Takaful - Reviewing the Use of Conventional Reinsurance

There has been a significant increase in the number of multinational Retakaful operators, including Retakaful windows operated by large international reinsurance groups. This has improved the availability, capacity, technical expertise, and financial strength of Shari’ah-compliant Retakaful protection.

In the past, Takaful operators were sometimes permitted to use conventional reinsurance because suitable Retakaful alternatives were unavailable or did not have sufficient capacity to cover large or specialised risks. This permissibility was generally based on need or necessity.

However, if suitable Retakaful protection is now widely available, the original reason for relying on conventional reinsurance may no longer be as strong. A Takaful operator should therefore first consider whether an adequate Retakaful provider can meet its requirements in terms of:

• Financial capacity
• Technical expertise
• Financial-strength rating
• Risk appetite
• Type of risk
• Geographical coverage

Example

Previously:

Takaful operator needs RM500 million protection

Available Retakaful capacity = RM100 million

Remaining RM400 million may have had to be placed with conventional reinsurance because sufficient Retakaful capacity was unavailable.

Today, suppose multinational Retakaful providers can provide the full:

RM500 million

In this situation, the argument that conventional reinsurance is necessary becomes much weaker because a suitable Shari’ah-compliant alternative is available.

Therefore, the Shari’ah ruling that allowed conventional reinsurance on the basis of need may need to be reviewed as market conditions change. A permission granted because no practical alternative existed should not automatically continue if adequate Retakaful alternatives later become available.

Simple Idea

Past: Limited Retakaful → Conventional reinsurance may be permitted because of need

Now: Greater Retakaful availability → Need for conventional reinsurance may decrease

Easy Formula

More Retakaful Capacity + Stronger Ratings + Wider Global Presence = Less Justification for Conventional Reinsurance

Takaful - Opportunity for Existing Insurance Customers to Switch

Takaful provides an opportunity for Muslims who currently use conventional insurance to move to a Shari’ah-compliant alternative without giving up the financial protection they need.

Some Muslims may already have conventional motor, medical, life, property, or business insurance because they need protection against financial loss. However, they may prefer an arrangement that is structured according to Shari’ah principles.

The availability of Takaful allows these customers to replace conventional insurance with products based on:

• Mutual assistance
• Risk sharing
• Tabarru’
• Shari’ah-compliant investments
• Proper separation of participants’ and shareholders’ funds
• Shari’ah governance

Example

Suppose Ahmad currently has conventional motor insurance because it is required and he needs protection for his vehicle.

If a suitable Motor Takaful product becomes available, Ahmad can switch from conventional insurance to Takaful while still receiving protection against covered motor risks.

Similarly:

Conventional life insurance → Family Takaful

Conventional medical insurance → Medical Takaful

Conventional property insurance → Property Takaful

This is important because Takaful does not only attract people who were previously uninsured. It can also convert existing insurance customers into Takaful participants.

Simple Idea

Already insured Muslim → Shari’ah-compliant Takaful becomes available → Switch to Takaful

Easy Formula

Existing Insurance Customers + Suitable Takaful Alternative = Potential Growth in Takaful Participation

Takaful - Creating Awareness Among Uninsured Muslims

Takaful also plays an important role in creating awareness among Muslims who do not currently have any form of insurance or financial protection. Some Muslims may avoid conventional insurance because they are concerned that it may contain elements that are not compliant with Shari’ah, such as riba, gharar, and maysir.

The availability of Takaful provides these individuals with a Shari’ah-compliant alternative. This means that Muslims who previously remained uninsured for religious reasons can now obtain financial protection without having to rely on conventional insurance.

Takaful is important because protecting oneself, one’s family, and one’s property is consistent with the objectives of Maqasid al-Shari’ah, which seek to preserve and promote essential human interests.

In this context, Takaful can contribute particularly to the protection of:

• Life (nafs) – by helping families cope financially after death, disability, illness, or accident
• Progeny/family (nasl) – by providing financial support to dependants and children
• Wealth (mal) – by protecting property, businesses, vehicles, and other assets against financial loss

Example

Suppose Ahmad does not purchase conventional life insurance because he believes it is not Shari’ah compliant.

If Ahmad dies unexpectedly, his wife and children may lose their main source of income.

With Family Takaful, Ahmad can contribute to a Shari’ah-compliant protection arrangement. If he dies during the coverage period, his eligible beneficiaries may receive a Takaful benefit to help with:

• Daily living expenses
• Housing costs
• Education
• Outstanding financial obligations
• Other family needs

Therefore, Takaful does more than simply compete with conventional insurance. It can also bring previously uninsured Muslims into the financial protection system by providing an option that is consistent with their religious values.

Simple Idea

No conventional insurance due to Shari’ah concerns

→ Takaful provides acceptable alternative

→ More Muslims obtain financial protection

Easy Formula

Takaful Awareness + Shari’ah-Compliant Protection = Greater Financial Inclusion

And from the perspective of Maqasid al-Shari’ah:

Protection of Life + Protection of Family + Protection of Wealth = Important Objective of Takaful

Takaful - Can Underwriting Surplus Be Invested?

Yes. Underwriting surplus can be invested if it is retained in the Participants’ Risk Fund (PRF) rather than immediately distributed to participants.

Once the surplus is retained, it becomes part of the PRF’s available assets. The Takaful operator may invest an appropriate portion of it in Shari’ah-compliant investments such as Sukuk, Islamic deposits, Islamic money-market instruments, or Shari’ah-compliant equities.

Example

Suppose the PRF has an underwriting surplus of:

RM5 million

The operator may decide to:

RM2 million → Keep liquid for future claims

RM3 million → Invest in Shari’ah-compliant assets

If the RM3 million investment earns RM150,000, that investment return generally adds to the PRF, subject to the particular Takaful model.

However, the operator cannot simply invest the entire surplus in risky or long-term assets. It must still consider:

• Expected future claims
• Liquidity requirements
• Solvency requirements
• Regulatory investment limits
• Diversification
• Shari’ah compliance

The main purpose of the PRF remains paying claims and protecting participants, so financial safety comes before maximising investment returns.

If the underwriting surplus is instead distributed to participants, that distributed amount is no longer available for the operator to invest as part of the PRF.

Simple Flow

Underwriting surplus arises

→ Retained in PRF

→ Can be invested appropriately

→ Investment return strengthens PRF

OR

→ Distributed to participants

→ No longer part of PRF

Easy Way to Remember

Retained underwriting surplus = Can be invested

Distributed underwriting surplus = Cannot remain invested by the PRF

So:

Underwriting Surplus + Retention in PRF → Shari’ah-Compliant Investment → Potential Growth of PRF

Takaful - What Is Underwriting Surplus?

Underwriting surplus in Takaful is the amount remaining in the Participants’ Risk Fund (PRF) after the fund has received contributions and paid all relevant risk-related obligations for the period.

In simple terms:

Money collected for risk protection − Claims and related costs = Underwriting surplus

Suppose a Takaful operator receives RM10 million in tabarru’ contributions into the PRF.

During the year:

• Claims = RM6 million
• Retakaful cost = RM1 million
• Claims-related expenses and reserves = RM1 million

The remaining amount is:

RM10m − RM6m − RM1m − RM1m = RM2 million

The RM2 million is the underwriting surplus.

The important point is that underwriting surplus arises from the risk protection activities of the PRF, not from the operator’s shareholders’ fund.

It may arise because:

• Claims were lower than expected
• Contribution income was sufficient
• Retakaful costs were manageable
• Expenses were controlled
• Loss experience was favourable

What Happens to the Surplus?

The treatment of underwriting surplus depends on the Takaful model, regulations, and contract terms.

It may be:

• Retained in the PRF to strengthen reserves
• Distributed partly to participants
• Used to reduce future contributions
• Shared according to an approved surplus-sharing mechanism

It does not automatically belong entirely to the shareholders.

Example

Suppose the PRF produces a surplus of RM5 million.

The operator may decide, according to the applicable rules, to:

RM3 million → Retain in the PRF

RM2 million → Distribute to eligible participants

The exact treatment varies between Takaful arrangements.

Underwriting Surplus vs Investment Profit

These are different.

Underwriting surplus

= Comes from the risk side of the business

Example:

Contributions exceed claims and related expenses

Investment profit

= Comes from investing the PRF or other funds in Shari’ah-compliant investments

Example:

Sukuk investment earns RM500,000

So:

Underwriting surplus ≠ Investment profit

Underwriting Surplus vs Shareholder Profit

They are also not the same.

Underwriting surplus

= Belongs to the risk fund according to the Takaful structure

Shareholder profit

= Income earned by the operator from sources such as:

• Wakalah fees
• Mudarabah profit share
• Investment return on shareholders’ own funds
• Other permitted operator income

Easy Way to Remember

Underwriting surplus = Extra money left in the Participants’ Risk Fund after paying claims and other risk-related obligations

Simple Formula

PRF Contributions

− Claims

− Retakaful Costs

− Expenses

− Required Reserves

= Underwriting Surplus

If the result is negative:

PRF Contributions < Claims and obligations = Underwriting Deficit

Takaful - Takaful as an Alternative to Conventional Insurance

From a product-design perspective, Takaful can provide an alternative form of financial protection for both Muslims and non-Muslims. Although Takaful is structured according to Shari’ah principles, a person does not need to be Muslim to participate. The practical objective remains similar to insurance: protecting individuals, families, and businesses against the financial consequences of unexpected events.

For Muslims, Takaful is particularly attractive because it is designed to provide protection while avoiding elements that are considered inconsistent with Shari’ah, such as riba, excessive gharar, and maysir. Funds are also required to be invested in Shari’ah-compliant assets.

For non-Muslims, the attraction may come from the broader features of the Takaful model rather than its religious basis. These can include:

• Mutual assistance
• Collective risk sharing
• Greater transparency in fund management
• Ethical investment
• Potential participation in underwriting surplus, depending on the model
• Stronger emphasis on participant welfare

Therefore, Takaful can be marketed as an ethical and mutual form of protection, rather than only as a religious product.

The statement that Takaful can be a superior product from the consumer’s perspective refers to the potential advantages of a properly designed Takaful arrangement. In a genuine Takaful structure, participants do not merely transfer their risks to a company for the company’s profit. Instead, participants contribute to a common risk fund and mutually support members who experience covered losses.

Example

Suppose 10,000 people participate in a Motor Takaful scheme.

They contribute to a common Participants’ Risk Fund.

If some participants suffer covered accidents:

Participants’ contributions → Common Risk Fund → Claims paid to affected participants

If the fund performs well and produces an underwriting surplus, that surplus may, depending on the model and applicable rules, be:

• Retained to strengthen the fund
• Distributed partly to participants
• Used to reduce future contributions
• Applied in another manner specified by the Takaful arrangement

This can create a stronger sense that the fund exists for the benefit of the participants, rather than purely for shareholders.

By comparison, in conventional stock insurance, policyholders generally pay premiums to an insurer that assumes the insured risks. If the insurer performs well, the residual profits generally belong to the shareholders of the insurance company.

Therefore, from the source’s perspective:

Conventional insurance → Protection provided through a commercial risk-transfer contract

Takaful → Protection provided through mutual risk sharing and participant cooperation

However, the phrase “where it can be implemented without compromise” is important.

Takaful may only provide these superior features if the actual operation genuinely reflects its principles. If the operator simply copies conventional insurance products, focuses mainly on shareholder returns, provides poor service, charges excessive contributions, or does not clearly distinguish the Takaful structure, then the theoretical advantages may be reduced.

For example, if a Takaful product:

• Uses proper fund separation
• Has transparent fees
• Invests only in Shari’ah-compliant assets
• Treats participants fairly
• Provides efficient claims service
• Offers competitive contributions
• Shares or manages surplus fairly
• Gives priority to participant interests

then the consumer may receive both effective financial protection and additional ethical or mutual benefits.

However, if the product is merely a conventional insurance product with different terminology, the customer may see little practical advantage.

Simple Idea

Takaful is not only for Muslims.

It can appeal to:

Muslims → Shari’ah-compliant protection

Non-Muslims → Ethical, mutual and transparent protection

Easy Formula

Effective Protection + Mutual Risk Sharing + Ethical Investment + Transparency + Participant Focus = Potential Consumer Advantage of Takaful

But:

Takaful can only demonstrate these advantages when its principles are implemented properly and without significant compromise.

Takaful - Lack of Product Innovation

In many countries where Takaful operates, the products offered are often very similar or almost identical to conventional insurance products. Instead of designing products that are uniquely based on the principles and objectives of Takaful, operators may simply copy an existing insurance product and adapt its terminology.

For example, a conventional motor insurance policy may be reproduced as a Motor Takaful product with almost the same:

• Coverage
• Exclusions
• Benefits
• Pricing structure
• Claims process
• Distribution method

The main visible changes may simply be:

Premium → Contribution

Policyholder → Participant

Insurance Fund → Participants’ Risk Fund

This is sometimes described as a “carbon copy” or “cut-and-paste” approach. The product may satisfy the basic Shari’ah requirements, but there may be little real innovation in how protection is designed or delivered.

The problem is that Takaful has its own distinctive principles, such as:

• Mutual assistance
• Risk sharing
• Tabarru’
• Participant welfare
• Shari’ah-compliant investment
• Social responsibility
• Financial inclusion

Therefore, Takaful products could potentially be designed in ways that reflect these principles more clearly instead of simply imitating conventional insurance.

Example

A conventional insurer offers standard health insurance.

A Takaful operator copies the same product and changes only the contractual structure.

This is product imitation.

A more innovative Takaful operator might instead develop a plan that includes:

• Preventive healthcare incentives
• Affordable protection for low-income families
• Surplus-sharing features
• Digital access for underserved communities
• Community-based mutual support

This would make the product more clearly aligned with the broader objectives of Takaful.

Lack of innovation can also make Takaful products difficult to distinguish from conventional insurance. If customers see no meaningful difference in benefits or service, they may simply compare the two products based on price.

This increases price competition and may reduce profitability.

Simple Idea

Same product + Same benefits + Same service → Customer compares mainly on price

For long-term success, Takaful operators need to move beyond simply copying conventional insurance products. They should develop products that are:

• More innovative
• More inclusive
• More customer-focused
• More clearly based on mutual assistance
• More responsive to new risks and social needs

Easy Formula

Copying Insurance Products → Little Differentiation → More Price Competition

Whereas:

Takaful Innovation + Shari’ah Values + Customer Needs = Stronger Product Differentiation

Takaful - Price Competition and Unsustainable Business Model

Takaful operators do not only compete with other Takaful operators; they also compete with conventional insurance companies. Because customers often view Takaful and insurance as providing similar protection, price can become an important factor when they choose between products.

When many operators compete for the same limited group of customers, they may try to attract business by reducing Takaful contribution rates. Conventional insurers may also lower their premiums, forcing Takaful operators to respond with even more competitive pricing.

The problem is that Takaful operators already face relatively high costs, including distribution expenses, customer education, Shari’ah governance, administration, underwriting, technology, and claims management. If contribution rates are continuously reduced while these costs remain high, the operator’s financial margin becomes very small.

Example

Suppose the appropriate contribution for a Motor Takaful product is:

RM1,000

because the operator expects:

• Claims = RM700
• Distribution and administration = RM200
• Financial buffer = RM100

However, because competitors charge only RM900, the operator reduces its contribution to RM850.

The operator may attract more customers, but:

RM850 contribution < RM900 expected claims and expenses

This means the business is being priced at an unsustainable level.

Repeated underpricing can also weaken the Participants’ Risk Fund. If contributions collected are insufficient to cover claims, reserves, and related expenses, the fund may experience recurring deficits and may require financial support such as qard from the shareholders’ fund, depending on the Takaful structure.

Therefore, competing mainly on price can create an unsustainable business model. An operator may increase its number of customers but still fail to generate sufficient income to cover its long-term costs and claims.

Simple Idea

More competition → Lower contribution rates → Lower margins → Greater risk of deficits → Sustainability problem

Takaful operators therefore need to compete on more than just price. They can differentiate themselves through better customer service, efficient claims handling, innovative products, digital services, strong Shari’ah governance, and products that genuinely meet customer needs.

Easy Formula

Takaful vs Takaful + Takaful vs Insurance → Strong Price Competition

If:

Price Competition + High Operating Costs + Underpricing = Unsustainable Takaful Business

A more sustainable approach is:

Fair Pricing + Good Underwriting + Efficient Costs + Better Service + Product Differentiation = Sustainable Takaful

Takaful - Limited Public Awareness and Market Growth

A major challenge facing the Takaful industry is the lack of public awareness and understanding. Insufficient effort may be devoted to educating people about why financial protection is important, how Takaful works, and how it differs from conventional insurance. If consumers do not understand the concept, many may simply continue using conventional insurance or remain uninsured.

Without greater awareness, Takaful operators are forced to compete for the same limited group of existing customers. This creates what can be described as a static consumer pool, meaning the total number of people interested in Takaful does not grow significantly even though more operators enter the market.

Example of a Static Consumer Pool

Suppose there are only 100,000 customers who currently understand and are willing to buy Takaful.

If there are:

5 Takaful operators, each may compete for part of those 100,000 customers.

If the market later grows to:

10 Takaful operators

but the number of interested customers remains at 100,000, the operators are still competing for the same group.

Therefore:

More operators + Same number of customers = Greater competition

When many operators compete for a limited number of customers, they may begin competing mainly through price. Each operator may try to offer a lower contribution than its competitors in order to attract participants.

For example:

Operator A → RM1,000 contribution

Operator B → RM950

Operator C → RM900

If this price competition continues, contribution rates may become too low relative to claims, operating expenses, and reserves. This can reduce profitability and potentially weaken the financial sustainability of the Takaful funds.

Simple Idea

Static customer base → More operators competing for same customers → Price competition → Lower margins → Sustainability pressure

For the Takaful industry to grow successfully, market awareness must increase at the same time as the number of operators increases. It is not enough simply to establish more Takaful companies. The number of people who understand, trust, and are willing to purchase Takaful must also expand.

Consumer education should therefore explain:

• Why financial protection is important
• What Takaful means
• How mutual risk sharing works
• What tabarru’ is
• How the Participants’ Risk Fund operates
• How Takaful differs from conventional insurance
• Why Takaful is structured according to Shari’ah principles
• What benefits participants receive

Greater awareness can expand the market beyond consumers who already purchase Takaful for religious reasons. It may also attract customers who value ethical finance, mutual protection, transparency, social responsibility, and Shari’ah-compliant investment.

The source highlights the large gap between the size of the Muslim population and Takaful’s share of the global insurance market. It states that Muslims represent around 25% of the global population, while Takaful accounts for less than 0.5% of global insurance premiums.

This suggests that the potential market is much larger than the current level of Takaful participation described in the text.

Simple Illustration

Imagine a market of 1,000 people.

If:

250 are Muslims

but only a very small proportion purchase Takaful, then there is considerable potential to increase participation if awareness, affordability, accessibility, and trust improve.

The problem is therefore not simply the number of Takaful operators. It is also whether the industry can convert a larger part of the population into informed and willing participants.

Greater public awareness can also reduce excessive price competition. If the overall number of Takaful customers grows, operators do not have to fight as aggressively for the same small group.

For example:

Before education

10 operators compete for 100,000 customers.

After successful education and market development

10 operators compete in a market of 500,000 customers.

The larger customer base gives operators more opportunity to grow without relying mainly on price cutting.

Therefore, the long-term success of Takaful depends on both supply and demand.

Increasing supply means:

More Takaful operators + More products + Better distribution

Increasing demand means:

More awareness + Better understanding + Greater acceptance + More customers

Both must develop together.

Easy Way to Remember

More Takaful operators without more customers

→ Same consumer pool

→ Fierce competition

→ Lower prices

→ Lower margins

→ Sustainability problems

More Takaful operators + Greater public awareness

→ Larger customer base

→ Greater market penetration

→ Better growth opportunities

→ Stronger Takaful industry

Simple Formula

Consumer Education → Greater Awareness → Greater Acceptance → Larger Takaful Market → Less Pressure from Competing for the Same Customers → More Sustainable Growth

Takaful - Captive Customer Base and Pricing Advantage

Insurers that have access to a captive customer base through their own distribution network are usually in a stronger competitive position. A captive customer base means the insurer already has direct access to a group of potential customers, for example through its agents, branches, employer groups, or bancassurance arrangements with banks.

Because these customers are easier to reach, the insurer may spend less on advertising, commissions, and customer acquisition. This lowers the average distribution cost per policy and may allow the insurer to offer more competitive pricing while still maintaining an acceptable profit margin.

Example

Suppose Insurer A sells insurance through a bank with 1 million existing customers.

The bank can directly offer motor, home, or life insurance to these customers.

Insurer A therefore does not need to spend as much money finding new customers.

If its distribution cost is low, it may be able to offer a motor policy for:

RM900

and still make a reasonable profit.

By contrast, Insurer B has no dedicated distribution network and no bank partnership. It must compete for customers through advertisements, brokers, comparison websites, and independent agents.

This may increase:

• Marketing expenses
• Agent commissions
• Customer acquisition costs
• Price competition

Insurer B may therefore have to reduce its price simply to attract customers.

For example:

Normal profitable price = RM950

But because competitors are offering RM900, Insurer B may reduce its price to:

RM880

If claims and operating costs remain high, its profit margin becomes very small.

This can create a sustainability problem. If the insurer continually lowers prices to win customers but cannot reduce claims or operating costs, it may eventually become financially unsustainable.

Simple Idea

Captive customer base → Easier access to customers → Lower distribution cost → Better pricing flexibility

Whereas:

No dedicated distribution network → Harder to attract customers → More price competition → Lower profit margins → Sustainability risk

Easy Example

Insurer with bank partnership

Bank customer needs a car loan

→ Bank offers motor insurance immediately

→ Easy sale

→ Lower acquisition cost

Insurer without bank partnership

Must advertise and compete for the same customer

→ Higher acquisition cost

→ Greater pressure to cut prices

Simple Formula

Strong Distribution Network + Captive Customers = Lower Customer Acquisition Cost + Better Pricing Power

Weak Distribution Network = Higher Competition + Price Cutting + Lower Profitability