Islamic insurance (Takaful) means the act of group of people reciprocally granting each commercial profit sharing contract between the providers of funds for a business venture and the entrepreneurs who actually conduct the business. In other words, the Takaful business conducted by the company and the individual members of a group of participants who desire to reciprocally guarantee certain loss or damage that may be inflicted upon any one of them. This chapter deals with the conceptual issues, principles of contract insurance, types of general insurance policies, insurance in an Islamic perspective, modas operandi of Islamic Insurance Company, and other relevant matters.

We all know that life is full of uncertainties and it is general human tendency to avoid the uncertainties of life as far as possible. Social scientists of modern age have, therefore, stressed much need for the study of the subject of risk. In fact scientific study and management of risk is very important in the present context of worldly affairs. We know that different types of risk are involved in the society and one should know how to avoid or deal with it.

In the present day society, insurance is one of the most used, desired and prime methods of handling risks. However, insurance is a complex subject and is also a subject of much misunderstanding. It has been observed that much of the misunderstanding has arisen due to two main reasons:

i)              We have failed to understand the basic nature of risk

ii)         The relationship and difference between insurance and other methods of handling risk have not been properly understood.

Therefore, in order to grasp the functions and nature of insurance we will try to understand some basic concepts of risks and insurance.

Risk and Insurance

Risk has been defined as the uncertainty as to the occurrence of an economic loss. Risk and probability are not synonymous. Before analyzing the relationship between risk and insurance, we must understand the difference between risk and probability.  The term's hazard and peril are more closely related to probability than they are to risk. For example, collision is a peril that causes the automobile accident and loss. The condition that makes the occurrence of collision more likely is called the hazard. For example, foggy weather is the hazard that creates the peril of collision. This means probability of collision increases when the hazard of foggy weather creates the peril of collision. Therefore, one can say that probability is the long run chance that out of a given number of possibilities, certain number of specific events will occur. But risk is the uncertainty as to occurrence of a loss. This is measured in the terms of degree of variation that actual events bear to probable events. The larger the number of exposures, the smaller is the risk. This is because under this situation, the smaller is the variation that actual events bear to the probable events. This called the law of large numbers.

The law of large number states that for a very large number of exposures, one can predict precisely the actual number of occurrence of an event. This law has proved very significant in the study of the subject of insurance.  This is mainly because, the risks of the insurer is that he does not know what is the actual probability of a loss. It is, therefore, necessary to estimate the actual probability. The law of large number is of vital significance in analyzing this problem (Majumdern & Dewan 1999, p.23). According to this law, one can estimate the probability of occurrence of certain events more precisely by increasing the number of observations by sampling process. It has been observed that the average value of a very large number of observations will be very close to the actual average of the population from which the observations were taken. For example, probability of death at certain age can be estimated by way of a large number of observations in a sampling process.

It may be noted that foundation of insurance rests upon the law of large numbers. The insurers obtain a very large number of observations. In the case of life insurance mortality records of people at different ages are analyzed and summarized to find out the probability of death at certain age. In the case of general insurance the insurers usually have the statistical records of loss against different perils and thus they can fairly measure the underlying probability of a loss against, fire, accident, mechanical breakdown etc.

How to Handle Risk

An individual is always concerned because of the uncertainties of life. He does not know whether or not a given loss will occur to him individually. For an individual, the risk is very large. This is simply because an individual cannot obtain a sufficient number of exposures to have an accurate prediction as to the occurrence of loss. It is not the probability of loss which causes difficulty, but rather the uncertainly as to whether an individual will be among those who are expected to suffer loss. Had the loss been certain, one could perhaps prepare him for it in advance. Since this is not the case, one should try to reduce risk through insurance and other means.

One can handle risk by assuming it. Most of the people do it knowingly and unknowingly. In many cases we pass through life by way of accepting or assuming many small risks. However, in many occasions one has to accept it simply because one cannot afford to pay for it's reduction or transfer.  If one can afford to pay the price of risk transfer, the insurance company or some other organization will bear the risk. In that case the insurance company will bear the risk for a price. But how will the insurance company bear the risk? The insurance company handles risk by utilizing the combination method as the basis of their insuring operation. The method of combination is the system of handling risk that usually involves the use of large numbers. The insurance companies persuade a large number of individuals, known as insured to pool their individual risks in a large group. When sufficiently large numbers are grouped the actual loss experience over a period of time will closely approximate the probable loss experience. The insurance company has little or no risk at all if this method is used properly When all of the individual objects are pooled into one group, the risk is no longer present, if the requisites of insurable risks are met with.

It may be noted here, that insurance companies do not cover all risks. That is to say, all risks are not insurable. Usually it is only the “pure” risks that are insurable and not the “speculative” risks. A pure risk can cause only loss but a speculative risk causes either a profit or loss. For example, there is risk in any investment and business venture due to market fluctuations. This is a speculative risk and therefore, not insurable. However, a businessman can insure the assets and legal liabilities against specified perils like fire, flood, cyclone, negligence, collision, etc. Similarly, one cannot insure the risk of gambling.  However, all pure risks are not insurable as there are many situations that can cause loss where the loss  a of large number does not operate satisfactorily. For many situations large number of required statistical records are not available. If the insurers cannot obtain statistics over a sufficient length of time on losses resulting from a particular peril, they cannot accurately predict the probable loss experience. In that situation it is not prudent to cover such risk. So it is evident that the prime requisite of insurable risk is that the number of objects must be of sufficient number. This means that the probable loss must be subject to advance estimation in order that it can be made accurate and the objects to be insured must be similar so that reliable statistics of loss can be formulated. For example, in case of fire and theft insurance, commercial buildings and private dwellings should be grouped separately as the hazards against these risks are different. Similarly the properties situated in the cyclone belt should not be grouped with that of the properties located in the cyclone free zone. This means the physical and social environment of the group ought to be roughly similar. Therefore, it is evident that from the viewpoint of the insurer, one of the prime requisites of insurable risks is that the number of objects must be sufficient in number and quality so that a reasonably close calculation of probable loss can be made (Greene 1962, p.47).

Requisites of Insurance for Covering Risk

Apart from what has been discussed above, the other requisites of insurance may be summarized as following:

(a)       Insurance must be effected by means of a legal contract and must meet the general requirements of contract as follows:

i)       It must be made by parties with legal capacity to contract; and

ii)       It must be affected with a meeting of the minds of the parties.

(b)       For any insurance contract to be valid it is necessary to have insurable interest of the insured on the subject of insurance. This means that an insured must suffer a financial loss himself.

(c)        Property and liability insurance are subjected to the principle of indemnity which states that a person must not be indemnified more than his actual loss in the event of damage caused by a insured peril.

(d)       Principle of subrogation ought to be followed where the principle of indemnity is in existence. Under this principle, the insurer is entitled to subrogation, which means that they acquire the right to recover from liable third parties. This is necessary to reinforce the principle of indemnity i.e. to prevent the insured to receive more than actual loss.

(e)       Principle of utmost good faith must be followed in every insurance contract and for that matter breach of warranty, material misrepresentation and concealment of facts makes the contract void.

(f)         Last, but not the least, there are the principles of loss determination and payment.

Uninsurable Risks

Not all risks are insurable. This is mainly because there are some risks, which in the true sense cannot be termed as risks. Therefore, the authors of risk management have differentiated between pure risk and speculative risk. Normally the pure risk is insurable and speculative risk is handled by methods other than insurance. In pure risk, there is uncertainty as to whether the loss will occur or not, but there is a chance of producing a profit out of that event. But in case of speculative risk there is uncertainty of an event that could produce either a profit or loss. For example, a business venture and a gambling contract are the risks of speculative nature and, therefore, not insurable. Market risks such as price changes and/or changes in the exchange rate of currency are not insurable. These risks are not subject to advance calculation, hence the insurer would have no realistic basis for computing his premium. Further, in times of rising prices no one would be interested to have insurance coverage against such risk and in times of failling prices an insurer can not afford to take on the risk because he can not avail the opportunity of spreading the risk over which to average out good years with bad years.  The speculative risks are handled businessmen by way of hedging, whereby a speculator assumes the price risk.

Insurance and Gambling

Although it is common to confuse insurance with gambling, from economic and legal point of view gambling and insurance are two distinct matters. It is true that insurance company pays an insured a great deal more money than it has received, in terms of premiums, but this does not mean that insurance is thereby a gambling contract. The very purpose of insurance is to eliminate risks, whereas gambling creates a new risk.

For example,  “A” and “B” may agree that if the property of  “C” comes under fire,  “A” will pay taka 1,000.00 to “B” and if there is no fire,  “B” should pay taka 100.00 to “A”.  In this case before this gambling contract neither party had any risk of loosing or gaining any money from this source. When “A” and “B” agree to the above proposition, each party becomes subject to a new risk of loosing money. Moreover, neither “A” nor “B” has any insurable interest on the property of “C”. However, if an insurance contract has to be effected it is only “C” (who can insure) to the extent of loss (up to agreed value) against a fixed premium. “C” in this case in fact has exchanged a large uncertain loss for a small but certain loss called the premium.

Although, insurance as being practiced in the modern world cannot be termed as gambling, this cannot be called also Islamic, simply because it is not gambling. However, insurance as a device to combat loss can rightly be used in an Islamic Society by way of applying the basic principles of insurance and eliminating the forbidden practices.

Principles of Insurance Contract

Insurance is affected by means of a legal contract and must meet the general requirements of contract. Thus the insurance contract must not be against public policy, must be enacted by parties with legal capacity to contract, must be affected with a meeting of the minds of the parties and must be supported by a consideration. Insurance is a contract of adhesion and any ambiguities are construed against the insurer. The following legal doctrines are vital to the understanding of insurance contract.

Insurable Interest: A fundamental legal principle underlying all insurance contracts is the principle of insurable interest. This means insurance is operative only in respect of the interest of the insured in the event of property concerned and it is this interest that is the subject matter of insurance contract. It means it is not the bricks and materials used in building which is the subject matter of insurance. The subject matter of insurance is the legally recognized relationship of the owner of the building whereby he will suffer loss if the building is caught in fire.  This is essential; otherwise an individual would claim indemnification, even when he had not suffered any loss. The doctrine of insurable interest is also necessary to prevent insurance from becoming gambling.

Principle of Indemnity: The principle of indemnity ensures that a person does not get more than his actual loss, in the event of damage caused by an insured peril. It is important to note that only the contracts of property and liability insurance is subjected to this doctrine. Life insurance, health insurance and personal accident insurance policies are not contracts of indemnity (as no money payment can actually indemnify for loss of life or for bodily injury to the insured).

There are several ways by which an insured can be indemnified i.e. by cash payment, repair, replacement and reinstatement.  In every instance the onus of proving that that the loss was caused by an insured peril rests upon the insured. The onus of proving that the loss was caused by other than in insured peril rests upon the insurer.

Without application of this principle, the insured would be tempted to make profit out of the happening of loss. There would be a tendency in the direction of over insurance. There are, however, some exceptions to the application of this principle in property insurance. For example, in marine insurance, for commercial convenience, it is customary to issue “value” policies i.e. the insured value is mutually agreed between the insured and the insurer. In the event of loss, the indemnity is measured in terms of the value fixed by the policy.

Principle of Subrogation: This principle states that the insurer, if and when indemnifies the insured, is entitled to recover from third party liable for the loss. One of the important reasons for this doctrine is to reinforce the principle of indemnity i.e. to prevent the insurer from collecting more than his actual loss. Another reason for subrogation is to hold premiums below what they would otherwise be. This, however, does not allow the insurer to lodge claim against the insured, even if the insured is negligent. The principle of subrogation also does not apply to personal accident and life policies.

Principle of Utmost Good Faith: This principle imposes a higher standard of honesty on parties to an insurance contract. The proposer must disclose before the contract is concluded all material facts, which he knows or ought to know. Failure to make such disclosure renders the contract avoidable at the insurers option. It is, important to note that avoiding the contract does not follow unless the misrepresentation is material to the risk. It is generally held that even an innocent misrepresentation of a material fact is no defense to the insured, if the insurer elects to avoid the contract. The insurer, however, in good faith pay the claim even if there is breach, and a breach of warranty may also be waived by the insurers. However, unless it is waived, a warranty must be complied with strictly and literally. It makes no difference whether the breach of warranty is material or immaterial, fraudulent or innocent.

TYPES OF GENERAL INSURANCE POLICIES

Marine Insurance: Marine policies relate to three areas of risk:  the hull, the cargo and the freight.  The risks against which these items may be insured are “perils of the sea,” fire, theft, collision as well as a wide range of other perils. Cargo is usually insured on a warehouse (of departure) to warehouse (of arrival) basis and frequently covered against "all risks."

Aviation Insurance: Most policies are issued on an "all risks" basis subject to certain restrictions. The buyers of these policies are the large commercial airlines, the corporate or business aircraft owners, private owners and  flying clubs. Usually a comprehensive policy is issued covering the aircraft itself (the hull), the liabilities of passengers and liabilities to others.

Fire Insurance:  A standard fire policy is used for almost all business insurance, the basic intention of the fire policy is to provide compensation to the insured person in the event of there being damage to the property insured. The standard fire policy covers damage to property caused by fire, lightning or explosion, where this explosion is brought about by gas or boilers used for domestic purposes.

This is limited in its scope as property can be damaged in other ways, and to meet this need a number of extra perils, known as special perils, can be added on to the basic policy. These perils can include:

»                   Storm, tempest or flood

»                   burst pipes

»                   earthquake

»                   aircraft

Accident Insurance: Personal Accident Insurance - The intention of the basic policy is to provide compensation in the event of an accident causing death or injury. What are termed "capital sums," is paid in the event of death or certain specified injuries, such as loss of limbs or sight as may be defined in the policy. The policy is usually extended to include a weekly benefit up to 104 weeks or more for compensation if the insured is temporarily totally disabled due to an accident and a reduced weekly benefit if he is temporarily only partially disabled from carrying out his normal duties. In the event of permanent total disablement (other than loss of eyes or limbs) an annuity is paid. Practice varies among insurers, some of whom pay a lump sum.

Sickness Insurance - Personal accident cover can be extended to provide a weekly benefit for an agreed upon period which may be restricted to 52 weeks, in the event the insured is temporarily totally disabled from engaging in his usual occupation due to sickness.

Engineering Insurance: The cover is intended to provide compensation to the insured in the event of the insured plant being damaged by some extraneous cause or its own breakdown.

Engineering insurers provide an inspection service on a wide range of engineering plants and this is a service much sought after by industry. Engineering covers can be summarized thus:

a)                  damage to or breakdown of specific items of plant and machinery

b)                  an inspection service of those items

c)                   cost of repair of own surrounding property due to (a)

d)                  legal liability for injury caused by (a)

e)                  legal liability for damage to property of other caused by (a).

Theft Insurance: Theft insurance was first introduced towards the end of the nineteenth century and was originally called "burglary insurance." Insurance companies included in their policies a phrase to the effect that theft, within the meaning of the policy, had to involve force and violence either in breaking in to or out of the premises of the insured for cover to apply.

Motor Insurance: The minimum requirement by law is to provide insurance in respect of legal liability to pay damages arising out of injury caused to any person. A policy for this risk only is available and is termed as an "Act Only" policy. A “'Third Party Only'” policy would satisfy the minimum legal requirements and in addition would include cover for legal liability where damage was caused to some other person's property. The most common form of cover is the “'Comprehensive Policy”' which adds accidental loss of or damage to the vehicle to the third party, fire and theft cover.

Miscellaneous Insurance

Money insurance - The policy provides compensation to the insured in the event of money being stolen either from his business premises, his home or while it is being carried to or from the bank.

Glass insurance - Accidental damage to glass, mainly plate glass windows but also glass doors and shelves, is covered by the Glass Insurance Policy. It is also possible to include damage to the shop front and the contents of the window.

TYPES OF LIFE INSURANCE POLICY

Life assurance contracts available are many and the basis of all these policies can be found under the following headings :

Terms Insurance: This is the simplest and oldest form of insurance and provides for payment of the sum assured on death, provided death occurs within a specified term. Should the life assured survive to the end of the term then the cover ceases and no money is payable. This is a very cheap form of cover and is suitable, for a young married man who wants to provide a reasonable sum for his wife in the event of his death. It can also be used for a variety of specific purposes such as business journeys.

Whole Life Insurance: The chosen sum assured is payable on the death of the assured whenever it occurs. Premiums are payable throughout the life of the assured until retirement of the assured. Although premiums may cease at, say, age sixty, the policy is still in force.  Should the person die at age seventy-five, the policy would provide the benefits for his widow or family.

Endowment Insurance: The chosen sum assured is payable at the end of a given term of years or upon earlier death. These contracts are taken out as savings plans for the future with the added attraction of life cover.  Endowment contracts will always be popular because each proposer earnestly hopes that he will live to the end of the term and spend the proceeds himself.

Annuities: When a person has a reasonably large sum of money and wants to provide an income for himself after he retires, or at some other time, he can approach a life assurance company and purchase an annuity. The annuity may start at once, when it is called an immediate annuity, or may start at some date in the future (a deferred annuity). Regardless of when it starts it can take various forms. It may provide an annuity for the life of the person, the annuitant, or it may be payable irrespective of death for a certain period, as in the case of the "annuity certain." The guaranteed annuity is similar in that it provides the annuity for a guaranteed period and thereafter until the annuitant dies.

Pension Schemes: These schemes are designed to provide an income at retirement. So far as insurers are concerned they may be asked to arrange a scheme, rather than a firm doing all the work itself. This involves collecting the premiums, investing them and paying pensions to retired people. Many schemes are endowment policies with group life insurance cover to provide benefits, should the death of a member occur before retirement age, but there are different ways in which this can be done.

INSURANCE IN AN ISLAMIC FRAMEWORK

Insurance is a socio-economic institution that reduces risk both to society and to individuals. This accomplished by combining, under one management, a large group of objectives so that the aggregate loss to which society is subject become predictable. Insurance has scientific basis and is effected by legal contract, under which the insurer for consideration promises to reimburse the insured for any loss suffered during the tenure of the contract.

There are many social and economic value of insurance, but the greatest value lies in the benefits following from the reduction of risk in society. Insurance has the advantage as a device to handle risk and, therefore, it is necessary that its services be extended in order to bring about the greatest economic advantage to a given society. In order to establish the validity of this point we must have clear concept about the socio-economic objectives of an Islamic Society.

Belief in Allah is central in the Islamic concept of society. This is the organizing force without which life losses it’s full meaning. Belief in a supernatural power reduces man's vanity and despair. Belief in one Allah does not mean that the individuals in the society are just the dolls in the hand of the Almighty. In fact, Islam fosters initiative and responsibility. The Quran insistently and consistently reminds people that they are judged on