GIM9025 - Mutual insurance: Islamic takaful insurance arrangements

Takaful is an Arabic word meaning, roughly, ‘joint guarantee’, or ‘ourselves together’ and is the name generally applied to Islamic insurance. It thus has a highly mutual flavour about it. However, most of the structures actually employed result in an entitlement to surplus in favour of an ‘operator’, or potential distribution of assets on winding up to charitable causes rather than to members and it follows that they will not be mutual in the English and Scots law sense.

Takaful arrangements will need to be consistent with Islamic principles as interpreted by scholars. Usually a board of scholars is appointed to ensure this. Conventional contracts of insurance are generally unacceptable, because of the unpredictable nature (gharar) of the payments, and also because fund investment is not permitted in fixed income securities (usury, or riba) or in equities whose returns depend on unethical goods and services: for example, gambling (maisir), and forbidden (haram) goods such as tobacco and alcoholic drinks.

Common operating models are wakala, mudaraba, and a hybrid of the two. Under the wakala model, the operator’s profits will be fees from the takaful asset pool less any operating expenses. This would not destroy mutuality, but it is often part of the arrangements that a charitable distribution will be made on winding up. Furthermore, the arrangements generally involve a company with shareholders who control it according to their best interests, different from those of the contributors to the takaful pool as policyholders. This breaches the principle discussed at the end of GIM9020. Under mudaraba, a share of surplus will go to the operator in addition to a fee - a further breach of mutual principles. This is, however, not necessarily disadvantageous as the tendency for insurance companies to make underwriting losses and to rely on investment surpluses means that a mutual could well pay more tax - see GIM9050. This may not, however, be so in early years when the fund is being built up with the creation of a non-deductible equalisation element (see GIM7000+ for the rules on equalisation reserves). The underwriting profit may at that time be relatively larger.

The question of whether the arrangements amount to insurance at all is primarily for the Financial Services Authority. But it is likely that they will, and some takaful operators have received FSA authorisation. Legal analysis suggests that no essential elements of an insurance contract are fundamentally incompatible with Shari’a principles governing takaful, so it follows that takaful will or at least can be compatible with an insurance contract.

In most cases, therefore, takaful arrangements will fall to be treated as non-mutual insurance contracts and will attract the same treatment as other insurance contracts generally.