In the business insurance and model, insurance companies give policies (such as life, auto, and health insurance) to clients in exchange for a premium. Premiums are paid to insurance firms by clients in order to acquire policies that fulfill their demands. All premiums received by each insurance firm are deposited into a pool fund, which is subsequently invested in safe, revenue-generating enterprises. The payment of a premium and the occurrence of an insured event frequently occur at different times. In order to take advantage of this, insurers invest the pool fund in a variety of ways to produce revenue that can be used to settle claims.
An insurance companies’ overall profitability is heavily influenced by investment income. The claim fund is made up of the pool money and investment revenue together. The company is considered to be in profit if its overall expenses, including the cost of paying claims, are less than the amount held in the claim fund; if the opposite is true, the company is said to be in loss. The corporation incurs an underwriting loss if the premiums received are less than the cost of the claims. If the income from investments exceeds the underwriting loss, the company can be profitable despite the underwriting loss.
Insurance is a purchase and selling agreement. It is not acceptable in Islam since three banned ingredients are present. Insurance may assist an economy, organizations, and individuals in a variety of ways. Shariah, on the other hand, forbids the functioning of insurance, at least in its current form, due to the inherent elements of riba, gharar, and qimar in insurance transactions. As a result, Islamic scholars have deemed traditional insurance to be illegal.
Riba in insurance
Riba al Quran and Riba al Hadith are the two sorts of riba, and we may grasp what they mean by looking at the examples below.
Premiums of USD 10 million were received by an insurance business. The corporation invests the premium money for a profit rather than leaving it idle until it is needed to settle a claim. The insurance firm need a secure and profitable return on investment. This could be provided by non-permissible investments such as making interest-bearing loans to banks and leasing companies or investing in the stocks of companies that conduct non-Shariah-compliant business. The insurance company earns a return of USD 1 million by lending USD 7 million to banks and leasing companies in the form of interest-bearing loans. This is known as riba al Quran. This amount is placed in the claim fund and used to pay clients who make claims for their insured losses.
Person “A,” on the other hand, purchases car insurance for a USD 1 million worth car, and pays a USD 30,000 as an annual premium. The car is got an accident, and the damage is estimated to be USD 40,000. The insurance company compensates person “A” for the loss. The client paid USD 30,000 but received USD 40,000 in return in this case. As a result, the excess of USD 10,000 received by the client is riba al Hadith.
Gharar in Insurance
Gharar derives from the Arabic word gharar, which means “absence” or “insufficient information,” resulting in uncertainty. This could be in the form of a contract, price, subject, or transaction outcome.
Assume a person purchases insurance for a car worth USD 600,000 and pays an insurance premium of USD 20,000. Neither the individual nor the insurance company knows whether a loss will occur, when it will occur, or how much the loss will be. If no loss occurs, the client will lose money, while the insurer will profit. If the car is stolen, the client will receive USD 600,000 in compensation and will profit (as the client receives USD 580,000 more than they paid), while the insurer will suffer a loss. As a result, at the time of the agreement, it is clear that the client has a duty to pay the company’s premium of USD 20,000, but the insurance company’s duty is unclear.
The word maysir, which appears in the Holy Quran, derives from the word yusr, which means “ease.” This meaning implies that money or goods are easily acquired or lost in gambling and similar transactions. Technically, maysir is a contract in which one party’s profit is the other party’s loss based on an uncertain event. Making a profit at the expense of another party’s loss without providing that party with any product or service is also known as maysir.
Gambling-like transactions can also be found in traditional insurance practice. Assume a client purchases home insurance for USD 100,000 and pay an annual premium of USD 2000 to the insurance company. If the client’s house is damaged within that year (for example, by fire), the company will compensate the client up to USD 100,000, depending on the extent of the damage. If a fire breaks out and destroys the house, the company will pay USD 100,000. If there is no fire, however, the client will lose their USD 2000. The company or the client has no control over whether or not a fire breakout. If it occurs, the client receives a net benefit of USD 98,000, while the insurance company loses that amount; if it does not occur, the client loses USD 2000, while the insurance company gains that amount.
Riba is classified into two types: riba al Quran and riba al-Hadith. Riba al Quran refers to a conditional or understood increase versus a loan or debt, whereas riba al-Hadith refers to excess compensation without any consideration resulting from the sale of specific goods. Both types of riba can be found in insurance. Gharar derives from the Arabic word gharar, which means “absence” or “insufficient information,” resulting in uncertainty. This could be in the form of a contract, price, subject, or transaction outcome. Gharar comes on many levels, and excessive gharar is forbidden. Excessive gharar results in unreasonable benefit for one side and undue loss for the other, which is forbidden. Maysir (gambling) is also seen in the insurance industry. The parties involved in maysir jeopardize their property rights by tying it to the occurrence of an unpredictable event. The end result is always a win for one party at the expense of the other.