Ebtihaj's Encyclopedia of Economics Wiki

In conventional insurance , element of interest and gambling makes it unacceptable under Islamic principles. The premiums paid to the insurance company by the people are invested in interest based financial instruments and from those funds, compensation is provided to the insured in case of contingencies.

The contingent nature of consideration to the insured brings the element of gambling and uncertainty as well.

In recent years, Muslim scholars have proposed an alternate system of insurance which is known as “Takaful” system. But, in that, the shareholders establish the Takaful Company for the purpose of profit. Seeking profit from the business of guaranteeing risk against certain events is not ideal.

Muslim scholars have also unanimously favored equity financing based financial intermediation over debt based financial intermediation. But, it is to be noted that when debt based financial intermediation would no longer remain a predominant feature of financial system, then, both the conventional insurance and “Takaful ” would not have risk free fixed contractual cash inflows to depend on, arising out of debt based financial system.

Fostering an economy which predominantly uses equity financing based financial intermediation, an alternate system of insurance is recommended which would not depend on debt based financial intermediation.

The alternative is as follows:

People can insure themselves against contingencies on their own by investing in mutual funds, pension funds, REITs, equity markets etc. The insurance needs of salaried individuals can be catered by the employers themselves by establishing the mutual insurance system on their own.

Regarding commercial insurance, it needs to be kept in mind that not all risks are insurable. In fact, the risks generally insured by the commercial enterprises against accidents, fire, destruction etc are remote risks than the frequently occurring business risks which are uninsurable i.e. loss of customer’s confidence, increased competition, regulation, decreased sales etc.

Furthermore, in equity based financial intermediation, losses will be mutually borne rather than creditors getting fixed stipulated interest at the cost of only shareholders suffering from business cycle downturns.

Furthermore, ‘Gharimeen’ is a head of Zakat. The Zakat funds allocated for distribution in this head can be used to pay the debts and accidental losses of the commercial enterprises.

Proportional Zakat linked with income would act as an automatic stabilizer in an Islamic economy. Besides, the proportional income levy, Zakat on wealth redistributes stock of wealth too in the economy. Zakat enables the distributive allocation that works independently of business cycles and help stabilize the extremes of business cycles.