IFE 760

ISLAMIC INSURANCE: TAKAFUL & RETAKAFUL

PRINCIPLES

RE-TAKAFUL: A REALITY CHECK

PREPARED BY

AHMAD SAUFE NAWI (2009114839)

MOHAMED ABDULLAHI JAMA (2009994757)

SYED MOHAMED SADEQ (2009606522)

SUBMITTED TO

ASSOCIATE PROFESSOR DR HJH ZURIAH ABDUL RAHMAN

TABLE OF CONTENT

Introduction

Re-Takaful (Reinsurance) 1

Concept and Nature of Re-Takaful 2

Parties to Re-Takaful

Objectives and Function of Re-Takaful 3

Method of Re-Takaful4

Re-Takaful Flow Chart Operation 5

General Re-Takaful Product 6

The Operational Mechanisms of General Re-Takaful Protection 7

Adherence to Islamic Principles

Syariah Rullings On Takaful and Retakaful 9

The differences between Re-Takaful and Reinsurance 11

The contract of Re Takaful 12

Problem and challenges of Re – Takaful 13

Malaysia Approach 14

Malaysia Takaful Market : Reality Check 15

Challenges and Opportunities for the re-Takaful Industry 17

Conclusion 23

RE-TAKAFUL – A REALITY CHECK

INTRODUCTION

Re-Takaful (Reinsurance)

Re-takaful has a close relationship with takaful operations where Re-Takaful is a form of takaful

and the competitiveness of Re-Takaful market is depend on the competitiveness of the direct

takaful market. Actually Re-Takaful is a form of insurance whereby the Takaful operator pays an

agreed upon premium from the Takaful fund to the reinsurance company or Re-Takaful

operator, and in return, the Reinsurance company or the Re-Takaful operator will provides

security for the risk reinsured. Reinsurance is best thought of as "insurances for insurance

companies”. Or we also can say that Re-Takaful is a “takaful for takaful operators”. It is a way

for a primary insurer to protect against unforeseen or extraordinary losses. Reinsurance serves

to limit liability on specific risks, to increase individual insurers’ capacity, to share liability when

losses overwhelm the primary insurer’s resources, and to help insurers stabilize their business

in the face of the wide swings in profit and loss margin inherent in the insurance business.

From the above diagram, takaful holders are individuals or companies that buy the Takaful

products either General Takaful products or Family Takaful products and pay an agreed upon

premium to the Takaful operator to protect them from unforeseen risk and also extraordinary

losses. Then, the Takaful operator will take a portion of money from Takaful fund and pays

premium to the Re-Takaful operator to get reinsurance protection to spread its risks.

Reinsurance contracts may cover a specific risk or a broad class of business.

Re-Takaful

Operator

Takaful Operator Takaful Holders

Concept and Nature of Re-Takaful

Re-Takaful or Islamic reinsurance is essentially about handling risk. It is a risk aversion method

in which the Takaful ceding company resorts to either a conventional reinsurer or a Re-Takaful

operator to reinsure original insured risks against an undesirable future situation if the risk

insured were above the normal underwriting or claim. Thus, a Takaful ceding company may,

based on limited financial resources, hedge against possible incapability to meet all Takaful

reinsurance protection from a financially capable reinsurer, which will take over the coverage of

the large proportion of the risk (M. Burhan Arbouna,1965).

Fathi Lashin, a member of the Syariah Supervisory Board of the Dubai Islamic Bank stated that

Re-Takaful does not, in principle, differ from Takaful operations. The Shariah principles applying

to Takaful apply to Re-Takaful operations as well. The difference, if any, is that in the Re-Takaful

operations, the participants are Takaful operators instead of individual participants. It is argued

that the current practice of insurance business has shown that a Takaful ceding company

cannot do without Re-Takaful facility. Therefore, there is a need for Takaful operators to split

risks by way of establishing Re-Takaful operators. By doing so, they share their risks with Re-

Takaful companies. The Re-Takaful operator, on the other hand, assumes the responsibility of

managing and investing the premiums of Takaful operators on the basis of Profit Loss Sharing

(M. Burhan Arbouna,1965).

Parties to Re-Takaful

There are two parties involve in Re-Takaful operations:

1) The insured (ceding company), that is, the direct insurer, which desires to relieve itself

from the part of the risks, insured. This party we call it as Takaful operator

2) The insurer that is the company, which accepts that portion of risk, which is reinsured.

This party we call it as Re-Takaful operator.

Therefore, the competitiveness of Re-Takaful market depends on the competitiveness of the

direct Takaful market. Thus, Re-Takaful operators cannot operate without the operation of

Takaful operators. In addition, the Syariah laws leading the process of Takaful also apply

generally to the Re-Takaful operator.

Objectives and Functions of Re-Takaful

Re-Takaful is “to enhance Takaful activity by distributing risks. It is mainly for covering large

risks and large accumulation of risks subject to common loss”. It is to ensure that Takaful funds

are managed to meet indemnity obligations of the insured and reinsured and to assure the

continuity of Takaful operations. This means Re-Takaful gives the underwriting capacity to the

Takaful ceding company. Thus the objectives of Re-Takaful can be summarized in the

following:(Wahbah Al-Zuhaily, 1995).

1) Protecting the Takaful operator from the threat of insolvency, underwriting and interest

of the participants, forging co-operation among the participants and investing the

accumulated fund in an Islamic way

2) Provides underwriting flexibility and further consolidating the financial stability of the

Takaful operator in order to compete with conventional insurance companies in

accepting risks. This means Re-Takaful “build a very close continuing business interest in

common between the Takaful ceding company and the reinsurer because they are both

at risk.”

3) It may allow the Takaful operator to utilize the retained deposit reserves of the Re-

Takaful fund in the interest of its clients without paying interest as a process of making

the reinsurance industry an interest free business.

Facultative / Treaty

METHODS OF RE-TAKAFUL

Actually the methods apply in Re-Takaful is also apply for Reinsurance. From the above

chart, facultative reinsurance means that reinsurance of individual risks by offer and

acceptance wherein the reinsurer retains the “faculty” to accept or reject each risk offered.

Then, from the treaty, it is divided into two; proportional and non-proportional.

Under proportional we have quota share and also surplus where quota share is the basic

form of participating treaty whereby the reinsurer accepts a stated percentage of each and

every risk within a defined category of business on a pro rata basis. Participation in each risk

is fixed and certain. Surplus is the excess of assets over liabilities. Statutory surplus is an

insurer’s or reinsurer’s capital as determined under statutory accounting rules. Surplus

determines an insurer’s or reinsurer’s capacity to write business.

On the other hand, non-proportional consists of excess of loss and stop loss. Excess of loss is

a form of reinsurance under which recoveries are available when a given loss exceeds the

cedant’s retention defined in the agreement. While stop loss is a form of reinsurance under

which the reinsurer pays some or all of a cedant’s aggregate retained losses in excess of a

predetermined dollar amount or in excess of a percentage of premium.

Non-proportional Proportional

Stop Loss Excess of

Loss

Surplus Quota

Share

Re-Takaful Flow Chart Operation

INVESTMENT

The diagram above shows example of Re-Takaful flow chart operation, which was taken from

Asean Re-Takaful (Labuan) Limited (ARIL). Firstly, the company invests RM1, 000,000 that are

taken from Re-Takaful Fund. Let say the investment brings profit of RM100, 000 to the

company; this profit will be added back to the Re-Takaful Fund. Now the company has RM1,

100,000 in the Re-Takaful Fund. This amount of money will be use for operational cost of Re-

Takaful to pay for claims up to RM 500,000 and also reserve for RM 300,000. Then, the surplus

profit of RM 300,000 will be divided between Re-Takaful Company and also cedants, which are

the Takaful operators. The Re-Takaful company will get 60% from the profit which is RM

180,000 and Takaful operators will get 40% from the surplus profits which is RM 120,000.

Profits

RM100,000

Re-Takaful

Fund

RM1,000,000

RM1,000,000

Re-Takaful

Fund

RM1,100,000

RM1,100,000

Operational Cost of

Re-Takaful

Surplus

Profit

RM300,000

RM300,000

Company

RM180,000

Cedants

RM120,000

Claims

RM500,000

Reserve

RM300,000

GENERAL RE-TAKAFUL PRODUCTS

1) Fire/Property Re-Takaful

The Fire/Property Re-Takaful normally covers or protects the policyholder’s property

from damage or loss due to fire, lightning, explosion (domestic) or any other related

perils. The additional coverage is extended also to any damages, which are caused by:

Riot, strike, or malicious damage

Explosion

Impact damage

Bursting or overflowing of water tanks or pipe

Earthquake or volcanic eruption

Flood

Aircraft damage

Windstorm

This Fire/Property Re-Takaful policy covers building and/or machine, stocks and also

householders.

2) Misc Accident Re-Takaful

It offers coverage for misc accident for individual for instance misc accident on the way

to the workplace or traveling, coverage for drivers and also passengers where the scope

of coverage are the medical expenses, suffering from physical or mental disability either

temporary or permanent and also death.

3) Marine Re-Takaful

There are two types of Marin Re-Takaful:

Marine Cargo Re-Takaful

Marine Hull Re-Takaful

4) Motor Re-Takaful

It offers coverage for private car or motorcycle as well as commercial transportation.

5) Engineering Re-Takaful

In Engineering Re-Takaful normally it covers loss of profit due to machinery breakdown,

boiler and pressure vessel, erection all risk, storage tanks, and others.

6) Special Risks Re-Takaful

THE OPERATIONAL MECHANISMS OF GENERAL RE-TAKAFUL PROTECTION

The Takaful operators can establish a Re-Takaful scheme base on two bases. The first basis is

co-operation and the second one is solidarity. It is because, Re-Takaful operation is needed to

strengthen the Takaful sector and since relations of reinsurance with conventional reinsurance

may throw hesitation on the genuineness of Islamic insurance as a whole, a co-operative

reinsurance is relevant to meet this need. Therefore, in this situation, to strengthen the

function of the Takaful operation, co-operative reinsurance mechanisms have to be developed.

In doing so, the mechanisms below might function as guidelines for Islamic reinsurance

operations:

1) All Takaful operators must give a portion of money as a donation based premiums to

establish a Re-Takaful fund;

2) This payment shall be equal to the defined risks of each Takaful operator. The money

may be paid in advance and be submitted to a company purposely established to

manage the fund or presented to a professionally capable and reliable fund manager for

investment purposes in interest of all contributing parties;

3) The person or individual who manage the fund will be paid on the basis of ijara (hire

contract) or according to the rules of Profit Loss Sharing (mudharaba). This manager is

responsible to compensate any Takaful operator who facing with financial difficulties in

meeting its original obligation;

4) Takaful operators also may defer payment of their premium instead of advanced

payment of contributions but with a pledge to settle their financial obligation at a later

date. In this case, the established company or professional manager of the Re-Takaful

fund must accept the pledge. In addition, in the case of perils, the Re-Takaful manager

must indemnify the losses suffered by a Takaful operator and subsequently recoups its

expenses from each Takaful operator according to the agreement;

5) Initially, the mechanisms of the Re-Takaful operation above may face with impediments.

If there is any immediate extraordinary losses occur, which have to be paid the

indemnities according to the Re-Takaful agreement, it will threaten the perpetuity of

the fund. For instance, a Re-Takaful operator may issue a reinsurance policy to operate

within a certain period of time and the reinsured risk may arise a few days after the

inception of the agreement. But the Re-Takaful operator have no enough fund to settle

the claim of the Takaful operators are yet to accumulate substantially. So that, to solve

the problem, this situation could be resolved by sorting to Islamic banks for qard al-

hassan (interest free loan) to serve as a deposit reserve or Ihtiyati madfu’ for the Takaful

operator. This fund will be a part of the Re-Takaful portfolio and be invested in the

interest of all participants. This fund will be part of the Re-Takaful portfolio and be

invested in the interest of all participants, the Takaful operators. If there are immediate

extraordinary losses arise, the coverage of such losses would be met by this reserve.

ADHERENCE TO ISLAMIC PRINCIPLES

A Takaful or Re-Takaful company must strictly adhere to principles of co-operation, protection

and mutual responsibility and will avoid acts of interest (riba), gambling (al- maisir) and

uncertainty (al-gharar).

The two main principles are the prohibition of Riba and Gharar.

Riba - is the main point of distinction between Islamic and non-Islamic financial means. Riba

refers to a creditor exploiting a transaction for unfair gain, for example, paying too little for an

item or repaying significantly less of a loan than its original value. Very commonly it can occur

through applying interest or usury (extortionately high rates of interest) in his/her transactions.

This is expressly forbidden in Islam.

Gharar - is the selling of items which have an uncertain existence or uncertain characteristics

making the transaction risky and similar to gambling.

It is therefore important to distinguish insurance from gambling.

It is imperative that the Re-Takaful or Takaful Company will conduct all its affairs in a manner

that meets the Islamic Shari’ah Principles whether it is to do with investing its funds, in carrying

out its business in all classes of insurance or in any other related financial field.

All operations and contracts are set-up to ensure that any element of speculation, uncertainty

and gambling is eliminated or minimized from them.

Syariah Rullings On Takaful and Re-Takaful

The 1985Islamic Fiqh Academy ruling Resolution No. (9) Concerning Insurance And Re-Insurance

Resolves

1. The Commercial Insurance Contract, with a fixed periodical premium, which is

commonly used by commercial insurance companies, is a contract, which contains

major element of risk, which voids the contract and, therefore, is prohibited (Haram)

according to the Sharia.

2. The alternative contract, which conforms, to the principles of Islamic dealings is the

contract of co-operative insurance, which is founded on the basis of charity and co-

operation.Similarly is the case of re-insurance based on the principles of co-operative

insurance.

3. The Academy invites the Muslim countries to work on establishing co-operative insurance

institutions and co-operative entities for the re-insurance, in order to liberate the Islamic

economy from the exploitation and violation of the system, which Allah has chosen for

this Ummah.

European Council for Fatwa and Research ruling Cooperative and mutual insurance

"Commercial insurance is originally haram as agreed upon by most contemporary scholars. It is

well known that in most non-Islamic countries there are co-operative and mutual insurance

companies. There is no harm from the Shari`ah point of view to participate in these services.

So, it is unlawful for a Muslim living in a country where there is such a co-operative insurance

company to make an agreement with a commercial insurance company. But, if a co-operative

insurance company is not found one may enter into a contract with a commercial insurance

company only by way of necessity. If a person is forced by law to insurance or by way of need, it

is obligatory for him to be content with the minimum proportion of insurance that covers his

need or to the minimum of such transaction he's being forced to carry out."

THE DIFFERENCES BETWEEN RE-TAKAFUL AND REINSURANCE

THE CONTRACT OF RE-TAKAFUL

The Reinsurance or Re-Takaful operation is a company-to-company relationship and it is

basically about handling risk where the agreement is between the Takaful operator and also Re-

Takaful operator. Thus, the original policyholders are not the party of the reinsurance

agreement. Nonetheless, the insured party may want to know that a professional and reliable

reinsurer is administering the original policy since this concern its security. But, the insured

party has not and cannot have any direct interest in the reinsurance contract. On the other

hand, some legal scholars emphasized that the contract of Re-Takaful should stay between the

Takaful operator and Re-Takaful operator, whereas the original policyholders of Takaful fund

are not involved in the contract in any way. Therefore, the operational and legal relationship of

the Re-Takaful and Takaful operators may be summarized in below:

1) The Re-Takaful operator assumes responsibility to invest the fund on the basis of

mudharabah and shares the profits with Takaful operators by mobilizing premiums or

contribution of Takaful companies;

2) The profit earned will be distributed between Re-Takaful operator and Takaful operators

according to the percentage that have been agreed in the agreement certificates issued;

3) If there is any perils occur, The Re-Takaful operator indemnifies the defined risks and

settles expenses of the process of Takaful from the gross premiums, reserves and profits

from investment;

4) If there is surplus, it should be proportionately accredited into the Takaful operators’

account

In the event of insolvency of the Takaful operators, the Re-Takaful operator should provide

a loan from the Re-Takaful shareholder’s fund by which the Takaful operators settles claims

and incoming premiums will cover the loan

PROBLEMS AND CHALLENGES OF RE-TAKAFUL

The main problem worldwide is the lack of Re-Takaful companies that are capitalized to the

levels required by insurers and more particularly the lack of ‘A’ rated Re-Takaful companies.

This has resulted in takaful companies having to reinsure on a conventional basis, contrary to

the preferred option of seeking cover on Islamic principles. The Shari’ah scholars have allowed

dispensation to takaful companies to reinsure on conventional basis so long as there are no Re-

Takaful alternatives available. Takaful companies therefore actively promote co-insurance.

A number of large conventional reinsurance companies from Muslim countries take on

retrocession. Therefore a large proportion of risk is placed with international reinsurance

companies that operate on conventional basis.

The retrocession from takaful companies ranges from some 10% in the Far East where Takaful

companies have relatively smaller commercial risks (so far), to the Middle East where up to 80%

of risk is reinsured on conventional basis.

Re-Takaful companies need to ensure that they are capitalized sufficiently to enable them to:

Protect the financial stability of takaful companies from adverse underwriting results

Stabilize claims ratios from one year to the next

Minimize claims accumulation from losses within and between different classes

Geographically spread risk

Increase capacity

Increase the profitability of insurers through permitting greater flexibility in the size

and type of risks accepted

Secure technical support and help

The Malaysian approach

The Malaysian Takaful market was built over the years through a carefully planned

gradual and pragmatic approach. At the inception stage, the focus was on instituting a solid

foundation on which an Islamic financial industry was built and run on a parallel system with

the conventional financial system.

What ensued in the early 90s was a period of institutional building, activity generation and

invigorating the market. Competition was introduced after the turn of the century to inculcate

market efficiency and improve operational capacity through enhancements in industry

infrastructure, human capital development and building a robust consumer protection

framework.

Indeed, building a dual financial system does pose its own set of unique challenges. Regulators

are faced with a balancing act where a delicate equilibrium is maintained in ensuring a

level playing field between conventional and Islamic players thus ensuring no regulatory

arbitrage, yet accord due recognition to the uniqueness of Takaful particularly in instilling

Shariah as the main pillar.

The central bank, in furthering its mandate of promoting financial stability and financial

inclusion, took cognizance of these factors at all times. In so doing, Shariah became the main

guiding principle as the industry navigated its way towards a strong and sustainable future.

Strong governmental support, effective and efficient consumer protection framework,

world-class talent pool, a facilitative legal framework rk and a strong institutional

framework were among the key building blocks.

As Takaful began to take on an international dimension, Malaysia gradually opened its doors to

strategically position itself for international integration through the granting of four composite

licenses to joint ventures with foreign parties. The country’s vision to strengthen its position as

an international Islamic financial center was then crystallized and international Takaful operator

licenses were introduced where the holder may write foreign currency Takaful business.

In tandem with this development, the re-Takaful market in Malaysia was opened up to

allow wholly foreign-owned players to establish a presence either as a dedicated Shariah

compliant branch or a subsidiary.

Concomitant with the underlying principles of Takaful where brotherhood, solidarity and

togetherness form the underlying premise, the internationalization of Takaful specifically and

Islamic finance generally calls for a shared vision among all stakeholders and for this to

materialize, shaping Islamic finance together is the key to the continued success of Takaful as

a viable industry. Lying at the heart of this concept is the need to nurture, recognize and

preserve a mutually beneficial and reinforcing co-existence.

While differences in opinions and approaches are acceptable norms and recognized as healthy

in developing the market to the next level, this cannot stand in the way of greater collaboration

and inter-linkages so that the synergistic benefits of cooperation can be enjoyed across the

board. Four major areas can significantly benefit if shaping Islamic finance together is fully

embraced:

Globalizing Takaful to ensure greater outreach.

Preserving the role of Shariah as the main pillar of Takaful, wherever practiced.

Resolving the identity that Takaful should possess.

Resolving operational issues commonly experienced in many jurisdictions.

Malaysian Takaful Market: A Reality Check

Over the last three decades, the global Takaful industry has experienced tremendous growth,

particularly in the last five years. Takaful contribution was a mere US$550 million in 2000 but by

2007, it had grown to US$3.4 billion or 9.2% of the global insurance market.

In 1979, the National Fatwa Committee in Malaysia issued a fatwa on life insurance

which led to the enactment of the Takaful Act 1984 and the subsequent formation of

Syarikat Takaful Malaysia. As direct Takaful players increased in number and business

volume grew, a natural demand was created for re-Takaful that led to the establishment of

re-Takaful operators in the 1990s in the likes of Malaysian-based Asean Re-Takaful

International. It was not long after that the likes of Hannover Re, Munich Re and Swiss Re

joined the ranks of re-Takaful players, the latter two of which were licensed in Malaysia

recently.

According to the World Takaful Report by Ernst & Young, Malaysia is one of the larger Takaful

markets in the world, with a market share of between 20% and 25% in the past five years. In

2009, t he Malaysian market comprised eight direct Takaful operators, four re-Takaful

operators and one international Takaful operator, permitted to write only non-ringgit Takaful

business. Despite being one of the larger markets, the Malaysian Takaful industry commands

a mere 10.4% market share in terms of contribution and 7.7 % of the overall Malaysian

insurance industry assets.

The insurance industry assets, in turn, represent 5.1% of the assets of the entire financial

system . It is interesting to note that despite the global financial turmoil, the assets and

contribution of the Takaful industry continued to grow, albeit at a more conservative rate.

In terms of insurance penetration, Malaysia was ranked 33rd globally at 4.3% (as a percentage

of GDP) in 2007, with the Takaful penetration rate at 0.32%. By comparison, the world average

insurance penetration rate in 2007 is 7.1% while the Asian average is 7.5% and the OIC average

is less than 2%. Developed nations like the UK and US are at 12.4% and 9.4% respectively.

Although Malaysia is generally ahead of OIC countries, the reality check is that the

country’s insurance penetration rate is below the Asian regional and global average. What

this translates to is a tremendous opportunity and growth potential for the industry despite

challenging times.

Challenges and Opportunities for the re-Takaful Industry

The fundamentals for the future growth of takaful and re-takaful are positive. The economies of

the target markets, such as the Middle e East and Southeast Asia a are not so much affected by

the global financial crisis despite the recent turmoil in Dubai. For example Indonesia’s gross

domestic product (G DP) grew by 4% even in 2009 and Malaysia’s increased by over 10% i n the

first quarter of 2010. The population of the target markets is growing rapidly and the

demographics are favorable with 60% to 70% of the population below the age of 30.

Insurance and Takaful markets are underdeveloped and have a low insurance penetration.

Islamic banks are well established and continue to grow. Islamic insurance can benefit from this

as Islamic banks are one of the most promising distribution channels for Takaful products.

There is an increasing Islamic consciousness among Muslims which makes the value proposition

of Takaful more appealing to them. Also, non-Muslims are becoming more aware of the

advantages of Takaful such as the surplus sharing mechanism.

In the meantime, most global reinsurers such as Swiss Re have established a re-Takaful

operation in order to fulfill the increasing capacity and service needs of Takaful operators.

In view of the above and other positive fundamentals, Swiss Re expects that Takaful

contributions will rise from US$2.2 billion in 2008 to almost US$6 billion worldwide by

2015. Nevertheless, conventional insurance and reinsurance will continue to dominate even

in most Muslim countries. Based on the forecast of Swiss Re’s economic research team, the

market share of Takaful will only increase from 4% in 2008 to 6.3% in 2015.

Challenges for re-Takaful

Some of the obstacles which could hamper the growth of Takaful and re-Takaful are:

1. Takaful awareness

Despite an increasing Islamic consciousness, awareness about Takaful is still low. A study by the

Universiti Malaya published in November 2008 has shown that only 40% of the population

knows about Takaful even though Takaful companies have been operating in Malaysia for over

20 years.

Many of the Takaful operators have only been set up in the past few years and they have to

compete with well-established conventional insurers. In order to ‘catch up’, it is important that

Takaful differentiates its value proposition clearly from conventional insurance.

For this, it is paramount to have a distinctive branding strategy by the Takaful industry

highlighting the benefits of Takaful both to Muslims and non-Muslims.

2. Products and services

Products and services need to appeal to a wide range of customers such as low-income people

in the case of micro Takaful, and corporations in the case of commercial Takaful. In addition,

Takaful and also re-Takaful operators have to compete with conventional companies which

often provide a high level of service and competitive prices.

This is made even more difficult because the operational costs of Takaful and re-Takaful

operators tend to be higher due to the additional expenses in order to achieve Shariah

compliance. Therefore, it is very difficult to compete on price only. Other ways have to be

found to attract customers.

3. Regulation and harmonization

Differences are a blessing and strength of Islam. Nevertheless, it would be beneficial for the

development of both Takaful and re-Takaful if operating models and practices are harmonized.

This is needed to grow the industry on a global scale.

Currently, customers are confused about the various Takaful and re-Takaful practices. There

needs to be a level of global self-organization for ‘quality assurance’ to help consumers decide

which practices and models are acceptable to them.

Another important challenge is consumer protection to protect against the bankruptcy of

established operators. In most countries, there is currently only limited Takaful specific

regulation. At the same time, there have been some initiatives launched recently to expand the

regulatory framework.

Examples are the setting up of a Takaful operational framework by Bank Negara Malaysia and

the draft paper on solvency requirements by the Islamic Financial Services Board. One

particular challenge is to take into consideration the specifics of Islamic insurance and

reinsurance. An adequate regulatory framework will have a positive effect on Takaful.

4. Human resources

There is also a shortage in the number of suitable Shariah scholars with the necessary

know how both in Islamic finance and also Fiqh. As a result, many scholars sit in various boards.

In order to address this issue, it may be an option to establish full time national Shariah

boards which look after the Shariah issues of all Takaful and re-Takaful operators. This will

be an important step towards the harmonization of practices.

For Takaful and re-Takaful operators, it is also difficult to find suitable employee s with

at least some background in Islamic finance especially if they want to expand into new

business lines.

5. Shari ah observance

Unfortunately, it is still common practice for Takaful and also re-Takaful operators to use

conventional reinsurance and retrocession even though sufficient re-Takaful and retro-

Takaful capacity for most risks is currently available. In addition, a lot of the re-Takaful

practices are questionable from a Shariah perspective.

Examples of this are the application of a profit commission in individual re-Takaful contracts,

the setting up of a separate fund for an individual client, the coverage of risks from

conventional insurers in a re-Takaful fund, the use of ‘cut and paste’ conventional wordings,

and the fronting of re-Takaful business without letting the Takaful operator know that the

majority is retro ceded on a conventional basis.

Re-Takaful is a very young industry and by this, it is understandable that a lot of conventional

practices are still being used. However, these practices need to be phased out over time.

Otherwise, the integrity of re-Takaful will be questioned and it will lose its reputation. In the

end, Takaful operators will ask themselves why they should use re-Takaful if it is basically the

same as conventional reinsurance.

These are just some of the challenges facing the industry. There are also others such as the lack

of critical mass which is a key prerequisite for a risk sharing mechanism such as Takaful and re-

Takaful. This can make it unsustainable to cover certain risks (such as industrial risks) on a

Takaful basis. Another obstacle is the lack of tradable Shariah compliant assets which impedes

the growth especially of long-term business.

Opportunities for re-Takaful

What does it take to overcome these and other challenges and turn them into opportunities?

The following are some areas where re-Takaful can play an important role in the development

of Takaful.

1. Product development and innovation

In order for Takaful to become available alternative, it is necessary for operators to offer

innovative products addressing consumer demands. Re-Takaful operators can play a vital

role by bringing in their technical expertise and experience from other markets.

It is not sufficient to take conventional products and just change a few terms and conditions.

The ultimate aim should be to come up with truly Shariah based products. In addition, the

different demands of the various customer segments have to be considered.

2. Underwriting support and capacity

Re-Takaful can also play an important role in providing underwriting support and capacity. A

problematic issue is the provision of re-Takaful capacity for industrial risks as they are not

necessarily suited for risk sharing. It will only become feasible once there is a large enough pool

of such risks so that the re-Takaful fund does not become unbalanced because of them.

However, for other risks there is nowadays enough capacity available so that re-Takaful

operators can differentiate themselves from the competition not only with regards to the terms

and conditions offered, but also the services provided.

3. Commitment to Shari ah compliance

It is necessary to set some benchmarks for Shariah compliant re-Takaful practices and a more

consistent application of re-Takaful. A good example is the development of standard re-Takaful

wordings by the Malaysian Takaful Association. The various re-Takaful operators need to be

fully committed to Shariah compliance in order to ensure a level playing field and to promote

re-Takaful on a global scale which in turn will ensure the growth of the Takaful industry.

4. Involvement of Shariah scholars

Shariah scholars need to be better informed about re-Takaful so that they can

understand and highlight questionable re-Takaful practices. This way they can encourage

Takaful operators to use Shariah compliant re-Takaful rather than conventional reinsurance.

5. Favorable re-Takaful regulation

Re-Takaful operators also need to ensure that current regulatory initiatives take into

consideration the specific nature of re-Takaful compared to Takaful and also conventional

reinsurance. Any new regulation has to ensure that the ‘ease of doing’re-Takaful business is

maintained.

The way forward

Re-Takaful has undergone significant changes in the last two years but further improvements

are necessary to meet the needs and expectations of the Takaful industry.

Firstly, the re-Takaful industry must facilitate business transactions by standardizing re-Takaful

wordings, models and practices. A step in the right direction has been undertaken by the

Malaysian Takaful Association (MTA). It is working on a template for a general re-Takaful treaty

that have set parameters to account for company specifics. Munich Re is supporting the

process and the aim is to have a final version adopted by the industry sometime in 2010/11

after the current c consultation process is completed.

Secondly, we need to increase the underwriting and claims handling capabilities of the direct

writers.

Hand in hand goes an increase of re-Takaful capacities for certain lines of business if and where

need be.

In this respect one must bear in mind that an increase in capacity will likely only result in

Cannibalization of the conventional reinsurance business, worse so if accepted at lower rates

and conditions. If the only value add of a re-Takaful operator is undercutting of rates and terms,

it gets us nowhere.

What the market really needs are re-Takaful operators who can add value in terms of training

and new product initiatives like micro Takaful or private public partnerships (PPP) to target the

often cited untapped Takaful potential.

Last but not least further education of professionals and scholars about the current re-Takaful

market, practices and capabilities is urgently required in view of the significant changes t

he market has undergone in recent years. We would in particular also encourage a stronger

involvement of scholars in re-Takaful discussions to accelerate the switch from reinsurance

to re-Takaful. Munich Re Re-Takaful has released a publication titled “Takaful and Re-Takaful

— Principles and Practices” that aims to close the knowledge gap between Takaful

practitioners, scholars and professionals with primarily conventional insurance background.

Conclusion

To conclude that, Re-Takaful operation is a must for Takaful operators to share their risk and

protect against unforeseen and extraordinary losses. The method of Re-Takaful is actually

similar to method of Conventional Reinsurance. The only differences between the two

reinsurances ie; Conventional Reinsurance and Islamic Reinsurance (Re-Takaful) are in term of

the operational procedures where in Conventional Reinsurance, it involve a high degree of

gharar and riba through reinsurance commission which the direct reinsurance company get

from the reinsurance treaty. On the other hand, the Re-Takaful operation is depend on actual

expenses spent by the Takaful operator in the process of Re-Takaful. Furthermore in

Conventional Reinsurance, insurable interest is vested. On contrary, under Islamic laws, the

reinsured party doesn’t get an insurable interest or to reinsure the property of the original

insured party without permission from the policyholder.

REFERENCES

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World Takaful Report 2010, Ernst & Young