Takaful - Priority of Retakaful Over Conventional Reinsurance

Takaful operators are generally required by their Shari’ah committees to give priority to Retakaful whenever suitable Retakaful protection is available. This is because Retakaful is designed to provide reinsurance-type protection in a manner that is consistent with Shari’ah principles and supports the development of a fully Shari’ah-compliant Takaful system.

If a Takaful operator cannot obtain sufficient or appropriate Retakaful protection, it may be permitted to use conventional reinsurance on the basis of necessity. This may happen where the Retakaful market does not have enough capacity, suitable technical expertise, acceptable financial strength, or appropriate coverage for a particular risk.

For example, suppose a Takaful operator needs RM500 million of protection for a large industrial risk. If Retakaful providers can only provide RM350 million, the operator should first use the RM350 million Retakaful capacity. The remaining RM150 million may then be placed with a conventional reinsurer if there is no suitable Shari’ah-compliant alternative.

The IFSB-8 guidance emphasises that Takaful operators should, as far as possible, use Retakaful operators rather than conventional reinsurers. The objective is to support the development of a financial system in which the Takaful operation remains Shari’ah compliant throughout the entire risk-sharing chain.

Simple Process

Participant → Takaful Operator → Retakaful Operator

is preferred over:

Participant → Takaful Operator → Conventional Reinsurer

Similarly, AAOIFI Shari’ah Standard No. 41 generally does not permit Takaful operators to use conventional reinsurance except where it is required as a temporary or transitional arrangement because of a public need that reaches the level of necessity.

This means conventional reinsurance is not intended to become the normal or permanent solution for Takaful operators. It is an exception that may be used when sufficient Islamic reinsurance protection is genuinely unavailable.

The justification for this exception comes from the practical difficulty created by the lack of adequate Retakaful coverage. If the Takaful operator has large risks that cannot be safely retained and there is insufficient Retakaful capacity, refusing all reinsurance protection could expose the Participants’ Risk Fund to serious financial harm.

Example

Suppose a Takaful operator has:

Participants’ Risk Fund = RM400 million

but accepts a risk with a possible loss of:

RM1 billion

The operator cannot safely retain the entire risk.

If available Retakaful operators can only provide:

RM500 million

the remaining risk may have to be protected through conventional reinsurance because otherwise the Takaful fund could face an excessive exposure.

In this situation, conventional reinsurance may be tolerated because of necessity, not because it is preferred.

The concept of necessity is recognised in Shari’ah through principles derived from the Qur’an and Sunnah. These principles allow certain normally prohibited arrangements to be used in exceptional circumstances when there is a genuine and serious need and no adequate lawful alternative is available.

However, the permission must remain limited to what is actually necessary.

Easy Way to Remember

First choice: Retakaful

Second choice: Conventional reinsurance only when suitable Retakaful is unavailable

Reason: Necessity or serious public need

Nature of permission: Temporary and limited, not permanent

Simple Formula

Suitable Retakaful Available → Must Give Retakaful Priority

Suitable Retakaful Unavailable + Genuine Necessity → Conventional Reinsurance May Be Permitted

The ultimate objective is:

Takaful + Retakaful = Fully Shari’ah-Compliant Risk Protection System