Takaful

This is a first part of the series on Islamic finance.

Normal commercial insurance is not Islamic because
a. It is perceived as gambling or a game of chance. The insurance company issues the policy with the hope that it will make money and if the stated even occurs loses money.
b. It invests its surplus money in interest bearing instruments

Because of these reasons the Islamic world had come up with 2 very good insurance instruments.

• Mudharabah Model
• Wakalah Model

The essence of these models is that all the investors pool their money together and promise to pledge each other in case of death or financial distress. In a good year the corpus will have more money than it needs and hence would return them back to the policy holders. Hence creating a cooperative society which shares its risks by hedging them.

This is how the insurance started. A group of workers (esp. lumberjacks) setting aside a small sum to pay for the medical expenses in case of an accident at worksite. Most insurance companies issue policies worth many times more than their net worth. If the various models used by securitization experts can fail, so can the mortality predictions of the actuaries in insurance agencies. Monoline Insurance companies have failed; nobody knows the real net worth of the financial institutions. Hence it’s time for the insurance companies to return to the basics.

I could find a few Malaysian and Middle eastern firms issuing such policies for businesses, however I am yet to find a personal insurance policy in India following these principles. Its probably because of IRDA rules.