Is Retakaful Commission against Shariah principles?

Proportional Retakaful is adopted from conventional reinsurance.  Quota share and surplus are the most important form of proportional reinsurance. One of the most important feature of proportional reinsurance is the existence of reinsurance commission.

When proportional reinsurance method is adopted by retakaful to form proportional retakaful treaty, many are in the opinion that retakaful commission (term used to replace reinsurance commission) does not comply with shariah principle.  This is mainly because takaful operator should not receive any income other than wakala fee (if wakala model is used) or any other income agreed with participants.  Takaful is not entitled for other benefits from retakaful operator. 

Let’s discuss this issue first by understanding what is reinsurance commission under conventional reinsurance and then see how it fit in retakaful set up. 

The purpose of reinsurance commission is to reimburse the cost incurred in procuring the business (the acquisition cost) in proportion of the premium ceded, and to make some contribution toward expenses for servicing the business.  This is logical since the reinsurer receives a share of the all-inclusive direct premium which includes the pure risk premium, acquisition costs and overheads.  The reinsurer, therefore, returns certain portion of the premium to the ceding company by way of reinsurance commission, expressed in an all-embracing percentage of the premium, as compensation for expenses incurred.  The level of reinsurance commission is determined by considering factors such as loss cost, actual acquisition cost incurred, profitability, investment income prospects, original pricing and the impact of competition in the market.

Now, let’s bring this logic to retakaful set up.  Retakaful is actually contract between two risk pools, i.e. takaful pool managed by takaful operator and retakaful pool managed by retakaful operator.

In securing every participant or risk, takaful operator does incur the same cost as direct conventional insurer.  Therefore, when a part of risk is being ceded to retakaful operator on gross contribution basis under proportional retakaful, all-inclusive direct contribution including the pure risk contribution, acquisition costs and overheads is being passed on to the retakaful pool.  Therefore, to be fair to both parties, the retakaful pool must return its proportional share on acquisition costs and internal overheads incurred by takaful operator.  This refund is done in form of retakaful commission from the retakaful pool to the takaful pool.  

Under this scenario, retakaful commission has nothing against the shariah principle.  In fact, its existence is important to ensure the fairness between takaful pool and retakaful pool.

The shariah principle will be violated, however, if the retakaful commission is refunded to takaful operator shareholder account, instead of takaful pool.  Takaful operator is not entitled to receive it since these expenses which retakaful commission reimbursed for are incurred by takaful pool, not takaful operator.

Other point worth to discuss is the fact that in the reality of conventional reinsurance, level of reinsurance commission is not really determined based on  costs incurred by the cedant.  Reinsurance commission is essentially the price of proportional reinsurance cover.  Higher commission equal to cheap capacity and vice versa.  The result of individual treaty is basically becoming the main factor determining reinsurance commission.  When treaty result is good, reinsurers are prepared to give higher commission, so that cedant enjoy higher margin above its actual costs.  On  the other hand, when treaty result is poor, the commission is lower.  It may go below the actual level of actual cost.  Would this practice acceptable under retakaful?

Many may say no, because this practice may be considered undermine the mutual value of takaful or retakaful.

My personal opinion, however, I will support this practice to be adopted by retakaful as it has element of rewarding good management of takaful portfolio.  It encourages takaful operator to do its best effort to ensure that risk portfolio it builds and cede to retakaful pool is of high quality, balance and sustainable.

Would it be unfair to takaful operator, especially when its portfolio has poor result and receive retakaful commission lower than actual costs incurred? 

My personal opinion again, I don’t think so.  To manage portfolio of poor result or low quality or high volatility, definitely retakaful pool will require more fund or resources.  Consequently, to allow this portfolio to be ceded into the retakaful pool, it needs to contribute more that others cedant portfolios which are relatively of better quality.  This is actually fair solution.  Level of risk is determined by level of volatility.  More volatile a portfolio, more risky it is, the higher its charge.
               
Having said that, we can always come up with the option that is considered closer to mutual value under takaful, especially in the case of portfolio with poor result.  Retakaful operator and takaful operator may agree to ensure that whatever bad the result, the retakaful commission should not be lower than actual costs incurred by the takaful pool.  This option may give lower push to takaful operator to improve the quality of takaful portfolio under its management.

Above all though, it is important for takaful and retakaful industry to promote the highest level of transparency, especially when it come to costs incurred.  Ideally, takaful operator should disclose its actual costs to retakaful operators.  This will make their negotiation on retakaful commission much easier and fair.  This kind of transparency is hardly to be found in conventional reinsurance.

Wallahu’alam.  Any comment or thought are most welcome.

   
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