Takaful - Definition and Purpose of Retakaful

Retakaful is a Shari’ah-compliant arrangement of mutual assistance and risk sharing among Takaful risk funds. It allows Takaful risk funds to collectively share risks that may be too large, unusual, or financially damaging for one individual Takaful risk fund to bear on its own.

In simple terms:

Participants share risks through Takaful.

Takaful risk funds share part of their risks through Retakaful.

1. How Retakaful Works

At the first level, individual participants make tabarru’ contributions into a Takaful risk fund, normally the Participants’ Risk Fund (PRF).

That fund pays the covered claims of participants.

At the second level, the Takaful operator may determine that its PRF should not retain all of the risks it has accepted.

The operator therefore arranges Retakaful on behalf of the Takaful risk fund.

An agreed portion of the contribution is paid as Retakaful tabarru’ into a common Retakaful fund.

Therefore:

Participants

→ Tabarru’ →

Takaful Risk Fund

→ Retakaful tabarru’ →

Retakaful Fund

The Retakaful fund then provides protection against the specified portion of risks ceded to it.

2. Why Do Takaful Risk Funds Need Mutual Assistance?

Imagine several Takaful operators manage separate risk funds:

Takaful Risk Fund A

Takaful Risk Fund B

Takaful Risk Fund C

Takaful Risk Fund D

Each fund has its own participants and risks.

Through a Retakaful arrangement, portions of these risks can be pooled at another level.

Therefore, if Risk Fund A suffers an unusually large covered loss, the Retakaful fund can provide the agreed recovery.

This creates another layer of mutual assistance.

Easy Way to Think About It

Takaful = mutual assistance between individual participants

Retakaful = mutual assistance at the level of Takaful risk funds

3. Why Does a Takaful Operator Resort to Retakaful?

The main purpose is risk management.

A Takaful operator may face unforeseen, extraordinary or exceptionally large losses that could seriously weaken the Participants’ Risk Fund.

Retakaful allows the operator to reduce the amount of risk that its own risk fund must retain.

Example - Catastrophic Factory Loss

Suppose a Takaful risk fund normally handles claims comfortably.

It then provides protection for a large industrial facility.

A catastrophic fire results in:

RM100 million covered loss

If the PRF had to bear the entire RM100 million, it could place enormous financial pressure on the fund.

Suppose, however, an appropriate Retakaful arrangement means:

Takaful Risk Fund bears = RM20 million

Retakaful arrangement bears = RM80 million

The Takaful risk fund’s exposure to the extraordinary loss has therefore been substantially reduced.

This helps protect the financial stability of the fund.

4. Retakaful Helps Ensure the Viability of Takaful

Retakaful is not simply about paying large claims. It supports the long-term viability and stability of the Takaful operation.

Without sufficient Retakaful, one catastrophic event or an unexpectedly bad claims period could severely weaken a Takaful risk fund.

Retakaful can therefore help the operator:

manage extraordinary losses

stabilise claims experience

increase underwriting capacity

protect the financial position of the PRF

and ultimately:

maintain continued protection for Takaful participants.

5. AAOIFI Definition of Retakaful

The definition quoted in your text from AAOIFI Shari’ah Standard No. 41 emphasizes that Islamic insurance companies make the Retakaful arrangement on behalf of the insurance funds they manage.

This is a very important point.

The Takaful operator itself is not supposed to be treated as the party personally carrying the participants’ underwriting risk.

Instead:

Takaful Operator = Manager

Takaful Risk Fund = Bears the underwriting risk

Therefore, the operator arranges Retakaful for the risk fund.

Under the AAOIFI definition provided in your text, participating insurance funds make contributions on a donation (tabarru’) basis, creating a separate Retakaful fund.

That Retakaful fund then assumes an agreed portion of the risks faced by the participating insurance funds.

So conceptually:

Takaful Risk Funds

↓

make tabarru’ contributions

↓

Retakaful Fund

↓

shares/covers an agreed portion of the risks faced by those Takaful funds.

AAOIFI’s Main Idea

The definition highlights several important features:

Mutual agreement — Islamic insurance/Takaful companies participate in the arrangement on behalf of the funds they manage.

Separate Retakaful fund — a distinct fund is established rather than simply treating the money as ordinary shareholder funds.

Tabarru’ — contributions are made on the basis of donation.

Risk sharing — the Retakaful fund assumes an agreed part of the risks faced by the participating Takaful funds.

6. IFSB-25 Definition

The definition quoted from IFSB-25 explains Retakaful as an arrangement where a Takaful undertaking cedes a portion of its risks through either:

Treaty Retakaful

or

Facultative Retakaful

The Takaful undertaking does this as a representative of the participants.

Again, this reinforces the point that the operator is acting on behalf of the participants/risk fund.

What Does “Cede a Portion of Its Risks” Mean?

Cede simply means:

Pass or allocate an agreed portion of the risk to the Retakaful arrangement.

For example:

A Takaful risk fund has:

RM100 million exposure

It decides to retain:

RM30 million

and cede:

RM70 million to Retakaful

Therefore:

Retain = Keep the risk

Cede = Pass/share the risk with Retakaful

7. Treaty vs Facultative Retakaful

The IFSB definition also mentions Treaty and Facultative Retakaful.

Treaty Retakaful

The Takaful operator and Retakaful operator establish an arrangement covering an agreed category or portfolio of risks.

For example, a treaty might cover qualifying property risks written by the Takaful operator during the year, subject to the treaty terms.

The operator does not have to negotiate an entirely new Retakaful contract for every individual qualifying risk.

Facultative Retakaful

Facultative Retakaful deals with an individual risk separately.

For example, suppose the Takaful operator receives an application to cover a huge oil refinery worth:

RM2 billion

The risk may be too large or unusual for the existing treaty.

The operator can approach a Retakaful provider specifically for that particular refinery.

The Retakaful provider can individually assess whether it wants to accept the risk and on what terms.

Easy Memory

Treaty = Portfolio/group of risks

Facultative = One particular risk

8. IFSA 2013 Definition

The definition from Malaysia’s Islamic Financial Services Act 2013 (IFSA 2013) in your text describes Retakaful as Takaful cover arranged by one Takaful operator with another Takaful operator in respect of risks belonging to the Takaful fund it administers.

The protection may cover the risks:

wholly

or

partly

depending on the arrangement.

Again, notice the same central principle:

The Retakaful protection relates to the risks of the Takaful fund being administered by the operator.

9. What Do All Three Definitions Have in Common?

Although AAOIFI, IFSB and IFSA phrase their definitions differently, the central concept is very similar.

A Takaful operator manages a:

Takaful Risk Fund

↓

The fund contains risks that may be too large or volatile to retain completely.

↓

The Takaful operator acts on behalf of the participants/fund and arranges:

Retakaful

↓

Part of the risk and the associated Retakaful contribution/tabarru’ is ceded to:

Retakaful Fund

↓

When a qualifying loss occurs:

Retakaful Fund provides the agreed recovery

↓

to:

Takaful Risk Fund

10. Very Clear Example From Beginning to End

Suppose Ahmad and thousands of other participants contribute to a Takaful scheme.

Their tabarru’ contributions create:

PRF = RM100 million

The Takaful operator manages this RM100 million fund.

The operator realises that some industrial risks could create extremely large claims.

It therefore arranges Retakaful.

Suppose the PRF pays:

RM5 million Retakaful tabarru’

into the Retakaful arrangement.

Later, a major covered loss occurs:

RM30 million

Under the agreed Retakaful arrangement:

Takaful Risk Fund bears = RM10 million

Retakaful recovery = RM20 million

Therefore, the RM20 million recovery goes back for the benefit of the:

Takaful Risk Fund

It is not simply RM20 million profit belonging to the Takaful operator’s shareholders.

Easy Way to Remember

There are two levels of pooling.

Level 1 — Takaful

Individuals/businesses

→ Tabarru’ →

Takaful Risk Fund

Purpose:

Share participants’ risks

Level 2 — Retakaful

Takaful Risk Funds

→ Retakaful tabarru’ →

Retakaful Fund

Purpose:

Share portions of risks faced by the Takaful risk funds

Simple Formula

Participants pool their risks

= Takaful

Takaful risk funds pool/share part of their risks

= Retakaful

And the overall purpose is:

Risk Sharing + Protection Against Extraordinary Losses + Greater Underwriting Capacity + Stability of the Takaful Risk Fund = Sustainable Takaful Operations