Takaful - Basic Difference Between Retakaful and Reinsurance

The key point in this passage is who actually bears the underwriting risk.

In a Takaful arrangement, the Takaful operator itself is primarily the manager of the Takaful business. Under a Wakalah structure, it acts as a wakil (agent) managing the Participants’ Risk Fund (PRF) on behalf of the participants.

Therefore, when Retakaful protection is needed, it is fundamentally being arranged for the Takaful risk pool, not for the operator’s shareholder fund.

1. The Takaful Operator Is the Manager, Not the Risk Pool

Suppose:

Participants → contribute tabarru’ → Takaful Risk Pool (PRF)

The PRF bears the participants’ covered underwriting risks.

The Takaful operator manages the fund by performing functions such as underwriting, claims administration, investment management, and arranging an appropriate Retakaful programme.

Under a Wakalah model, the operator receives an agreed Wakalah fee for performing its management responsibilities.

So:

Takaful Operator = Manager/Wakil

Takaful Risk Pool = Bears participants’ underwriting risk

This distinction is extremely important.

2. Who Actually Takes Up Retakaful?

Since the Takaful risk pool bears the underwriting risks, Retakaful protection is arranged for that risk pool.

Therefore, the Retakaful tabarru’ or contribution is deducted from the:

Takaful Risk Pool (PRF)

rather than being treated simply as a personal expense of the Takaful operator’s shareholders.

The reason is straightforward:

The fund bearing the risk is the fund that needs the Retakaful protection.

Example

Suppose the PRF contains:

RM100 million

The Takaful operator determines that some of the risks in the fund are too large to retain completely.

It arranges Retakaful protection costing:

RM5 million

The RM5 million Retakaful contribution/tabarru’ is therefore charged to:

Participants’ Risk Fund

After paying the Retakaful contribution:

RM100m − RM5m = RM95m

The PRF now has Retakaful protection according to the agreed treaty.

3. What Happens When a Large Claim Occurs?

Suppose a large covered factory claim of:

RM20 million

occurs.

Under the Retakaful arrangement, suppose the Takaful risk pool is responsible for:

RM5 million

and the Retakaful arrangement is responsible for:

RM15 million

The Retakaful recovery of RM15 million belongs to the Takaful risk pool.

So conceptually:

Retakaful Risk Pool → RM15m recovery → Takaful Risk Pool

It does not become RM15 million of profit for the Takaful operator/shareholders.

This makes sense because the PRF was the fund exposed to the original claim.

4. Follow the Money

This is the easiest way to understand the passage.

When Retakaful protection is purchased:

Takaful Risk Pool

→ pays Retakaful contribution/tabarru’ →

Retakaful Risk Pool

When a qualifying Retakaful claim occurs:

Retakaful Risk Pool

→ pays Retakaful recovery →

Takaful Risk Pool

Therefore:

PRF pays for the protection → PRF receives the benefit of that protection.

The Takaful operator stands in the middle as the manager arranging and administering the process.

5. Why Shouldn’t the Takaful Operator Earn an Extra Commission?

The passage makes another important point.

Under the Wakalah arrangement, the Takaful operator has already received a Wakalah fee for managing the Takaful operation.

One of its management responsibilities is to arrange an appropriate Retakaful programme for the PRF.

Therefore, under the approach described in your text, the operator should not arrange Retakaful and then separately take an additional commission for itself merely for arranging that protection.

Think of it this way:

Participants: “We already pay you a Wakalah fee to professionally manage our risk fund.”

Operator: “Part of my job is deciding how much risk the fund should retain and how much Retakaful protection it needs.”

Therefore:

Wakalah fee → already compensates operator for management

and the operator should not improperly extract additional benefit from the Retakaful arrangement.

6. Example of Why This Matters

Suppose:

PRF = RM100 million

The operator arranges Retakaful costing:

RM5 million

Imagine the Retakaful provider gives an arranging commission of:

RM500,000

If the operator simply takes the RM500,000 for its shareholders, it could create a conflict of interest.

The operator might be tempted to choose a Retakaful arrangement because:

“It gives us a higher commission.”

rather than:

“This is the best Retakaful programme for the participants’ risk fund.”

The passage therefore emphasises that the operator, acting as wakil, should arrange the optimal Retakaful programme in the interests of the PRF, rather than using the arrangement to generate additional benefits for itself.

7. What If Conventional Reinsurance Is Used Instead?

The same basic principle continues to apply.

Suppose suitable Retakaful protection is unavailable and, subject to the relevant Shari’ah requirements, the Takaful operator uses conventional reinsurance.

The conventional reinsurance is still being purchased to protect the:

Takaful Risk Pool

Therefore, the reinsurance premium would ordinarily be charged to the Takaful risk fund under the approach described in the text.

And if the conventional reinsurer later makes a recovery payment, that recovery belongs to the:

Takaful Risk Pool

Example

Suppose:

PRF pays RM4 million reinsurance premium

Later, a major covered loss occurs.

The conventional reinsurer owes:

RM10 million recovery

The flow is:

Takaful Risk Pool → RM4m premium → Conventional Reinsurer

Then:

Conventional Reinsurer → RM10m recovery → Takaful Risk Pool

Again, the RM10 million is not shareholder profit for the Takaful operator.

Takaful Risk Pool → Reinsurance Premium → Conventional Reinsurer

Conventional Reinsurer → Reinsurance Recovery → Takaful Risk Pool

not the Retakaful risk pool.

Retakaful vs Conventional Reinsurance in This Context

The practical function is similar: both provide additional protection against risks that the Takaful risk pool does not wish to retain completely.

The fundamental difference is that Retakaful is structured according to Shari’ah principles, whereas conventional reinsurance follows the conventional insurance/reinsurance contractual framework.

For a Takaful operation, Retakaful should therefore be used where suitable protection is available, while conventional reinsurance may only be used under the necessity-based conditions discussed earlier.

Easy Way to Remember

Think of the Participants’ Risk Fund as the customer needing protection.

The Takaful operator is the manager acting for that fund.

Therefore:

Who bears the original underwriting risk?

→ Takaful Risk Pool

Who pays the Retakaful contribution?

→ Takaful Risk Pool

Who receives Retakaful recoveries?

→ Takaful Risk Pool

Who arranges the Retakaful programme?

→ Takaful Operator as Wakil

Who receives the Wakalah management fee?

→ Takaful Operator

Simple Formula

Participants → Tabarru’ → Takaful Risk Pool

Then:

Takaful Risk Pool → Retakaful Contribution → Retakaful Risk Pool

If a qualifying loss occurs:

Retakaful Risk Pool → Retakaful Recovery → Takaful Risk Pool

Meanwhile:

Takaful Operator = Wakil/Manager → receives agreed Wakalah fee for managing the arrangement

One-Sentence Summary

Retakaful is protection arranged by the Takaful operator on behalf of the Takaful risk pool: the risk pool bears the Retakaful cost and receives the Retakaful recoveries, while the operator acts as manager rather than treating those recoveries as its own income.