Scholars at DSN-MUI so far incline to a view that risk sharing element is absent in non-proportional retakaful. What does exist is actually transfer or sharing of loss, as suggested by its name, excess of loss. What we are not sure at this stage is how deep scholars understanding on excess of loss and how it works. I sense there may be misunderstanding or misperception on certain key concepts such as risk, loss, proportional vs non-proportional, risk sharing vs risk transfer.
This write-up aims to discuss this issue and hopefully to clear the cloud by providing a fair understanding on the non-proportional retakaful. Let’s begin by aligning everyone understanding on basic of proportional and non-proportional method.
This is Quota Share retakaful, a basic form of proportional method of retakaful, as pictured below:
Suppose a small fire occured and burn kitchen of the mansion and raise a claim of RM 5m. Risk Fund of ABC will pay 25% of it (RM 1.25m) and remaining 75% (RM 3.75m). Applying the same logic, for a claim of RM 20m, Takaful and Retakaful risk fund will be liable to RM 5m and RM 15m respectively.
In the case of a very unfortunate event of massive fire that burns the mansion completely down and cause a total loss, Takaful Risk Fund will pay maximum 25m and RM 75m to be borne by Retakaful Risk Fund.
As we can see, regardless of size, any claim will be split 25% : 75% between Takaful Risk Fund and Retakaful Risk Fund. Retakaful Risk Fund participates in each and every loss, regardless of the size.
Excess of loss retakaful
Despite its maximum liability of both parties is limited to the same level as QS, the mechanic how risk or loss being distributed is very different. Takaful Risk Fund begin to benefit from retakaful cover only when the loss is higher than 25 million. Retakaful risk fund will pay any amount above (or in excess) 25m. Any loss up to 25m will need to be borne by Takaful Risk Fund and retakaful pays nothing. From example above, loss of 5m and 20m are fully retained by Takaful Risk Fund. In other words, there is no proportional relationship between liability of Takaful and Retakaful risk fund. Many see the absence of this proportional relationship as the absence of risk sharing. Opinion that lead to serious conclusion that excess of loss is not Shariah compliant.
I beg to differ
The main problem of conventional insurance from shariah point of view is the fact that it works on the basis of risk transfer. Risk is transferred from an insured to insurer (insurance companies). Risk or uncertainty is being exchanged with premium. Shariah views this as trading of uncertainty, which is equal to gambling.
Shariah does recognize existence of risk or uncertainty and permit or even encourage effort to mitigate or manage it. Risk management is completely lawful under shariah. The only issue is that shariah does not allow risk or uncertainty to be subject matter of any exchange or buy-sell or commercial contract. You should not trade uncertainty.
Shariah has solution to this problem i.e. sharing of risk. Instead of transferring risk to other party, risk is now being shared among owner of identical or similar risks on the basis of helping or guaranteeing each other. It is no longer commercial in nature anymore, it is benevolent.
How exactly this risk sharing among risk owners to be done in practice, either on proportional or non-proportional, Shariah does not provide detail guidance. Shariah does not explicitly forbid non-proporsional risk sharing either. It is up to consideration, innovation and agreement amongst the parties. Perhaps, the only restriction is that whatever method used and agreed, it should be fair to all parties involve. Well, this is standard condition for all kind of relationship anyway.
Main indicator of fairness here is whether contribution received by each Risk Funds commensurate to level of risks being assumed by each of them. Under QS it is pretty clear, since Retakaful Risk Fund bears 75% of each and every loss, it deserve to receive 75% of contribution.
Under non-proportional arrangement, it may be a little bit tricky as Retakaful Risk Fund will only involve when loss is higher than 25m. It does not pay anything at all if loss falls below that level. It does not participate in each and every loss. On the other hand, Takaful Risk Fund does participate in each and every loss. Takaful Risk Fund is liable to any loss from zero to retention level. So, in this case, exposure to loss is not the same between two risk funds. Takaful Risk Fund is more exposed than Retakaful Risk Fund. Therefore, Takaful risk fund is entitled to higher contribution than Retakaful Risk Fund. Isn’t it fair? I personally believe so, it is a just arrangement.