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Islamic Insurance: Takaful concept and outlook

By Ahmed Ali Alvi & Samer Hijazi
Posted: 20th July 2011 10:09

The need for Islamic Insurance:

The growth of conventional life and non-life insurance remains underdeveloped in the Muslim world. This is because conventional insurance incorporates several elements that are outlawed by the Shariah. For instance, it has an element of gharar, or uncertainty, embedded in the very design of its products. Moreover, as the insured person could benefit from a disproportionately large payout, or alternatively, may get no return at all from the payment of a stream of premiums, many insurance products are deemed to have an element of maysir, or gambling.  Also, the insurer would typically earn interest on its various investments as well, which means that conventional insurance has an element of riba.  Due to these features, as early as 1903, conventional life insurance was declared impermissible by a number of prominent Islamic scholars in the Arab world.  But it was only in 1985 that the Grand counsel of Islamic Scholars, confirmed that decision.

Every society has risk-management needs, and as such, the formal prohibition of conventional insurance accelerated the need for an Islamic alternative.  The need was especially felt in case of life insurance which fulfilled an important social role in providing protection against poverty, want and misfortune. Islamic scholars, therefore, approved and an alternate form of insurance based on collective security, cooperative principles and charity, laying the foundations for “Takaful”.

Concept of Takaful and models in use:

Takaful literally means “mutual guarantee” and was a social practice in Islamic culture to mitigate the burden of an individual by dividing it among fellow members.  To meet the broader risk-mitigation needs of Muslims, Takaful has evolved into a pact between a group of people who agree to indemnify each other collectively against loss or damage that any of them may suffer, out of a fund donated collectively.  Three business models between the Takaful fund operator and the participants are common in practice: mudharabah (profit and loss sharing) which is commonly used in Malaysia and Asia Pacific, wakala (where an agency contract with a performance fee replaces profit and loss sharing, as shown in Figure 1 below) and a third model (wakala-mudharabah) whereby wakala is adopted for underwriting activities and mudharaba for investment activities which are the predominant models in the Middle East.  More recently an additional model, waqf, has been developed which is in effect a form of trust.

Takaful is not only conceptually different from conventional insurance, but differences manifest in the products Takaful operators offer and the way they invest their premia as compared to their conventional counterparts as well.  In terms of product portfolio, Takaful companies may not insure prohibited activities (e.g. alcohol/armaments shipments) or ‘prohibited’ counterparties (e.g. banks) while, in theory, the motivation is not profit-maximization but mutual support.  In terms of investment portfolio, conventional insurance companies invest their premia in a range of interest-bearing and profit-generating securities, whereas Takaful companies may invest only in Shariah compliant concerns. In addition, both the product portfolio and the investment portfolio of Takaful companies are subject to the oversight of a committee of Sharia’a scholars.

Outlook of Takaful:

Takaful has experienced a rapid growth in recent years.  From 2006 to 2010, the industry worth almost doubled from US$5.9bn to US$11.1bn and the number of dedicated Takaful insurance companies mushroomed from 138 to 195(1).  This growth in Takaful, however, has been primarily restricted to increased penetration in existing Muslim markets i.e. in the GCC, Far-east and Africa.  In the Western economies, Takaful remains very much at the formative stage.  This is primarily because of existing impediments at the regulatory and technical fronts coupled with resource constraints.

At the regulatory front, a key challenge is the lack of standardization in the industry.  Regional variations exist in practices and in the choice of Takaful models.  However, there is a global trend towards the Wakala model, which has also been approved by AAOIFI.  Having a global standard for Takaful models, however, would greatly facilitate the development of this industry.  There are a lot of technical challenges faced as well, particularly around valuation and risk-management.  For instance, the appropriate treatment of Qard Hassan or the interest free benevolent loan by the Takaful operator in the event of a fund deficit is still much debated.  Such issues are coupled with a shortage of Shariah scholars with experience and knowledge of both Islamic jurisprudence and Takaful.  The need for each Takaful operator to have a Shariah Supervisory Board with three or more such scholars means that these Shariah scholars sit on multiple boards and this increases the costs of Shariah compliance for each Takaful operator.  Moreover, there are no specialist Takaful professionals and most Takaful operators train conventional insurance professionals in the Shariah aspects of Takaful.  This has inhibited innovation in the Takaful industry.

With a standardization in Takaful practices and models, convergence of Shariah interpretations across regions, availability of skilled Takaful professionals and Shariah scholars, and overcoming of the various technical challenges around valuation and risk management, growth in the Takaful industry could surely be expected to mimic the success of Islamic Banking which is now seen as a mainstream offering. Though the industry is headed in the right direction and hurdles are gradually being overcome, resolution of many key issues still seems a long way off.  For the time being, it is looked at as a niche alternative to the cheaper mainstream products.

Despite the challenges and constraints, Takaful’s growth potential remains undeniably high.  The mutual guarantee offered by Takaful is underpinned by the same ethical and transparency guidelines which govern Islamic banking.  As proven in the case of Islamic banking, Takaful’s ethical propositions may attract consumers well beyond the Muslim communities.


KPMG has long been supporting the industry by advising and working to meet the needs of banks, takaful providers and other Islamic financial institutions (IFIs) across national boundaries. KPMG maintains a dedicated Islamic Finance Group (IFG) which comprises of a global network of professionals with in-depth knowledge of Islamic finance and provides practical, value added assistance to KPMG firms’ clients across a range of issues. Members of the team are based in KPMG’s three operating regions: EMA (Europe, Middle East and Africa), Asia Pacific and the Americas with centres of excellence based in Bahrain, Malaysia and the UK. KPMG firms have received accolades as the advisors of choice for the Islamic finance industry on multiple occasions, including the award, “Best Islamic Assurance and Advisory Services Provider” in Euromoney’s Islamic Finance Awards for four years in a row.  Mr Ali Alvi can be contacted on +44 207 311 8098 or by email at  Mr Hijazi can be contacted on +44 207 694 2807 or by email at

 (1) World Islamic Insurance Directory, 3rd and 5th edition, published jointly by Takaful Re (TRL) and MiddleEast Insurance Review (MIR)


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