Introduction to takaful insurance in the Malaysian construction sector

Islamic finance is a growing specialism within the financial sector. Construction insurance that is compatible with Muslims' beliefs is an important part of that market and for the protection of the construction industry


  • Dr Puteri Nur Farah Naadia Mohd Fauzi MRICS

21 April 2022

Georgetown, Penang/Malaysia - Feb 28 2020: Aerial view Seri Tanjung Pinang housing development.

Muslims are required to anticipate the potential for future loss of earnings and take precautions to mitigate it. The concept of mitigating risks by taking safety precautions to avoid loss and damage is emphasised in the Quran.

In Islam, risks are managed through risk sharing, which is the practice of not placing one's future in the hands of others, but rather taking steps to protect oneself against future risks and difficulties while still placing one's trust in the Lord. This is accomplished through a protection scheme such as takaful, which is Shariah-compliant insurance.

In the context of Islamic financial transactions, risk implies several meanings, such as exposure or loss due to unpredictable events in future. This has led people to find ways of mitigating risk or to seek protection and guarantee for compensation, should it occur, through the procurement of insurance.

Due to their complexity, construction projects are exposed to high levels of risk. As a result, risk mitigation in construction is critical to ensuring losses are controlled and works are to be completed as planned. Traditionally, there have been a number of methods for risk mitigation: avoidance, reduction, retention, transfer and sharing.

Concept and principles of takaful

The term takaful is derived from the Arabic root word kafl, which means a guarantee, responsibility, or an act of providing for one's needs.

It is important to highlight that the principle of human solidarity is strongly emphasised in the practice of takaful. This is shown in the concepts of mutual assistance and contribution, called ta'awun and tabarru' respectively, which govern the takaful's operation.

Participants in a takaful scheme donate to a common fund. The fund is managed by an operator responsible for assisting participants should a specified event occur. If no claim is made by participants, the fund is distributed according to an agreed split.

The primary goal of takaful contributions is not to profit from uncertainty, but to fulfil mutual protection and assistance obligations. The fund may also be used for income-generating investment activities as long as the investments are Shariah-approved. Profits from the investment will be used to supplement the takaful fund.

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Comparing takaful and conventional insurance

A Shariah Advisory Board is required for takaful operators. The Shariah Advisory Board is composed of Shariah experts and scholars who ensure that the operator's management of the fund complies with Shariah, which prohibits uncertainty, gambling and usury, none of which are prohibited in conventional insurance.

In the practice of takaful, identified risks are shared among takaful participants; no individual or entity is involved in risk transfer. A takaful operator is appointed to manage the fund and ensures that participants pay equal contributions and are compensated fairly in the event of loss or damage.

By contrast, in conventional insurance an insured party enters into an agreement to purchase a policy, in which the insured agrees to pay a fixed premium in exchange for the insurer agreeing to bear risks and compensate the insured in the event of loss or damage covered by the policy.

In terms of the contractual relationship, a conventional insurance contract is an exchange contract in which the insurer and the insured enter into a sell and purchase agreement. For a premium, the insurance company sells a guarantee to a prospective insured in the form of an insurance policy. The insured will receive an insurance policy upon signing, which entitles them to make a claim in the event of loss or damage caused by the specified and agreed events.

In contrast, a takaful contract prohibits the buying and selling of insurance policies. The key comparisons between conventional insurance and takaful are shown in Table 1.

(click on table to enlarge)


Table 1: differences between takaful insurance and conventional insurance

  Takaful Conventional
Risk Shared risk between participants Transfers risks to one party
Principle Cooperation and contributions Commercial factors
Contract Combination of contributions and profit-sharing Sale and purchase agreement
Operations Free from uncertainty, gambling and usury Presence or possibility of uncertainty, gambling and usury
Subscription Contributions as donations
Premium payment

Table 1: differences between takaful insurance and conventional insurance

  Takaful Conventional
Risk Shared risk between participants Transfers risks to one party
Principle Cooperation and contributions Commercial factors
Contract Combination of contributions and profit-sharing Sale and purchase agreement
Operations Free from uncertainty, gambling and usury Presence or possibility of uncertainty, gambling and usury
Subscription Contributions as donations
Premium payment

Application of takaful to construction works

In the construction sector, in accordance with the major standard forms of construction contracts, it is a condition precedent to the commencement of the works for a contractor to insure the works against loss and damage.

In Malaysia specifically, clauses 18.0 (Insurance of works) and 48.0 (Defects after completion) of the P.W.D. 203 & 203A Standard Form of Contract (Rev1/2010) provide for the protection of construction works and the requirement to obtain insurance.

Additionally, the standard form of contract requires two additional insurances: insurance against personal injury and property damage, and worker's compensation as specified in the Employees' Social Security Act 1969 (Malaysian SOCSO Act 1969).

To protect works fully, insurance must be purchased up to the full value of the works. A contractor is required to obtain and maintain insurance coverage for works from the commencement of work to the date of practical completion. If the contractor is granted an extension of time, the contractor's insurance policy must be extended one month prior to practical completion to cover the additional period of work.

In Malaysia, contractors have the option of insuring their work through takaful or conventional insurance. Insurance against damage to property and third parties is provided through an insurance policy or takaful scheme referred to as contractor's all risks (CAR), a bundled policy that covers both works insurance and third-party liability arising out of construction contract works. A typical CAR policy specifies nine major provisions:

  • scope of coverage

  • parties covered

  • specified risks based on the construction contract and additional client requirements

  • exclusion clause

  • extension risks coverage with additional rates

  • sum cover for the full amount of work/contract sum

  • a deductible clause requiring the insured to bear small claims

  • premium/contribution rates determined by the undisclosed risk, and

  • maintenance period for the purpose of covering any rectification of defects discovered during a defect liability period specified in a construction contract.

In terms of work insurance, a comparative analysis of the current CAR indicates that there are no negatives experienced by selecting takaful over conventional insurance. The main difference is simply compliance with Shariah principles.

Growing market popularity

The Malaysian Central Bank reports that Islamic business transactions, including those in the construction industry, have continued to grow in popularity. Based on the Insurance and Takaful Statistical Report, 2021, takaful has recorded significant growth of 20.6% on average for the past three years since the year 2018. 

Takaful has shown good performance in terms of its earned contribution income, increasing by over 24%  from 2020 to 2021. Overall takaful business has also shown growth of 13.5% from 2020 to 2021.

In Malaysia, the public has access to both conventional and takaful insurance. Their respective businesses are subject to stringent regulation by the appropriate regulatory agencies. The growth of takaful indicates that it is considered as a viable alternative to traditional insurance.

In addition, Deloitte reports that Islamic finance has seen significant growth across the globe over the last decade, representing one of the fastest-growing sectors in the global financial system since its inception in the late 1960s. The takaful industry is contributing towards the current trend of positive and stronger market penetration.

In conclusion, the risks and general policies covered by both types of works protection are similar. The difference between takaful and conventional protections schemes is merely the concepts and principles underlying their operations and systems.

Contractors that are experienced in using takaful for the protection of works are satisfied that this form of insurance also help others rather than focusing on making profits. The participants in a takaful scheme do not merely think of their own benefits but ultimately care for and help others within a similar scenario.

Dr Puteri Nur Farah Naadia Mohd Fauzi, MRICS, is assistant professor and programme director, quantity surveying/construction project management at the School of Energy, Geoscience, Infrastructure and Society, Heriot-Watt University

Contact Dr Puteri: Email

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