Takaful - Absence of Large Numbers and Retakaful Sustainability

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

1. Why Large Numbers Are Important

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

Simple Idea

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

2. Why Takaful Can Work With Smaller Numbers

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

Example

Suppose a Motor Takaful operator covers:

100,000 cars

Historical data may show that approximately:

5,000 claims occur each year

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

Simple Idea

Many similar risks → Claims become more predictable

3. Why Retakaful Needs Even Larger Numbers

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

Simple Idea

Takaful pools individual risks

Retakaful pools large risks from many Takaful operators

4. Retakaful Claims Are More Variable and Volatile

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

Example

A Retakaful operator may experience:

Year 1

• Contributions = RM500 million
• Claims = RM200 million

Year 2

• Contributions = RM500 million
• Claims = RM250 million

Year 3

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

Simple Idea

Normal year → Small claims

Catastrophe year → Extremely large claims

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

5. Example Comparing Takaful and Retakaful

Takaful

Suppose:

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

The operator can use historical information to estimate expected claims.

Simple Idea

High number of participants + Manageable claim amounts = Easier pooling

Retakaful

Suppose a Retakaful operator covers only:

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

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

Claims may suddenly reach:

RM2 billion

Simple Idea

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

6. Why Diversification Is Important

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

Example

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

A more diversified operator may cover:

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

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

Simple Idea

More geographical and business diversification → Lower concentration risk

7. Low Volume of Retakaful Business

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

Example

A Retakaful company may need:

RM1 billion of annual business

to cover:

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

But suppose it only receives:

RM300 million

in annual Retakaful contributions.

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

Simple Idea

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

8. Limited Financial Capacity

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

Example

A Takaful operator wants to transfer:

RM500 million of aviation risk

But the Retakaful operator can only safely accept:

RM100 million

The remaining RM400 million must be placed elsewhere.

Simple Idea

Limited capital → Limited risk-taking capacity

9. The Combination Creates a Difficult Problem

Two problems reinforce each other:

Problem 1 – Low Business Volume

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

Problem 2 – Limited Capacity

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

Together:

Low business volume + Low capacity → Difficulty achieving sufficient scale

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

10. Why Standalone Retakaful Can Struggle

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

Example

Annual fixed expenses:

RM50 million

If contributions are:

RM1 billion

Fixed expenses represent only:

5% of contributions

But if contributions are only:

RM200 million

The same RM50 million represents:

25% of contributions

Simple Idea

Small business volume → Higher cost per unit of business

11. Historical Examples

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

12. What Retakaful Needs to Become More Sustainable

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

Simple Process

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

Easy Way to Remember

Takaful

Many individual risks + Usually manageable claims → Pooling easier

Retakaful

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

Main Problem

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

Result

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

Simple Formula

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