TAKAFUL IN TANZANIA: WHERE WE COME FROM AND WHERE WE ARE-PART 1

Takaful (Islamic Insurance) has been established in its modern form for more than 28 years and firms that offer Shari’ah-compliant insurance protection have grown significantly in both number and scale. Takaful contributions (premiums) are expected to increase in volume substantially over the next decade.

What is Takaful?

Islamic insurance or takaful is a concept of mutual cooperation to guarantee mutual protection of the members. Takaful is derived from the Arabic word kafalah, which is a pact that guarantees individuals in a group against loss or damage sustained by anyone of them. According to Takaful Act of Malaysia 1984: “a scheme based on brotherhood, solidarity and mutual assistance which provides for mutual financial aid and assistance to the participants in case of need whereby the participants mutually agree to contribute for that purpose”. According to AAOIFI Sharia standard no 26 provides "is an agreement between persons who are exposed to risks to protect themselves against harms arising from the risks by paying contributions on the basis of 'commitment to donate' (iltizam bi al tabarru')." The Islamic Financial Services Board and International Association of Insurance Supervisors gives the following descrition "Takaful is the Islamic counterpart of conventional insurance, and exists in both life (family) and general forms. It is based on the concept of mutual solidarity and a typical Takaful undertaking will consists of a two tier structure that is hybrid of a mutual and commercial form of company."


The development of takaful in modern times was initially undertaken in Sudan in 1979 and Malaysia in 1984. As the result of the 1985 fiqh Academy ruling declaring that conventional insurance was haram (forbidden), while insurance based on cooperative principles, sharia compliance, and charitable donations are acceptable.

The performance of Islamic insurance widely known Takaful has showed a remarkable growth from time to time. It can be seen by, a lot of Takaful operators in the present day and of course the average growth rate, it is 20% per year currently.

Why Takaful and not conventional Insurance.

There are two or three reasons.

First and foremost, incompatible with Sharia rules and principles.

Conventional insurance suffers from fundamental problems in its modus operandi, mainly due to occurance of Sharia non-compliant elements i.e. Gharar (uncertainty), Riba (Interest) and Maysir (gambling).

Uncertainty (Gharar).
The word carries a wide range of negative connotations such as deception, risk, hazard, uncertainty, ignorance etc.Any transaction entered into should be free from excessive uncertainty. The purpose of this prohibition is to avoid fraud, injustice and exploitation. In a conventional insurance, uncertainty arises when insured pays a premium but does not know whether he is going to make a clam in the future. And the amount of financial benefit to be received is not known as well. Similarly, the insurer does not know whether he is going to be called upon to pay claims under the policy, nor the amount to be paid to the insured.

Gambling (Maisir).
It means taking risk that is created by the contract itself (contract risk as opposed to trade / commercial risk).Gambling is obviously not permissible under Islamic law. In a game of gambling, one party is always hoping for a gain as a cost of loosing for another party. In the context of insurance, the policyholder hopes (bet) to gain a large sum from his small amount of contribution. What the policyholder actually hopes is that the claim will exceed his contribution. In this case, the company would probably be in deficit. However, the policyholder would loss the money paid for premium if the insured event does not occur. Here, the gambling is playing its role. When the policyholder does not make any claim during the period, the insurance operator may obtain all the profit at the expense of the policyholders.

Interest (Riba)
It means every excess in return of which the no reward or equivalent counter value is paid. An insurance contract wherein the policyholder expects to obtain a fix amount of profit that is greater than what he has contributed is considered as riba. on the other hand, the occurance of riba on conventional insurance is usually through the investment of premiums payments in interest bearing instruments such as Treasury bills or Term deposits.

Conventional insurers will often fail all of the prohibitions noted above in addition to having non-compliant product design and investments in prohibited industries.

Second, the problem of moral hazard.

Moral hazard refers to the notion that individuals will make different choices when they are covered by an insurance policy than when they are not (Ashley Gray, 2006). Moral hazard is a result of asymmetric information; it exists when a party with superior information alters his behavior in such a way that benefits him while imposing costs on those with inferior information (Ashley Gray, 2006). In the case of medical insurance (which has an increasing popularity in Tanzania nowadays) for example, cecause the insured’s health care is theoretically being paid by a third party (insurance company), he has an incentive to use health care less economically. It is worthy to quote Ashely Gray in full here to describe the moral hazard problem "There are two primary and widely-discussed types of moral hazard resulting from consumers’ actions and behaviors. First, insurance may discourage fully insured consumers to take preventative measures. Insured individuals have less motivation to take care of themselves and lead healthy lifestyles in order to prevent the need of future health care... Second, insurance may encourage consumers to obtain medical care that is not necessary or crucial to his health. For example, this moral hazard occurs when an insured person spends an extra day in the hospital than is required or purchases some procedure that he would not otherwise have purchased. In both situations, health insurance creates a moral hazard problem because insured consumers tend to overuse medical services that, under uninsured circumstances, they would not have." Due to the moral hazard problem, this year National Health Insurance Company was forced to exclude treatment of certain types of diseases.

Though moral hazard problem may exists even in Islamic insurance, it is to a higher degree mitigated by the mode operandi of the takaful business which provides disincentive to policyholders to engage in such practices. This is due to the fact that under Takaful (mudharaba model) scheme, in case of revenue exceeds claims made, policy holders receive a share of surplus/income from the participant takaful fund at the end of the year. This means that, Takaful besides having built in mitigating of moral hazard risk, it is an economic venue that provide protection against a risk but also income to policy holders.

What is the basis and objectives of Takaful?

According to the Institute of Islamic Banking and Insurance, the objectives of Takaful is "to diversify the risk among the members. In a practical sense, the main difference in this area between conventional insurance and takaful is that in insurance the Risk is transferred to the insurer while in takaful the Risk is shared mutually by the members of the common Takaful Fund under the takaful scheme." In brief, takaful aims

1. Help protect the community from the negative impact of adverse circumstances.
2. Improve quality of life through the peace of mind that comes from security.
3. Save and invest money through a shared system that distributes profit on premiums (subscriptions/contributions) invested by policyholders on an annual basis.

The Sharia basis of takaful can be deduced from the holy Qur'an and Sunnah. In the Qur'an, Almighty says " Help (ta'awun) ye one another in righteousness and piety.."(5:2).

The Prophet pbuh also urges people to help one another to overcome hardship of others: "Whoesoever removes a worldy hardship from a believer, Allah will remove from him one of the hardships of the hereafter."

In addition to above, the Prophet pbuh recommended for people to take certain precautions or strategies to mitigate or reduce risk. The Prophet pbuh notice a Bedouin leaving a camel and asked him " why don't you tie down your camel?" The Bedouin replied " I put my trust to Allah." The Prophet said, "Tie your camel first, then put your trust in Allah." This Hadith teaches us to take measures to safeguard our properties against risk of loss.

Finally, there is also a legal maxim that is relevant to takaful, which reads; "ad darar yuzal" meaning "damage or harm is removed" The maxim entails that once any damage occurred, efforts must be made to remove it. In this sense, takaful can be considered as an effort to remove damage or harm as and when it occurs, through the payment of compensation or coverage to the victim or his family.

Differences between takaful and conventional insurance.

According to Jacky Lim and others, these are the main points of different between takaful and conventional insurance:

1.Conventional insurance is a buy-sell (sale) contract in which the insurance company offers and sells protection and the participants (policyholders) accepts and buys at a certain price.The contract under takaful is usually involves the concepts of tabarru, mudaraba and wakala.

2.Conventional insurance accepts the transfer of risk from the insured against the price i.e premium. In Islamic insurance, the
members share all risks mutually and no transfer of risk is involved.Participants pooling their contributions essentially own the takaful fund and the Takaful Operator acts like a trustee of that pool to manage the business professionally with insurance know-how and provide the resources for doing so. The participants are the insured and the insurers in the first instance. The risk is
therefore borne by the participants collectively and they share in any surplus or loss from the pool.

3.Conventional insurance is based on profit-motive and its goal is to maximize revenue to shareholder. Islamic insurance, in contrast, is based on the motive of community welfare and protection. The nature of business is non-profit oriented though the Shari’ah upholds profit incentives from business ventures provided these are achieved by ethical ways and means for the overall benefit of society and the environment without undue excesses and exploitations.

4.In case of conventional insurance, when there is no claim during the period agreed, the policyholder will lose his premium that has been paid to the insurer. In Islamic insurance, however, when there is no claim being made during the period agreed, the underwriting surplus is given back to the policyholder, or donated to charity.

5.In conventional insurance the investment of premiums is completely at the judgment of the insurer with no involvement by policyholder. As such investment usually involves prohibited elements of riba and maisir. In contrast, the takaful contract specifies how and where the premiums would be invested. Usually, the takaful operator will invest the premiums in shari’ah compliant areas.

6.Conventional system of insurance is subject to exploitation. For example it is possible to charge a high premium (especially in monopolistic situations) and full benefit of such over-pricing goes to the company. The takaful system has a builtin mechanism to counter such over-pricing through its feature of profit sharing. No matter what premium is charged, if the overall results are good, any surplus goes back to the participants in proportion to their contributions.

7. The Islamic insurance company has an additional obligation to pay annual zakat while in conventional insurance, there is no such obligation.


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