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