Why is conventional insurance not shariah-compliant?

Islamic insurance is a touchy subject among Muslims. Because conventional insurance is widely understood to be prohibited, the very idea of insurance has been conflated with the prohibition on conventional insurance; as a result, many Muslims think that insurance as a concept is prohibited by Islam completely. Some say that everything happens by the will of Allah and by insuring against them, one is trying to go against the will of Allah.

Such a position has not been confirmed by the words and actions of Prophet Muhammad (ﷺ) himself, who not only instructed Muslims to “tie your camel , put your trust in Allah,” but approved the practice of Aquilah, common in early Islamic societies where members of a tribe contributed to a joint fund used to .

In fact, there is no disagreement among scholars that the practice of preparing against known risks is permissible, the only prohibition is on the way insurance is practiced when it incorporates riba, gharar and maisir.

Riba, commonly known as interest, is the profit generated on loaning money. This profit includes monetary and non-monetary profits, as long as they have financial value. Conventional insurance companies invest customer premiums into interest bearing instruments and therefore are riba-based and impermissible. In addition, scholars highlight the insurance contract itself as including riba since a small sum of money (premiums) is exchanged for a large sum of money (claims payment). The excess amount of the claims payment over the premiums is considered a form of riba.

Gharar refers to uncertainty in commercial contracts and what each party to the contract should receive In the case of conventional insurance, it is often the case that the insurance benefit is undefined and dependent on many factors, including subjective factors. For instance, car insurance has an undefined benefit. The amount that is paid by the insurance company is dependent on the extent of the damage and the insurance company may not approve the costs quoted by certain repair shops. There is a high level of uncertainty as to what the insured actually receives from the insurance contract.

Finally, conventional insurance is based on the transfer of risk, a concept in itself inconsistent with shariah principles. In such contracts, the insured/customer is paying the insurer/company to take on all the risk associated with the occurrence of a specific adverse event. If tragedy strikes, the insured/customer will receive a payout and is the winner of the contract. If nothing happens, the insurer/company keeps all the premiums and is the winner of the contract. This is a zero-sum game where either the insured wins or the insurer does; the interests of the insured and insurer are not aligned. This kind of contract invalidates conventional insurance on the prohibition of maisir, or gambling.

It is not difficult to see why Islamic scholars have prohibited conventional insurance. Even from a non-Muslim point of view, conventional insurance is a raw deal. Insurance is commonly viewed as a necessary evil, and insurance companies “are needed, but not liked; relied on, but not trusted”.

Fortunately, shariah principles have provided us with a better model of “insurance”, commonly practiced as Takaful, a form of cooperative insurance practiced in many Muslim countries today. The underlying principle of Takaful is one of mutual cooperation and aid.