Reinsurance for Takaful Business

Conventional insurance companies collect premiums from policyholders and assume from them the risks of insured losses. There is always a risk of insolvency for the insurance company in case of large number of claims. The need for reinsurance has arisen due to the large number of risks covered by the operators and the financial liability that results from it. No single operator possesses all the resources to handle all the claims all the time. This defines the need for reinsurance. Thus the insurance companies acquire insurance from other companies through reinsurance to distribute their risk. Even though Takaful operators let the participants distribute the risks through pooling of contributions in the spirit of cooperation, they are also in need of reinsurance to mitigate the risk of excessive claims. The Shari’ah compliant alternative to reinsurance is called Retakaful.

Retakaful helps divert some of risk from the Takaful operator. The operator acquires reinsurance from a Retakaful operator or a conventional reinsurer, if access to a Retakaful operator is not available. Retakaful mitigates the risks of excessive claim activity which might endanger the survival of the operator or the solvency of the participants’ funds. This situation may rise out of a natural disaster or accident in a given area or possibly due to a large number of claims from the contributors. The Retakaful operator or reinsurer assumes the risks of the Takaful operator.

Since Takaful contracts are based on Shari’ah principles of mutual cooperation, the Takaful operator is expected to follow the same principles in acquisition of Retakaful. The Retakaful Operator must be committed to the principles of co-operation, protection and mutual responsibility and strictly avoid elements of Riba, Maysir, and Gharar in their transactions. The Takaful operator must make sure that the Retakaful Company is stable, reliable, financially viable, and has good reputation in the industry.

The purpose of Retakaful is not to reinsure all the risks. They should procure Retakaful only to the extent needed and seek out companies that also committed to Shari’ah principles. The task of Retakaful operator is to provide financial stability to the Takaful operators, stabilize the claims ratios from one period to another, minimize the number of claims within and across risk classes, spread risks geographically, and enable Takaful operatorsto grow their business.

Retakaful indemnifies risks of large losses and allows the Takaful operator to manage the underwriting business and invest the contributions for financial gains. It also protects the operator from the risk of insolvency. Takaful business is still a nascent industry and models are still evolving. The industry requires support and sustainability to grow the mutual cooperation model based on Shari’ah. By stabilizing the Takaful business, the Retakaful operator helps promote the Takaful market as an Islamic alternative to traditional insurance.

Similar to the Takaful business, the Retakaful Operator must also be committed to Shari’ah principles and avoid involvement in Riba (interest), Maysir (gambling) and Gharar (excessive uncertainty). All the contracts and operations of Retakaful Operator must refrain from or minimize speculation, uncertainty, or gambling. Shari’ah forbids transactions dealing with uncertain or undefined things. Since insurance business deals with the risks of future unknown events, it could be akin to gambling if proper precautions are not taken. Shari’ah compliance must be observed in all affairs including investment of funds, all classes of insurance, and other financial activities. The business model of the Retakaful Operator should be also built on the concept of co-operation, protection, and mutual responsibility.

Reinsurance is a necessity of insurance business and it is conceivable that the Takaful Operator does not have access to an Islamic Retakaful company or a reinsurance provider is not able to meet all the stipulated Shari’ah requirements of the Takaful Operator. This situation may also arise if the Retakaful operators available are not at the high level of financial stability desired by the Takaful Operator. The Shari’ah scholars have permitted Takaful Operators to reinsure on a conventional reinsurance basis if there are no feasible Retakaful alternatives. In that case, the Operator can, under the guidance of it Shari’ah Supervisory Board, deal with a conventional reinsurance company for Retakaful and reinsurance. This is only allowed till such time as full Shari’ah complaint operator is available or the conventional reinsurance provider is able to modify the contract to bring it in line with the requirements of the Takaful Operator.

When dealing with conventional reinsurance provider, the Takaful Operator must not seek non-proportional arrangements with excessive coverage of losses or stop-loss arrangements due to the uncertainly involved in such arrangements. Islamic insurance is based on mutual cooperation and joint responsibility, and these elements should be present in any reinsurance dealings. It is preferred that reinsurance is procured on a pro-rata basis where the reinsurance provider shares in the original risk of the insurance provided by the Takaful Operator. In case of non-proportional arrangement is the only option, it could be based on profit commission or on a reciprocal basis.

As another alternative, some conventional reinsurance companies in Muslim countries take retrocession. It is the reinsurance of reinsurance where a reinsurance company will also obtain reinsurance from another larger provider. This way, larger risks are places with conventional international reinsurance companies.

When dealing with conventional reinsurance companies, certain conditions must be met for the Takaful operator to stay Shari’ah complaint. The dealings with conventional reinsurance companies have been only allowed in case no other alternatives exist and there is a risk of suffrage to society if such dealings are not conducted. The Takaful operator must not receive any interest. If interest cannot be avoided then it should be given out in charitable causes related to humanitarian or public service projects. Also, the need for cooperation with conventional insurance must be established to the extent that without it, the society could face social or financial problems.