Takaful - Proportional vs Non-Proportional Retakaful

The easiest way to distinguish them is:

Proportional Retakaful = Takaful and Retakaful share the risk from the beginning.

Non-Proportional Retakaful = Takaful bears losses first, and Retakaful only steps in when an agreed loss threshold is exceeded.

1. Proportional Retakaful

In proportional Retakaful, the Takaful risk pool and Retakaful risk pool share the original risk, contributions and claims according to an agreed proportion.

Retakaful does not need to wait for a claim to become very large before participating. It already has an agreed share of the risk.

The two main forms are:

Quota Share

and

Surplus Treaty

Example A — Quota Share

Suppose the agreement is:

Takaful = 60%

Retakaful = 40%

A property is covered for:

RM5 million

Therefore:

Takaful retains RM3 million

Retakaful accepts RM2 million

Suppose a claim of only:

RM500,000

occurs.

Even though the claim is relatively small, it is still shared:

Takaful pays 60% = RM300,000

Retakaful pays 40% = RM200,000

Why?

Because Retakaful already accepted 40% of the original risk.

Simple Idea

Risk shared first → Claim shared later in the same proportion

2. Proportional Retakaful — Surplus Treaty

Surplus Treaty is also proportional, but there is no single fixed percentage for every risk.

Instead, the Takaful operator decides how much of the original risk it wants to retain.

Suppose:

Property value = RM4 million

Takaful retention = RM1 million

Therefore:

Takaful retains 25%

Retakaful accepts 75%

Now suppose there is an:

RM800,000 claim

Even though RM800,000 is below RM1 million, the claim is still shared:

Takaful = 25% × RM800,000 = RM200,000

Retakaful = 75% × RM800,000 = RM600,000

This is because the RM1 million retention refers to the original risk, not the individual claim.

Simple Idea

RM4m risk → divided 25:75

Therefore:

Any covered claim → divided 25:75

3. Non-Proportional Retakaful

In non-proportional Retakaful, there is no predetermined percentage such as 60:40 or 25:75 that is automatically applied to every claim.

Instead, the Takaful operator bears losses up to an agreed retention or threshold.

Retakaful only becomes involved when the loss exceeds that level.

Two important forms are:

Excess of Loss

and

Stop Loss

4. Non-Proportional — Excess of Loss

Excess of Loss focuses on an individual loss.

Suppose:

Takaful retention = RM1 million per loss

If there is an:

RM800,000 claim

then:

Takaful pays RM800,000

Retakaful pays RM0

Why?

Because the loss has not exceeded the RM1 million retention.

Now suppose the claim is:

RM3 million

The Takaful operator bears:

First RM1 million

Retakaful may cover:

Next RM2 million

subject to the treaty limit.

So:

RM3m claim → RM1m Takaful + RM2m Retakaful

Notice that this is not a percentage split.

The Takaful operator simply absorbs the first layer, and Retakaful covers the excess layer.

Simple Idea

Takaful pays first → Retakaful steps in after the loss becomes too large

5. Non-Proportional — Stop Loss

Stop Loss works differently again.

Instead of looking at one individual claim, it looks at the total claims of the portfolio over a period, usually one year.

Suppose:

Annual contributions = RM10 million

Stop-loss threshold = 70%

Therefore:

70% × RM10m = RM7 million

The Takaful operator bears annual claims up to RM7 million.

If total annual claims are:

RM6 million

Retakaful pays:

RM0

because the threshold has not been reached.

If total annual claims become:

RM9 million

then:

Takaful bears RM7 million

Retakaful may cover RM2 million

subject to the treaty limit.

Simple Idea

Stop Loss protects against the situation where:

“The total claims for the whole year have become too high.”

The Big Difference

Proportional Retakaful

Think:

“We share the risk together from the beginning.”

The Retakaful operator accepts a proportion of the original risk.

Therefore, when a covered claim happens, Retakaful participates according to its proportion.

For example:

RM4m risk

↓

25% Takaful + 75% Retakaful

↓

RM800k claim

↓

RM200k Takaful + RM600k Retakaful

The claim does not have to cross a loss threshold first.

Non-Proportional Retakaful

Think:

“I will handle normal losses myself. You protect me when losses become too large.”

There is no automatic percentage sharing of every claim.

For Excess of Loss:

RM800k claim

with RM1m retention:

100% Takaful

Retakaful pays nothing.

But:

RM3m claim

with RM1m retention:

First RM1m → Takaful

Next RM2m → Retakaful

Why Are They Called Proportional and Non-Proportional?

It is called proportional because the Takaful and Retakaful pools share the business according to a proportion.

For example:

25% : 75%

or

60% : 40%

That proportion determines how contributions and claims are allocated.

It is called non-proportional because claims are not automatically divided according to a predetermined percentage.

Instead, Retakaful responds when an agreed loss threshold is exceeded.

For example:

First RM1m loss → Takaful

Loss above RM1m → Retakaful

Easy Way to Remember

Proportional

“SHARE with me.”

The original risk is divided between:

Takaful + Retakaful

Examples:

Quota Share → fixed percentage

Surplus Treaty → percentage depends on how much original risk Takaful retains

Non-Proportional

“PROTECT me when losses get too high.”

Takaful bears losses first.

Retakaful comes in after a threshold.

Examples:

Excess of Loss → individual loss becomes too high

Stop Loss → total annual claims become too high

Final Memory Formula

PROPORTIONAL

Share the original risk → Share contributions → Share claims

Quota Share + Surplus Treaty

NON-PROPORTIONAL

Takaful bears losses first → Threshold exceeded → Retakaful responds

Excess of Loss + Stop Loss

So, in one sentence:

Proportional Retakaful shares the risk from the beginning, whereas non-proportional Retakaful provides protection only when losses exceed an agreed level.

Takaful - Proportional Treaty Retakaful: Quota Share and Surplus Treaty

In a proportional treaty Retakaful arrangement, the Takaful operator’s risk pool and the Retakaful operator’s risk pool share the original Takaful business according to an agreed proportion. This means that both the contributions received and the claims paid are generally shared in the same agreed ratio.

Unlike non-proportional Retakaful, the Retakaful operator does not wait for a claim to exceed a certain retention level before participating. Instead, it shares the risk from the beginning according to the agreed treaty arrangement.

There are two common forms of proportional treaty Retakaful:

1. Quota Share Treaty

2. Surplus Treaty

1. Quota Share Retakaful

Under a quota share treaty, the Takaful operator and Retakaful operator share each and every risk according to the same fixed percentage.

The agreed percentage applies to all risks that fall within the treaty.

For example, the parties may agree that:

Takaful operator retains 60%

Retakaful operator accepts 40%

This 60:40 proportion is then applied to both the contribution and the claim.

Example of Quota Share

Suppose a participant pays a Takaful contribution of:

RM10,000

The agreed quota share is:

Takaful operator = 60%

Retakaful operator = 40%

Therefore:

Takaful risk pool keeps RM6,000

Retakaful risk pool receives RM4,000

Now suppose a covered claim of:

RM100,000

occurs.

The claim is also shared in the same proportion:

Takaful risk pool pays RM60,000

Retakaful risk pool pays RM40,000

So the same ratio applies to both:

Contribution: 60% / 40%

Claim: 60% / 40%

Simple Idea

Quota share means:

Every risk is shared in the same fixed percentage.

It does not matter whether the risk is small or large, provided it falls within the treaty.

Easy Formula

Takaful Share = Agreed % × Contribution or Claim

Retakaful Share = Agreed % × Contribution or Claim

2. Surplus Treaty Retakaful

Under a surplus treaty, the Takaful operator does not automatically share every risk in the same fixed percentage.

Instead, the Takaful operator first decides how much of each risk it is willing to retain in its own risk pool.

The portion of the risk that exceeds its desired retention is then ceded to the Retakaful operator, subject to the capacity of the treaty.

Therefore, the proportion shared between Takaful and Retakaful can be different for different risks.

Example of Surplus Treaty

Suppose the Takaful operator is willing to retain:

RM1 million per risk

A property covered under Takaful has a sum covered of:

RM4 million

The Takaful operator retains:

RM1 million

The excess is:

RM4 million − RM1 million = RM3 million

Therefore:

Takaful operator retains 25%

Retakaful operator takes 75%

because:

RM1m ÷ RM4m = 25%

and:

RM3m ÷ RM4m = 75%

Suppose the contribution for this risk is:

RM40,000

The contribution may be shared according to the same proportion:

Takaful operator = 25% × RM40,000 = RM10,000

Retakaful operator = 75% × RM40,000 = RM30,000

If a covered claim of:

RM800,000

occurs, the claim would also be shared proportionately:

Takaful operator = 25% × RM800,000 = RM200,000

Retakaful operator = 75% × RM800,000 = RM600,000

Another Surplus Example

Suppose the Takaful operator still retains a maximum of:

RM1 million per risk

Risk A

Sum covered:

RM1 million

The operator is comfortable retaining the whole amount.

Therefore:

Takaful = 100%

Retakaful = 0%

Risk B

Sum covered:

RM2 million

Takaful retains:

RM1 million

Retakaful receives:

RM1 million

Therefore:

Takaful = 50%

Retakaful = 50%

Risk C

Sum covered:

RM5 million

Takaful retains:

RM1 million

Retakaful receives:

RM4 million

Therefore:

Takaful = 20%

Retakaful = 80%

This shows why a surplus treaty does not use the same percentage for every risk.

The proportion changes according to the size of the original risk and the amount the Takaful operator wishes to retain.

Main Difference Between Quota Share and Surplus Treaty

Quota Share

A fixed percentage is applied to every risk.

Example:

60% Takaful / 40% Retakaful

Every eligible risk is shared using that same ratio.

Surplus Treaty

The Takaful operator first chooses how much of each risk it wants to retain.

Only the surplus above that retention is ceded to Retakaful.

Therefore, the sharing percentage can change from one risk to another.

Very Simple Example

Suppose the operator’s preferred retention is:

RM1 million

For a RM2 million risk:

50% Takaful / 50% Retakaful

For a RM4 million risk:

25% Takaful / 75% Retakaful

For a RM1 million risk:

100% Takaful / 0% Retakaful

That is the key feature of a surplus treaty.

Easy Way to Remember

Quota Share = Same percentage for every risk

Surplus Treaty = Takaful keeps what it wants, Retakaful takes the surplus

Simple Formula

Quota Share

Contribution and Claim × Fixed Agreed Percentage

Example:

60% Takaful + 40% Retakaful

Surplus Treaty

Total Risk − Takaful Retention = Amount ceded to Retakaful

Then the contribution and claim are shared according to the resulting proportion.

One-Line Summary

Proportional Retakaful means the Takaful and Retakaful risk pools share both contributions and claims proportionately; quota share uses a fixed percentage for every risk, while surplus treaty allows the Takaful operator to retain a chosen amount and cede only the excess to Retakaful.

Takaful - Permissibility of Conventional Reinsurance and Non-Proportional Retakaful

The use of conventional reinsurance by a Takaful operator may be permitted when there is a genuine practical necessity. This usually arises when there is insufficient Retakaful capacity or when suitable Islamic reinsurance protection is unavailable. In such circumstances, the need to protect participants and maintain the financial stability of the Takaful fund may become serious enough to be treated as necessity (darurah) under Shari’ah.

The justification is therefore not that conventional reinsurance is preferred, but that there may be no adequate Shari’ah-compliant alternative available for a particular risk. If the Takaful operator cannot obtain enough Retakaful protection, retaining the entire risk could expose the Participants’ Risk Fund to excessive financial loss.

Example

Suppose a Takaful operator needs RM500 million of external protection for a large industrial risk.

Available Retakaful capacity is only:

RM300 million

The remaining:

RM200 million

may potentially be placed with a conventional reinsurer if there is a genuine need and the relevant Shari’ah conditions are satisfied.

Simple Idea

Insufficient Retakaful + Serious need for protection = Conventional reinsurance may be temporarily permitted

Non-Proportional Retakaful

In a non-proportional Retakaful arrangement, the Takaful operator does not share every claim with the Retakaful operator according to a fixed percentage.

Instead, the Takaful risk pool first absorbs losses up to an agreed retention limit. The Retakaful risk pool only becomes responsible when the loss exceeds that retention.

This means that the Takaful operator uses its own protective provisions and Participants’ Risk Fund first. Only the amount above the agreed retention is passed to the Retakaful operator, subject to the maximum Retakaful cover.

Example

Suppose:

Takaful retention = RM1 million

Retakaful cover = RM4 million

If a covered loss is:

RM700,000

the entire loss is below the retention.

Therefore:

Takaful risk pool pays RM700,000

Retakaful pays RM0

If the loss is:

RM3 million

the Takaful risk pool bears the first:

RM1 million

The Retakaful operator may then pay:

RM2 million

So:

RM3 million loss = RM1 million Takaful + RM2 million Retakaful

This is different from a proportional arrangement because there is no fixed percentage sharing of every claim.

For example, under proportional Retakaful:

Takaful = 40%

Retakaful = 60%

Every covered claim would normally be shared using those percentages.

Under non-proportional Retakaful:

Takaful pays first up to retention

Retakaful only steps in after the retention is exceeded

Easy Way to Remember

Proportional Retakaful

= Both sides share every risk or claim by percentage

Non-Proportional Retakaful

= Takaful bears the first layer, Retakaful covers the excess

Simple Formula

Loss − Retention = Retakaful portion

subject to the agreed Retakaful limit.

Takaful - Excess of Loss vs Stop Loss Retakaful

Concise Overview

Both Excess of Loss and Stop Loss are non-proportional Retakaful arrangements. The main difference is that Excess of Loss looks at the size of an individual loss, while Stop Loss looks at the total claims or loss ratio for the whole portfolio over a period, usually one year.

1. Excess of Loss Retakaful

Under Excess of Loss, the Takaful operator first bears each individual claim up to an agreed retention limit. The Retakaful operator only pays when a particular loss exceeds that limit.

Example

Suppose:

Takaful retention = RM1 million

Retakaful cover = RM4 million

A factory suffers a covered loss of:

RM3 million

The Takaful operator pays:

First RM1 million

The Retakaful operator pays:

RM2 million

So:

RM3m claim = RM1m Takaful + RM2m Retakaful

If another claim is only:

RM700,000

the Retakaful operator pays nothing because the claim does not exceed the RM1 million retention.

Simple Idea

Excess of Loss asks:

“How big is this individual claim?”

If the individual claim exceeds the retention, Retakaful becomes involved.

2. Stop Loss Retakaful

Under Stop Loss, the Retakaful operator does not normally look at whether one individual claim is large or small. Instead, it looks at the total claims for the whole portfolio during the year.

The Retakaful operator begins paying only when the total annual loss ratio exceeds an agreed percentage.

Example

Suppose the Takaful operator receives:

RM10 million in contributions

The stop-loss threshold is:

70%

Therefore:

70% × RM10m = RM7 million

The Takaful operator bears total annual claims up to RM7 million.

If total claims for the year are:

RM6 million

Loss ratio:

RM6m ÷ RM10m = 60%

Since this is below 70%:

Retakaful pays nothing.

If total annual claims become:

RM9 million

Loss ratio:

90%

The Takaful operator bears:

RM7 million

The Retakaful operator may cover:

RM2 million

subject to the agreed maximum.

Simple Idea

Stop Loss asks:

“How high are the total claims for the whole year?”

Main Difference

Excess of Loss

Focuses on:

One individual large claim

Example:

RM3m claim

Retention RM1m

→ Retakaful pays RM2m

Stop Loss

Focuses on:

Total claims for the whole portfolio

Example:

Annual contributions RM10m

Stop-loss threshold 70% = RM7m

Annual claims RM9m

→ Retakaful may pay RM2m

Example Showing the Difference Clearly

Suppose there are 100 separate claims of RM100,000 each.

Total claims:

100 × RM100,000 = RM10 million

Under Excess of Loss

If the retention per claim is:

RM1 million

Each RM100,000 claim is below RM1 million.

Therefore:

Retakaful pays RM0

even though total claims are RM10 million.

Under Stop Loss

Suppose annual contributions are:

RM10 million

and the stop-loss threshold is:

70% = RM7 million

Total claims are RM10 million.

Therefore:

Retakaful may cover RM3 million

subject to the agreed limit.

This shows the key distinction:

Excess of Loss cares about each claim individually.

Stop Loss cares about the total annual claims.

Easy Way to Remember

Excess of Loss = One claim becomes too large

Stop Loss = The whole year becomes too bad

Simple Formula

Excess of Loss

Individual Claim

− Retention

= Retakaful payment, subject to limit

Stop Loss

Total Annual Claims

− Agreed Annual Threshold

= Retakaful payment, subject to limit

Takaful - Excess of Loss Retakaful

Excess of loss Retakaful is a non-proportional form of Retakaful protection. Under this arrangement, the Takaful operator first bears losses up to an agreed retention limit. The Retakaful operator only becomes responsible when a covered loss exceeds that retention level.

This means that the Takaful operator uses its own risk fund and protective provisions first. Only the portion of the loss above the agreed retention is passed to the Retakaful operator, subject to the maximum amount of Retakaful cover purchased.

Unlike proportional Retakaful, the Takaful operator and Retakaful operator do not share every risk or every claim according to a fixed percentage. The Retakaful operator only participates when the loss becomes large enough to cross the retention threshold.

Example

Suppose a Takaful operator has an excess of loss arrangement with:

Retention limit = RM1 million

Retakaful cover = RM4 million

This means:

• The Takaful operator bears the first RM1 million of any covered loss.
• The Retakaful operator may cover the amount above RM1 million, up to a maximum of RM4 million.

Situation 1 - Small Loss

A claim amounts to:

RM600,000

Because this amount is below the RM1 million retention:

Takaful operator pays RM600,000

Retakaful operator pays RM0

The Retakaful protection is not triggered.

Situation 2 - Larger Loss

A claim amounts to:

RM3 million

The Takaful operator bears:

First RM1 million

The remaining amount is:

RM2 million

The Retakaful operator may therefore pay:

RM2 million

So:

Takaful operator = RM1 million

Retakaful operator = RM2 million

Situation 3 - Very Large Loss

A claim amounts to:

RM7 million

The Takaful operator bears the first:

RM1 million

The Retakaful cover is limited to:

RM4 million

Therefore:

Takaful operator = RM1 million

Retakaful operator = RM4 million

The remaining:

RM2 million

would depend on whether the Takaful operator has another layer of protection or must bear the excess itself.

Why It Is Called “Excess of Loss”

It is called excess of loss because the Retakaful operator only pays the part of the claim that is in excess of the Takaful operator’s retention.

Simple Idea

Loss below retention → Takaful operator pays

Loss above retention → Retakaful pays the excess, within the agreed limit

No Proportional Sharing

In proportional Retakaful, both parties share every risk and claim according to an agreed percentage.

For example:

Takaful operator = 40%

Retakaful operator = 60%

If the claim is RM10 million, both share it proportionally.

In excess of loss Retakaful, there is no such fixed percentage sharing.

Instead:

Takaful operator bears losses up to the retention

then

Retakaful operator bears the excess

Simple Comparison

Proportional Retakaful

Every claim is shared according to a percentage

Example:

40% Takaful

60% Retakaful

Excess of Loss Retakaful

Claims are not shared by percentage

Instead:

Takaful operator pays first layer

Retakaful operator pays only after retention is exceeded

Easy Formula

If:

Retention = RM1 million

and

Loss = RM3 million

then:

Retakaful Payment = RM3m − RM1m = RM2m

subject to the maximum Retakaful limit.

Easy Way to Remember

Excess of Loss = Retakaful only steps in after the Takaful operator has absorbed the agreed first portion of the loss.

Takaful - Stop Loss Retakaful

A stop loss Retakaful arrangement protects the Takaful operator when its total claims for the year become too high. The Retakaful risk pool does not pay individual claims from the beginning. Instead, it only starts paying once the Takaful operator’s total annual loss ratio exceeds an agreed percentage.

The loss ratio is generally calculated as:

Total Claims ÷ Takaful Contributions × 100

The Takaful operator and Retakaful operator agree in advance on a particular loss-ratio level, called the attachment point or stop-loss threshold.

Example

Suppose the Takaful operator receives:

RM10 million in Takaful contributions

The stop-loss agreement starts when the annual loss ratio exceeds:

70%

Therefore:

70% × RM10 million = RM7 million

The Takaful operator must bear claims up to RM7 million.

The Retakaful protection only begins when total annual claims exceed RM7 million.

If total claims for the year are:

RM5 million

Loss ratio:

RM5m ÷ RM10m = 50%

Since 50% is below the agreed 70% threshold:

Retakaful pays nothing.

If total claims are:

RM9 million

Loss ratio:

RM9m ÷ RM10m = 90%

The Takaful operator bears the first:

RM7 million

The excess is:

RM9m − RM7m = RM2 million

The Retakaful arrangement may therefore cover the RM2 million excess, subject to the agreed maximum limit.

This means stop loss is concerned with the total accumulated claims for the whole portfolio during a period, rather than the size of one individual claim.

For example, the RM9 million total may come from:

• 1 very large claim, or
• 1,000 smaller claims

What matters is whether the overall annual loss ratio crosses the agreed threshold.

Why Is It Called “Stop Loss”?

It is called stop loss because it helps stop the Takaful operator’s annual underwriting losses from becoming excessively large.

The Takaful operator accepts normal claim fluctuations up to an agreed level, while the Retakaful operator provides protection against unusually bad overall claims experience.

Simple Idea

Claims below threshold → Takaful fund bears them

Claims exceed threshold → Retakaful starts paying the excess

Easy Formula

Takaful Contributions = RM10m

Stop-loss threshold = 70%

Attachment point = RM7m

If:

Claims ≤ RM7m → No Retakaful payment

If:

Claims > RM7m → Retakaful may pay the amount above RM7m, subject to the agreed limit

Important Point

The statement that the Retakaful pool is “not responsible for any loss, big or small” means that even a very large individual claim does not automatically trigger payment under a pure stop-loss arrangement. The total annual claims must first cause the agreed loss-ratio threshold to be exceeded.

So:

Stop Loss = Protection against excessive total annual claims, not simply against one large individual loss.

Takaful - Basis for Permitting Conventional Reinsurance

The main basis for permitting a Takaful operator to use conventional reinsurance is practical necessity. This situation may arise when there is not enough suitable Retakaful or Islamic reinsurance coverage available in the market to protect the operator against large or specialised risks.

If the Takaful operator cannot obtain sufficient Retakaful protection, keeping the entire risk may expose the Participants’ Risk Fund to serious financial loss. In such circumstances, using conventional reinsurance may become necessary to protect participants and maintain the financial stability of the Takaful operation.

This is also connected to the concept of dire public need. If the absence of reinsurance protection could cause serious harm to participants, businesses, or the wider community, that need may be treated as reaching the level of necessity (darurah) under Shari’ah.

Example

Suppose a Takaful operator covers a large industrial project worth RM1 billion.

The operator can safely retain only:

RM100 million

Available Retakaful providers can cover:

RM600 million

There is still:

RM300 million

of risk that cannot be covered through Retakaful.

If the operator keeps this RM300 million exposure, one major loss could seriously weaken the Participants’ Risk Fund. Therefore, conventional reinsurance may be used for the remaining amount because of practical necessity.

The permission is therefore not based on a preference for conventional reinsurance. It arises because the operator has no adequate Shari’ah-compliant alternative and needs protection against serious financial harm.

Simple Idea

Insufficient Retakaful coverage + Serious need for protection = Necessity

Therefore:

Conventional reinsurance may be temporarily permitted

Easy Formula

**Lack of Islamic Reinsurance Coverage

• Dire Public Need
• Risk of Serious Harm
• = Necessity that may justify limited conventional reinsurance**

The permission should remain limited to the amount and period genuinely required, and Retakaful should still be given priority whenever it is available.

Takaful - Priority of Retakaful Over Conventional Reinsurance

Takaful operators are generally required by their Shari’ah committees to give priority to Retakaful whenever suitable Retakaful protection is available. This is because Retakaful is designed to provide reinsurance-type protection in a manner that is consistent with Shari’ah principles and supports the development of a fully Shari’ah-compliant Takaful system.

If a Takaful operator cannot obtain sufficient or appropriate Retakaful protection, it may be permitted to use conventional reinsurance on the basis of necessity. This may happen where the Retakaful market does not have enough capacity, suitable technical expertise, acceptable financial strength, or appropriate coverage for a particular risk.

For example, suppose a Takaful operator needs RM500 million of protection for a large industrial risk. If Retakaful providers can only provide RM350 million, the operator should first use the RM350 million Retakaful capacity. The remaining RM150 million may then be placed with a conventional reinsurer if there is no suitable Shari’ah-compliant alternative.

The IFSB-8 guidance emphasises that Takaful operators should, as far as possible, use Retakaful operators rather than conventional reinsurers. The objective is to support the development of a financial system in which the Takaful operation remains Shari’ah compliant throughout the entire risk-sharing chain.

Simple Process

Participant → Takaful Operator → Retakaful Operator

is preferred over:

Participant → Takaful Operator → Conventional Reinsurer

Similarly, AAOIFI Shari’ah Standard No. 41 generally does not permit Takaful operators to use conventional reinsurance except where it is required as a temporary or transitional arrangement because of a public need that reaches the level of necessity.

This means conventional reinsurance is not intended to become the normal or permanent solution for Takaful operators. It is an exception that may be used when sufficient Islamic reinsurance protection is genuinely unavailable.

The justification for this exception comes from the practical difficulty created by the lack of adequate Retakaful coverage. If the Takaful operator has large risks that cannot be safely retained and there is insufficient Retakaful capacity, refusing all reinsurance protection could expose the Participants’ Risk Fund to serious financial harm.

Example

Suppose a Takaful operator has:

Participants’ Risk Fund = RM400 million

but accepts a risk with a possible loss of:

RM1 billion

The operator cannot safely retain the entire risk.

If available Retakaful operators can only provide:

RM500 million

the remaining risk may have to be protected through conventional reinsurance because otherwise the Takaful fund could face an excessive exposure.

In this situation, conventional reinsurance may be tolerated because of necessity, not because it is preferred.

The concept of necessity is recognised in Shari’ah through principles derived from the Qur’an and Sunnah. These principles allow certain normally prohibited arrangements to be used in exceptional circumstances when there is a genuine and serious need and no adequate lawful alternative is available.

However, the permission must remain limited to what is actually necessary.

Easy Way to Remember

First choice: Retakaful

Second choice: Conventional reinsurance only when suitable Retakaful is unavailable

Reason: Necessity or serious public need

Nature of permission: Temporary and limited, not permanent

Simple Formula

Suitable Retakaful Available → Must Give Retakaful Priority

Suitable Retakaful Unavailable + Genuine Necessity → Conventional Reinsurance May Be Permitted

The ultimate objective is:

Takaful + Retakaful = Fully Shari’ah-Compliant Risk Protection System

Takaful - Conditions for Using Conventional Reinsurance

Concise Overview

Takaful operators may sometimes be permitted to use conventional reinsurance when adequate Retakaful protection is unavailable. However, this permission is based on need or necessity and is therefore subject to strict conditions. The general principle is that the operator must use Retakaful as much as possible and limit conventional reinsurance to only what is genuinely required.

1. Retakaful Must Be Used First

The Takaful operator should first place its risks with Retakaful operators to the greatest possible extent.

Conventional reinsurance should only be considered when the available Retakaful market cannot provide enough:

• Capacity
• Technical expertise
• Financial strength
• Suitable coverage

Example

Suppose a Takaful operator requires:

RM500 million of protection

Available Retakaful capacity:

RM400 million

The operator should first place the RM400 million with Retakaful.

Only the remaining:

RM100 million

may potentially be placed with a conventional reinsurer if there is a genuine need.

Simple Idea

Retakaful first → Conventional reinsurance only for the unavoidable shortfall

2. Conventional Reinsurance Must Be Kept to the Minimum

The amount ceded to a conventional reinsurer should be no more than necessary.

The Takaful operator cannot use conventional reinsurance excessively simply because it is cheaper, easier, or more familiar.

The operator’s Shari’ah board should monitor and review the amount placed with conventional reinsurers.

Example

If:

Required external protection = RM1 billion

and:

Retakaful can provide RM850 million

then the conventional portion should generally be limited to the remaining:

RM150 million

rather than placing the entire RM1 billion conventionally.

3. The Reinsurance Period Should Be as Short as Necessary

Any agreement with a conventional reinsurer should only continue for the period required to satisfy the actual need.

The contract should not be extended unnecessarily if suitable Retakaful becomes available earlier.

Example

Suppose conventional reinsurance is required because no Retakaful provider can currently cover a specialised risk.

If adequate Retakaful capacity is expected to become available after one year, the operator should not automatically enter into a five-year conventional reinsurance arrangement.

Simple Idea

Temporary necessity → Temporary permission

4. Payments to Conventional Reinsurers Should Be Minimized

The amount paid to conventional reinsurance companies should also be kept to the lowest level necessary to meet the need.

This follows the Shari’ah maxim:

“Necessity is to be assessed and treated proportionately.”

This means that when an otherwise prohibited arrangement is permitted because of necessity, the operator should only use it to the extent required.

Example

If the necessary conventional reinsurance protection can be achieved with:

RM2 million of reinsurance premium

the operator should not unnecessarily purchase additional conventional coverage that increases the payment to:

RM5 million

unless the additional protection is genuinely required.

5. No Profit Commission from Conventional Reinsurers

According to the stated approach, the Takaful operator should not collect a profit commission or similar commission from the conventional reinsurance company.

A profit commission may arise where the reinsurer returns part of its underwriting result to the ceding company when claims experience is favourable.

The concern is that the Takaful operator should not seek to generate additional commercial benefit from an arrangement that is only being tolerated because of necessity.

Simple Idea

Conventional reinsurance is used to meet a need, not to create an additional source of profit.

6. Shari’ah Board Approval Must Be Obtained

Before entering into an agreement with a conventional reinsurer, the Takaful operator should obtain the approval of its Shari’ah board.

The Shari’ah board should assess issues such as:

• Whether there is a genuine need
• Whether sufficient Retakaful capacity is unavailable
• How much conventional reinsurance is necessary
• How long the agreement should continue
• Whether the arrangement complies with the applicable Shari’ah conditions

Example

A Takaful operator wants to place RM300 million with a conventional reinsurer.

Before signing the agreement, it should demonstrate to the Shari’ah board that:

• Suitable Retakaful providers were approached first
• Retakaful capacity was insufficient
• RM300 million is genuinely required
• The agreement is limited to the necessary period

Only after this review should the conventional reinsurance arrangement proceed.

7. Takaful Operators Should Work Toward Retakaful Alternatives

Takaful operators should not become permanently dependent on conventional reinsurance.

They should work toward increasing the availability of Retakaful capacity, including supporting the establishment and development of Retakaful operators.

The long-term objective is to reduce or eliminate the need to deal with conventional reinsurers.

Why This Is Important

Greater Retakaful capacity would provide:

• More Shari’ah-compliant risk sharing
• Greater financial capacity
• Better diversification
• Stronger technical expertise
• Less reliance on conventional reinsurance

Simple Process

Develop Retakaful market → Increase Retakaful capacity → Reduce necessity → Reduce conventional reinsurance

Main Shari’ah Principle

The permission to use conventional reinsurance is based on:

Necessity or genuine need

but it is controlled by the principle:

“Necessity is to be assessed and treated proportionately.”

Therefore, the permission should be limited in:

• Amount
• Duration
• Payment
• Purpose

Easy Way to Remember

When conventional reinsurance is necessary:

1. Use Retakaful first

2. Use conventional reinsurance only for the minimum shortfall

3. Keep the agreement as short as possible

4. Keep payments to the minimum necessary

5. Do not seek profit commissions

6. Obtain Shari’ah board approval

7. Work toward replacing conventional reinsurance with Retakaful

Simple Formula

Retakaful First + Minimum Conventional Amount + Shortest Period + Minimum Payment + Shari’ah Approval = Controlled Use of Conventional Reinsurance

Takaful - Darurah and the Changing Need for Conventional Reinsurance

In the past, the global Retakaful market had only a small number of active Retakaful operators. Their financial capacity, geographical reach, and technical ability were limited compared with large conventional reinsurers. Because of this shortage, many Takaful operators could not obtain enough Shari’ah-compliant Retakaful protection for all of their risks.

As a result, Takaful operators often had to cede part of their risks to conventional reinsurance companies. This was generally justified under the Shari’ah principle of darurah, or necessity.

The relevant maxim is:

“Necessities render the prohibited permissible.”

This means that when a genuinely necessary Shari’ah-compliant alternative is unavailable, a normally prohibited option may be temporarily permitted to the extent required to remove the hardship or danger.

Example - Situation in the Past

Suppose a Takaful operator needed:

RM500 million of external risk protection

but available Retakaful operators could provide only:

RM150 million

The remaining:

RM350 million

might have been placed with a conventional reinsurer because the Takaful operator did not have a sufficient Shari’ah-compliant alternative.

In this situation:

Insufficient Retakaful capacity → Genuine need → Limited use of conventional reinsurance

However, the Retakaful market has developed significantly. There are now more multinational Retakaful operators and Retakaful windows with stronger capital bases, greater technical expertise, wider international operations, and stronger financial ratings.

This means that some of the circumstances that previously justified the use of conventional reinsurance may no longer exist.

If a Takaful operator can now obtain sufficient protection from a financially sound and technically capable Retakaful provider, it becomes more difficult to justify conventional reinsurance purely on the basis of necessity.

Example - Situation Today

A Takaful operator requires:

RM500 million of protection

Suppose suitable Retakaful operators can now provide the full:

RM500 million

at an acceptable financial rating and technical standard.

The operator can no longer simply argue that conventional reinsurance is necessary because a lawful Shari’ah-compliant alternative is available.

This is connected to another important Shari’ah maxim:

“Necessity is assessed and treated proportionately.”

This means that even when necessity exists, permission to use a prohibited arrangement is only given to the extent necessary. It is not an unlimited permission.

Example of Proportionality

Suppose a Takaful operator needs:

RM1 billion of protection

Retakaful providers can supply:

RM800 million

but there is still no suitable Retakaful capacity for the remaining:

RM200 million

The necessity argument might apply only to the RM200 million shortfall, rather than allowing the entire RM1 billion to be placed with conventional reinsurance.

Simple Idea

Use the lawful alternative as much as possible.

Only the unavoidable portion should potentially rely on the necessity exemption.

Therefore, if the harm or difficulty can be removed through a lawful Shari’ah-compliant means, the justification for using the prohibited alternative disappears.

In other words:

When Retakaful becomes genuinely available and adequate, conventional reinsurance should not continue to be used merely because it was previously permitted.

This means the permissibility of conventional reinsurance should be reviewed continuously as market conditions change. A ruling based on necessity is not necessarily permanent because the underlying necessity itself may disappear.

Easy Way to Remember

Past situation

Few Retakaful operators

→ Insufficient capacity

→ Conventional reinsurance needed

→ Darurah may permit limited use

Present situation

More multinational Retakaful operators

→ Stronger capital and ratings

→ Greater Shari’ah-compliant capacity

→ Less need for conventional reinsurance

Two Important Shari’ah Maxims

1. Necessities render the prohibited permissible

Used when there is a genuine necessity and no adequate lawful alternative.

2. Necessity is assessed proportionately

Only the amount required to remove the necessity should be permitted.

Simple Formula

No Suitable Retakaful + Genuine Need → Limited Conventional Reinsurance May Be Permitted

But:

Suitable Retakaful Available → Necessity Removed → Conventional Reinsurance Exemption Should Be Reconsidered

And:

Partial Retakaful Availability → Use Retakaful First → Conventional Reinsurance Only for the Unavoidable Shortfall