountable to the Shari'ah compliance of all investments.
Besides, unlike the conventional insurance whereby the investment can be made in any scheme or project that may not be supported by the Shari'ah discipline, Takaful operators have to determine the investment fund's asset size in order to choose an appropriate type of instruments for investment such as Islamic private debt securities (Sukuk), Islamic financing facilities, government Islamic issuance and Islamic unit trusts.
For conventional insurance, they invest their funds in interest-based avenues and without any regard for the concept of Halal-o-Haram. For example, insurance funds invested in financial instruments such as bonds and stocks which contain the element of Riba (interests). The Riba element from the profit of the investment fund will be used for the payment of claims to the policyholders.
BONUS
In certain insurance, insurance companies may offer bonus or profit in general terms only especially with profit policies. In conventional insurance, there is no exact specification with regard to the profit-sharing in contract. Insurance companies may or may not giving bonus to policyholders. Besides depending on policies, companies also consider return on investment that they have made in order for them to give bonus. Bonus rate for policyholders will be varied from year to year up to the discretion of the Board of Directors of the insurance company.
Different from insurance, Takaful gives bonus as agreed between Takaful operator and participants (policyholder). Takaful operator will share the profits from investments with participants according to the ratio agreed between the operator and participants. Bonus sharing in Takaful is based on principles of al-Mudharabah, the ratio of bonus sharing could be 5:5 or 6:4 or 7:3 as agreed between the contracting parties.
In summary, for conventional insurance, bonus will only be given when insurance company make good profit and the bonus rate is under discretion of Board of Director; while Takaful will share bonus on the profit made from investment based on the ratio agreed.
REGULATIONS
Next, we differentiate between Conventional and Takaful in the aspect of regulations. Regulations affecting Takaful is based on the divinely revealed law that dictates the way of life for mankind, called Shari'ah. The authority of the Shari'ah is primarily drawn from the Qur'an and Sunna. The Qur'an is the holy book which Muslims believe containing God's word as directly revealed to the Prophet Muhammad. The Sunna refers to the spoken advice, acts and tacit approvals of the Prophet Muhammad. When there is a new situation arisen which requires an interpretation of the law, qualified Shari'ah scholars engage in ijtihad, which is a method of legal reasoning by analogy from the sources of the law to explore possible solutions to the problem.
A Takaful operator has an obligation to ensure that all aspects of the insurance operations are compliant with Shari'ah rules and principles. One of the aspects that give a huge impact is on how and where they invest the money because their investments must be complying with Shari'ah. Takaful firms cannot invest in conventional interest paying bonds, or in certain types of equity. Because of that, Takaful industry in Malaysia was shown by Takaful Act 1984 in November 1984 as well as Shari'ah Standard AAOIFI 2008 as their guidance in respect of what stated in Qur'an and Sunna.
On the other hand, conventional insurance law is based on the human thought and culture. The example of the conventional insurance law is principles (ICPs) which provide a globally accepted framework for the regulation and supervision of the insurance sector. They provide the basis for evaluating insurance legislation, and supervisory systems and procedures, and are used for that purpose by the IMF and the World Bank. Some of the ICPs are general principles which are universally applicable and appear to require no adaptation to apply to Takaful. One of the principles is ICPs 18 (Risk Assessment and Management) which state the supervisory authority requires insurers to recognize the range of risks that they face and to access and manage them effectively.
ACCOUNTS
No matter in Takaful or conventional insurance, they have to account the receipts of payment and premium as the normal company will do. In trading or manufacturing companies, payments that received from clients will be accounted as revenue for services rendered and goods provided. In conventional insurance, insurance company will account the insurance premium received from clients in general insurance account and life insurance account of fund. In general insurance, all premiums are paid into an insurer's general account. Thus, buyers are subjected to credit-risk exposure to the insurance company, which is low but not zero. [1] This is the same for life insurance.
For Takaful, the receipts of Takaful contribution are put into two accounts. One of the accounts is known as al-Tabarru (donation), which means to help or to take care of one's needs, while another account is treated in line with the principle of al-Mudharabah (profit and sharing). Takaful is operated based on shared responsibility, brotherhood, solidarity and mutual cooperation or assistance, which provides mutual financial security and assistance to safeguard participants against a defined risk. This is the main reason why Takaful does not account premium in general insurance account.
The differences in insurance and Takaful is insurance company will treat its premium received like normal trading company will do while Takaful will treat the Takaful contribution as donation which is not to commercialize it.
SUMMARY AND CONCLUSION
Overall, our report covered the introduction to conventional insurance and Takaful, the difference between the both in the aspects of nature, contract, premium, elements, investments, bonus, regulations and accounts.
We learned that conventional insurance is no doubt a good way to minimize financial losses when disasters happen but Takaful is also definitely a good alternative for conventional insurance where the system is absolutely based on justice, equal distribution of the profits and required far less premium than the conventional insurance policies. Anyway, it is imperative that public awareness be enhanced and let more Muslims and non-Muslims come to understand the real benefits of Takaful.
REFERENCES
Muhammad Asghar Shahzad. (n.d.). Difference between Islamic Insurance (Takaful) and Conventional Insurance. Retrieved Mar 26, 2011 from http://www.scribd.com/doc/18271425/Difference-between-Islamic-and-Conventional-Insurance
Tee Shiao Eek. (2010, December 5). Takaful for All. The Star Online. Retrieved Mar 26, 2011 from http://thestar.com.my/lifestyle/story.asp?sec=lifefocus&file=/2010/12/5/lifefocus/7530950
Mohd. Ma'sum Billah. (n.d.). Modern Re-Discovery of Takaful (Islamic Insurance): Principles & Practices. Retrieved Mar 26, 2011 from http://www.takaful.coop/doc_store/takaful/Rediscovery.pdf
Zailan Arshad, M. R. (2011). The Beauty of The Takaful Investment Fund. Retrieved March 27, 2011, from CPI Financial: http://www.cpifinancial.net/v2/Magazine.aspx?v=1&aid=1672&cat=IBF&in=33
Best's Insurance Resources. (2011). Retrieved March 2011, from A.M. Best Company: http://www.ambest.com/resource/glossary.html#G
Esman, N. K. (2011). Comparison Between Takaful and Insurance. Retrieved March 2011, from PerfSpot: http://www.perfspot.com/docs/doc.asp?id=5921
