Accounting Article

Takaful Insurance Business

by Mohammed Ashraf | Published on 6/10/2005

The astonishing results of the underestimated Islamic Banking in Pakistan have compelled the decision makers of normal interest-based banks to dedicate at least one of their branches as Islamic Bank. With such a wide spread appreciation from the general public in respect of Islamic Banking it is expected that any Islamic product like Takaful will reap the same result because Muslim jurists conclude the fact that insurance in Islam is based on the principles of mutuality and cooperation. Such Insurance encompasses the elements of shared responsibility, joint indemnity, common interest and solidarity. This article is an endeavour to understand ifs and buts of Takaful, corporate law areas and taxation aspects.

Concept of Takaful

Muslim jurists acknowledge that the basis of shared responsibility in the system of "aquila" as practised between Muslims of Mecca and Medina laid the foundation of mutual insurance. Islamic insurance was established in the early second century of the Islamic era when Muslim Arabs expanding trade into Asia mutually agreed to contribute to a fund to cover anyone in the group that incurred mishaps or robberies along the numerous sea voyages (marine insurance).

Takaful is an Arabic word meaning “guaranteeing each other” or joint guarantee. The Tabarru' system is the main core of the Takaful system making it free from uncertainty and gambling. Tabarru' means "donation; gift; contribution." Each participant that needs protection must be present with the sincere intention to donate to other participants faced with difficulties. Therefore, Islamic insurance exists where each participant contributes into a fund that is used to support one another with each participant contributing sufficient amounts to cover expected claims. The objective of Takaful is to pay a defined loss from a defined fund.

Muslim and Risk Control

It is a Muslim's belief that everything that happens in this world is by the will (Qadha and Qadar) of Allah. Similarly any accident or misfortune that befalls us, that results in the loss of life or belongings, is by the will of Allah (SWT). If that is the case, some people might ask, why should there be Takaful! Should we then not leave it to Allah and accept whatever accident, misfortune or catastrophe that befalls us? Whilst it is true that we should accept whatever "misfortune" that befalls us, we are also taught to avoid or reduce the possibility of these "misfortunes" by taking positive steps.

One day the Prophet (PBUH) saw a Bedouin leaving a camel and he asked the Bedouin, "why don't you tie down you camel?" The Bedouin answered, "I put my trust in Allah." The Prophet said, "Tie your camel first, then put your trust in Allah." What the Prophet (PBUH) has done here is teaching the Bedouin to reduce the risk of losing his camel. Similarly in many actions of the Prophet (PBUH), we saw that he took steps to reduce risks although he could have done otherwise if he wanted to.

For example, during the Hijrah, he went to hide in the cave first instead of going straight to Madinah. He commanded the companions to migrate to Madinah by batches instead of in one big group. Again this is to reduce risks. When he went to war, he put on his armour instead of wearing light clothes.

In this modern world, one of the ways that can be done to reduce the risk of loss due to accident or misfortune is through insurance. In fact it is almost impossible to live without being affected by insurance. The house that we buy or rent has got insurance cover. The car that we buy or rent has to have insurance. The bus that we board has insurance. Insurance is all around us whether we like it or not.

Issues in conventional Insurance

Conventional insurance contains elements contradictory to Islamic Shariah like Uncertainty [Gharar], Gambling [Maisir] and Interest [Riba]. The insurance contract contains uncertainty due to Uncertainty whether the payment will be accepted as promised, the amount to be paid is not known and the time it will occur is not known. Any form of contract which is lopsided in favour of one party at the expense and unjust loss to the other is classified as Gharar.

When a claim is not made the insurance company may acquire all the profits whilst the participant may not obtain any profit whatsoever. The loss of premiums on cancellation of a life insurance policy by the policyholder, or the "double standard" condition of charging a customary short period in general insurance, whilst only a proportional refund is made if the insurance company terminates the cover is also considered as unjust.

In furtherance, conventional insurance involves gambling because the participant contributes a small amount of premium in hope to gain a large sum; the participant loses the money paid for the premium when the insured event does not occur and the company will be in deficit if claims are higher than contributions.

When a life insurance policyholder dies after only paying part of the premium his dependants receive a certain some of money which the policyholder has not been informed of and has no knowledge as to how and from where it has been derived.

Apart from the above, conventional insurance involves interest because an element of interest exists in conventional life insurance products - as the insured, on is death, is entitled to get much more than he has paid, insurance funds invested in financial instruments such as bonds and stocks contain and element of Riba.  

Takaful in Practice

Theoretically, Takaful is perceived as cooperative insurance, where members contribute a certain sum of money to a common pool. The purpose of this system is not profits but to uphold the principle of "bear ye one another's burden." The role of this practice indicates that the policyholders are in fact the managers of the fund and the ones in ultimate control. However, the commercialisation of Takaful has produced several types of Islamic insurance, each reflecting a different experience, environment and perhaps a different school of thought. 

The Ta`awun model [Co-operative Insurance] practices the concept of pure Mudharabah in the daily transactions where it encourages Islamic values such as brotherhood, unity, solidarity and mutual cooperation. In the pure Mudharabah concept, the Takaful Company and the policyholder will only share the direct investment income; the policyholder is entitled to a 100% of the surplus with no deduction made prior to the distribution. This model is applicable to life family Takaful as the fund is entirely distributed to the participants.

The non-profit model includes social-governmental owned enterprises and programs operated on a non-profit basis which utilize a contribution that is 100% Tabarru (donation) from participants who willingly give to the less fortunate members of their community.

The Mudharabah model surplus is shared between the policyholders and Takaful Operator. The sharing of such profit (surplus) may be in a ratio of 5:5, 6:4, 7:3, etc. as mutually agreed between the contracting parties. Generally, these risk-sharing arrangements allow the Takaful operator to share in the underwriting results from operations as well as the favourable performance returns on invested premiums.

In Al Wakala Model, the Cooperative risk-sharing occurs among participants with a Takaful Operator earns a fee for services (as a Lawyer [Wakeel] or Agent) and does not participate or a share in any underwriting results as these belong to Participants as Surplus or Deficit, under the Al Wakala Model, the operator may also charge a fund management fee and a performance incentive fee.


Re-takaful has a close relationship with takaful operations where retakaful is a form of takaful and the competitiveness of retakaful market is depend on the competitiveness of the direct takaful market. Actually Retakaful is a form of insurance whereby the Takaful operator pays an agreed upon premium from the Takaful fund to the reinsurance company or Retakaful operator, and in return, the Reinsurance company or the Retakaful operator will provides security for the risk reinsured. Reinsurance is best thought of as "insurances for insurance companies”. Or we also can say that Retakaful is a “takaful for takaful operators”. It is a way for a primary insurer to protect against unforeseen or extraordinary losses. 


General Takaful Product


Pays Premium


Takaful Holders Operator


Takaful Operator




Family Takaful Product


from Takaful Fund


From the above diagram, takaful holders are individuals or companies that buy the Takaful products either General Takaful products or Family Takaful products and pay an agreed upon premium to the Takaful operator to protect them from unforeseen risk and also extraordinary losses.  Then, the Takaful operator will take a portion of money from Takaful fund and pays premium to the Retakaful operator to get reinsurance protection to spread its risks. Reinsurance contracts may cover a specific risk or a broad class of business.

Retakaful or Islamic reinsurance is essentially about handling risk. It is a risk aversion method in which the Takaful ceding company resorts to either a conventional reinsurer or a Retakaful operator to reinsure original insured risks against an undesirable future situation if the risk insured were above the normal underwriting or claim. Thus, a Takaful ceding company may, based on limited financial resources, hedge against possible incapability to meet all Takaful reinsurance protection from a financially capable reinsurer, which will take over the coverage of the large proportion of the risk.

Fathi Lashin, a member of the Shariah Supervisory Board of the Dubai Islamic Bank stated that Retakaful does not, in principle, differ from Takaful operations. The Shariah principles applying to Takaful apply to Retakaful operations as well. The difference, if any, is that in the Retakaful operations, the participants are Takaful operators instead of individual participants. It is argued that the current practice of insurance business has shown that a Takaful ceding company cannot do without Retakaful facility. Therefore, there is a need for Takaful operators to split risks by way of establishing Retakaful operators. By doing so, they share their risks with Retakaful companies. The Retakaful operator, on the other hand, assumes the responsibility of managing and investing the premiums of Takaful operators on the basis of Profit Loss Sharing.





1) Riba and Gharar

Retakaful operation does not earn commission as a profit or interest, because this commission is subject to Riba and dilutes the purpose of setting up a Takaful operation. The Retakaful operation is dependent on actual expenses spent by the Takaful operator in the process of Retakaful

The conventional reinsurance operation is subject to Riba and Gharar, which are not in line with Shariah principle. For instance, the reinsurance commission which the direct insurance company earned from the reinsurance treaty.  It is because this commission is frame in a way that renders the commission ribawi and implicate in a high degree of Gharar.

2) Principle of Insurable interest

According to Islamic laws with regards to insurable interest, which is holding specific financial interest in the subject matter of the insurance as a cardinal principle of the legality of the Retakaful, contract. Under Islamic laws, the reinsured party does not get an insurable interest or to reinsure the property of the original insured party without permission from the policyholder. However, because the Retakaful operation is based on Mudharabah principle, it vested a right to reinsure on the insurer because the permission from the policyholder is automatically inherent in the contract of Mudharabah

Insurable interest is vested in the reinsured party. The fact that the reinsured party has issued a policy and assumed liability to its original insured party has been held to give it insurable interest sufficient to enable it to reinsure. The point is that although the reinsured party (direct insurance company) has no actual legal interest in the property, the subject matter of the original insurance policy, it has assumed responsibility in regard to it, and has therefore put itself into a position, recognized by law, in which it would be prejudiced by its loss.


Principles of Contract

An insurance policy binds the parties unilaterally by an offer and an acceptance in reliance on the principles of contract. The fundamentals required in an insurance policy are the parties to the contract, legal capacities of the parties, offer and acceptance, consideration, subject matter, insurable interest and good faith, most of which are found in the general type of contracts. For example, a contract is a promise by an offer and an acceptance, which must be fulfilled as Allah (S.W.T.) has commanded to the effect: "O ye who believe! Fulfil your obligations." Surah al-Maidah, 5:1

As for the legal capacity as to age of the parties to the contract of insurance, a minor below the age of 15 (the age of rushd or majority or puberty) is not able to buy a policy unless the guardian holds the full supervision over the policy and also the policy should be for the benefit of the minor.

The Takaful Siswa allows an infant between the age of the majority and the fifteenth day of birth to hold a Takaful policy for education which is under the supervision of the respective guardian. This operational method may be justified by the following Qur’anic sanction: "Make trial of orphans until they reach the age of marriage; if then you find sound judgment in them, release their property to them; but consume it not wastefully" Surah an-Nisa, (4): 6

The requirement of minimum age of the parties in an insurance policy is the same as required in general contract. Hence the above principles and other relevant principles relating to contract are basically applied to the formation of an insurance contract.

Principles of Liability

An insurance policy covers losses arising from the death, accident, disaster and other losses to human life, property or business. The insurer (insurance company) undertakes in the policy to compensate against the losses to the agreed subject matter. Such undertaking is considered as vicarious liability. For instance, in the case of ‘Aquila practised in the ancient Arab tribes approved by the Holy Prophet (PBUH) if a person was killed by another from a different tribe either mistakenly or negligently, this would bring a liability to the members of his tribe to pay blood wit to the heirs of the slain. See Uddin M. Musleh, Concept of Civil Liability in Islam and the Law of Torts, Islamic Publication Ltd. Lahore, 1982 at 62, See also Niazi Liaqat Ali Khan, Islamic Law of Tort, Research Cell Dayal Singh Trust Library, Lahore, 1988, p. 339.

Moreover, the rights and obligations in an insurance policy mainly arise from the law of contract and tort. For example, in a case of a motor accident, the operator (insurance company) is liable on behalf of the person who causes that accident (i.e. the insured) to compensate the victim. Here, the operator is bound by the terms stipulated in the proposal to pay that compensation under the principles of vicarious liability under the law of Tort.

Principle of Utmost Good Faith

In an insurance contract, for the enforcement of the policy, the parties involved in it should have good faith. Therefore, non-disclosure of material facts, involvement of a fraudulent act, misrepresentations or false statements are all elements which could invalidate a policy of insurance, Allah (S.W.T.) says: "....Do not misappropriate your property among yourselves in vanities but let there be amongst you traffic and trade by mutual good will......" Surah an-Nisa, 4:29

Principles of ‘Mirath’ And ‘Wasiyah’

In a life policy, the assured (Muslim) appoints a nominee who must not be an absolute beneficiary. It must be noted that a nominee in a life insurance policy of a Muslim is a mere trustee who receives benefits from the policy and distributes them among the heirs of the deceased, in accordance with the principles of ‘Mirath’ and ‘Wasiyah’.

"For instance, A nominee shall receive the policy moneys payable on the death of the policy owner as an executor and not solely as a beneficiary and any payment to the nominee shall form part of the estate of the deceased policy owner and be subject to his debts and the licensed insurer shall be discharged from liability in respect of the policy moneys paid".

In the light of this provision, it is concluded that the nominee in a policy nominated by a Muslim policyholder should be treated as a mere executor and not as an absolute beneficiary of the policy.

Principles of Al-Wakala (Agencies)

The appointment of the agent by the insurer and the broker by the insured are of utmost important, in fact, such appointments are widely practiced for the purpose of making the transaction and dealings between the insurer and the insured more effective. The governing principles for the agents and brokers are laid down in the Mejelle as follows: "Wakalat is for someone to put business of his on another and to make him stand in his own place in respect of that business." See Mejelle al-Ahkam al-Adliyah by Tyser (trans.), C.R., The Mejelle, Law Publishing Company, Lahore n.d. art 1449.

Principles of Dhaman (Guarantee)

In an insurance policy, the insurer undertakes to provide material security for the insured against unexpected future loss, damage or risk. The idea of such guarantee is justified by the principles of ‘Dhaman’ or guarantee under Islamic law. In Fiqh, insurance can only be classed under Dhaman (guarantee), which is governed by some essential conditions. Among them the guarantor can only take upon himself a liability which has fallen or may possibly fall upon a person or property. Thus, Dhaman or guarantee may only be payable to the victim or if the victim dies, to his legal heirs, according to their respective shares in inheritance.

Principles of al-Mudharabah and al Musharakah

The operation of an insurance policy under Shariah is in fact based on the principles of al-Mudharabah financing, which is an alternative to the contemporary interest-based transaction. However, an insurance policy is a transaction wherein both parties agree that the participant pays regular contributions and the operator invests the accumulated contributions in a lawful business, in which both the insured and the operator share the profits in an agreed portion. At the same time, the insurer also undertakes to provide the insured with compensation (in consideration of the paid-contribution) against an unexpected future loss or damage occurring on the subject matter of the policy. This is how the principles of al-Mudharabah financing in an insurance policy. An insurance policy also operates on the basis of the principle of ‘al-Musharakah as both the operator and the participants are partners in the policy run by the insurance company.

Principles of Rights and Obligations

An insurance policy is based on the principles of rights and obligations arising from humanity and nature. For instance, it is logical and natural for every person in the society to feel obliged to provide material security and protection as a right for themselves, their property, family, for the poor and helpless widows, and for children against unexpected perils and dangers. Such a natural obligation and right could well be justified by the following Tradition of the Holy Prophet (PBUH.): "Narrated by Saad bin Abi Waqas ® ... the Holy Prophet (PBUH.) said ..... it is better for you to leave your offspring wealthy than to leave them poor asking others for help....."

The Holy Prophet (PBUH.) had also emphasized the importance of providing material security for widows and poor dependents in the following Tradition: "Narrated by Safwan bin Salim ®, the Holy Prophet (PBUH.) said: The one who looks after and works for a widow and a poor person, is like a warrior fighting for Allah’s cause or like a person who fasts during the day and prays all the night...."

Principles of Humanitarian Law

It is one of the purposes of humanitarian law to inculcate mutual understanding in the community, to protect one against unexpected loss, damage or other forms of risks or hardships. Hence, an insurance policy contributes towards alleviating hardships from a person arising from unexpected material risks, which is of course within the scope of the principles of humanitarian law. This has been justified in the following Tradition of the Holy Prophet (PBUH.), which reads:  "Narrated by Abu Huraira ®, ...the Holy Prophet (PBUH.) said ... whosoever removes a worldly grief from a believer, Allah (S.W.T.) will remove from him one of the grieves of the day of judgment. Whosoever alleviates a needy person, Allah (S.W.T.) will alleviate from him in this world and the next..."

Principles of Mutual Co-Operation

In a policy, both the operator and the participant mutually agree to lawful co-operation, in which the participant provides capital (through the payments of contributions) to the operator (insurance company), enabling the insurer to invest the accumulated contributions in a lawful business (on the basis of al-Mudharabah) . Meanwhile, the insurer, in return for the payments of the contributions, mutually agrees to compensate the insured in the occurrence of an unexpected loss or damage or risk on the subject matter. Such mutual co-operation among the parties in an insurance policy has been justified by the Divine principles of mutual co-operation, solidarity and brotherhood. Allah (S.W.T.) commanded: "... co-operate you one another in righteousness and piety" Surah al-Maidah, 5:3


SECP should move faster in this area of law and amending the existing law is no more a lasting and appropriate solution. In furtherance, the Insurance department needs to be equipped with necessary information and appropriate human resource. Many people are of the opinion that Islamic banks are under capitalized and are still growing more than average interest based banks. This is high time that people could have the alternate solution of Insurance, that is, Islamic Insurance – Takaful.

The author is an International tax advisor and teaches UK and Pakistani Taxation at various approved colleges of ICAP and ACCA. He is also a member of publication committee of ICAP. His articles on taxation and corporate law have been published in leading local and foreign newspapers and journals. He can be contacted at

Article courtesy of Mohammed Ashraf

Want to write for Accountancy?

Well, here's your chance. Click here to read details.


Follow Accountancy on TwitterFollow Accountancy on Facebook