Mysteries of Takaful Revealed – Part 1

Fatimatul Zahra Binti Mustapha explains the basic fundamentals and the framework of a Takaful contract





The Takaful industry has in recent years exhibited excellent growth as reflected in the threefold increase in the total assets of takaful operators from RM1.9 billion in 2001 to RM6.5 billion in 2006. More significantly, in terms of net contributions, the Takaful industry has a record market growth of an average of 18.9% in the past three years, and is fast emerging as one of the key players in the Malaysian insurance industry.


In Malaysia, Takaful is governed by the Takaful Act 1984 (Act). Section 2 of the Act defines takaful as “a scheme based on brotherhood 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”.


In essence, it is a system in which a group of people commit themselves to provide reciprocal guarantees to each other within the group against certain loss or damage that might be inflicted upon any individual or group of individuals.


Part one of this article examines the basic fundamentals and the framework of Takaful contracts, where else, part two will contain an in-depth discussion on the various Takaful products in Malaysia and the future of the Takaful industry.




Insurance was unanimously declared “haram” (prohibited) at the Fiqh Academy Conference in Jeddah in December 1985. Muslim scholars opined that insurance contains elements contradictory to the teachings of Islam. The scholars identified at least three prohibited elements in insurance, among others “gharar”,maisir” and “riba”. It also contradicts the doctrine of “adil” (fairness/equity) and ‘ihsan’ (good virtue/good deed).


It is fundamental in Islam that the goods sold and purchased in every contract of sale must be identifiable and ascertainable as to its nature, character and value prior to the conclusion of the contract. Under conventional insurance, the product offered for sale by the insurers to the policyholders is contingent upon an event such as fire, accident or theft. Given that the occurrence of the insured event is one of chance and cannot be predetermined and identified until the occurrence of the insured event, conventional insurance contains the prohibited element of “gharar” (uncertainty) and hence prohibited in Islam.


“Gharar” may also lead to “maisir” (gambling) as the contract becomes uncertain. The policyholder under a conventional insurance scheme would only be indemnified upon the occurrence of the insured event. Such occurrence is unascertainable and depends on probability of it happening. Therefore, the situation is analogous to gambling, where the opportunity to win depends on probability.


In insurance, the element of “maisir” is present when a policyholder hopes to receive comparatively large sums from claims upon the payment of premium which are smaller. In addition to that, there is a high chance of the policyholder losing all the premiums paid when none of the insured event occurs. Eventually, the contract leads to a chanced transaction where the insurer’s profits or losses are dependant on the chance of misfortune occurring (underwriting result). Nevertheless, insurance per se is not gambling. As with the case of other banking businesses, investments by insurers are made primarily with a view to profit through interest.


“Riba” (usury) is “haram” in Islam and hence, any form of transaction involving interest is haram. Therefore, insurance is prohibited in Islam if investments of premiums are made in “riba” based ventures. The practice of imposing penalty for late payment is also perceived as “riba” alongside with interest imposed on policy loan. Moreover, the refund of premium in the event the insured event never occurs is not made based on pro-rata basis and therefore is unfair to policyholders. This contradicts the doctrine of “adil” or fairness.




In Takaful system, the contributions by each participant must be made with an intention of “tabarru” (donation) to avoid all uncertainties that go with conventional insurance contracts. Essentially, in Malaysia there are two types of Syariah contracts are undertaken by takaful operators, namely mudharabah and wakalah.


Mudharabah based contract

The essence of this type of contract specifies how the profit (surplus) from the operation of takaful managed by the takaful operator is to be shared in accordance with the principle of al-Mudharabah between the participants as provider of capital and the takaful operator as entrepreneur. The sharing of profit is to be mutually agreed between the contracting parties prior to entering into the contract. The element of uncertainty is eliminated through the incorporation of the concept of “tabarru”, whereby the participants agree to relinquish as “tabarru” certain proportion of his takaful instalments or contributions that he/she undertakes to pay, thus enabling him/her to fulfil his/her obligation of mutual help and joint guarantee should any of his/her fellow participants suffer a defined loss. These amounts are placed in a fund called the Participants’ Special Account (PSA). The sharing of profits or surplus that may emerge from the operation of takaful is made only after the obligation of assisting the fellow participants has been fulfilled. The takaful contract will clearly state how profit from the operation managed by the takaful operator will be shared between the participants and the takaful operator. It is important to note that the management or operating expenses is to be borned solely by the takaful operator. Takaful operator is not allowed to deduct the participants’ contributions to cover its operating costs. Therefore, under the Mudharabah contract, the income of the takaful operator can only be calculated at the end of the contract.



Wakalah based Contract

Wakalah contract is also premised on the concept of risk sharing among participants with a takaful operator earning a fee for services as an agent (wakil). The agent does not participate or share in any underwriting results as these surpluses belong to the participants. Similarly, any deficit in the takaful operations will be borned by the participants. Thus, under the Wakalah contract, the management or operating expenses of the Takaful operator can be charged to the PSA.




The Takaful industry is expanding at a very rapid rate and well placed to become a major player in the insurance industry. The concluding segment of this article which will appear in the next issue (Issue1/2007), will examine the various Takaful products in Malaysia and the future of the Takaful industry.


Table: Comparison between Takaful and Conventional Insurance





Takaful contract specifies from the outset how the profits from Takaful investments are to be shared between the operator and the participants.

This will be in accordance with the principle of Mudharabah and the share distribution could be in different ratios i.e. 5:5 or 6:4 or 7:3 etc. as agreed between the participants and the operator in the contract regardless of the amount of investment profit made during the year.

May offer bonus or profits in general terms only especially with profit policies, i.e., there is no exact specification with regard to profit-sharing in the contract.

The insurer may also decide to give or not to give bonus for any particular year depending on the result of the investment returns. The rate of bonus may vary from year to year and is based upon the discretion of the insurer.


In a life Takaful policy, if the risk occurs, the beneficiary has the right to claim the policy value from the Participant’s Special Account (PSA) besides the entire accumulated amount from the Participant’s Account (PA).

Nevertheless, under this category of policy, the claim of a participant who survives at the maturity of the policy is confined to the amount available in the PA.

Under the conventional insurance system, if the risk occurs, the beneficiary has the right to claim the whole amount stated in the policy.

However, if the risk does not occur, the insured may only claim the policy value at maturity together with interest, if any.


Participants own the Takaful funds which are managed by the operator. Participants give up individual rights to gain collective rights over the contribution and benefits.

Insurance is a buy-sell contract in which policies are sold and the policyholders are purchasers.


A company is known as an operator, which acts as a trustee, manager and also entrepreneur.

Relationship between the company and the policyholders is on a one-to-one basis.


Takaful practices are free from the elements of “riba” (usury) and other un-Islamic elements, but revolves around the elements of Mudharabah (Profit and Loss Sharing), Tabarru’ (Donation) and other Syariah justified elements.

Insurance practices involve “riba” (interest) and some other elements, which may not be justified under the Syariah principles.

Extra Risk Premiums

Generally, the premium rates imposed are fixed by the actuarial evaluation, and no one is discriminated by foreseeable extra risk. Hence, no one shall be required to pay extra premium over the agreed ones.

However, if a particular policyholder is considered to pose an undue strain on the mutual fund owing to his/her poor health, the policyholder may have to increase his proportion of al-Tabarru’ i.e. the contribution from his/her premium to the PSA. This means that the proportion of his PA would be lesser than it would generally have been.

Usually an extra premium is charged in addition to the normal amount against the policyholder where an extra risk is determined and higher than average mortality rates are foreseen.


The extra risk is foreseen normally against smokers and people with high risk occupations such as fire fighters, miners etc.



Funds belong to the participants on a collective basis and are managed by the operator for a legitimate consideration with regards to the services rendered.

Funds belong to the company.


No contractual guarantees given by the operator.

Joint indemnity between the participants is a prerequisite for participating in a Takaful scheme.

The company guarantees the benefits.


The funds are invested in interest free Syariah justified scheme.
The entire procedure must comply with the Syariah guidelines. Investment returns must not be driven by any unethical commercial activities.

The funds may be invested in an interest-based scheme.

They can also be invested in any scheme or project, which may not be supported by the Shariah discipline.


The entire operation aims at paving the way of brotherhood, solidarity and mutual cooperation.

The operation aims for commercial gains based on business principles.


The proportion of the share of profits is determined in the contract for as long as the policy is in force, but the amount itself will depend on the investment performance or returns each year.

In a life insurance policy, it does not mean that the insurer can arbitrarily choose to give the policyholders a share of profit at whatever amount they wish and whenever they like.


Regulations affecting Takaful are based on Divine sanctions (Quran and Hadith).

Secondary sources of Islamic Law.

Insurance law is regulated and developed based on the human thought, norms and cultures.

Regulatory Framework

Syariah justified statutory provisions.

Juristic opinions (“Fatwa”).

Decisions of the Syariah supervisory bodies.

Relevant Syariah-based area.


Case laws/judicial precedents.

Legal literature.




Source: An Opportunity for ICMIF Member to Provide Islamic Insurance (Takaful) Products by Dr. Mohd. Ma’sum Billah and Sabbir Patel.



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