Takaful - Small Size of the Retakaful Industry and Dependence on Conventional Reinsurance

The Retakaful industry is still relatively small compared with conventional reinsurance. There are only a limited number of dedicated Retakaful operators, and many are smaller, have limited capital, and operate mainly within national or regional markets. In contrast, large conventional reinsurers generally have greater capital, stronger technical expertise, wider international networks, and greater capacity to absorb very large risks.

Because Retakaful capacity is limited, Takaful operators may not always be able to place all their large risks with Retakaful providers. This is particularly relevant for aviation, marine, oil and gas, large industrial projects, infrastructure, and catastrophe risks. For example, if a Takaful operator needs RM900 million of external protection but Retakaful providers can only accept RM400 million, the remaining RM500 million may need to be placed with conventional reinsurers.

The problem may also involve a lack of technical capacity, not only financial capacity. Some specialised risks require experienced underwriters, actuaries, catastrophe-modelling experts, and specialists in areas such as aviation, marine, or engineering. Large conventional reinsurers may already possess this expertise, while smaller Retakaful operators may not.

Regulatory requirements can also require Takaful operators to share large risks. A regulator may limit how much exposure an operator can retain to prevent a single major loss from threatening the Participants’ Risk Fund. If sufficient Retakaful capacity is unavailable, conventional reinsurance may sometimes be used to meet this requirement.

However, using conventional reinsurance creates a Shari’ah concern because conventional reinsurance may involve risk transfer, interest-based investments, and other structures that do not follow Retakaful principles. Therefore, its use may only be accepted under applicable Shari’ah rules where there is genuine need or necessity.

In the long term, the industry needs more well-capitalised Retakaful operators, stronger financial ratings, better technical expertise, wider geographical diversification, and greater underwriting capacity. A larger and stronger Retakaful market would reduce the Takaful industry’s dependence on conventional reinsurance.

Takaful - Small Size of the Retakaful Industry and Dependence on Conventional Reinsurance

• The Retakaful industry is still relatively small compared with the conventional reinsurance industry.
• There are only a limited number of dedicated Retakaful operators.
• Many standalone Retakaful operators are:
• Smaller in size
• Limited in capital
• Focused mainly on national or regional markets
• By comparison, the global reinsurance market is dominated by large conventional reinsurers with:
• Greater capital
• Stronger technical expertise
• Wider international networks
• Greater capacity to absorb very large risks

1. Limited Number of Retakaful Operators

• Takaful operators may sometimes find that there are not enough Retakaful providers available to take the risks they need to share.
• This is especially problematic for:
• Aviation
• Marine
• Oil and gas
• Large factories
• Infrastructure projects
• Catastrophe risks

Example

• A Takaful operator covers an industrial plant with potential exposure of RM1 billion.
• The operator only wants to retain RM100 million of the risk.
• Therefore, it needs to share:

RM900 million

• Available Retakaful operators may only have enough capacity to take:

RM400 million

• The remaining:

RM500 million

may have to be placed with conventional reinsurers.

Simple Idea

Large risk + Limited Retakaful capacity → Dependence on conventional reinsurance

2. Conventional Reinsurers Have Greater Capacity

• Large conventional reinsurers usually have:
• Larger shareholder capital
• Larger premium pools
• Better geographical diversification
• More technical expertise
• Stronger financial ratings
• They can therefore accept risks that may be too large for smaller Retakaful operators.

Example

A Retakaful operator may only be willing to accept:

RM100 million

of a large aviation exposure.

A global conventional reinsurer may be able to accept:

RM500 million or more

because it has a much larger global portfolio.

Simple Idea

More capital + Larger risk pool = Greater reinsurance capacity

3. Lack of Technical Capacity

• Sometimes the problem is not only money.
• A Retakaful operator may also lack sufficient technical expertise to assess or manage a specialised risk.
• Technical capacity includes:
• Experienced underwriters
• Actuaries
• Catastrophe-modelling specialists
• Aviation specialists
• Marine specialists
• Engineering-risk experts

Example

• A Takaful operator wants protection for a fleet of commercial aircraft.
• The available Retakaful provider may not have:
• Aviation underwriters
• Aircraft loss data
• Appropriate catastrophe models
• Experience handling very large aviation claims
• A major conventional reinsurer may already have a specialised aviation team.

Result

The Takaful operator may need to use conventional reinsurance because the Retakaful provider lacks the required technical expertise.

Simple Idea

Technical capacity = Ability to properly understand, price and manage the risk

4. Regulatory Requirements Can Also Force Risk Sharing

• Regulators may limit the amount of risk that a Takaful operator is allowed to retain.
• This prevents one very large claim from threatening the financial stability of the Takaful fund.
• Therefore, the operator may be required to transfer or share part of a large risk.

Example

Suppose a Takaful operator has:

Participants’ Risk Fund = RM500 million

It accepts a risk with potential loss of:

RM1 billion

The regulator may consider this too large for the operator to retain.

The operator may therefore be required to share most of the risk with Retakaful or reinsurance providers.

Simple Idea

Very large risk → Regulator limits retention → Operator must share the risk

5. Why Conventional Reinsurance May Be Used

A Takaful operator may use conventional reinsurance because of:

• Insufficient Retakaful capacity
• Lack of specialised technical expertise
• Weak financial rating of available Retakaful providers
• Lack of sufficient geographical diversification
• Regulatory requirements
• Very large or unusual risks

Simple Process

Takaful operator accepts risk

→ Needs to reduce exposure

→ Looks for Retakaful

→ Retakaful capacity insufficient

→ Remaining risk may be placed with conventional reinsurer

6. Shari’ah Concern

• This creates an important Shari’ah issue.
• Conventional reinsurance does not necessarily follow the principles used in Retakaful.
• Conventional reinsurance may involve:
• Risk transfer rather than mutual risk sharing
• Interest-based investments
• Other conventional contractual structures
• Therefore, the conventional reinsurer may not observe the same Shari’ah requirements as a Retakaful operator.

Simple Idea

Retakaful = Designed according to Shari’ah

Conventional reinsurance = May contain Shari’ah-prohibited elements

7. Example Showing the Problem

Suppose ABC Takaful covers a major port project.

Potential maximum loss:

RM2 billion

ABC Takaful decides:

• Retain itself = RM200 million
• Needs external protection = RM1.8 billion

Available Retakaful operators can provide only:

RM800 million

Remaining amount:

RM1 billion

ABC Takaful may then approach a large conventional reinsurer for the RM1 billion balance.

Result

ABC Takaful → RM200m retained

Retakaful → RM800m

Conventional Reinsurance → RM1bn

The Takaful operator has obtained sufficient protection, but part of the arrangement now involves conventional reinsurance.

Shari’ah Concern

• The conventional reinsurance portion may not follow Retakaful principles.
• Therefore, the use of conventional reinsurance may only be tolerated under applicable Shari’ah rules where genuine need or necessity exists.

8. Why the Industry Needs More Retakaful Capacity

• If the Retakaful industry becomes larger, Takaful operators will be less dependent on conventional reinsurers.
• The industry therefore needs:
• More Retakaful operators
• More shareholder capital
• Stronger financial ratings
• Better technical expertise
• Wider geographical operations
• Better risk diversification
• More specialised underwriting capability

Simple Process

More Retakaful operators

→ Larger risk pool

→ Greater diversification

→ Greater capacity

→ Less dependence on conventional reinsurance

Easy Way to Remember

Main Problem

Retakaful industry is small

Therefore:

• Few operators
• Smaller capital
• Limited capacity
• Limited technical expertise
• Limited geographical diversification

Result

Large Takaful risks may have to be shared with conventional reinsurers

Shari’ah Issue

Conventional reinsurance may not follow Retakaful Shari’ah principles

Long-Term Solution

More Retakaful operators + More capital + Better expertise + Wider diversification = Less dependence on conventional reinsurance

Takaful - What Is a Smaller Risk Pool and Lack of Diversification?

A smaller pool of risk and lack of diversification are related, but they are not exactly the same thing.

1. Smaller Pool of Risk

• A smaller risk pool means there are fewer risks, fewer participants, or less business being combined together.
• Because the pool is small, one large claim can have a much bigger impact on the fund.

Example

Suppose a Retakaful operator covers only 10 large factories.

• Total Retakaful fund = RM100 million
• One factory suffers a RM30 million loss

That single claim uses:

RM30m ÷ RM100m = 30% of the fund

Now suppose another Retakaful operator covers 1,000 different risks and has a fund of RM2 billion.

A RM30 million claim is much easier to absorb.

Simple Idea

Smaller pool = Fewer risks sharing the burden

Therefore:

One big loss → Bigger impact on the fund

2. Lack of Diversification

• Lack of diversification means the risks in the pool are too similar or too concentrated.
• Even if there are many risks, they may all be exposed to the same event.

Example

A Retakaful operator covers:

• 500 factories
• All located in the same flood-prone area

This is a large number of risks, but the pool is poorly diversified.

If a major flood occurs:

• Many factories may suffer losses at the same time
• The Retakaful operator may receive many large claims together

Simple Idea

Many risks does not automatically mean good diversification

If all the risks are similar:

One event may hit many of them at once

3. Example of Good Diversification

Suppose a Retakaful operator covers:

• Motor risks in Malaysia
• Property risks in Saudi Arabia
• Marine risks in Indonesia
• Family Takaful risks in UAE
• Engineering risks in Turkey

Now a flood in Malaysia may affect some Malaysian property or motor risks, but it is unlikely to affect all the other risks simultaneously.

Simple Idea

Different countries + Different types of risks = Better diversification

4. Smaller Pool vs Poor Diversification

Smaller Pool

• Problem is quantity
• There are too few risks
• One claim represents a large part of the total fund

Poor Diversification

• Problem is concentration
• Risks are too similar
• Many claims may occur from the same event

Example

Small pool but diversified

• 20 risks
• Different countries and industries
• Still small, but not highly concentrated

Large pool but poorly diversified

• 1,000 properties
• All in the same earthquake zone
• Large number, but still dangerous concentration

Why Retakaful Can Face Both Problems

Retakaful may have:

• Fewer Takaful operators contributing risks
• Smaller global business volume
• Large individual risks
• Concentration in particular countries or industries

Therefore:

Small pool + Poor diversification = Greater volatility

Example

A Retakaful operator covers only:

• 15 Takaful companies
• Mostly property risks
• Mostly in one region

A major earthquake occurs.

Several Takaful companies make large claims at the same time.

The Retakaful fund may be severely affected.

Easy Way to Remember

Smaller risk pool

= Not enough risks

Poor diversification

= Risks are too similar or concentrated

Best situation:

Large number of risks + Different types of risks + Different locations = Stronger and more stable pool

Simple Formula

Large Pool + Good Diversification → More Predictable Claims + Lower Volatility + Stronger Retakaful Fund

Takaful - Higher Cost of Retakaful Compared with Reinsurance

• In practice, Retakaful contributions may be somewhat higher than equivalent conventional reinsurance premiums.
• However, the difference is generally not necessarily very large.
• A higher Retakaful contribution by itself is not automatically a sufficient reason to invoke necessity (darurah) and choose conventional reinsurance instead.
• The higher cost may arise because of several structural and market-related factors.

1. Why Retakaful Contributions May Be Higher

Smaller Risk Pool

• Retakaful generally operates with a much smaller volume of business than conventional reinsurance.
• A smaller pool means:
• Fewer risks are being shared
• Less diversification
• Greater volatility of claims
• Higher impact from individual large claims
• The Retakaful operator may therefore need to charge higher contributions to maintain sufficient financial strength.

Example

Suppose:

• Conventional reinsurer pools risks from 1,000 insurers worldwide.
• Retakaful operator pools risks from only 100 Takaful operators.

If both face a RM100 million catastrophe claim:

• The large conventional pool can spread the loss across much more business.
• The smaller Retakaful pool feels a much greater financial impact.

Therefore:

Smaller Retakaful pool → Greater volatility → Potentially higher Retakaful contribution

2. Product Design Can Increase the Cost

• Retakaful products may be structured differently from conventional reinsurance.
• Certain features can increase the contribution required.
• One example is surplus sharing.

Example

• Takaful Operator A pays RM10 million in Retakaful contributions.
• At the end of the year, the Retakaful fund performs well and generates a surplus.
• Under the agreed arrangement, part of that surplus may be distributed or allocated according to the Retakaful model.
• Because such benefits form part of the product design, the initial contribution may be somewhat higher.

Simple Idea

Additional features in Retakaful → May increase contribution

3. Higher Cost Alone Does Not Automatically Create Necessity

• Shari’ah may permit conventional reinsurance in exceptional circumstances where suitable Retakaful is genuinely unavailable or inadequate.
• However, the fact that Retakaful is merely slightly more expensive does not automatically justify using conventional reinsurance.
• The Takaful operator should normally consider the Shari’ah-compliant Retakaful option first.

Example

Suppose:

• Retakaful contribution = RM10.5 million
• Conventional reinsurance premium = RM10 million

Difference:

RM500,000

• The conventional option is cheaper.
• However, the small price difference alone would not necessarily amount to a situation of necessity.

Simple Idea

Cheaper conventional reinsurance ≠ Automatically a necessity

4. Financial Strength Rating of the Retakaful Provider

• Cost is not the only consideration.
• A Takaful operator must also consider the financial strength rating of the Retakaful provider.
• Ratings are usually provided by recognised rating agencies.
• They indicate the provider’s ability to meet its financial obligations and pay claims.

Why Is Rating Important?

• Retakaful is often used for very large risks.
• The Takaful operator must have confidence that the Retakaful provider will be able to pay when a major claim occurs.

Example

A Takaful operator wants to protect a major aviation risk.

It has two potential Retakaful providers:

• Provider A → Strong financial rating
• Provider B → Weak financial rating

Even if Provider B charges a lower contribution, the Takaful operator may reject it because the provider may not meet its required financial-strength standards.

Simple Idea

Low price is not enough → Retakaful provider must also be financially strong

5. What Is Risk Appetite?

• Risk appetite refers to the amount and type of risk an organisation is willing to accept.
• A Takaful operator may establish minimum requirements for the Retakaful companies with which it is willing to deal.
• One requirement may be a minimum financial-strength rating.

Example

Suppose a Takaful operator has a policy stating:

“We will only place major risks with Retakaful providers rated A or above.”

Two providers are available:

• Retakaful Company A → Rating A
• Retakaful Company B → Rating BBB

Even if Company B is cheaper, the Takaful operator may choose Company A because Company B falls outside its risk appetite.

Simple Idea

Risk appetite = How much risk the Takaful operator is willing to tolerate

6. Why a Weak Rating Could Lead to Conventional Reinsurance

• Historically, there may have been situations where:
• Retakaful was available
• But the available Retakaful operators did not have sufficiently strong ratings
• A Takaful operator covering a very large risk might therefore have been unwilling or unable to place the risk with them.
• It could then consider a highly rated conventional reinsurer, subject to the applicable Shari’ah rules on necessity or need.

Example

A Takaful operator needs:

RM500 million of protection

Available Retakaful provider:

• Capacity = RM500 million
• Rating = below the Takaful operator’s minimum requirement

Conventional reinsurer:

• Capacity = RM500 million
• Strong international rating

The issue is therefore not simply price.

It is:

“Will the provider still be financially capable of paying RM500 million if a major loss occurs?”

7. Retakaful Windows Have Reduced the Rating Problem

• The text explains that this rating problem should now be less significant.
• Many large international conventional reinsurers have established Retakaful windows.
• These windows offer Shari’ah-compliant Retakaful services while benefiting from the:
• Financial strength
• Expertise
• Capital resources
• Global network
• Reputation

of the larger reinsurance group.

Example

• A major global reinsurer has a strong international credit rating.
• It establishes a separate Retakaful window.
• A Takaful operator can obtain:
• Shari’ah-compliant Retakaful protection
• From a financially strong international group

Simple Idea

Large reinsurer + Retakaful window = Shari’ah-compliant protection backed by stronger financial capacity

Overall Reasons Retakaful May Cost More

Retakaful contributions may be higher because of:

• Smaller volume of business
• Smaller risk pool
• Less diversification
• Greater claim volatility
• Product design
• Surplus-sharing arrangements
• Higher operating costs
• Limited economies of scale

However:

Higher Retakaful cost alone does not automatically justify choosing conventional reinsurance.

Easy Way to Remember

Cost Issue

Smaller Retakaful pool → Higher risk per operator → Potentially higher contribution

Rating Issue

Retakaful provider must be financially strong enough to pay large claims

Risk Appetite

Takaful operator decides the minimum level of financial risk it is willing to accept from its Retakaful providers

Modern Development

Large international reinsurers → Establish Retakaful windows → Strong ratings + Shari’ah-compliant Retakaful capacity

Simple Formula

Retakaful Selection = Shari’ah Compliance + Price + Financial Rating + Capacity + Risk Appetite

Not simply:

Choose whichever option is cheapest

Takaful - Why Window-Based Retakaful Can Be More Profitable Than Full-Fledged Retakaful

• In the Retakaful industry, many full-fledged standalone Retakaful operators have struggled to survive.
• By contrast, many stronger Retakaful operations today operate as Retakaful windows within larger insurance or reinsurance groups.
• One important reason is that a window can remain viable with a much smaller volume of Retakaful business than a standalone company.

1. What Is a Full-Fledged Retakaful Operator?

• A full-fledged Retakaful operator is a separate company established specifically to conduct Retakaful business.
• Its main source of business comes from:
• Retakaful contributions
• Investment income
• Other income related to Retakaful operations
• It must maintain its own:
• Capital
• Staff
• Office
• IT systems
• Shari’ah governance
• Underwriting team
• Claims department
• Accounting
• Risk management
• Regulatory compliance

Simple Idea

Full-fledged Retakaful = Separate company that must support all its own costs

2. What Is a Retakaful Window?

• A Retakaful window is a Shari’ah-compliant Retakaful operation within a larger conventional reinsurer or insurance group.
• The Retakaful business is operated separately in accordance with Shari’ah requirements.
• However, the window may benefit from the parent company’s existing:
• Employees
• Technology
• Offices
• Claims expertise
• Underwriting systems
• Global network
• Administrative infrastructure

Simple Idea

Retakaful Window = Retakaful business using the infrastructure of a larger existing company

3. Why Windows Need Less Business to Be Profitable

• A standalone Retakaful company has many fixed costs.
• These costs must be paid even if the company receives only a small amount of business.

Example – Full-Fledged Operator

Suppose a standalone Retakaful company has annual fixed expenses of:

RM50 million

Its Retakaful contributions are only:

RM150 million

The RM50 million cost represents:

33% of its contribution income

This creates pressure on profitability.

Window Example

Suppose a large conventional reinsurer already has:

• Offices
• IT systems
• Claims staff
• Underwriters
• Accounting systems
• Global distribution network

It opens a Retakaful window.

The additional annual cost of operating the window may only be:

RM10 million

If the window receives the same:

RM150 million of Retakaful contributions

its fixed operating cost represents only:

6.7% of contribution income

Simple Idea

Same amount of Retakaful business + Lower operating cost = Better chance of profitability

4. Shared Infrastructure

• Retakaful windows can use the parent company’s existing infrastructure.
• This significantly reduces the cost of establishing and operating the business.

Shared Resources May Include

• Office buildings
• Technology
• Human resources
• Finance department
• Legal department
• Risk-management systems
• Claims systems
• Underwriting expertise
• Investment-management systems

Example

A standalone Retakaful company may need to spend:

RM20 million

to develop a new claims and IT system.

A Retakaful window may already have access to the parent reinsurer’s existing system.

Therefore, it may only need minor modifications.

Simple Idea

Shared infrastructure → Lower costs

5. Economies of Scale

• Large reinsurance groups already operate at a significant scale.
• Adding Retakaful business allows them to spread their fixed costs across:
• Conventional reinsurance business
• Retakaful business
• This creates economies of scale.

Example

A global reinsurance company spends:

RM100 million

on technology and administration.

If it only had Retakaful business worth RM200 million, the cost would be very high relative to the business volume.

But if it already handles:

RM10 billion of conventional reinsurance

and adds:

RM200 million of Retakaful

the additional Retakaful business can use much of the existing infrastructure.

Simple Idea

Large parent company → Costs spread across more business → Lower average cost

6. Access to Existing Expertise

• Retakaful requires specialised knowledge in:
• Underwriting
• Catastrophe modelling
• Actuarial analysis
• Claims
• Investment
• A large conventional reinsurer may already employ these specialists.
• A Retakaful window can therefore access this expertise without creating an entirely new team.

Example

A parent reinsurer already has:

• Aviation underwriters
• Marine specialists
• Catastrophe-modelling experts

When it opens a Retakaful window, these specialists may also support Shari’ah-compliant Retakaful business.

Simple Idea

Existing expertise → Lower recruitment and training cost

7. Access to a Larger Global Network

• Large conventional reinsurance companies often already have relationships with:
• Insurance companies
• Takaful operators
• Brokers
• Governments
• Large corporations
• A Retakaful window can use this network to obtain business.

Example

A global reinsurer already operates in:

• Malaysia
• Saudi Arabia
• UAE
• Indonesia
• Europe

Its Retakaful window can access Takaful operators in these markets without establishing a completely new distribution network.

Simple Idea

Existing client network → Easier access to Retakaful business

8. Full-Fledged Operators Need Critical Mass

• Standalone Retakaful operators need a sufficiently large amount of business to cover their fixed costs.
• This minimum business volume is sometimes referred to as critical mass.

Example

Suppose a standalone Retakaful operator needs:

RM500 million annual contributions

to operate efficiently.

But the market only provides:

RM200 million

The company may struggle to:

• Cover expenses
• Build reserves
• Earn acceptable returns
• Maintain sufficient capital

A window may be able to survive with the same RM200 million because its operating costs are lower.

Simple Idea

Standalone operator → Needs high business volume

Window → Can survive with lower business volume

9. Rating Advantage

• Retakaful clients often prefer providers with a strong financial strength rating.
• Ratings are important because Takaful operators want confidence that the Retakaful provider will be able to pay large claims.
• A Retakaful window within a large international reinsurance group may benefit from:
• Stronger capital
• Larger asset base
• Established reputation
• Stronger financial rating

Example

A Takaful operator has two choices:

• Small standalone Retakaful company with weak financial rating
• Retakaful window of a major global reinsurer with a strong rating

The Takaful operator may prefer the window because it appears financially stronger.

Simple Idea

Stronger parent company → Greater confidence in claim-paying ability

10. Why Many Standalone Retakaful Operators Struggled

• Standalone Retakaful operators have faced several challenges:
• Small global Takaful market
• Low Retakaful business volume
• High fixed operating costs
• Need for substantial capital
• Large and volatile claims
• Limited diversification
• Difficulty achieving economies of scale

Simple Relationship

Low business volume + High costs + Large volatile risks = Sustainability problem

11. Example Comparing Both Models

Suppose both businesses receive:

RM200 million Retakaful contributions

Full-Fledged Retakaful

Annual expenses:

• Staff = RM20m
• Technology = RM15m
• Office and administration = RM10m
• Compliance and governance = RM5m

Total expenses:

RM50 million

Expense ratio:

RM50m ÷ RM200m = 25%

Retakaful Window

Because the parent company already provides infrastructure:

• Additional staff = RM5m
• Technology = RM2m
• Shari’ah governance = RM2m
• Additional administration = RM1m

Total additional cost:

RM10 million

Expense ratio:

RM10m ÷ RM200m = 5%

Result

The window has much lower operating expenses relative to its business volume.

Simple Idea

Same business volume → Window has lower cost → Greater chance of profit

Easy Way to Remember

Full-Fledged Retakaful

• Separate company
• Own capital
• Own employees
• Own technology
• Own offices
• Own administrative systems
• Needs large business volume
• Higher fixed costs

Simple Idea

High fixed cost → Needs critical mass

Retakaful Window

• Operates within a larger existing company
• Shares infrastructure
• Shares expertise
• Uses existing distribution network
• Lower additional operating cost
• Can operate with smaller business volume

Simple Idea

Shared resources → Lower cost → Lower volume needed for profitability

Main Reason

The main advantage of a Retakaful window is:

It does not need to build an entire reinsurance company from the beginning.

Therefore:

Existing Parent Infrastructure + Lower Additional Costs + Existing Expertise + Stronger Financial Capacity = Greater Chance of Retakaful Window Profitability

Takaful - Retakaful Contributions and Retakaful Shareholders

1. What Is a Retakaful Premium / Contribution?

• In conventional reinsurance, the insurer pays a reinsurance premium to the reinsurer.
• In Retakaful, it is more accurate to refer to this as a Retakaful contribution.
• The Takaful operator pays this contribution to the Retakaful operator so that part of the Takaful operator’s large risks can be shared.

Example

• A Takaful operator covers a factory with a potential loss of RM500 million.
• The Takaful operator does not want to keep the entire risk.
• It retains RM100 million and shares RM400 million with a Retakaful operator.
• To obtain this Retakaful protection, the Takaful operator pays a Retakaful contribution.

Simple Process

Participant → Takaful Operator → Retakaful Contribution → Retakaful Operator

Why Is the Contribution Paid?

• To obtain protection against large losses
• To increase the Takaful operator’s risk capacity
• To reduce the burden on the Participants’ Risk Fund
• To make very large risks more manageable

Simple Idea

Retakaful contribution = Amount paid by the Takaful operator to share part of its risk with the Retakaful operator

2. Where Does the Retakaful Contribution Come From?

• The Retakaful contribution is generally funded from the relevant Takaful risk fund, because Retakaful is used to protect that fund against large claims.
• It is treated as part of the cost of managing the participants’ risks.

Example

• Participants’ Risk Fund receives RM50 million in contributions.
• The Takaful operator decides that RM5 million should be used for Retakaful protection.
• That RM5 million is paid to the Retakaful operator.

Simple Idea

Participants’ Risk Fund → Retakaful contribution → Retakaful protection

3. What Are Retakaful Shareholders?

• A Retakaful operator may be established as a shareholder-owned company.
• The shareholders are the owners and investors of the Retakaful company.
• They provide the company with shareholder capital.

Example

Suppose investors establish ABC Retakaful.

• Shareholders invest RM200 million.
• That money becomes shareholder capital.
• The capital helps the Retakaful operator:
• Obtain a licence
• Meet regulatory capital requirements
• Establish operations
• Hire staff
• Build systems
• Provide financial strength
• Support the Retakaful fund when necessary

Simple Idea

Retakaful shareholders = Owners who invest capital in the Retakaful company

4. Role of Shareholder Capital in Retakaful

• Shareholder capital provides additional financial strength.
• This is important because Retakaful deals with potentially very large and volatile claims.

Shareholder Capital Can Help With

• Initial establishment costs
• Operating expenses
• Regulatory capital requirements
• Technology and infrastructure
• Absorbing operational losses
• Providing financial support to the Retakaful risk fund when required

Example

• Retakaful shareholders invest RM200 million.
• The Retakaful operator uses part of this money for:
• Systems
• Staff
• Liquidity
• Shari’ah-compliant investments
• The capital also provides a financial cushion.

5. Is Shareholder Capital Used Directly to Pay Claims?

• Normally, claims are primarily paid from the Retakaful risk fund.
• That fund is built from Retakaful contributions received from Takaful operators.
• However, if the Retakaful fund suffers a deficit, shareholder support may become important.

Example

Retakaful risk fund has:

RM300 million

But claims amount to:

RM350 million

There is a deficit of:

RM50 million

• Depending on the Retakaful structure, the shareholders’ fund may provide Qard, an interest-free loan, to support the risk fund.

Simple Process

Retakaful contributions → Retakaful Risk Fund → Claims

If insufficient:

Shareholders’ Fund → Qard → Retakaful Risk Fund

6. Difference Between Retakaful Contribution and Shareholder Capital

Retakaful Contribution

• Comes from Takaful operators
• Paid to obtain Retakaful protection
• Goes into the Retakaful risk-sharing arrangement
• Used to support claims and related obligations
• Similar in purpose to a reinsurance premium, but structured according to Shari’ah

Shareholder Capital

• Comes from the owners/investors of the Retakaful company
• Represents ownership capital
• Supports the company’s operations and financial strength
• Is separate from the Retakaful risk fund
• May support the risk fund through Qard if there is a deficit

Simple Example Bringing Both Together

Suppose ABC Retakaful is established.

Shareholders

• Invest RM200 million
• This forms the shareholders’ fund.

Takaful Operators

• Various Takaful operators purchase Retakaful protection.
• Together they pay RM100 million in Retakaful contributions.
• These contributions go into the Retakaful risk fund.

Now:

Shareholder capital = RM200 million

Retakaful contributions = RM100 million

They are not the same thing.

If Claims Are RM70 Million

• Claims are mainly paid from the Retakaful risk fund.
• RM100m contributions − RM70m claims = amount remaining before other expenses and reserves.

If Claims Are RM130 Million

• The risk fund may face a shortfall.
• The shareholders’ fund may provide Qard, depending on the structure.

Easy Way to Remember

Retakaful Contribution

= Money paid by Takaful operators

= Used for Retakaful protection

Retakaful Shareholders

= Owners of the Retakaful company

= Provide capital and financial support

Simple Formula

Takaful Operators → Retakaful Contributions → Retakaful Risk Fund → Claims

Shareholders → Shareholder Capital → Support Retakaful Company + Possible Qard Support

Takaful - Example of a Sufficiently Large Number of Risks

• A sufficiently large number of risks means having enough separate risks in the pool so that overall claims become more predictable and manageable.
• The idea is that one individual loss should not have too much impact on the whole fund.

Example 1 – Motor Takaful

Suppose a Motor Takaful operator covers only:

• 20 cars

If 5 cars are involved in serious accidents, the claims may be very large compared with the size of the pool.

Small Pool

• 20 cars covered
• 5 serious claims
• Very difficult to predict
• A few claims can heavily affect the fund

Larger Pool

Now suppose the operator covers:

• 100,000 cars

From past experience, it may estimate that:

• Around 5% will make claims
• Around 5,000 claims may occur
• Average claim may be approximately RM5,000

The operator still cannot predict exactly which cars will have accidents, but it can estimate the overall level of claims more reliably.

Simple Idea

20 risks → Very unstable

100,000 risks → More predictable

Example 2 – Retakaful

Retakaful needs an even larger and more diversified pool because each risk can be very large.

Suppose a Retakaful operator accepts risks from only:

• 3 Takaful operators

Each Takaful operator has large factory risks.

If one major earthquake affects all three, the Retakaful operator may face extremely large claims at the same time.

Small Retakaful Pool

• 3 Takaful operators
• Similar types of property risk
• Same geographical area
• One catastrophe can affect all of them

This is not a sufficiently large and diversified pool.

Better Retakaful Example

Suppose the Retakaful operator instead accepts business from:

• 50 Takaful operators
• 15 different countries
• Several types of risk:
• Motor
• Property
• Marine
• Family Takaful
• Engineering
• Agriculture

Now one event is less likely to affect the entire portfolio.

Example

A flood in Malaysia may affect:

• Malaysian property risks

But it may not affect:

• Motor risks in Saudi Arabia
• Marine risks in Indonesia
• Family Takaful risks in the UAE

Simple Idea

More risks + Different countries + Different types of risks = Better pooling

Why the Number Must Be Large

The larger the number of risks:

• The easier it is to estimate expected claims
• The less impact one individual claim has
• The more stable the financial results become
• The better the risk can be spread

Simple Example

If a fund contains only:

10 large risks

and one claim is RM100 million, that one claim may seriously damage the fund.

But if the fund contains:

10,000 diversified risks

the impact of one RM100 million loss may be more manageable relative to the entire pool.

Easy Way to Remember

Sufficiently large number of risks does not simply mean “many customers.”

It means having:

• Many risks
• Different types of risks
• Different geographical locations
• Enough financial volume
• Good diversification

Simple Formula

Large Number + Diversification = More Predictable Claims + More Stable Risk Pool

Takaful - Absence of Large Numbers and Retakaful Sustainability

• One major challenge faced by the Retakaful industry is the absence of a sufficiently large number of risks to create an effective risk pool.
• Retakaful requires a much larger pool of risks than ordinary Takaful.
• This is because the risks transferred to Retakaful operators are generally:
• Larger
• Less frequent
• More unpredictable
• More volatile
• Capable of producing very large claims

1. Why Large Numbers Are Important

• Takaful and Retakaful rely on the principle of risk pooling.
• When many independent risks are pooled together, losses become easier to predict and manage.
• This is related to the law of large numbers.
• The larger the number of risks in the pool:
• The more predictable the overall claims become
• The easier it is to estimate contributions
• The easier it is to absorb individual losses

Simple Idea

More risks in the pool → Better predictability → More stable financial results

2. Why Takaful Can Work With Smaller Numbers

• Ordinary Takaful may cover large numbers of relatively common risks.
• Examples include:
• Motor accidents
• House fires
• Medical claims
• Personal accidents
• Although individual claims are uncertain, the operator may have thousands or millions of participants.

Example

Suppose a Motor Takaful operator covers:

100,000 cars

Historical data may show that approximately:

5,000 claims occur each year

• The operator cannot predict exactly which 5,000 cars will have accidents.
• However, with a large participant base, it may estimate the overall number and cost of claims reasonably well.

Simple Idea

Many similar risks → Claims become more predictable

3. Why Retakaful Needs Even Larger Numbers

• Retakaful does not normally deal with small individual risks.
• It receives risks from Takaful operators.
• These risks may include:
• Aviation
• Marine
• Oil and gas
• Major industrial plants
• Large property portfolios
• Natural catastrophes
• These claims can be extremely large and irregular.
• Therefore, a Retakaful operator needs a much larger and more diversified pool.

Simple Idea

Takaful pools individual risks

Retakaful pools large risks from many Takaful operators

4. Retakaful Claims Are More Variable and Volatile

• Variability means that claim amounts can differ greatly from one year to another.
• Volatility means that financial results can change sharply and unpredictably.

Example

A Retakaful operator may experience:

Year 1

• Contributions = RM500 million
• Claims = RM200 million

Year 2

• Contributions = RM500 million
• Claims = RM250 million

Year 3

• A major earthquake occurs.
• Claims = RM1.2 billion
• Therefore, Retakaful results can change dramatically because one catastrophe can create many large claims at the same time.

Simple Idea

Normal year → Small claims

Catastrophe year → Extremely large claims

This is why Retakaful needs a large financial pool and broad risk diversification.

5. Example Comparing Takaful and Retakaful

Takaful

Suppose:

• 100,000 Motor Takaful participants
• Average claim = RM5,000
• Claims occur regularly

The operator can use historical information to estimate expected claims.

Simple Idea

High number of participants + Manageable claim amounts = Easier pooling

Retakaful

Suppose a Retakaful operator covers only:

• 10 Takaful companies
• Each has exposure to major industrial and catastrophe risks

One earthquake may affect several Takaful operators at the same time.

Claims may suddenly reach:

RM2 billion

Simple Idea

Small number of very large risks = Harder to predict and manage

6. Why Diversification Is Important

• A Retakaful operator should ideally have risks from:
• Many Takaful companies
• Different countries
• Different industries
• Different types of risk
• This reduces the possibility that one event will affect the entire portfolio.

Example

A Retakaful operator covering only properties in one country may suffer badly if a major earthquake affects that country.

A more diversified operator may cover:

• Motor risks in Malaysia
• Property risks in Saudi Arabia
• Marine risks in Indonesia
• Family Takaful risks in the UAE

A single event is less likely to affect all these risks simultaneously.

Simple Idea

More geographical and business diversification → Lower concentration risk

7. Low Volume of Retakaful Business

• The global Takaful market is much smaller than the conventional insurance market.
• Therefore, there is also less business available for Retakaful operators.
• A standalone Retakaful company may not receive enough contributions to build a sufficiently large risk pool.

Example

A Retakaful company may need:

RM1 billion of annual business

to cover:

• Claims
• Staff
• Technology
• Capital costs
• Shari’ah governance
• Administration
• Investment management

But suppose it only receives:

RM300 million

in annual Retakaful contributions.

The business may struggle to cover its expenses and build sufficient reserves.

Simple Idea

Low business volume → Small pool → Higher average costs → Sustainability problem

8. Limited Financial Capacity

• Retakaful operators also require substantial financial resources.
• They must be capable of absorbing very large losses.
• If their capital and risk funds are too small, they cannot accept large amounts of business.

Example

A Takaful operator wants to transfer:

RM500 million of aviation risk

But the Retakaful operator can only safely accept:

RM100 million

The remaining RM400 million must be placed elsewhere.

Simple Idea

Limited capital → Limited risk-taking capacity

9. The Combination Creates a Difficult Problem

Two problems reinforce each other:

Problem 1 – Low Business Volume

• Not enough Takaful operators or risks are being placed with Retakaful providers.

Problem 2 – Limited Capacity

• Retakaful operators do not have enough capital to accept very large risks.

Together:

Low business volume + Low capacity → Difficulty achieving sufficient scale

This makes it difficult for a standalone Retakaful operator to become financially sustainable.

10. Why Standalone Retakaful Can Struggle

• A standalone Retakaful operator depends mainly on Retakaful business.
• It needs enough contributions to:
• Pay claims
• Build reserves
• Cover operating costs
• Maintain capital
• Support technology and specialist staff
• If the volume of business is too small, these fixed costs are spread across too little business.

Example

Annual fixed expenses:

RM50 million

If contributions are:

RM1 billion

Fixed expenses represent only:

5% of contributions

But if contributions are only:

RM200 million

The same RM50 million represents:

25% of contributions

Simple Idea

Small business volume → Higher cost per unit of business

11. Historical Examples

• The text identifies early attempts to establish standalone Retakaful operators that were not successful.
• Examples include:
• Asean Retakaful International (L) Limited in Labuan, Malaysia
• Takaful Re Limited in Dubai, UAE
• Their experiences demonstrate how difficult it can be to operate a standalone Retakaful business when:
• Market volume is limited
• Risk pools are small
• Financial capacity is insufficient
• Large claims are volatile

12. What Retakaful Needs to Become More Sustainable

• Larger number of Takaful operators
• Greater volume of Retakaful business
• More capital
• Larger contribution pools
• Greater geographical diversification
• Wider variety of risks
• Better underwriting
• Stronger investment management
• More skilled professionals

Simple Process

More Takaful business → More Retakaful contributions → Larger pool → Better diversification → Greater capacity → More sustainable Retakaful industry

Easy Way to Remember

Takaful

Many individual risks + Usually manageable claims → Pooling easier

Retakaful

Fewer but much larger risks + Highly volatile claims → Much larger pool required

Main Problem

Too few risks + Too little business + Limited capital = Small Retakaful pool

Result

Small pool → Large claims become difficult to absorb → Standalone Retakaful operator may struggle to survive

Simple Formula

Large Numbers + Diversification + Strong Capital + High Business Volume = Sustainable Retakaful

Takaful - Reinsurance Capacity vs Retakaful Capacity

• The global reinsurance market is much larger than the Retakaful market.
• This means conventional reinsurers generally have a much greater financial capacity to absorb very large losses than Retakaful operators.
• The difference is mainly caused by:
• Larger premium pools
• Larger shareholder capital
• Longer market history
• Greater number of reinsurance companies

1. Global Insurance Premiums

• In 2020, total global insurance premiums were estimated at approximately:

USD6,300 billion

• This represents premiums collected by insurance companies around the world.

Simple Idea

Global insurance market = USD6.3 trillion in premiums

2. Global Reinsurance Premiums

• Total global reinsurance premiums were estimated at approximately:

USD320 billion

• This is approximately 5% of total global insurance premiums.

Calculation

USD320 billion ÷ USD6,300 billion ≈ 5%

• This means that part of the risks originally accepted by insurance companies was passed on to reinsurers.

Simple Process

Policyholder → Insurance company → Part of risk → Reinsurance company

Simple Idea

Insurance premiums = USD6,300bn

Reinsurance premiums ≈ USD320bn

3. Global Reinsurance Capacity

• Global reinsurance capacity was estimated at more than USD500 billion.
• Reinsurance capacity does not come only from reinsurance premiums.
• It is supported by:
• Reinsurance premiums collected
• Shareholder capital
• Accumulated financial resources

Simple Structure

Reinsurance Premiums + Reinsurance Shareholder Capital → Reinsurance Financial Capacity

• In simplified terms, this large financial base determines how much loss the global reinsurance industry can absorb.

Example

• A large earthquake causes losses across many insurance companies.
• Those insurers may have transferred part of their risks to reinsurers.
• Because global reinsurers have hundreds of billions of dollars of financial capacity, they can absorb a substantial portion of these losses.

Simple Idea

Large financial pool → Greater capacity to absorb catastrophic losses

4. Global Takaful Contributions

• By comparison, total global Takaful contributions were estimated at only around:

USD30 billion

• This is significantly smaller than the conventional insurance market of USD6,300 billion.

Comparison

Conventional Insurance = USD6,300bn

Takaful = USD30bn

• Therefore, the total pool supporting the Takaful industry is much smaller.

5. Estimated Global Retakaful Contributions

• If we assume Retakaful represents approximately the same 5% share of Takaful contributions as reinsurance represents of insurance premiums:

5% × USD30 billion = USD1.5 billion

• Therefore, estimated global Retakaful contributions would be approximately:

USD1.5 billion

Simple Calculation

USD30bn × 5% = USD1.5bn

6. Reinsurance vs Retakaful

Reinsurance

• Reinsurance premiums ≈ USD320 billion
• Financial capacity exceeds USD500 billion
• Very large global risk pool
• Greater ability to absorb catastrophic losses

Retakaful

• Estimated contributions ≈ USD1.5 billion
• Much smaller risk pool
• Lower financial capacity
• More limited ability to absorb very large losses

Simple Idea

Reinsurance pool = Very large

Retakaful pool = Much smaller

7. Why the Size of the Pool Matters

• Reinsurance and Retakaful exist to help insurers and Takaful operators manage large risks.
• The larger the financial pool:
• The more risk can be accepted
• The larger the claims that can be absorbed
• The greater the ability to support insurers/Takaful operators

Example

Suppose an aviation loss produces a claim of:

USD500 million

For a large global reinsurance market:

• USD500 million is relatively small compared with its total financial capacity.

For a much smaller Retakaful market:

• A USD500 million loss represents a much larger proportion of the industry’s available resources.

Simple Idea

Same claim + Smaller fund = Much greater financial impact

8. Why This Is a Challenge for Takaful Operators

• Takaful operators may want to cover large risks such as:
• Aircraft
• Ships
• Oil and gas projects
• Large factories
• Infrastructure
• However, they may need significant Retakaful protection.
• If Retakaful capacity is limited, Takaful operators may struggle to transfer/share enough of these large risks.

Example

• A Takaful operator covers an aircraft with potential exposure of:

USD300 million

• It wants to retain only USD50 million.
• It therefore needs Retakaful protection of:

USD250 million

• If Retakaful operators cannot provide sufficient capacity, the Takaful operator may have difficulty accepting the risk.

Simple Process

Large risk → Takaful operator → Needs Retakaful → Limited Retakaful capacity creates difficulty

9. Why Reinsurance Has Greater Capacity

• Conventional reinsurance has:
• A much larger insurance market supporting it
• More premiums
• More shareholder capital
• More established international reinsurers
• Greater geographical diversification
• Therefore, risks can be spread across a much larger financial base.

Simple Idea

Large insurance industry → Large reinsurance industry → Greater risk-bearing capacity

10. Why Retakaful Has Lower Capacity

• The global Takaful industry itself is much smaller.
• Therefore, Retakaful receives fewer contributions.
• There are also fewer major Retakaful providers.
• This results in a smaller pool available to absorb losses.

Simple Relationship

Smaller Takaful market → Smaller Retakaful market → Lower loss-absorbing capacity

Easy Numerical Comparison

Conventional Market

• Global insurance premiums = USD6,300bn
• Global reinsurance premiums = USD320bn
• Reinsurance share ≈ 5%
• Reinsurance capacity = More than USD500bn

Takaful Market

• Global Takaful contributions = USD30bn
• Estimated Retakaful contribution at 5% = USD1.5bn

Main Lesson

• The difference between USD320 billion of reinsurance premiums and approximately USD1.5 billion of Retakaful contributions shows how much smaller the Retakaful market is.
• Consequently, Retakaful has a more limited capacity to absorb very large losses.
• This is one reason why the Takaful industry needs:
• More Retakaful operators
• Greater capital
• Larger contribution pools
• Stronger financial resources

Easy Way to Remember

Insurance market is huge → Reinsurance pool is huge → Can absorb huge risks

Takaful market is smaller → Retakaful pool is smaller → Capacity for huge risks is more limited

Simple Formula

Larger Risk Pool + More Capital = Greater Capacity to Absorb Losses

Takaful - Key Success Factors for the Takaful and Retakaful Industry

The successful development of the Takaful and Retakaful industry depends on several important factors.

1. Transparency of Processes

• Takaful operators should clearly explain how their operations work.
• Participants should understand:
• How contributions are allocated
• How much goes into the Participants’ Risk Fund
• What fees are charged
• How claims are assessed and paid
• How investments are managed
• How surplus and deficit are treated

Example

• Ahmad contributes RM1,200 to a Takaful plan.
• The operator clearly shows:
• Tabarru‘ portion
• Wakalah fee
• Investment allocation
• Surplus treatment

Simple Idea

Transparency = Participants know where their money goes and how the fund is managed.

2. Innovative Takaful Products

• Takaful operators need to create products that respond to new and changing risks.
• Innovation helps the industry remain relevant and competitive.

Examples

• Cyber Takaful
• Climate-risk Takaful
• Micro-Takaful
• Crop Takaful
• Livestock Takaful
• SME Takaful
• Digital Takaful
• Health-related Takaful

Example

• A small online business faces cyberattack risks.
• A Takaful operator develops Cyber Takaful to protect against covered cyber losses.

Simple Idea

New risks → New products → More relevant Takaful solutions

3. Sustainable Takaful Models

• Takaful models should remain financially strong over the long term.
• Contributions should be sufficient to support:
• Claims
• Reserves
• Expenses
• Other obligations
• Operators should avoid structures that repeatedly create deficits.

Example

• If contributions are too low, claims may continuously exceed the fund.
• The operator may repeatedly need to provide Qard.
• This would weaken long-term sustainability.

Simple Idea

Sustainable Takaful = Adequate contributions + Strong reserves + Good risk management

4. Inclusive Takaful Models

• Takaful should be available to a wider range of society.
• Products should not only target high-income customers.
• Inclusive models may serve:
• Low-income households
• Farmers
• Rural communities
• Small businesses
• Underserved groups

Example

• A Takaful operator offers Micro-Takaful for RM10 per month.
• This gives lower-income families access to basic protection.

Simple Idea

Inclusive Takaful = Affordable protection for more people

5. Harnessing Technological Advancement

• Technology can improve:
• Efficiency
• Distribution
• Claims processing
• Customer service
• Underwriting
• Fraud detection
• Data management
• Digitalisation can also reduce operating costs.

Example

• A participant submits a motor claim using a mobile application.
• Photos and documents are uploaded online.
• The claim is processed faster than through a fully manual system.

Simple Idea

Technology = Faster service + Lower cost + Better customer experience

6. Robust Shari’ah Governance

• Strong Shari’ah governance is essential to maintain trust and compliance.
• Takaful and Retakaful operators must ensure that:
• Products are Shari’ah-compliant
• Investments are Shari’ah-compliant
• Contracts are properly structured
• Fees are transparent
• Fund management follows approved Shari’ah principles
• Shari’ah committees should review and monitor operations continuously.

Example

• A Takaful operator wants to invest in a new financial instrument.
• The Shari’ah Committee reviews the instrument before approval.
• If it contains riba or other prohibited elements, it is rejected.

Simple Idea

Strong Shari’ah governance = Innovation without compromising Shari’ah compliance

Overall Key Success Factors

The Takaful and Retakaful industry needs:

• Transparency
• Product innovation
• Sustainable models
• Inclusive models
• Technology
• Strong Shari’ah governance

Easy Way to Remember

Transparency + Innovation + Sustainability + Inclusion + Technology + Shari’ah Governance = Successful Takaful and Retakaful Operations