Takaful - Small Size of the Retakaful Industry and Dependence on Conventional Reinsurance

• The Retakaful industry is still relatively small compared with the conventional reinsurance industry.
• There are only a limited number of dedicated Retakaful operators.
• Many standalone Retakaful operators are:
• Smaller in size
• Limited in capital
• Focused mainly on national or regional markets
• By comparison, the global reinsurance market is dominated by large conventional reinsurers with:
• Greater capital
• Stronger technical expertise
• Wider international networks
• Greater capacity to absorb very large risks

1. Limited Number of Retakaful Operators

• Takaful operators may sometimes find that there are not enough Retakaful providers available to take the risks they need to share.
• This is especially problematic for:
• Aviation
• Marine
• Oil and gas
• Large factories
• Infrastructure projects
• Catastrophe risks

Example

• A Takaful operator covers an industrial plant with potential exposure of RM1 billion.
• The operator only wants to retain RM100 million of the risk.
• Therefore, it needs to share:

RM900 million

• Available Retakaful operators may only have enough capacity to take:

RM400 million

• The remaining:

RM500 million

may have to be placed with conventional reinsurers.

Simple Idea

Large risk + Limited Retakaful capacity → Dependence on conventional reinsurance

2. Conventional Reinsurers Have Greater Capacity

• Large conventional reinsurers usually have:
• Larger shareholder capital
• Larger premium pools
• Better geographical diversification
• More technical expertise
• Stronger financial ratings
• They can therefore accept risks that may be too large for smaller Retakaful operators.

Example

A Retakaful operator may only be willing to accept:

RM100 million

of a large aviation exposure.

A global conventional reinsurer may be able to accept:

RM500 million or more

because it has a much larger global portfolio.

Simple Idea

More capital + Larger risk pool = Greater reinsurance capacity

3. Lack of Technical Capacity

• Sometimes the problem is not only money.
• A Retakaful operator may also lack sufficient technical expertise to assess or manage a specialised risk.
• Technical capacity includes:
• Experienced underwriters
• Actuaries
• Catastrophe-modelling specialists
• Aviation specialists
• Marine specialists
• Engineering-risk experts

Example

• A Takaful operator wants protection for a fleet of commercial aircraft.
• The available Retakaful provider may not have:
• Aviation underwriters
• Aircraft loss data
• Appropriate catastrophe models
• Experience handling very large aviation claims
• A major conventional reinsurer may already have a specialised aviation team.

Result

The Takaful operator may need to use conventional reinsurance because the Retakaful provider lacks the required technical expertise.

Simple Idea

Technical capacity = Ability to properly understand, price and manage the risk

4. Regulatory Requirements Can Also Force Risk Sharing

• Regulators may limit the amount of risk that a Takaful operator is allowed to retain.
• This prevents one very large claim from threatening the financial stability of the Takaful fund.
• Therefore, the operator may be required to transfer or share part of a large risk.

Example

Suppose a Takaful operator has:

Participants’ Risk Fund = RM500 million

It accepts a risk with potential loss of:

RM1 billion

The regulator may consider this too large for the operator to retain.

The operator may therefore be required to share most of the risk with Retakaful or reinsurance providers.

Simple Idea

Very large risk → Regulator limits retention → Operator must share the risk

5. Why Conventional Reinsurance May Be Used

A Takaful operator may use conventional reinsurance because of:

• Insufficient Retakaful capacity
• Lack of specialised technical expertise
• Weak financial rating of available Retakaful providers
• Lack of sufficient geographical diversification
• Regulatory requirements
• Very large or unusual risks

Simple Process

Takaful operator accepts risk

→ Needs to reduce exposure

→ Looks for Retakaful

→ Retakaful capacity insufficient

→ Remaining risk may be placed with conventional reinsurer

6. Shari’ah Concern

• This creates an important Shari’ah issue.
• Conventional reinsurance does not necessarily follow the principles used in Retakaful.
• Conventional reinsurance may involve:
• Risk transfer rather than mutual risk sharing
• Interest-based investments
• Other conventional contractual structures
• Therefore, the conventional reinsurer may not observe the same Shari’ah requirements as a Retakaful operator.

Simple Idea

Retakaful = Designed according to Shari’ah

Conventional reinsurance = May contain Shari’ah-prohibited elements

7. Example Showing the Problem

Suppose ABC Takaful covers a major port project.

Potential maximum loss:

RM2 billion

ABC Takaful decides:

• Retain itself = RM200 million
• Needs external protection = RM1.8 billion

Available Retakaful operators can provide only:

RM800 million

Remaining amount:

RM1 billion

ABC Takaful may then approach a large conventional reinsurer for the RM1 billion balance.

Result

ABC Takaful → RM200m retained

Retakaful → RM800m

Conventional Reinsurance → RM1bn

The Takaful operator has obtained sufficient protection, but part of the arrangement now involves conventional reinsurance.

Shari’ah Concern

• The conventional reinsurance portion may not follow Retakaful principles.
• Therefore, the use of conventional reinsurance may only be tolerated under applicable Shari’ah rules where genuine need or necessity exists.

8. Why the Industry Needs More Retakaful Capacity

• If the Retakaful industry becomes larger, Takaful operators will be less dependent on conventional reinsurers.
• The industry therefore needs:
• More Retakaful operators
• More shareholder capital
• Stronger financial ratings
• Better technical expertise
• Wider geographical operations
• Better risk diversification
• More specialised underwriting capability

Simple Process

More Retakaful operators

→ Larger risk pool

→ Greater diversification

→ Greater capacity

→ Less dependence on conventional reinsurance

Easy Way to Remember

Main Problem

Retakaful industry is small

Therefore:

• Few operators
• Smaller capital
• Limited capacity
• Limited technical expertise
• Limited geographical diversification

Result

Large Takaful risks may have to be shared with conventional reinsurers

Shari’ah Issue

Conventional reinsurance may not follow Retakaful Shari’ah principles

Long-Term Solution

More Retakaful operators + More capital + Better expertise + Wider diversification = Less dependence on conventional reinsurance