Learn 8 Differences Between Sharia and Conventional Insurance

Insurance is a financial product that provides financial protection against various future risks, such as accidents, illness, or death. There are two types of insurance you can choose from: sharia and conventional. However, before choosing, make sure you understand the differences between sharia and conventional insurance.

Differences Between Sharia and Conventional Insurance

In theory, the main differences between sharia and conventional insurance lie in their basic principles, contracts, fund ownership, fund and risk management, fund oversight, profit sharing, and forfeiture systems. If you are still unsure which to choose, read the explanation below!

1. Principles

The first difference between sharia and conventional insurance lies in the principles that underpin them. As the name suggests, sharia insurance is based on the principles of Islamic law. These principles emphasize mutual help among participants, justice, honesty and trustworthiness, and mutual consent and trust between participants and the insurance company.

Conventional insurance, on the other hand, is based on the following main principles.

• Indemnity: The insurance company compensates the participant with an amount of money equal to their loss.
• Utmost good faith: Insurance participants may request a premium refund if they meet the requirements that demonstrate good faith.
• Subrogation: If a participant has received compensation from one party, they are no longer entitled to file a claim against another party.
• Insurable interest: The participant has an interest in the assets or property being insured.

2. Contracts or Agreements

The next difference between sharia and conventional insurance is in the contract. In sharia insurance, there are two types of contracts: the tijarah contract (profit sharing or mudharabah) and the tabarru’ contract (voluntary fund contribution or grant). The tijarah contract is commercial in nature, while the tabarru’ contract focuses on mutual assistance without a profit motive.

An insurance agreement must state the rights and obligations of each party, the method and timing of premium payments, and other agreed terms. In addition, the implementation of a sharia insurance contract must be free from riba (interest), gharar (fraud), maysir (gambling), zhulm (injustice), risywah (bribery), and must not involve haram goods or immoral activities.

Meanwhile, a conventional insurance contract takes the form of a sale-and-purchase transaction, in which the company offers protection against possible risks. In return, participants receive that protection by paying premiums on a regular basis.

3. Ownership of Funds

The next difference between Islamic and conventional insurance relates to ownership of the insurance funds. In Islamic insurance, the funds are owned collectively, so that when one participant experiences a risk, other participants also contribute to compensation through those funds.

In conventional insurance, by contrast, the insurance funds are owned individually and by the company. Each participant receives insurance benefits that vary, depending on the agreement with the company or the type of insurance the participant chooses.

4. Fund Management System

The fund management system is also one of the factors that distinguish Islamic and conventional insurance. In Islamic insurance, funds are managed based on the principle of tabarru’, whereby each participant contributes funds to help other participants who suffer losses. In addition, there is a mudharabahsystem, which is a profit-sharing investment mechanism between the participant and the company.

An Islamic insurance company acts only as a wakalah or agent, tasked with managing the tabarru’ funds and providing insurance services, such as disbursing money from the shared pool to participants who need it. As compensation for its services, the company receives a fee (ujrah).

In contrast to Islamic insurance, the premiums paid in conventional insurance are managed directly by the company in accordance with the agreement of both parties. The amount of the premium is determined by the company and agreed to by the participant. If a risk occurs, the claim can be paid out directly from the company's account.

5. Fund Oversight

The fund overseer in Islamic insurance is the Sharia Supervisory Board (DPS), which consists of Islamic scholars, sharia experts and Islamic insurance practitioners, and which is accountable to the Indonesian Ulema Council (MUI). The DPS ensures that the company's operations remain in line with sharia principles and free from transactions that conflict with the rules of muamalah.

Conventional insurance, on the other hand, has no special body overseeing all of its operations, so practices that do not align with sharia principles often occur. Nevertheless, all insurance companies must be registered and operate in accordance with the regulations of the Financial Services Authority (OJK).

6. Risk Management

Risk management is also one of the points that set Islamic and conventional insurance apart. In Islamic insurance, risk management follows the principle of sharing risk, whereby each participant bears the risk together with the others (ta’awwun), and the burden of risk is shared fairly among all participants.

Conventional insurance, meanwhile, applies transfer risk, whereby the risk a participant faces is fully transferred to the insurance company. As a consequence, participants are required to pay premiums as compensation for the risk the company takes on.

7. Profits

The main aim of Islamic insurance is to help one another in the mission of worship, economic activity and the empowerment of the community. Therefore, if there is any profit from surplus writing, reinsurance commissions, or investment returns, that profit is shared equally among all participants and the company.

This differs from conventional insurance, where all profits from managing the funds belong entirely to the company. As a result, there is no sharing of profits with insurance participants.

8. Forfeiture of Funds

The last difference between Islamic and conventional insurance concerns forfeited funds. In conventional insurance, funds may be forfeited if no claim is made within the insurance period. In Islamic insurance, however, the money participants have paid is not forfeited, because they are entitled to withdraw those funds.

Meanwhile, in conventional insurance, if the policy has ended or the participant fails to pay the premium, the insurance coverage is temporarily suspended, and the funds may be forfeited. To reactivate it, the participant needs to contact the insurance company.

Now That You Understand the Difference Between Islamic and Conventional Insurance?

When comparing the differences between Islamic and conventional insurance, you need to understand the principles of fund management and how premiums are handled. The choice of insurance depends on personal preference: whether you prioritize a system based on sharia values or the convenience of a more flexible conventional system.

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