Insurance is a major component of a risk management strategy for private households. Unfortunately, one cannot insure against the occurrence of a loss or damage, but insurance helps to cope with its financial consequences. Additionally, insurance linked pension plans are important instruments to build up provisions for one’s old age. Personal risk management is getting increasingly important for a believing Muslim, too. The issue is that conventional insurance policies infringe Shari’ah law due to the following three reasons:

1.)   Insurance includes elements of interest (riba) as conventional insurers usually invest a large share of their capital in interest-bearing securities.

2.)   Insurance includes elements of uncertanty and speculation (gharar), because when an insurance contract is signed, one cannot know neither if and when a claim occurs nor what the amount of the claim would be. From an Islamic legal point of view, the subject matter of the contract is a claim. But as the claim doesn’t exist yet when the contract is signed, it must not be the subject matter of the contract.

3.)   Insurance includes elements of gambling (maysir). It’s prohibited in Islamic to sign a contract when both parties do already know in the beginning that one of them will win, the other one will lose – especially as it is not known who will be the winner and loser. Thus, a typical conventional whole life insurance policy is regarded as a bet on life and death and as such it is prohibited in Islamic law.

The Shari’ah-compliant alternative of conventional insurance is called Takaful. Due to the specific construction of a Takaful, the policyholders are at the same time the owners of the Takaful fund. Every premium is paid into the Takaful fund and any claims are paid out of it. The insurance company, in this case the so-called Takaful operator, is just the manager of this Takaful fund. This means that the participants (policyholders) of such a Takaful do insure themselves against possible losses, so there is no risk transfer from policyholders to insurance company like in conventional insurance. The Takaful operator does practically the same as an conventional insurance company: it advises its clients, it collects contributions (premiums), pays claims out of the Takaful funds, arranges for reinsurance, etc. With buying a Takaful policy, believing Muslims get same offering like in conventional insurance, but in a fully Shari’ah compliant way.