What Is Takaful?

It’s like insurance

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Takaful, also called Islamic insurance, is a system of cooperative insurance for followers of Islam. Members of a takaful contract contribute to a pool of money that’s used to financially support a member when they experience a covered loss.

Take a closer look at the definition of takaful and how it works, including the different types of takaful. Learn the similarities and differences between Islamic insurance and conventional insurance, and why takaful is an important insurance alternative for Muslims.

Definition and Examples of Takaful

The term takaful often translates to “solidarity” or “mutual guarantee,” which is the principle of the practice as an alternative to conventional insurance. Members of the takaful contract work together to protect one another from loss by pooling their collective financial resources. Takaful works by a group of participants choosing to pay monthly premiums in exchange for coverage from specified accidents or misfortunes. The participants mutually agree to use the total premiums for the benefit of any group members who experience a covered loss.

The concept of takaful originates from the beginning of Islam. Community members used social insurance practices to pool resources and help cover losses.

The takaful system is based on Sharia, or Islamic religious law, which is the code of conduct and religious guidelines for Muslims. Specifically, takaful follows Islamic principles including welfare, shared responsibility, and cooperation.

  • Alternate name: Islamic insurance

How Does Takaful Work?

Unlike conventional insurance, participants in a takaful contract are both the insurers and the insured. Each member of the takaful group agrees to make regular contributions or premiums. The money is put into individual accounts and invested in Sharia-compliant investments. Part of joining the takaful contract is agreeing to donate a portion of the funds from your account if another member faces a loss. Likewise, your co-members agree to help cover you if you face losses.

In practice, takaful can look a lot like conventional insurance. For example, say you protect your home with property takaful. A storm causes damage to your home and leaves it uninhabitable. Luckily, your takaful agreement covered additional living expenses after an accident. You’ll receive compensation for your lodging while you wait for repairs to finish on your home, much like additional living expenses on a homeowners insurance claim.

It may seem like takaful is the same as conventional insurance, such as car insurance or homeowners coverage. However, a takaful agreement is Sharia-compliant, while conventional insurance is not. Conventional insurance violates three specific concepts in Sharia: gharar, maysir, and riba.

  • Gharar: This is the concept of uncertainty, risk, or fraud in financial and business transactions. Under conventional insurance, you pay premiums for the promise that you’re covered if you experience a specific loss. However, you may never experience a loss or need to file a claim. Gharar is violated because both parties are uncertain whether you’ll use your insurance product or not.
  • Maysir (Maisir): Maysir, or gambling, is prohibited in Islam as wealth should derive from productive work rather than winnings from games of chance or luck. Conventional insurance is often considered a type of gambling in Islam because of the uncertain risk and reward of a policy. For example, a person could only have insurance for a few months before experiencing a loss and getting the full value of the policy. On the other hand, someone may never need to use their policy and pay premiums for years without a benefit. 
  • Riba: Meaning “interest” or “usury,” riba is prohibited in contracts by Islamic religious law. Many conventional insurance companies invest premiums into bonds and funds that bear interest, which violates guidelines against riba.

Generally, conventional insurance violates certain principles of Sharia, making takaful an important alternative for Muslims looking to reduce risk.

What Does Takaful Cover? 

As an alternative to conventional insurance, takaful contracts are offered to cover many of the same things as insurance policies. The system is usually split into two types of coverage: general takaful and family takaful.

  • General Takaful: These are takaful contracts that cover your property, such as your home, business, or car. These takaful groups work similarly to conventional insurance while maintaining Sharia compliance. For example, you can enter a personal liability takaful contract that helps protect you from lawsuits, just like personal liability insurance.
  • Family Takaful: Family takaful provides benefits similar to life insurance. Family takaful plans have a set length and help protect you and your family from risks such as death or illness. They also help you grow long-term savings. Contributions to family takaful plans go into two accounts: a donation to help cover takaful group loss and a personal account where funds are invested in Sharia-compliant investments to grow savings.

Types of Takaful

Conventional insurance policies consist of policyholders and the insurance company. The policyholders pay the insurance company to insure them against risk. In takaful, however, the contract participants are both the insurer and the insured. To manage the takaful contract and coverage, several models of contracts are used:

  • Wakalah (agency)
  • Mudharabah (profit-sharing)
  • Hybrid Model

Wakalah

This model works by the Islamic insurance company, or takaful operator, becoming an agent for the takaful contract. The agent manages the funds for participants. Participants pay the agent a fee for their services. 

Mudharabah

While wakalah contracts are fee-based, mudharabah contracts are a profit-sharing venture between takaful participants and the contract manager. The takaful participants provide capital in the form of their premium payments. The manager of the contract provides expertise and managerial skills to invest the participants’ money into Sharia-compliant investments.

Profit made by the investments is shared among the participants and the manager at an agreed-upon rate. The shared profit pays for the manager’s time and experience rather than a straight fee. The manager doesn’t receive compensation if the investments don’t make a profit.

Hybrid Model

The mixed, or hybrid, model of takaful combines elements of both wakalah and mudharabah. In this model, the takaful manager receives a set wakalah fee as well as a portion of any profits from takaful fund investments. 

Takaful vs. Conventional Insurance

While both takaful and conventional insurance provide similar results—protection from losses—the methods behind each are different. In takaful, the risk is reduced within a social group as a collaborative insurance measure. In conventional insurance, the risk is reduced for individuals through a contract with an insurance company.

Takaful Conventional Insurance
Risk is shared between participants. Risk is transferred to the insurance company.
Any investments must be compliant with Sharia law. Investments do not need to meet religious standards.
Profits from fund investments are returned to takaful participants. Profits of the insurance company may be distributed to third-party shareholders, who may or may not be policyholders.

How To Get Takaful

Takaful isn’t widely available worldwide, as regulatory restrictions in countries like the U.S. make it difficult for providers to offer takaful contracts. In countries with a higher Muslim population, like Malaysia, takaful is offered as an alternative to regular insurance. 

If you are a Muslim looking to sign up for takaful in a country with limited options, you may want to speak with your local religious leaders about insurance or alternatives that are acceptable to mitigate your risk of loss. If you live in a country with takaful options, you can sign up for a takaful plan by researching takaful operators in your area.

Key Takeaways

  • Takaful is a cooperative system that protects participants from risks using pooled resources that conforms to Islamic religious law.
  • Known as Islamic insurance, takaful is an alternative option to conventional insurance.
  • Takaful participants agree to use their premiums to help cover the losses of other group members.