What is the ruling on car insurance in Islam? Are we allowed third party car insurance?

In the name of Allah the Most Gracious, the Most Merciful.

Assalamu Alaykum Wa Rahmatullahi Wa Barakatuh

All praise and gratitude are due to Allah SWT. May the blessings and peace of Allah SWT be upon His Messenger PBUH.

Before proceeding to give an answer as to the permissibility of car insurance in Islam, we need to look into the questions related to it.

What is an ‘insurance’?

Although various definitions have been offered, one of the most helpful is to define insurance as a mechanism (or a service) for the transfer to someone called the insurer  of  certain  risks  of  financial  loss  in  exchange  of  the  payment  of  an agreed fixed amount.  The payment is due before the contingent claim is serviced by the insurer.

Although various definitions of insurance have been offered over time, one of the most helpful provides:

“the insurance is a mechanism (or a service) for the transfer to someone called the insurer of certain risks of financial loss in exchange of the payment of an agreed fixed amount.  The payment is due before the contingent claim is serviced by the insurer.” (J. Francois Outreville)

In simple words insurance is a way to manage your risk. It allows you to avert the risk of financial losses as a result of specified but unpredictable events from an individual or entity to an insurer in return for a fee or premium. If a specified event occurs, the individual or entity can claim compensation or a service from the insurer. Insurance is therefore a means of reducing uncertainty and controlling damages by bringing in a lot of people who pay to cover their risks.

In the conventional and western definition of insurance it is stated that it is ‘transfer of risk’, however, Herbert S. Denenberg has noted,

“scholars may endlessly contend about what insurance is, whether its essential nature is transfer, pooling, some combination of the two, or something else altogether.” – The Legal Definition of Insurance: Insurance Principles in Practice

The scholars who differed on the Islamic ruling on insurance, in our opinion, differ on the essential nature and function of insurance. Those who argued that it is forbidden in Islam saw it as ‘risk-transferring’ in nature and those who permitted argued that it is ‘risk-sharing’. In our opinion it is the latter. However, to understand further an Islamic perspective on insurance we need to look into three more questions: what is the Islamic definition of a ‘risk’, what is the ruling on managing a risk, and, does Islam allow risk transfer or merely risk sharing? These will be examined in turn.

What is the Islamic definition of ‘risk’?

From an Islamic perspective, risk is generally defined ‘as uncertainty or the possibility of harm or loss that may arise from engaging in a particular transaction or investment’.

It acknowledges that all business activities involve some level of risk, and it seeks to manage or mitigate these risks in a manner that is consistent with Islamic principles.

Allah SWT commands in a Quranic verse:

“And spend in the way of Allah and do not throw [yourselves] with your [own] hands into destruction [by refraining].” (Al-Baqarah, 2:195)

The meaning of destruction here is very close to description of khatr (danger), which is an exposure to damage.

Risk Management in Islam

In Islam, risk management is an important aspect of personal and business conduct. It is based on the principle of mitigating potential harm and maximizing benefits while adhering to the teachings and guidelines of Islamic law. Islamic risk management aims to protect individuals, businesses, and society as a whole from excessive uncertainty and potential harm.

An example of the concept of risk management in Islam can be explained through the famous command from the Prophet (peace be upon him) to a Bedouin. The Prophet PBUH asked the Bedouin why he left the camel untied. The Bedouin answered, “I trust in Allah.” Hence, the Prophet PBUH said, “Tie your camel, then trust in Allah.” From the Hadith, it is explained that Prophet (peace be upon him) commanded the Bedouin not to leave his camel untied then trust in Allah. (Sunan al-Tirmidhī: 2517)

It clearly shows that even though everyone should rely on Allah’s will, people should always think clearly and wisely to make the best decision in certain circumstances, so long as it does not violate the Shariah.

According to the above Quranic verse and Hadith, in both cases, Allah’s will can be roughly classified as an unpleasant outcome to humans due to their actions where they are not alert to the probability of an unfavourable outcome to occur. It should be managed in the best way to reduce terrible damages. Another Quranic verse precisely shows the significance of strategic planning to control and mitigate anticipated risks. The absence of efficient risk management will harm certain parties to the extent that the risk most likely endangers one’s life. It is stated in Surah Yusuf:

([Joseph] said, “You will plant for seven years consecutively; and what you harvest leave in its spikes, except a little from which you will eat. Then will come after that seven difficult [years], which will consume what you saved for them, except a little from which you will store. Then will come after that a year in which the people will be given rain and in which they will press [olives and grapes]” (Quran, 12:47-49).

In the above verses, Prophet Yusuf AS interpreted the dream of the king of Egypt as that the Egyptians would face seven years of drought after seven years of prosperity. Hence, he advised the king to develop an economic strategy in order to overcome the upcoming catastrophe. The Egyptians had to implement the proposal by actively planting crops during the first seven years and store much of the proceeds as a preparation to face seven years of drought, as interpreted by Prophet Yusuf. As a result, the country survived the seven years of drought. Furthermore, the Prophet Ya’qub said,

“O my sons, do not enter from one gate but enter from different gates; and I cannot avail you against [the decree of] Allāh at all. The decision is only for Allāh; upon Him I have relied, and upon Him let those who would rely [indeed] rely.” (Quran, 12:67)

This verse explained Prophet Ya’qub’s advice to his sons to make the best plan and seek various alternatives so that they will not fall into danger. It depicts a variety of approaches to manage and reduce risks. In Islam, risk management is essential in financial transactions. It falls within the ambit of one of the highest objectives of Maqasid Al-Shariah (the purposes of the Shariah), which is the protection of wealth (hifz al-mal).

Following on that we present some key principles and practices of risk management in Islam:

1. Trust in Allah (Tawakkul): Muslims are encouraged to put their trust in Allah and recognize that ultimate control over outcomes lies with Him. However, this does not mean neglecting practical measures and due diligence in managing risks.

2. Avoidance of Prohibited Activities (Haram): Islamic risk management emphasizes the avoidance of activities that are explicitly prohibited in Islam, such as engaging in usury (riba), gambling (maysir), and speculative transactions (gharar).

3. Due Diligence and Knowledge: Muslims are encouraged to acquire knowledge and make informed decisions when assessing risks. This involves conducting proper research, seeking expert advice, and understanding the potential consequences of their actions.

4. Diversification: Islam encourages diversification of risks to avoid overexposure to a single source of risk. This principle is often applied in investment and business contexts, where diversifying across different industries, sectors, and asset classes helps to spread risk.

5. Ethical and Social Responsibility: Islamic risk management emphasizes ethical conduct and social responsibility. This means conducting business and making decisions with integrity, transparency, and fairness. It also involves considering the broader societal impact of one’s actions.

6. Prudence and Moderation: Islamic risk management encourages individuals and businesses to adopt a cautious and moderate approach to risk-taking. This involves avoiding excessive speculation, leverage, and unsustainable practices that can lead to financial instability or harm.

Is transfer of risk permissible in Islam?

In Islamic finance, the concept of risk transfer is approached differently compared to conventional finance. Islamic principles emphasize fairness, justice, and the avoidance of excessive uncertainty (gharar) and speculation (maysir). Therefore, the permissibility of risk transfer in Islam depends on the specific circumstances and the nature of the risk transfer arrangement.

In general, risk transfer is permissible in Islam as long as certain conditions are met. The key principle is that risk transfer should be based on a genuine underlying transaction and should not involve prohibited elements such as excessive uncertainty and speculation. Islam also emphasizes that a risk is not a factor of prohibition to such contracts. We note that many transactions involving risk are not allowed while many transactions not involving any risk are.  This is explained by Ibn Taimiyyah in al-Fatawa al-Misriyyah. According to him, “Allah and the Prophet PBUH allowed all risks because not every transaction which involved the probability of loss, gain, or neutral is prohibited. What is prohibited is the risk that causes one to have an invalid property. Even if the activities do not include any risk but causes to attain invalid property, they would be prohibited.

Some scholars argued that insurance leads towards having wrong intentions and acquiring impermissible properties. Our answer to that is that the insurance contracts, generally stipulate strict conditions to negate the wrong and ill-intended use of the contract. The contract will be invalid and self-contradictory if it supports the wrong intended use. As far as the speculation of its wrong use is concerned, we will say ‘speculation of a speculation proves itself to be contradictory in judgement and ruling.’

In our opinion car insurance is permissible because:

• If it is defined as risk sharing it is permissible according to all scholars.
• If it is risk-transferring (although it is debatable at its basic definition level), Islam allows it as long as it is based on an honest underlying contract.
• In both, risk-sharing and risk-transferring cases, insurance is a risk management strategy of joining a pool of large number of people facing the same kind of risks. Risk management is a commandment of our beloved Prophet (peace be upon him) and it is not against the belief of ‘trusting in Allah’, as is clear from the hadith of ‘tieing your camel’.

And Allah Knows Best.