Takaful - Consumer Perception and Service Quality

Many customers perceive Takaful as being very similar to conventional insurance because both provide financial protection against specified risks. From the customer’s point of view, the practical experience may appear similar: they pay a contribution, receive a certificate of protection, and expect compensation when a covered event occurs. However, many customers do not fully understand the underlying Shari’ah contract, the role of tabarru’, or the relationship between the participant, the Participants’ Risk Fund, and the Takaful operator.

Some customers choose Takaful mainly because of religious considerations. They prefer a protection arrangement that avoids elements such as riba, gharar, and maysir and that is structured according to Shari’ah principles. For this group, Shari’ah compliance is an important reason for selecting Takaful instead of conventional insurance.

However, for many customers, service quality is still the most important factor when deciding whether to purchase or continue with a Takaful plan. Even if a product is Shari’ah compliant, customers may be dissatisfied if the service is poor, the plan is difficult to understand, or claims are delayed.

Good service begins with providing a clear and adequate explanation of the Takaful plan. Customers should understand what is covered, what is excluded, how much contribution they must pay, how claims are made, and what benefits they may receive. The operator should also explain the basic structure of Takaful so that the customer understands that it is based on mutual assistance rather than a conventional risk-transfer arrangement.

Another important factor is offering a plan that is suitable for the customer’s actual needs. The operator should not simply sell the same product to everyone. For example, a young family may need strong family protection and medical coverage, while a small business owner may require property, liability, or business interruption protection.

Customers also consider whether the Takaful contribution rate is reasonable and affordable. If the contribution is too high compared with the benefits offered, customers may choose another Takaful provider or even a conventional insurer. Therefore, operators need to balance affordability with the financial sustainability of the Participants’ Risk Fund.

The most important service factor is often claims handling. Customers expect claims to be processed quickly, fairly, and transparently. A Takaful operator may have strong Shari’ah governance and good products, but if claims are delayed or handled poorly, customers may lose confidence in the operator.

Example

Suppose Ahmad is choosing between two protection plans.

Operator A

• Strong Shari’ah branding
• Poor explanation of benefits
• Higher contribution
• Slow claims process

Operator B

• Also Shari’ah compliant
• Clearly explains the plan
• Offers suitable coverage
• Charges a reasonable contribution
• Processes claims quickly

Ahmad may prefer Operator B because the overall service quality and customer experience are better.

This means that Takaful operators cannot rely only on their Islamic identity to attract and retain customers. They must combine Shari’ah compliance with strong service quality, suitable products, fair pricing, and efficient claims management.

Simple Idea

Religious preference may attract the customer, but good service helps retain the customer.

Simple Formula

Customer Preference = Shari’ah Compliance + Clear Explanation + Suitable Product + Reasonable Contribution + Efficient Claims Service

Takaful - Can the Participants’ Risk Fund Be Invested?

Yes. The Participants’ Risk Fund (PRF) can be invested, but the operator cannot simply invest any amount it wants. The amount invested is subject to liquidity needs, expected claims, solvency requirements, regulatory investment limits, asset concentration limits, and Shari’ah requirements.

Clarifying the Investment Limit

There is no single universal rule saying, for example, that exactly 60% or 70% of every PRF must be invested. The permitted amount depends on the jurisdiction, the regulator, the type of Takaful business, the expected pattern of claims, and the characteristics of the investments.

Therefore, the earlier example of:

RM4 million liquid + RM6 million invested

was only an illustration, not a regulatory requirement.

1. Enough Liquidity Must Be Maintained

The PRF exists primarily to pay participants’ covered claims. Therefore, the operator must keep enough assets in cash or highly liquid investments to meet expected claims when they fall due.

For example, if a General Takaful operator expects many motor claims to be paid over the next few months, it should not place most of the PRF into long-term investments that cannot easily be sold.

Higher short-term claim needs → More liquidity required → Less money available for long-term investment

2. Regulatory Investment Limits Apply

The regulator may specify what types of assets Takaful funds can invest in and may impose limits on exposure to particular investments.

For example, regulations may restrict excessive investment in:

• Equities
• Property
• A single company
• A single Sukuk issuer
• Foreign assets
• Illiquid investments
• Higher-risk assets

The purpose is to prevent the PRF from becoming too concentrated or exposed to excessive investment risk.

3. Solvency Must Be Protected

The operator must ensure that investment decisions do not weaken the PRF’s ability to meet its liabilities.

For example, suppose:

PRF assets = RM100 million

Expected claims and liabilities = RM80 million

The operator cannot simply invest the whole RM100 million in volatile equities in search of higher returns. A severe market decline could reduce the value of the assets and make it difficult for the fund to meet claims.

Therefore:

Investment return is important, but claim-paying ability comes first.

4. Shari’ah Limits Also Apply

Every PRF investment must comply with Shari’ah principles.

The operator cannot invest the PRF in:

• Conventional interest-bearing bonds
• Conventional interest-based deposits
• Companies whose activities fail applicable Shari’ah screening
• Other prohibited investments

Suitable investments may include:

• Islamic bank deposits
• Sukuk
• Islamic money-market instruments
• Shari’ah-compliant equities
• Other approved Islamic investments

5. Asset-Liability Matching Is Important

The investment period should also match the expected timing of claims.

General Takaful

Claims may arise relatively quickly.

Therefore, the PRF normally needs a greater proportion of:

Short-term + liquid investments

Longer-Term Liabilities

Where obligations are expected further into the future, the fund may be able to hold more:

Medium- or long-term Shari’ah-compliant investments

Example

Suppose a PRF contains RM100 million.

The operator estimates that it may need RM30 million relatively soon for claims and other obligations.

It might therefore maintain:

RM30 million → Cash / highly liquid Islamic instruments

and invest part of the remaining funds in:

Sukuk + Islamic money-market instruments + Shari’ah-compliant equities

However, the actual allocation must remain within the operator’s regulatory, solvency, risk-management, and Shari’ah limits.

Easy Way to Remember

The PRF is not limited by one fixed investment percentage.

Instead, the operator asks:

How much must remain available for claims?

How much can safely be invested?

What investments are permitted by Shari’ah and regulation?

Simple Formula

PRF Investment Limit = Available Funds − Required Liquidity − Claim Obligations − Required Financial Buffers

subject to:

Shari’ah Rules + Regulatory Limits + Solvency Requirements + Diversification Requirements

So, the main principle is:

PRF can be invested, but protection of participants and ability to pay claims take priority over earning the highest possible investment return.

Takaful - Can the Participants’ Risk Fund Be Invested?

Yes. The Participants’ Risk Fund (PRF) can be invested, but the operator normally does not invest all of it. Part of the fund must remain sufficiently liquid so that claims can be paid when they arise.

The Takaful operator may invest part of the PRF in Shari’ah-compliant investments such as Islamic deposits, Sukuk, Islamic money-market instruments, or other approved assets. The purpose is to earn additional returns and strengthen the risk fund.

Example

Suppose the PRF contains RM10 million.

The operator may keep:

RM4 million → Cash or highly liquid Islamic deposits

and invest:

RM6 million → Sukuk and other Shari’ah-compliant investments

If claims of RM3 million arise, the operator can use the liquid portion of the PRF to pay them.

The investment profit earned from the PRF generally remains part of the Participants’ Risk Fund. It strengthens the fund and can help meet future claims, reserves, and other obligations according to the Takaful model.

For example:

PRF = RM10 million

Investment return = RM300,000

The fund may then become:

RM10.3 million, before claims and other expenses.

This is different from the Individual Investment Fund. The Individual Investment Fund is mainly for a participant’s personal savings and investment, whereas the PRF is a collective fund for mutual protection.

Easy Way to Remember

Individual Investment Fund → Invested for the individual participant

Participants’ Risk Fund → Invested to strengthen the collective risk pool

So the flow is:

Participants’ contributions → PRF → Part kept liquid + Part invested → Investment returns added to PRF → Claims paid from PRF

Takaful - Difference Between Individual Investment Fund and Participants’ Risk Fund

The Individual Investment Fund and the Participants’ Risk Fund (PRF) have different purposes in Takaful. The Individual Investment Fund is mainly for the participant’s personal savings and investment, while the Participants’ Risk Fund is a collective pool used to pay claims and provide mutual protection.

1. Individual Investment Fund

The Individual Investment Fund belongs to the individual participant and is commonly found in Family Takaful products. Part of the participant’s contribution is placed into this account and invested in Shari’ah-compliant assets so that it can grow over time.

The participant may receive the accumulated value of this fund at maturity, surrender, or according to the terms of the Takaful certificate. Investment returns generated by the fund are generally credited to the participant, subject to the applicable fees and Takaful model.

Simple Idea

Individual Investment Fund = My personal savings/investment account

2. Participants’ Risk Fund

The Participants’ Risk Fund is a collective fund belonging to the participating group. Participants contribute part of their money as tabarru’, or donation, into this fund for the purpose of helping any participant who suffers a covered loss.

Claims are mainly paid from this fund. Unlike the Individual Investment Fund, the money in the PRF is not simply the participant’s personal savings that can be withdrawn whenever desired.

Simple Idea

Participants’ Risk Fund = Our common protection fund

Example

Suppose Ahmad pays a Family Takaful contribution of RM1,000.

For illustration, the contribution may be divided as follows:

RM700 → Individual Investment Fund

RM300 → Participants’ Risk Fund

The RM700 is invested for Ahmad’s personal long-term savings and may grow through Shari’ah-compliant investments.

The RM300 goes into the common risk pool together with contributions from other participants.

If another participant, Ali, dies or suffers a covered event, the Takaful benefit relating to risk protection is paid from the Participants’ Risk Fund.

Main Difference

Individual Investment Fund

= Individual participant’s money

= Savings and investment purpose

= Accumulates for that participant

= May be received at maturity or surrender, depending on the contract

Participants’ Risk Fund

= Collective participants’ money

= Mutual protection purpose

= Used to pay covered claims

= Built mainly from tabarru’ contributions

Easy Way to Remember

Individual Investment Fund = “My money for my future.”

Participants’ Risk Fund = “Our money to help anyone in the group who suffers a covered loss.”

Simple Flow

Participant’s Contribution → Split

Part 1 → Individual Investment Fund → Savings + Investment

Part 2 → Participants’ Risk Fund → Tabarru’ + Claims

The exact split and treatment depend on the particular Family Takaful product and operating model. General Takaful products may mainly use a Participants’ Risk Fund and may not have a separate individual investment fund.

Takaful - Investment Management

The particular Takaful model adopted by an operator can influence how its funds are invested. Different models may determine how investment profits are allocated and how the operator manages participants’ funds. However, the common objective is to invest available funds in a Shari’ah-compliant manner so that they can grow while remaining sufficiently safe and liquid.

⸻

Takaful operators generally manage several types of funds. These may include the participants’ individual or investment fund, the Participants’ Risk Fund, and the operator’s own shareholders’ fund. Instead of leaving all these funds as idle cash, the operator invests appropriate amounts to generate returns and strengthen the financial position of the Takaful arrangement.

⸻

A major challenge is the limited availability of suitable halal investment opportunities. This problem can be especially serious in countries where the Islamic financial system is still at an early stage of development. Such markets may have only a small number of Islamic banks, Sukuk, Shari’ah-compliant shares, and other Islamic financial instruments available for investment.

⸻

For example, Takaful operators need Islamic bank accounts or Islamic money-market instruments where they can place short-term funds while earning competitive Shari’ah-compliant returns. This is particularly important because part of the Participants’ Risk Fund must remain liquid so that claims can be paid when they arise. If there are very few Islamic banking facilities available, the operator may find it difficult to achieve both liquidity and attractive returns.

⸻

Investment in shares or equities creates another challenge. A Takaful operator cannot simply invest in any listed company. The company must satisfy the relevant Shari’ah screening requirements, including restrictions relating to prohibited business activities and excessive involvement in interest-based financing.

⸻

This can become difficult in markets where companies depend heavily on conventional bank loans and interest-based financial instruments. Even if the company’s main business activity is permissible, excessive conventional debt or non-compliant financial income may cause its shares to fail the applicable Shari’ah screening criteria. Therefore, the number of suitable stocks available to the Takaful operator may be limited.

⸻

Sukuk provide another important investment avenue for Takaful operators because they can offer Shari’ah-compliant income and may be suitable for matching longer-term obligations. However, not every Sukuk has the same level of liquidity. Some Sukuk may be difficult to sell quickly in the secondary market.

⸻

Liquidity can be particularly important for certain debt-based Sukuk or similar instruments. Some Shari’ah scholars and standards, including relevant AAOIFI principles, place restrictions on the trading of instruments that predominantly represent debts or receivables. Consequently, a Takaful operator may not always be able to freely buy and sell such instruments at market prices.

⸻

This creates an important investment-management problem. The operator may find an investment that is Shari’ah compliant and provides a good return, but if it cannot easily convert that investment into cash, it may not be suitable for a fund that needs to pay claims at short notice.

⸻

Example

Suppose a General Takaful operator has RM100 million available in its Participants’ Risk Fund. It cannot invest the entire RM100 million in long-term or illiquid Sukuk because claims may arise unexpectedly.

It may therefore allocate the money between:

• Islamic bank deposits for short-term liquidity
• Highly liquid Shari’ah-compliant instruments
• Sukuk for more stable returns
• Shari’ah-compliant equities for potential growth

The operator must balance return, safety and liquidity.

⸻

Takaful operators must also consider regulatory requirements when making investment decisions. Shari’ah compliance alone is not sufficient. The operator must also comply with the investment rules imposed by the regulator in the jurisdiction where it operates.

⸻

One important consideration is the solvency ratio. Regulators require Takaful operators to maintain sufficient financial resources to meet their obligations to participants and claimants. Certain investments may carry greater risk or may receive less favourable treatment when calculating regulatory capital. Therefore, an operator cannot simply select an investment because it provides the highest return.

⸻

For example, investing heavily in volatile shares might produce higher potential returns, but it could also increase the possibility of investment losses and weaken the operator’s solvency position. The operator must therefore construct a portfolio that supports both investment growth and financial stability.

⸻

Investment management in Takaful therefore requires the operator to balance several objectives at the same time:

Shari’ah Compliance + Return + Safety + Liquidity + Solvency + Regulatory Compliance

⸻

The overall challenge is that Takaful operators must grow participants’ and shareholders’ funds without compromising Shari’ah principles or their ability to meet claims. This becomes more difficult in markets where Islamic investment instruments are limited or where Shari’ah-compliant securities have insufficient liquidity.

Simple Idea

Takaful funds should not remain idle → Funds are invested → Investments must be halal → They must also provide suitable returns, remain sufficiently liquid, and satisfy regulatory and solvency requirements.

Takaful - Retakaful Windows and Profitability

Most, if not all, Retakaful operations that have a sufficiently acceptable rating from major rating agencies are now operated as Retakaful windows within larger reinsurance companies.

One important reason is that Retakaful windows can often operate more profitably than standalone Retakaful operators because they can share the parent company’s existing infrastructure, staff, systems, technical expertise, and distribution network.

A standalone Retakaful operator has to bear all of its own operating costs, including offices, employees, technology, underwriting systems, claims management, compliance, and Shari’ah governance. This means it usually needs a much larger volume of business before it can become profitable.

By contrast, a Retakaful window can operate with a lower volume of business because many of these costs are already covered by the larger parent company. As a result, the additional cost of running the Retakaful window is lower.

Therefore, Retakaful windows may achieve profitability more easily, while standalone Retakaful operators may struggle if the market does not provide enough business to cover their higher fixed costs.

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