What Is Retakaful (Reinsurance) in Islamic Finance?

By Faleel Jamaldeen

Retakaful is the Islamic alternative to the reinsurance industry. In the conventional insurance industry, an insurance company reduces its risk of paying large claims by insuring a portion of its risk with another insurance company. The third party is called a reinsurer, and it helps the insurance company in situations involving natural disasters, widespread fires, riots, and other major events that significantly affect many policyholders at once.

The necessity of retakaful

In a nutshell, a takaful company pays premiums to a retakaful company so the retakaful company assumes a portion of the takaful company’s risks. Why is retakaful important? In reality, a takaful company can’t bear the whole risk of covering its participants’ claims. If disaster strikes, the takaful fund may be depleted quickly and become insolvent, in which case everyone — the participants, the shareholders, and the takaful operator — loses.

By splitting the risk with a retakaful company, the takaful operator is much better able to manage the company through periods of high claims. Therefore, retakaful ensures the stability of takaful companies and the entire industry.

How retakaful works

Retakaful operates the same way that takaful does. The only difference is that participants (policyholders) of regular takaful products are individuals, businesses, and other commercial organizations. In a retakaful contract, participants (policyholders) are various takaful companies, and the fund operator is the retakaful company. Of course, retakaful companies need to operate according to sharia law and must make any investments or hedges accordingly.

The takaful operator and the retakaful operator sign the retakaful contract. The original policyholders of the takaful products aren’t directly involved in the retakaful contracts (even though the retakaful premiums are paid using a portion of the takaful policyholders’ fund).

If a takaful operator faces insolvency because of unexpected claims by its participants, the retakaful operator provides a qard hasan (interest-free loan) to cover the liability. The loan amount must be paid in subsequent years or is deducted from any retakaful surplus belonging to the takaful operator in the following year.

The contributions or premiums collected by the retakaful company from the takaful operators are invested based on the wakala, mudaraba, or wakala-mudaraba combined contract, and profits and fees are shared between the takaful and retakaful companies based on the specific contract agreement.

Spotting some of the players in the retakaful industry

Like the rest of the Islamic finance industry, the retakaful industry is relatively new when compared to conventional insurance; retakaful came into existence only in the late 1970s.

Retakaful operators take two business forms: They exist either as independent companies or as windows (arms or divisions) of conventional reinsurance companies. Currently, more than two dozen dedicated retakaful operators are in operation, as well as six retakaful windows. The first independent retakaful operators to set up shop were these:

  • 1979: Sudan National Reinsurance Company

  • 1983: Sheikhan Takaful Company in Sudan

  • 1985: Islamic Insurance and Reinsurance Company in Bahrain and Saudi Arabia

  • 1985: BEST RE in Tunisia

Other independent retakaful operators now do business from the Bahamas, Egypt, Iran, Kuwait, Malaysia, Saudi Arabia, Singapore, and United Arab Emirates.

The following conventional reinsurance companies provide retakaful window facilities:

  • Mitsui Sumitomo (headquartered in Tokyo, Japan)

  • Swiss Re (headquartered in London, England)

  • Kuwait Re (headquartered in Kuwait City)

  • Hannover Re (headquartered in Hannover, Germany)

  • Trust Re (headquartered in Bahrain)

  • Labuan Re (headquartered in Malaysia)