Takaful is a relatively new insurance product that is marketed as an Islamic alternative to conventional insurance and is often referred to as “Islamic” Insurance.

So how does Takaful work? Here's how the site Islamic-banking.com explains it:
"All participants (policyholders) agree to guarantee each other and, instead of paying premiums, they make contributions to a mutual fund or pool. The pool of collected contributions creates the Takaful fund."

Since this blog is called Practical Islamic Finance, I didn't like this answer. I wanted to know with more clarity what this meant for customers seeking insurance. What differences would they experience if they chose to use Takaful as opposed to conventional insurance? Put differently, I wanted to know what practical value Takaful offers.

Why Takaful Is a Better Insurance Product Than Conventional Insurance

I spent hours online trying to find any quality literature that could explain why Takaful is a better insurance product than conventional insurance. There's a lot of nonsense about how Takaful is done in the spirit of charity and donation as opposed to conventional insurance which is only focused on profits. The response to this is that in both cases customers are seeking insurance and Takaful operators wouldn't be in business if they weren't aiming to generate profits. Moreover, when does Islam frown upon profits in the first place?!?

You'll also see a lot of diagrams desperately trying to explain how participants' funds are separated from shareholders' funds in Takaful whereas they are all lumped together in conventional insurance. The missing element in this distinction is an explanation of why this matters and isn't a complete waste of time. It sure seems like a waste of time to me.

There's obviously a difference in that Takaful companies only invest their money in Sharia-compliant products but this kind of goes without saying when you're talking about any company that claims to be "Islamic". Additionally, if a company only invests its money in Sharia-compliant products this doesn't mean it is offering a new or improved product. If Toyota decides to invest all its cash reserves in Sharia-compliant products this has no effect on the quality of the cars it produces.

There's also a commonly repeated claim that Takaful operators share surpluses with the insured but conventional insurers do not. This is false. Conventional insurance companies normally operate in highly competitive environments. So when they generate substantial surpluses competitors enter the market offering the same service at a lower cost forcing the company generating surpluses to lower its prices. This dynamic essentially has the effect of passing surpluses to the insured in the form of lower premiums. There are also policies that many insurance companies adopt which are designed to include the insured in surpluses such as rewarding safe drivers with partial refunds of their premiums. Yes, much of the profit is taken by the insurance company but the same is true for Takaful companies, so nothing really different.

There is one practical difference between Takaful and conventional insurance which I was able to find on a Takaful company's website:
"In case of the deficit of a Participants’ Takaful Fund, the Takaful operator (Wakeel) provides free interest [interest-free] loan (QardHasan) to the Participants."

This means that from the customer’s point of view, Takaful is an inferior insurance product compared to conventional insurance! This is because when you purchase conventional insurance the amount of coverage you’re entitled to isn’t left to chance. However, with Takaful insurance, the coverage the customer ultimately receives depends on what is left in the Takaful fund when they make their claim.

Now we know that the prophet Muhammad (ﷺ) prohibited transactions where the object of sale is not adequately defined, this is known in Arabic as Al-Gharar. As an example, the Prophet (ﷺ) forbade the sale of fish in the sea. This is because key attributes of the object of sale, which is the fish, are unknown before they are caught. Such as the weight, the type and the count of the fish. This same ambiguity regarding what is being bought is present in Takaful. When someone purchases Takaful insurance, the amount and period of protection they’re buying isn’t known at the time of purchase because it depends on what other people have already claimed from the Takaful fund before the customer makes their claim.

So, it’s clear that Takaful involves major ambiguity surrounding key attributes of the object of sale, which the Prophet (ﷺ) prohibited. This prohibition is unaffected by the consent of the buyer, just like gambling and interest.
Further, the Gharar in Takaful not only opens the door for a dispute between customers and the Takaful company but also invites disputes between Takaful customers among themselves.

Let’s say Adam and Kareem are making the same contributions to a Takaful fund meant to cover damages from car accidents. Later, both Adam and Kareem get in an accident. Adam files his claim one day before Kareem does. When Adam files his claim there is money left in the Takaful fund to cover his damages and he gets cash, no strings attached. When Kareem files his claim, there is nothing left in the Takaful fund and he is either given nothing or given a loan (as some Takaful operators do). How is this going to make Kareem feel about Adam who took the last of the money in the fund? It seems very likely that this arrangement will create feelings of enmity and ill will between Kareem and Adam and between Kareem and the Takaful operator. This is directly opposed to what is known as "Maqasid Al-Shariah" [the goals of the teachings of the Islamic faith] relating to the development of communal bonds between people.

Proponents of Takaful justify this Gharar by saying Takaful customers are making "donations" not purchasing a service!

I’m sorry but payments made by Takaful customers are not donations, even if customers agree to call them that.

A true donation is by definition something given with no expectation of return. If I make a donation to my mosque, this doesn’t entitle me to make a claim against any assets of the mosque. Additionally, the money I donate to the mosque is not used strictly in service of other people who made donations.

But when Takaful customers make their payments they are purchasing the right to make claims against the money in the Takaful fund. Further, the takaful fund only covers those who contribute to it.

So it can’t be a charity nor can the payments made into the fund be considered donations. Again, even if customers agree to call it that. If I agree to buy a lottery ticket and let’s say I do it in the spirit of brotherhood and I consider my purchase a charitable contribution because the proceeds of the lottery are going to help schools, this does not make my activity not gambling and permissible in Islam! Gambling is prohibited in Islam regardless of the spirit with which you engage in your gambling, the same is true with Al-Gharar.

Further, I am inclined to believe that Takaful companies know that their customers DON’T consider their payments to be donations on account that when they advertise Takaful they advertise the benefits it offers customers, they don’t talk about the virtue of charity or the rewards that whosoever gives to charity will reap in the afterlife. You cannot advertise Takaful as a good insurance product and then when customers purchase your product call their payments a donation! I mean let’s call a spade a spade here.

Conclusion

In conclusion, I find that the arrangement known as Takaful, wherein a Takaful operator manages money collected from customers seeking insurance and does not commit to ensuring those customers in return for their contributions to the Takaful fund is an arrangement which involves major ambiguity regarding the object of sale which qualifies as Al-Gharar, and therefore is an arrangement which is at least highly discouraged in Islam, if not outright prohibited (Haram).

I can also say, with certainty, that conventional insurance adheres more closely to the principles of Sharia than Takaful does, because the object of sale in conventional insurance, which is an amount of protection, is clearly defined whereas it is left to chance in Takaful.
Basically, whoever invented Takaful 30 or 40 years ago, took conventional insurance infused it with Al-Gharar and then called the product "Islamic!"

Takaful is definitely not “Islamic” insurance and should never be referred to as such.
For customers, I would say: stay away from Takaful and use conventional insurance instead. For Takaful operators, I would say: if you're truly trying to do something Islamic, it is much more Islamic for you to simply offer conventional insurance and commit to only investing your customers’ premiums in Sharia-compliant products.