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Chapter 4:
Permissible Insurance Alternatives
When thinking about reducing certain types of risk (one can never "eliminate" a
risk in the sense of full "insurance"), one often thinks of "buying insurance".
The typical financial insurance contract used in North America and elsewhere
would entail signing a policy with an insurance company whereby the insured
makes periodic premium payments, and the insurance company promises to
compensate the insured for damages or part thereof according to a well specified
formula. The majority of Islamic ,jurists have concluded that this contract is
invalid based on the prohibition of Gharar. Moreover, since many insurance
contracts also include an investment component (e.g. certain types of term and
life insurance), the insurance companies' investments in interest bearing bonds
render such contracts invalid based on the prohibition of Riba.
The first thing to notice is that "buying insurance" is not the only method of
risk reduction. We have already seen in the previous chapter how simple
diversification schemes can reduce risks. As a matter of fact, the endorsed
Islamic alternative to conventional insurance is the notion of cooperative or
mutual insurance,
[Note: Jurists often use the Arabic term "takaful', which
means cooperative mutual insurance, for this contract. However, since variations
on this term have recently been "trademarked" in Europe and the U.S., I shall
refrain from using it lest the reader assume that I am endorsing any particular
institution to the exclusion of others.] which is based precisely on the same
logic of diversification used in that chapter.
Let us abstract from the prohibition based on Rliba for a second, and consider
only the argument for prohibiting financial insurance based on the prohibition
of Gharar. This prohibition, unlike the prohibition of Riba, is relative. AlBaji
Al 'Andalusi (n.d., vol.5, hashiyah, under bay'u al Gharar) states:
His (pbuh) prohibition of bay'u at Gharar renders such a. sale defective. The
meaning of bay'u al Gharar, and Allah knows best, refers to sales in which
Gharar was the major component (ghalaba `alayhi) until the sale is justifiably
described as bay'zc al Gharar. This is the type of sale which is unanimously
forbidden. On the other hand, minor (yasir) Gharar does not render a sales
contract defective, since no contract can be entirely free of Gharar. Thus, the
[legal] scholars differ in determining which contracts are defective due to
differences in opinion regarding the extent of Gharar inherent in each: sic.
whether it is substantial and invalidates the contract, or minor and retains the
contract's validity.
Taqiyyudin Al Subki explicitly summarizes the opinions of earlier jurists thus
(Al Nawawi (continuation by Al Subki) (1995, vol. 9)):
The scholars said that the criterion for invalidity of the contract based on Gharar, or its validity despite the existence of Gharar, is thus: if necessity
dictates committing Gharar which cannot be avoided without incurring an
excessive cost, or if the Gharar is trivial (haqir), the sale is rendered valid,
otherwise it is rendered invalid .... Thus, the differences among scholars are
based on this general principle, where some of them render a particular form of
Gharar minor (yasir) and inconsequential, while others render the same form
consequential, and Allah knows best.
'Ibn Taymiya (1998, vol. 4) makes the same point as follows:
In this regard, the corrupting factor in Gharar is the fact that it leads to (kawnuhu
matiyyat) dispute, hatred, and devouring others' wealth wrongfully. However, it
is known that this corrupting factor would be overruled if it is opposed by a
greater benefit (al maslahah al rajihah).
Thus, Al Darir (1997, pp.44 51) lists four necessary conditions for Gharar to
invalidate a contract:
- It must be major.
- The potentially affected contract must be a commutative financial contract
(this includes sales, but excludes gifts and charitable contributions, including
"sharing" arrangements).
- The Gharar must affect the principal components of the contract (e.g. the
price and object of sale, language of the contract, etc.).
- That there is no need met by the contract containing Gharar which cannot be
met otherwise.
Many contemporary jurists, e.g. Al Zuhayli (1997, vol.5, pp.3415 3431), have
argued that commercial insurance satisfies all four conditions. This opinion
dates back at least to 'Ibn `Abidin (n.d., vol.3, p.273 onwards), who issued a
fatwa forbidding marine insurance.
[Note: As we have seen, the origin of the
term risk, re secure, suggests that the origins of the analysis of risk and
insurance lie in this area.] The Gharar, it is argued, results from the fact
that the premium (price) is paid, where what is being bought is not well
defined. The proponents of this view say that the insured may pay one small
premium and collect a large sum if he can make a legitimate claim, and he may
pay many premia without ever collecting any sum of money. Notice that
"security/insurance" itself is not a valid object of sale under Islamic
jurisprudence. In commercial insurance, jurists argue:
- The Gharar is argued to be quite substantial, since the amount to be
collected from the insurance company may vary between zero and a very large
sure, depending on chance.
- The commercial insurance contract is a sale contract, which is a commutative
financial contract.
- The Gharar affects the object of sale, and therefore it is integral to the
contract.
- The cooperative insurance alternative can meet the needs that are met by
commercial insurance.
In cooperative insurance, a group of subscribers contribute to a pool of funds.
Whenever one of the members makes a legitimate claim (relative to the specific
form of cooperative insurance to which they subscribed), they draw money out of
the pool. In the meantime, the funds in the pool are invested in an Islamic
manner, and without exposing the policy holders to any extra significant risk.
Unclaimed profits are then distributed among the policy holders. Notice that Al Zuhayli (1997, ibid.) argued
that
The difference between commercial and cooperative insurance is that the insurer
in the former is not an institution separated from the insured. Moreover, the
members of the insuring organization are not seeking to make profits, but only
to reduce the losses which affect some of them. In contrast, the insurance in
exchange for fixed installments is implemented by an insurer which is a profit
seeking corporation. Such profits are made at the expense of the insured...
In fact, this logic is exactly applicable to the distinction between mutual and
stock insurance companies as they exist in the U.S. The logic inherent in the
above quote (that stock insurance companies seek to make profits at the expense
of policy holders, while mutuals provide better insurance) in fact agrees with
our most sophisticated economic understanding of the structure and operations of
such companies.
[Note: The economically oriented reader may consult Mayers and
Smith (1988), Smith and Stutter (1995), and the references therein.]
Unfortunately, most of the "cooperative insurance"' companies established in
Islamic countries are in fact similar in ownership structure to stock insurance
companies. In principle, however, a mutual insurance company which invests its
funds in Islamically acceptable ways would satisfy all the conditions put forth
by the ,jurists as a valid alternative to commercial insurance. While no Islamic
cooperative insurance companies are currently operating in North America, some
efforts are underway both in the U.S. and Canada to establish such
organizations. Until such a time, Muslims may still reduce risks through direct
diversification, and in the absence of permissible insurance alternatives, most
jurists agree that the use of available insurance vehicles becomes temporarily
permissible if needed or required by law.
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