Applied Islamic Banking

By:
Prof. Dr. Mohd. Ma’sum Billah
masum@applied-islamicfinance.com
masum2001@yahoo.com
+6019-3699542

INTRODUCTION

Retakaful has a close relationship with takaful operations where retakaful is a form of takaful and the competitiveness of retakaful market is depend on the competitiveness of the direct takaful market. Actually Retakaful is a form of insurance whereby the Takaful operator pays an agreed upon premium from the Takaful fund to the reinsurance company or Retakaful operator, and in return, the Reinsurance company or the Retakaful operator will provides security for the risk reinsured. Reinsurance is best thought of as "insurances for insurance companies”. Or we also can say that Retakaful 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 Retakaful operator to get reinsurance protection to spread its risks. Reinsurance contracts may cover a specific risk or a broad class of business.

CONCEPT AND NATURE OF RETAKAFUL

Retakaful 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 Retakaful 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.

Fathi Lashin, a member of the Syariah Supervisory Board of the Dubai Islamic Bank stated that Retakaful does not, in principle, differ from Takaful operations. The Syariah principles applying to Takaful apply to Retakaful operations as well. The difference, if any, is that in the Retakaful 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 Retakaful facility. Therefore, there is a need for Takaful operators to split risks by way of establishing Retakaful operators. By doing so, they share their risks with Retakaful companies. The Retakaful operator, on the other hand, assumes the responsibility of managing and investing the premiums of Takaful operators on the basis of Profit Loss Sharing.

According to Dr. Maasum Billah, conceptually, the function of reinsurance is not against the principles of Syariah. However, the operation of the conventional reinsurance companies are not in compliance with the rules and practices of the syariah as evidence by the Resolution No. (9) concerning insurance and reinsurance of the Islamic Fiqh Academy which states:

“The Islamic Fiqh Academy, emanating from Organisation of Islamic Conference (OIC), meeting in its Second Session in Jeddah, Kingdom of Saudi Arabia, from 10 to 16 Rabiul Thani, 1406 H (28 th December 1985);

And after reviewing the presentations made by the participating scholars during the Session on the subject of Insurance and Reinsurance”

And after closely examining all types and forms of insurance and deeply examining the basic principles upon which they are founded and their goal and objectives;

And having looked into what has been issued by the Fiqh Academies and other edifying institution in this regard;

PARTIES TO RETAKAFUL

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

The insurer, that is the company, which accepts that portion of risk, which is reinsured. This party we call it as Retakaful operator.

As being mention earlier, the competitiveness of Retakaful market is depend on the competitiveness of the direct Takaful market. Thus, Retakaful operators cannot operate without the operation of Takaful operators. In addition, the Syariah laws leading the process of Takaful also apply generally to the Retakaful operator.

OBJECTIVES AND FUNCTIONS OF ISLAMIC REINSURANCE

Retakaful 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 Retakaful gives the underwriting capacity to the Takaful ceding company. Thus the objectives of Retakaful can be summarized in the following:

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

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 Retakaful “build a very close continuing business interest in common between the Takaful ceding company and the reinsurer because they are both at risk.”

It may allow the Takaful operator to utilize the retained deposit reserves of the Retakaful fund in the interest of its clients without paying interest as a process of making the reinsurance industry an interest free business.

THE DIFFERENCES BETWEEN RETAKAFUL AND REINSURANCE

DIFFERENCES	RETAKAFUL	REINSURANCE
1) Riba and Gharar	Retakaful operation does not earn commission as a profit or interest, because this commission is subject to riba and dilutes the purpose of setting up a Takaful operation. The Retakaful operation is dependent on actual expenses spent by the Takaful operator in the process of Retakaful	The conventional reinsurance operation is subject to riba and gharar, which are not in line with Syariah principle. For instance, the reinsurance commission which the direct insurance company earned from the reinsurance treaty. It is because this commission is frame in a way that renders the commission ribawi and implicate in a high degree of gharar.
2) Principle of Insurable interest	According to Islamic laws with regards to insurable interest, which is holding specific financial interest in the subject matter of the insurance as a cardinal principle of the legality of the Retakaful, contract. Under Islamic laws, the reinsured party does not get an insurable interest or to reinsure the property of the original insured party without permission from the policyholder. However, because the Retakaful operation is based on mudharabah principle, it vested a right to reinsure on the insurer because the permission from the policyholder is automatically inherent in the contract of mudharabah	Insurable interest is vested in the reinsured party. The fact that the reinsured party has issued a policy and assumed liability to its original insured party has been held to give it insurable interest sufficient to enable it to reinsure. The point is that although the reinsured party (direct insurance company) has no actual legal interest in the property, the subject matter of the original insurance policy, it has assumed responsibility in regard to it, and has therefore put itself into a position, recognized by law, in which it would be prejudiced by its loss.

The Reinsurance or Retakaful operation is a company-to-company relationship and it is basically about handling risk where the agreement is between the Takaful operator and also Retakaful 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 concerns 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 Retakaful should stay between the Takaful operator and Retakaful 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 Retakaful and Takaful operators may be summarized in below:

The Retakaful 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;

The profit earned will be distributed between Retakaful operator and Takaful operators according to the percentage that have been agreed in the agreement certificates issued;

If there is any perils occur, The Retakaful operator indemnifies the defined risks and settles expenses of the process of Takaful from the gross premiums, reserves and profits from investment;

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

In the event of insolvency of the Takaful operators, the Retakaful operator should provide a loan from the Retakaful shareholder’s fund by which the Takaful operators settles claims and incoming premiums will cover the loan.

Actually the methods apply in Retakaful 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. S urplus 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.

Fire/Property Retakaful

The Fire/Property Retakaful 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 Retakaful policy covers building and/or machine, stocks and also householders.

Misc Accident Retakaful

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 skop of coverage are the medical expenses, suffering from physical or mental disability either temporary or permanent and also death.

Marine Retakaful

Marine Cargo Retakaful
Marine Hull Retakaful
Motor Retakaful

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

Engineering Retakaful

In Engineering Retakaful normally it covers loss of profit due to machinery breakdown, boiler and pressure vessel, erection all risk, storage tanks, and others.

Special Risks Retakaful

The Takaful operators can establish a Retakaful scheme base on two bases. The first basis is co-operation and the second one is solidarity. It is because, Retakaful 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:

All Takaful operators must give a portion of money as a donation based premiums to establish a Retakaful fund;

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;

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;

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 Retakaful fund must accept the pledge. In addition, in the case of perils, the Retakaful manager must indemnifies the losses suffered by a Takaful operator and subsequently recoups its expenses from each Takaful operator according to the agreement;

Initially, the mechanisms of the Retakaful operation above may face with impediments. If there is any immediate extraordinary losses occurs, which have to be paid the indemnities according to the Retakaful agreement, it will threaten the perpetuity of the fund. For instance, a Retakaful 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 Retakaful 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 apart of the Retakaful portfolio and be invested in the interest of all participants. This fund will be part of the Retakaful 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.

The diagram above shows example of Retakaful flow chart operation, which was taken from Asean Retakaful ( Labuan) Limited (ARIL). Firstly, the company invests RM1, 000,000 that are taken from Retakaful Fund. Let say the investment brings profit of RM100, 000 to the company; this profit will be added back to the Retakaful Fund. Now the company has RM1, 100,000 in the Retakaful Fund. This amount of money will be use for operational cost of Retakaful 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 Retakaful Company and also cedants, which are the Takaful operators. The Retakaful 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.

As a conclusion, we can say that Retakaful operation is a must for Takaful operators to share their risk and protect against unforeseen and extraordinary losses. The method of Retakaful is actually similar to method of Conventional Reinsurance. The only differences between the two reinsurances ie; Conventional Reinsurance and Islamic Reinsurance (Retakaful) 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 Retakaful operation is depend on actual expenses spent by the Takaful operator in the process of Retakaful. 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.