What if the concept of insurance were against your religion? Muslims—followers of Islam—do not believe in insurance, and they make up 28% of the world’s population.

By  Coletta Kemper

While living in Dubai, a friend of mine took out a $30,000 loan, interest free. My first reaction was “Wow, what a great deal!” Being the Westerner that I am, my second thought was “How does the lender make a profit?” After all, isn’t profit the engine of capitalism and economic development?

It certainly is in the West and in many other parts of the world, but in Islamic countries interest, or riba, is prohibited. In Islamic cultures money has no intrinsic value and is intended to be used for exchange only. Those with money are not allowed to benefit or suffer from having it. To profit, the product or service offered has to be definable. 

Of course, banks do make money, but Islamic finance, including insurance, must comply with core Islamic principles. Islamic law also dictates that financial products avoid uncertainty/deception (al-gharar) and gambling (al-maisir)—concepts that some think apply to insurance.

These ideas piqued my interest, so I turned to my favorite source of information, Wikipedia, to learn more about the underlying principles that govern how insurance operates in the Muslim world. 

According to the “Wik,” Islamic or takaful insurance is deeply rooted in Islamic law. The concept has been practiced for more than 1,400 years and comes from the Arabic word kafalah, which means “guaranteeing each other” or “joint guarantee.” In other words, the takaful precept is based on a system of mutual cooperation and responsibility among participants.

To take it another step back in history, these principles are derived from the words of the Islamic prophet Muhammad. Not unlike Judeo-Christian teachings, Muhammad preached the virtues of helping your neighbor, responsibility for others and mutual protection of the community over the individual. But profiting at the expensive of another is strictly taboo.

Traditional insurance is not allowed in Muslim communities because it is thought to violate these principles. As a result, the insurance market has been underserved for years in Islamic cultures, exposing its people and businesses to considerable financial risk.

Fortunately, using the takaful concept of mutuality and avoiding the three “no’s”—interest, uncertainty and gambling—business models for insurance that comply with Islamic law have been created.

Takaful insurance is somewhat like a mutual insurance company. Members pool resources to protect against risk and share in any profit. The idea is that when the risk is spread among a large number of people, it is no longer “uncertain” for the individual. 

The basic rules of takaful are:

• Policyholders cooperate for their common good;
• Every policyholder pays a subscription to help those who need assistance;
• Losses are divided and liabilities spread according to the community pooling system;
• Uncertainty is eliminated in respect of subscription and compensation;
• It does not benefit at a cost to others.

There are two basic takaful business models: mudharabah and al-wakala.

Mudharabah Model (profit sharing). Shareholders and fund participants pay a takaful installment or “donation” (premium) to the takaful operator. The premium is considered a contribution or a donation that will assist fellow members who suffer a loss. This approach takes the problem of al-gharar (uncertainty) out of the equation. After claims are handled, any surplus is distributed among the participants, shareholders and the operator. The mudharabah model is widely used across Asia but is banned in many Arabian Gulf states.