Conventional and Islamic Insurance - Literature review Example

Conventional and Islamic Insurance Conventional and Islamic Insurance Before elaborating the differences that exist between ical and Islamic insurance, it is necessary to understand the insurance concept and the projections of sharia scholars concerning it. It is also necessary to comprehend the conceptual frameworks for both conventional and mutual insurance before determining the striking variations in their methods of operation. Insurance gives a way that helps individuals to transfer uncertainties to the insurer for exchange of premiums (Alhumoudi 2013, p. 23). During the exchange, the insurer promises the insured that they will compensate them in the event of the occurrence of the insured risks. The convention helps individuals or firms to exchange of uncertainties of financial losses with the certainty of the premiums they pay. Fixed premiums assure the insured that that they will not pay more at the end of the year. The service of providing the certainties for the premiums paid gives individuals to budget confidently for their needs. For this case, the system offers a method of financial security in modern corporate undertakings. Taking precautionary measures or ikhtiar in the hope that the action will be beneficial in the events of danger and associated consequences is an act that is in line with the teachings of Islam. The Holy Quran gives the account of the story of Prophet Youssef concerning how he filled silos after seven years of a bumper harvest as a precaution for seven years of hunger. This action means that Muslims have the religious obligation to work hard as a way of avoiding ill luck and the consequences of unpreparedness. One such means that prepares individuals to meet uncertainties of life is insurance policing. For this case, insurance does not have contradictory approaches to the teachings of Islam. The concept strengthens on religious ground because it permits pooling of resources in order to give assistance to the needy. However, basing on the latter notion, there are arguments that the origin of modern insurance is blood money of the Arab trial custom (Hussain & Pasha 2011, p. 25). This wok attempts to elaborate the principles of conventional and Islamic insurance. Consequently, the work will explain the two forms of insurance and their underlying principles of operation. The rationale for such processes is to determine the differences and similarities between mutual, conventional, and takaful insurance contracts (Oguz 2013, p. 34). Money Exchanged For Money Sharia scholars consider insurance contacts as being the exchange of money for money. Conventionally, the insured exchanges their premiums for the hope that they will receive monetary compensation in the event of an occurrence of insured risks (Hussain & Pasha 2011, p. 25). For this case, money is the center stage of all insurance contracts, which makes insurance not only an Islamic concern, but also an issue of the western nations. In this context, the concept of exchanging money for money gives insurance the following definition: A contract in which the insurer, in return for payable premium, assumes to pay the Insured money or its equivalent upon the happening of a prospected event contrary to the financial interest of the Insured. The exchange of money for money is not a bad action if there are no variations in the amounts and time involved. In case of variations in the aspects of the contract, they result in the problem of riba buyu (Oguz 2013, p. 45). Another problem that results from insurance contracts is the fact that at times there is no compensation because of the failure of the insured risks to occur. The latter problem arises in other problems called gharar and maisir respectively. As such, the existence of the three concepts is cause of the objection that most sharia scholars have concerning insurance contracts. Insurance Business and Its Conflict with Islam Islam does not prohibit contracts or object trade just for the sake of it, but it seeks to ensure fair play and justice concerning all dealings between the concerned parties. The religion prohibits only those events that may result in the exploitation of others or those that the sharia considers unjust. There are three prohibited terms related to insurance contracts. The first one is Gharar, which means uncertainty, Maisir, which means gambling and Riba, which means usury (Oguz 2013, p. 35). Takaful: An Insurance Instrument for the Muslims The concept of Takaful evolved from personal common interest in the industrial period of the early 1900s. Insurance contracts of the world cover only about eighty million people out of the 2.5 billion poor people of the world. In addition, there is little knowledge concerning insurance among the poor in the world (Alhumoudi 2013, p. 45). As such, the Muslims have a specialized banking system that works on principles of Islamic sharia and those that seek to avoid the three mentioned problems. Takaful is a word of the Arabic origin developed from the verb Kafal, which means taking care of one another or guaranteeing each other. The scheme requires that participants or members of in the group jointly agree to guarantee themselves against damage or loss. The entire group agrees to indemnify an affected person or still offer help to them. Takaful, therefore, is legally binding to all the members. It requires that the members pay the agreed amount according to the outline of the contract. Therefore, Takaful is an Islamic system of insurance based on the principle of donation with origin from the teachings of Sunnah and the Quran. For instance, the Holy Quran instructs people to help one another in piety and righteousness, but not in sin and rancor. Takaful means mutual guarantee or simply guaranteeing one another in literal terms. The contract calls for a common pooling of resources as a way of enabling the group to pay for losses and damages that an individual could not afford singly. In this case, a group of individuals uses their resources to pay for larger events such as marriages, births, and other activities. It is a type of mutual insurance similar to the European and American cooperative schemes. The contract has its foundation on the concepts of cooperation in which the insurer is also the insured, which means they share in the profits or losses of the group. The existence of the contact is to spread risks and help to alleviate financial losses that may befall somebody. A fundamental concept of Islamic economic setup is to ensure equitable distribution of resources. Takaful is a system that encourages people to contribute money to help others mutually at times of need. The economic system is, therefore, one that combats pilling of wealth and its concentration to a few people in the society. The law of inheritance in the same Islamic concept requires that individuals distribute their wealth in the society through division of the estate of the deceased across a large number of beneficiaries. The system does not allow the benefiting of one heir at the expense of others in the society. The nominee of a family Takaful is only a trustee, but the policy money should benefit all heirs at equal rates. The scheme ensures sharing of financial responsibilities and helping each other among individuals. The system gives mutual financial support to the members of a given Takaful scheme. Methods of Operation of Takaful Members of a given scheme contribute to a common pool, in which they make both direct and indirect payments for all expenses and claims. In the event of a surplus, the members share equally while the same members contribute to make up for deficits. The scheme means a joint guarantee because it is an agreement among members of a society to ensure each other of financial stability. Every basic objective of the project is to make payments from a joint pool of resources. An independent body called Sharia supervisory body is in charge of overseeing the events of Takaful contracts. Takaful is, therefore, a mutual insurance method, which bases on the value of the people and the principle of donation. Conventional Insurance The term refers to an agreement by a policyholder to pay upon the completion of the agreed premiums as sum of money that will compensate their financial losses. The event that leads to the loss of economic status must have measurable elements of uncertainty (Wahab, Lewis & Hassan 2007, p. 380). The risk of the event may relate to the fact that as much as the event is bound to happen, its time of happening remains uncertain. Another element of uncertainty may be the fact that the cause of the events resulting in losses relates to accidents and may never happen. Islam does not accept modern conventional insurance contracts because of the idea that they exploit people. For example, life insurance entails the use of principles of uncertainty, gambling, and interests that conflict directly with Islamic sharia. Many conventional insurers invest and make profits from money, which conflicts with Takaful. In the same line of thought, Takaful is a system of insurance-based interest-free mechanisms. An entity of the latter mechanism ensures that both shareholders and the policyholders have ventures that do not charge any interest. Similarly, a bank that operates on Takaful principles should not run any business that charges interest on people. Methods of Operation of Conventional Insurance Conventional insurance has three basic operating principles. The first is the idea of risk, which drives individuals and parties involved in the contact towards entering the contracts (Wahab, Lewis & Hassan 2007, p. 380). Risks in this context are events that the insured and the insurer cannot predict concerning the timing of their happening. At the same time, a risk could be one that will only happen because of accidental causes. From such a perspective, it implies that the insured risks may not occur at all. However, the conventional insurance framework allows the insured and the insurer to weigh the effects of the risks using monetary terms as premiums. The compensation, in this case, will always be up to the limits of the paid premiums and the terms of the contract. Another operating principle is that of gambling (Archer, Abdel & Nienhaus 2009, p. 67). For this case, the involved parties do not have certainties concerning the happening of the insured risks. The costs of the compensation may not be equal to the premiums paid because the contracts target to indemnify a person’s financial status up to the extent of the damages caused by the occurred risks. The last concept is that of interest in which the insurance firms place their assets in operations that yield profits such as loans and bonds. Profits realized in the course of the operations belong to the insurance company because they run businesses that target to make profits. The policyholders, in this case, do not have a right of knowing the profits that the contract makes. The Differences between Conventional Insurance and Mutual Insurance This section of the paper addresses the conceptual differences between conventional and mutual insurance. The first concept is that mutual insurance involves a jointly owned guarantee system that gives possible contingency or indemnity for its members (Tolefat & Asutay 2013, p. 66). On the contrary, conventional insurance has its foundation based on compensation according to the premiums paid. It implies that mutual insurance has principles of taawun, trusteeship, solidarity, and brotherhood while conventional insurance targets to take material gains from others in the society. Another concept is that mutual insurance works on the concepts of tabarru and taawun. The participants agree mutually to guarantee and help each other through contributions from one another for mutual corporation sake. On the other hand, conventional insurance works on the principle of risk transfer where one party seeks personal protection on behalf of others. Another difference between the two insurance conventions is the fact that mutual insurance aims to bring equity to all the involved parties. The concept of the scheme is to give help to the policyholders in times of need. The concept does not target to make profits, but to ensure the well-being of the involved parties. In relation to the same notion, conventional insurance seeks to make profits for the businesses (Htay 2013, p. 100). Traditional insurance bases on the indemnity according to the terms of insurance and the amount of premiums. On the contrary, mutual insurance bases on the idea of cooperation in terms of restitution because members have equal rights and responsibilities. Another conceptual difference between the two insurance systems is the mutual insurance operates based on equal spread of risks and profits among the insured. On the other hand, the conventional insurance frameworks focus on benefiting individuals and organizations according to their contribution. In the event of losses, the insured benefits from indemnity while the insurer suffers because of the compensation process. Therefore, it implies that conventional insurance ensures that the insured has a guaranteed indemnity status at all times. Differences between Conventional Insurance and Takaful After an analysis of the operating principles of the two methods of insurance, it is convenient to establish the differences between them. Conventional insurance is an institution of business that operates on contract principle (Archer, Abdel & Nienhaus 2009, p. 67). The terms of the contract dictate the direction of both the insured and the insurer. On the contrary, Takaful is a mutual or cooperative institution founded on mutual contract principles. Another difference is that conventional insurance offers transfer of intermediate financial risks from one party to another as the central service. In contrast, takaful bases on the principle of donation where there is no shifting of risks because both the insured and the insurer share the same chances of risks. The primary motivation of conventional insurance is to make profits from the operations of the insurance company. In this case, case of takaful shareholders of a corporation does not have any rights to participate in profits that the company generates. The last difference is the policyholders of a conventional insurance contract do not have the right to vote on the decisions of their business as well as accessing the financial records. On the other hand, Takaful provides equal chances for all people in the group to have such privileges as the ones denied in conventional insurance (Iqbal 2005, p. 56). Similarities between Takaful and Conventional Insurance This analysis has analyzed the fundamental operating principles of both Takaful and conventional insurance. Therefore, the similarity between them is the fact that both of them provide mechanisms that guarantee the insured of their financial stability (Swartz & Coetzer 2010, p. 334). Such a factor means that the two systems provide mechanisms that give an assurance that occurrence of risks will not interrupt business. Another similarity is the idea that both systems have guiding factors that dictate the actions of both the insured and the insurer. For instance, takaful is under the watch of a regulatory body called Sharia Supervisory Body while conventional insurance has guidelines from the terms of contract. The two systems also borrow from the concept of pooling of risks though in different versions. For instance, in takaful, the creation of donations from members while conventional contracts pool risks from their grouping basing on their characteristics. Essentially, both insurance mechanisms have principles that guide them consequently dictate the outcome. Bibliography Alhumoudi, Y 2013, Islamic insurance Takaful and its applications in Saudi Arabia (Doctoral dissertation). Archer, S., Abdel Karim, R. A & Nienhaus, V 2009, Takaful Islamic insurance concepts and regulatory issues, Singapore, John Wiley & Sons (Asia) Ltd. Hassan, K., & Mahlknecht, M 2011, Islamic capital markets: products and strategies, Chichester, West Sussex, U.K, Wiley. Htay, S. N. N 2013, Accounting, auditing and governance for Takaful operations, Singapore, Wiley. Hussain, M. M., & Pasha, A. T 2011, Conceptual and operational differences between general takaful and conventional insurance. Australian Journal of Business and Management Research, 1, 8, pp.23-28. Iqbal, M 2005, General Takaful Practice: Technical Approach to Eliminate Gharar (uncertainty), Maisir (gambling), and Riba(usury), Gema Insani. Oguz Gonulal, S 2013, Takaful and mutual insurance: alternative approaches to managing risks, Washington, D.C.: World Bank. Swartz, N. P., & Coetzer, P 2010, Takaful: An Islamic Insurance Instrument. Journal of Development and Agricultural Economics, 2, 10, pp.333-339. Tolefat, A. K., & Asutay, M 2013, Takaful Investment Portfolios a Study of the Composition of Takaful Funds in the GCC and Malaysia, New York, Wiley. Wahab, A. R. A., Lewis, M. K., & Hassan, M. K 2007, Islamic takaful: Business models, Shariah concerns, and proposed solutions, Thunderbird International Business Review, 49, 3, pp. 371-396. Read More