Types of Takaful in Islam

Dubai is an important takaful insurance market center.
... Sam Robinson/Photodisc/Getty Images

Takaful is an insurance contract that is compliant with Shariah, the body of Islamic law. The name derives from the Arabic verb “kafalah” that means mutual guarantee. Islamic insurance is based on the principle of mutuality where policyholders own the company and share in its profits. There are three main types of takaful: mudharaba, wakala and a hybrid of the two.

1 Religious Prohibitions

Islamic law forbids “riba,” a concept that means interest, usury and the exploitation of the poor. It also prohibits “gharar,” meaning risk, uncertainty, hazard and deceit. “Maysir,” which is the acquisition of wealth by chance, or gambling, is also proscribed. Conventional insurance works on the concept of risk transfer where an insurance company accepts a risk from a policyholder in exchange for a premium. The company invests the premiums on capital markets to make further profits. In Islamic jurisprudence, this is viewed as gambling on uncertainty and in the process, exploiting a policyholder by making money from money.

2 Policyholders' Fund

In an arrangement that bears some similarity to mutual, or cooperative, insurance, takaful policyholders pay premiums into a policyholders' fund. Administrative expenses and reinsurance are paid from this fund. Any surplus at the end of the financial years is the underwriting profit. This may be allocated in part to a policyholders' reserve fund, and in part distributed among policyholders as a dividend. Underwriting losses in the policyholders’ fund are covered by an interest-free loan from a shareholders’ fund.

3 Shareholders' Fund

The shareholders’ fund consists of paid-up shareholders’ capital and reserves together with investment income. All investments must be Shariah-compliant, meaning that these should be on a profit-and-loss sharing basis rather than speculative investment in capital markets. The shareholders are liable for the losses of the policyholders' fund, but this liability is limited to the amount of equity they hold in the company.

4 Mudharaba

Mudharaba is one of the oldest concepts in Islamic finance and is based on profit-sharing. This type of takaful is practiced widely in the Asia-Pacific region. The company’s management is paid from the profits the company makes and shares in the surplus and losses. The ratio of profit-sharing is pre-agreed on the basis of the company’s performance.

5 Wakala

The wakala version of takaful is an arrangement where an agent manages the company and receives a fee for his services. The fee is pre-agreed at the beginning of a financial year and may be a fixed amount or an agreed share of investment profits or shareholder or policyholders' funds. The agent does not share in any of the company’s liabilities. This type of takaful was developed in Sudan.

6 Hybrid

The mudharaba and wakala models can be combined to produce a hybrid type of takaful. The managing agent of the company receives a fixed fee from policyholders’ funds as in the wakala model and also a share of the profits on the basis of the mudharaba model, but from the company’s investments only. The policyholders have a right to share in both the underwriting profits and in investment profits.

Based in London, Maria Kielmas worked in earthquake engineering and international petroleum exploration before entering journalism in 1986. She has written for the "Financial Times," "Barron's," "Christian Science Monitor," and "Rheinischer Merkur" as well as specialist publications on the energy and financial industries and the European, Middle Eastern, African, Asian and Latin American regions. She has a Bachelor of Science in physics and geology from Manchester University and a Master of Science in marine geotechnics from the University of Wales School of Ocean Sciences.