Having recognized the importance of retakaful to the takaful industry, a significant issue is to determine how retakaful is to be modelled in order effectively to play its role of supporting the industry while complying with shariah principles.
The basic model of retakaful is as shown in the diagram below.
Diagram above shows how the principle of mutual help within the takaful pool is extended to the Retakaful Pool. No part of the risk is being shifted to the retakaful operator as a company, which acts as the manager of the retakaful pool. The role of the retakaful operator is similar to that played by the takaful operator to the takaful pool. The retakaful operator cannot claim all of the contributions payable from the takaful pool to the retakaful pool as its income. In fact, its income is limited to the fee (wakala) and/or profit sharing (mudharaba).
Once participants decide to join a takaful pool, they pay a certain amount of contribution to the takaful fund for the risk they place into the pool. This contribution is mainly used to pay claims and all other expenses arising out of the management activities of the takaful operator such as acquisition costs and administration costs. The takaful operator is also entitled to receive a portion of this contribution as its fee. This fee is income for the operator and is credited to its account. All claims made by the participants will be paid out of the takaful fund.
As manager of the takaful fund, the takaful operator is obliged to take all reasonable measures to ensure that the takaful mechanism amongst participants is managed in a sound and professional manner for the benefit of the participants. It must exercise prudent underwriting so that the quality of the portfolio being managed remains sound. It also has to invest the funds in shariah compliant investment instruments and earn a reasonable investment yield at acceptable levels of risk and diversification.
The takaful operator has to monitor the health and robustness of the takaful fund in relation to the liabilities attached to it. If, in its professional judgment, the assets available in the Takaful fund are likely to be inadequate to pay expected claims, the operator has an obligation to take proper and corrective action to resolve the issue. Retakaful is one of the mechanisms the takaful operator will use to manage this situation. In this way, Retakaful mitigates problems of capital adequacy of Takaful funds, which may be particularly troublesome in the case of a new Takaful fund which has not had time to build up prudential reserves to provide a solvency margin. The use of Retakaful also reduces the potential dependence of a Takaful fund on a Qard facility from its operator.
When arranging retakaful, the takaful operator basically shifts a part of liability assumed by the Takaful Fund to the other fund, namely the retakaful fund. Although retakaful contracts are concluded and signed between the takaful operator and the retakaful operator, it is fundamentally a contract between the takaful fund and the retakaful fund. In this contract, both takaful and retakaful operators are acting on behalf of their respective funds.
By shifting liability to the retakaful fund, the takaful fund must transfer a part of its fund, as a contribution to the retakaful operator. Expenses that relate to all retakaful activities, such as claims, acquisition costs and administration costs, are paid out of the retakaful contribution received. The retakaful operator will also receive its fee or profit sharing from the retakaful contribution. The percentage or amount of contribution to be allowed for the retakaful operator’s fee should be agreed at the inception of the contract between the takaful operator and the retakaful operator.
Shifting partial liabilities by using retakaful means reducing the possibility of the takaful fund experiencing a deficit that may lead to the takaful operator triggering the Qard facility, a benevolent loan that has to be granted by the takaful operator to the takaful fund in case the fund is in deficit. Retakaful therefore protects the takaful fund as well as the capital of the takaful operator.
The retakaful pool has the same characteristics as the takaful pool. Given that the takaful pool is built on the basis of Tabarru’ among the participants, the retakaful pool will follow this. The retakaful pool widens the spectrum of mutual help by combining participants of many different takaful pools which are managed by different takaful operators. Through its global nature, retakaful reduces the risk volatility across geographical boundaries.
The retakaful operator plays an important role as a manager of the retakaful pool, similar to the takaful operator (cedant) who is the manager for the takaful pool. In this role, the retakaful operator is entitled to be remunerated. The remuneration depends on the model adopted in the underlying retakaful contract. If the mudharabah concept is applied, then their remuneration will be based on profit sharing. Under the wakala or the waqf model, the retakaful operator will receive an agreed fee, regardless of the result of the pool. A combination of models is possible, in particular the wakala model for the pool underwriting management contract and the mudharabah for managing the fund investments.
Should the retakaful fund experience a deficit, then the retakaful operator is responsible and duty bound to grant a Qard to secure claimants’ rights to payment of claims. It is to be noted that a retakaful operator has no obligation to support a deficit of the original takaful pool via a Qard facility, as this obligation falls under the takaful operator’s responsibility as its manager. Similarly, the takaful operator will not be called upon to make a Qard to a retakaful fund to which it has ceded business in case of a deficit arising in that retakaful fund.
Adopted from Akoob, M. (2008). Reinsurance and Retakaful. In S. Archer, R. Karim, & V. Neinhaus, Takaful and Islamic Insurance: Concept and Regulatory Issues. Singapore: John Wiley & Sons (Pte) Ltd