Takaful – Facultative Retakaful

Case Scenario

A Takaful operator underwrites a large commercial property risk. After assessing the exposure, the operator decides that retaining the entire risk within its own Takaful Fund would create excessive financial exposure. It therefore approaches a Retakaful operator and requests protection for 30% of this individual risk.

Unlike Treaty Retakaful, the Retakaful operator is not automatically required to accept the risk. The Takaful operator provides detailed information about the particular policy, and the Retakaful operator independently examines the risk before deciding whether to accept or reject it.

After evaluating the information, the Retakaful operator accepts 30% of the risk. Consequently, the Takaful operator retains 70% of the risk and contribution and is responsible for 70% of any loss, while the Retakaful operator receives 30% of the contribution and bears 30% of any covered loss.

Key Notes

Meaning of Facultative Retakaful

The word facultative means optional or based on free choice.

Therefore:

• The Takaful operator may offer an individual risk to a Retakaful operator.
• The Retakaful operator may accept or decline the risk.
• Each risk is considered individually.
• Acceptance is not automatic.

Facultative or Selective Method

Under Facultative Retakaful:

• The Takaful operator presents an individual risk to the Retakaful operator.
• Relevant information about the risk is provided.
• Each Takaful policy is negotiated separately.
• The Retakaful operator studies the information.
• The Retakaful operator decides whether the risk is acceptable.
• Once accepted, the Retakaful operator becomes committed to its agreed share.

Role of the Takaful Operator

The Takaful operator:

• Underwrites the original Takaful policy.
• Identifies the individual risk requiring Retakaful protection.
• Provides relevant information to the Retakaful operator.
• Negotiates the amount of risk to be placed.
• Retains the remaining portion of the risk.

Role of the Retakaful Operator

The Retakaful operator:

• Examines each proposed risk separately.
• Reviews the information supplied by the Takaful operator.
• Determines whether the risk is acceptable.
• May accept or reject the proposal.
• Becomes responsible only for the portion it accepts.

Proportional Facultative Retakaful – Example in Note Form

The example shown in the source divides the arrangement 70:30.

Risk

Takaful Operator (TO):

• Retains 70% of the risk.

Retakaful Operator (RTO):

• Accepts 30% of the risk through Facultative Retakaful.

Contribution

Takaful Operator:

• Retains 70% of the contribution.

Retakaful Operator:

• Receives 30% of the contribution.

Loss

Takaful Operator:

• Bears 70% of the covered loss.

Retakaful Operator:

• Bears 30% of the covered loss.

Simple Numerical Example

Suppose:

• Total risk = US$1,000,000
• TO retains = 70%
• RTO accepts = 30%

Therefore:

• TO’s risk exposure = US$700,000
• RTO’s risk exposure = US$300,000

If an eligible loss of US$100,000 occurs:

• TO bears US$70,000
• RTO bears US$30,000

This demonstrates the proportional nature of the arrangement.

Facultative Retakaful vs Treaty Retakaful

Facultative Retakaful

• Individual risks are considered separately.
• Acceptance is optional.
• Each risk is separately evaluated.
• Separate negotiation takes place.
• Retakaful operator can accept or reject each proposal.

Treaty Retakaful

• Covers a portfolio or class of risks.
• Risks falling within treaty conditions are generally accepted automatically.
• Individual evaluation is normally unnecessary.
• The Retakaful operator relies more heavily on the ceding Takaful operator’s underwriting standards.

Key Point

Facultative Retakaful is a selective arrangement in which each individual risk is separately presented to the Retakaful operator, who has the freedom to accept or reject it. Once accepted, the Retakaful operator becomes responsible for its agreed proportion of the risk and corresponding losses.

Questions and Answers

Question 1

What does the term “facultative” mean?

Answer:

It means optional or involving freedom of choice.

Solution:

The Retakaful operator has the right to accept or reject each individual risk.

Question 2

How does Facultative Retakaful operate?

Answer:

The Takaful operator presents an individual risk and relevant information to the Retakaful operator for separate assessment.

Solution:

Provide complete and accurate information so that the Retakaful operator can properly evaluate the risk.

Question 3

Must the Retakaful operator accept every risk offered?

Answer:

No. The Retakaful operator is free to accept or decline each proposal.

Solution:

The Takaful operator should seek alternative protection if the risk is rejected.

Question 4

When does the Retakaful operator become committed?

Answer:

It becomes committed once it accepts the particular risk.

Solution:

Clearly document the accepted proportion and contractual terms.

Question 5

In the example, how much risk does the Takaful operator retain?

Answer:

The Takaful operator retains 70%.

Solution:

The remaining 30% is placed with the Facultative Retakaful operator.

Question 6

How is the contribution divided?

Answer:

The Takaful operator retains 70%, while 30% is paid to the Retakaful arrangement.

Solution:

Allocate the contribution according to the agreed proportional participation.

Question 7

How are losses divided?

Answer:

The Takaful operator bears 70%, while the Retakaful arrangement bears 30%.

Solution:

Apply the agreed proportional percentages to covered losses.

Question 8

What is the main difference between Facultative and Treaty Retakaful?

Answer:

Facultative Retakaful evaluates individual risks separately, whereas Treaty Retakaful generally accepts risks automatically when they fall within the treaty.

Solution:

Choose the method according to the nature and volume of risks requiring protection.

Question 9

Why is detailed risk information important?

Answer:

Because the Retakaful operator needs sufficient information to decide whether to accept the individual risk.

Solution:

Maintain accurate underwriting documentation and disclose all relevant risk information.

Question 10

What is a major advantage of Facultative Retakaful?

Answer:

It allows individual or unusual risks to be separately assessed and specifically protected.

Solution:

Use Facultative Retakaful where individual risk characteristics require specialised assessment.

Practical Application

Facultative Retakaful is particularly useful when a Takaful operator encounters a large, unusual, specialised, or individually significant risk that requires separate assessment. The Takaful operator should provide sufficient underwriting information to enable the Retakaful operator to assess the proposal. Once an agreed proportion is accepted, the corresponding risk, contribution, and covered loss are allocated according to that proportion.

Critical Analysis

Facultative Retakaful provides greater flexibility than Treaty Retakaful because the Retakaful operator can independently examine each individual risk before committing itself. This allows better control over unusual or particularly large exposures. However, individual evaluation and negotiation can make the process more time-consuming and administratively demanding than treaty arrangements.

The method also requires effective communication between the Takaful and Retakaful operators. Accurate disclosure of risk information is essential because incomplete or inaccurate underwriting information could lead to inappropriate risk assessment and pricing. Therefore, Facultative Retakaful provides greater selectivity but requires stronger individual risk analysis.

Conclusion

Facultative Retakaful is a selective form of Retakaful in which individual risks are separately presented, evaluated, and negotiated. The Retakaful operator has the freedom to accept or reject each proposed risk and becomes committed only after acceptance. In a proportional arrangement, the risk, contribution, and covered losses are divided according to the agreed percentages. This makes Facultative Retakaful particularly suitable for individual risks requiring specialised assessment and tailored Retakaful protection.