How Can Insurance Be Islamic?

How Can Insurance Be Islamic?
July 5, 2010

In the world of Islamic economics and finance, conventional financial instruments such as credit cards, mortgages and insurance are generally considered impermissible. Like Judaism and Christianity, Islam prohibits usury and financial interest. Considering credit cards and mortgages depend on financial interest to remain viable for conventional banks, both are generally considered impermissible.

In an effort to provide Muslims with the convenience and flexibility of credit cards and mortgages, Islamic banks have developed shari’ah compliant financial products that eliminate interest. Instead, these Islamized credit cards and mortgages incorporate a profit-and-loss approach, where the lender assumes ownership risk in the goods and services financed.

However, what of insurance? Why does insurance need to be Islamized? Conventional insurance serves a very important function in the global economy by mitigating risk. Insurance policies effectively transfer risk from the insured to the insurer for a monetary amount. In the event of an insurance claim event, the insured is guaranteed a monetary payment from the insurer to make the insured whole.

The unequivocal guarantee that an insurer provides is especially problematic for family insurance products such as life insurance. Because a life insurance policy guarantees payment in the event of death, most Muslim jurists consider this a bet against God. In Islam, only God knows when a person will die. Any wager or hedge against this date is theologically insoluble.

In Islam, God is considered omniscient and omnipotent. Therefore, God’s knowledge is perfect. More specifically, what God knows to happen must happen. If what God knows to happen does not happen, then God is either not omniscient or not omnipotent. However, denouncing God’s omniscience or omnipotence is anathema to Islamic theology and doctrine.

Moreover, conventional insurance typically invests the policy premiums in a variety of financial instruments that include interest. Therefore, most Muslim jurists consider insurance and more specifically life insurance impermissible.

Instead of conventional insurance products, Islamic insurers offer mutual protection through a takaful fund. The word “takaful” is a derivative of “kafalah” which means “surety,” “guarantee,” or “mutual care.”

Indeed, this type of a mutual care has been in use throughout Islamic history. In addition to the myriad proscriptions mentioned above, Islam also demands that each Muslim care for members of the community. The Qur’an says that one should “spend of your substance, out of love for Him, for your kin, for orphans, for the needy, for the wayfarer, for those who ask, and for the ransom of slaves” (2:177).

Accordingly, takaful embodies the spirit of social solidarity and mutual care. Instead of insurance policy premiums, a voluntary donation is made to a communal takaful fund. Using the law of large numbers, the takaful fund operator uses statistical data and mathematical calculations–similar to conventional actuarial sciences–to ensure that the fund is sufficiently capitalized to fund any insurance claim events.

All takaful funds are invested in shari’ah compliant investments that are free from interest and impermissible investments (e.g., equities engaged in the manufacture, distribution, or sale of porcine food products, alcoholic beverages, pornography, gambling, etc.).

Unlike a conventional insurance policy, because the tabarru payment is a donation, policy “premiums” do not accumulate any cash value for the insured. According to proponents of takaful, this prevents an insured party from profiting from an insurance policy.

While critics of takaful–and Islamic banking and finance in general–may argue that takaful is simply another example of an Islamic financial product being superficially Islamized, takaful does appear to promote social solidarity and mutual care.