1. Spotlight on Takaful in Malaysia
122 s April 2015 s www.asiainsurancereview.com
Bringing retakaful to the
next level
Mr Marcel Papp and Mr Delil Khairat of Swiss Re Retakaful
give an update on two retakaful initiatives by the Malaysian Takaful
Association. They are: Development of a market standard retakaful
wording and a market retakaful pool for large risks.
R
etakaful is still a very young industry. Whilst the
first takaful operators were established more than
30 years ago, retakaful only really took off in the
past five to 10 years with big conventional reinsurers such
as Swiss Re or Munich Re setting up retakaful operations.
Therefore, it is not surprising that several issues in retakaful
have not yet been addressed.
Working committees were set up by the Malaysian Taka-
ful Association (MTA) to come up with Shariah compliant
and also practical solutions. The committees include mem-
bers from various local takaful and retakaful operators
(including Swiss Re Retakaful and ACR Retakaful), as well
as other stakeholders such as lawyers and Shariah advisers.
Development of a market standard
retakaful wording
Just imagine how (re)takaful operators would react if they
are forced to pay claims out of the shareholder’s rather
than the risk fund. This clearly goes against one of
the core principles of takaful which is that claims
payments are to be made out of the risk fund, and
that the operator only has to provide money out
of the shareholders’ fund as interest-free loan
(Qard) if the risk fund is in deficit and that
there is no money left in it to pay claims.
However, most if not all the retakaful
wordings used worldwide are phrased
in a way that such a scenario can be-
come reality. This is not surprising
as retakaful wordings are based
on conventional ones by mostly
changing a few words in order
to ‘retakafulise’ them. Henceforth,
the fundamental differences between
retakaful and reinsurance are not taken
into consideration.
For example, there are four different parties
in a retakaful contract, namely the shareholder’s
and risk funds of the retakaful operator and the
shareholder’s and risk funds of the takaful operator. In
most cases, the retakaful wordings will mention only the
retakaful and takaful operators without any reference to
their different funds.
Current retakaful wordings ambiguous
Why is it necessary to change something which has worked
for the past 10 years or so?
First of all, there are legal and reputational risks with
the current retakaful wordings. Secondly, even more im-
portantly, it is a Shariah requirement that the relationships
between the various parties are accurately reflected in the
contract. Current retakaful wordings are ambiguous and
not transparent which goes against some of the core Sha-
riah principles.
When the MTA working group was set up more than one
and a half years ago, none of the members expected that so
many issues need to be addressed and that it would take
such a long time to develop a standard retakaful wording.
Moreover, whenever one issue was addressed, a new and
bigger one would come up and needed to be addressed too.
It took the working group a long time to develop a fea-
sible model which reflects the money flows and contractual
relationships between the risk and shareholders’ funds of
the retakaful and takaful operators accurately. This was a
pre-requisite for any further work as any wording needs to
properly reflect the various relationships between four (or
more) contracting parties.
Another challenge was the fact that in the Wakala
model used by most operators, the risk fund is not
a separate legal entity and so cannot enter into any
contractual relationship. However, this hurdle can
now be overcome without the need to change the
operating model thanks to a helpful proposal by
Professor Andrew White (professor for Islamic
law at the Singapore Management University)
and Mr Steven Dewhurst (lawyer at DAC
Beachcroft).
Industry players need to
commit to new wordings
once it is finalised
There is still a lot of work to be done
by the MTA working group in finalis-
ing the standard retakaful wording. They
are working with various stakeholders such
as the Shariah scholars, lawyers, IFSB and the
Malaysian regulator to ensure that these wordings
will be acceptable to the various stakeholders.
Most importantly, industry players (including the (re)
takaful operators and brokers) have to commit themselves
to use it even if it means to change certain well-established
business practices once the wordings are finalised.
Market pool for large risks
Since the first takaful operator began its operation 30 years
ago in 1984, Malaysia has proved itself as the most success-
ful takaful market globally. Contribution by the general
takaful business in 2014, made up 11.5% of the country’s
Mr Marcel Papp Mr Delil Khairat

2. Spotlight on Takaful in Malaysia
www.asiainsurancereview.com s April 2015 s 123
general insurance gross premium (including the combined
conventional insurance and takaful). This is definitely the
highest market share amongst takaful market worldwide.
The takaful market in Malaysia is still very much domi-
nated by personal lines such as Motor, Personal Accident
and house-owner/personal fire. Motor alone, which is still
operating in a tariff market, constitutes 60% of total gross
general takaful contribution.
Spreading capacity through treaty and
facultative retakaful
MTA recently conducted a small survey on the retakaful
placement of Malaysian takaful operators. The survey
showed that most of treaties have been placed or shared
with shariah compliant capacity (retakaful) and only a
small part is placed with conventional reinsurer. Majority
of the treaties have 100% retakaful operators on the panel.
On the other hand, the facultative retakaful gives a
completely different picture. The takaful operators place
a very large portion of their facultative reinsurance to
conventional reinsurers, while retakaful operators absorb
only a tiny portion.
How can we reconcile this conflicting fact? Why is re-
takaful so effectively used in treaty but not for facultative,
thus leaving a huge “leakage” to conventional reinsurers?
Reduction of volatility within the risk funds
In addition to getting extra capacity, takaful operators use
retakaful to reduce volatility within its risk funds to a more
manageable level. In many instances, larger part of volatil-
ity is shifted to retakaful risk funds so that lower volatility
remains in the takaful risk funds. By doing so, retakaful
also helps to reduce the probability of ruin in the takaful
industry when a large single loss or catastrophic losses,
either natural or man-made, happen.
While reinsurance and retakaful are fundamentally dif-
ferent from a legal point of view (ie risk transfer versus risk
sharing), the techniques used in managing risk portfolio
are the same. Portfolio diversification remains as the main
technique that is being used, coupled with effective protec-
tion programme (retrocession) if necessary.
As in the case with reinsurance, retakaful is also all about
spread and scale. Diversifying higher volatility requires
retakaful operators to build a much larger portfolio and
ensure that it is well dispersed by territory, lines of business
and retakaful types and methods.
Retakaful types and methods are also important sources
of diversification since different types and methods bring
different profile of risks into the retakaful pool. As quota
share and surplus treaties operate on a portfolio basis, they
give a better balanced portfolio to the retakaful risk fund,
rather than facultative risks.
Facultative reinsurance and facultative retakaful, on the
other hand, is to do with peak or unusual/complex risks that
naturally bring even higher volatility. To absorb the volatil-
ity of facultative risks, a retakaful operator needs to build
an even more robust, larger and sustainable portfolio. This
also means that more capital is needed. Furthermore, since
facultative reinsurance/retakaful is generally transacted and
administered on an individual basis, it requires heavier
resources than treaty, in terms of underwriting expertise,
risk management, business infrastructure and businesses
services (back office). This is definitely not an easy task.
Takaful operators still not keen on commercial
business
In addition, most of takaful operators still strategically view
personal lines as backbone of the business. Therefore, the
building of capability for developing commercial lines is
usually not their focus. Market statistics has also confirmed
this. This leads to a small pool of underlying commercial
risks that does not allow retakaful operators to build
large and sustainable portfolio from it. One may argue
that retakaful operators should look to overseas market to
diversify. Unfortunately, the same problem on the lack of
push on commercial lines exists everywhere in the global
takaful market.
In various occasions, we have seen poor quality risks, that
were rejected by conventional market players, flowing into
the (re)takaful market. This indicates that the conventional
market is aware of the lack of takaful market capability to
deal with commercial risks, and so made attempts to make
use of and abuse it. (Re)takaful market suffers from this
anti-selection when it comes to commercial risks.
Bringing the (re)takaful industry into the
commercial risk sphere
Despite these challenges, facultative retakaful remains as a
crucial element in bringing the development of the takaful
industry to the next level by penetrating into the commer-
cial risk sphere. While normal market force and individual
players’ effort do not seem to be effective in dealing with
the problem, a market initiative could be a solution.
In mid-2014, a working group was formed by the MTA
to elaborate and execute the idea of setting up a Market
Retakaful Pool for large risks. This market pool working
group has been deliberating various aspects of the retakaful
pool, not only to resolve limited facultative capacity issue,
but also to address all other associated problems such as
lack of underwriting capability and lack of resources to
administer facultative retakaful.
The Working Group currently sees pool sustainability as
the main concern. For instance, how to ensure that the pool
size is large enough and has a better risk spread in terms of
sum insured and occupation so that the pool will be able
absorbed the volatility. Relying on individual facultative
submission may not be able to sustain the pool. Underwrit-
ing expertise is also a scarce resource and the involvement
of a human facultative underwriter may need to be wisely
allocated to relatively large and complex risk only.
A couple of ideas did pop up from the working group
including the introduction of compulsory cession to the
pool and a facultative facility to capture small, medium and
relatively homogeneous facultative portfolio with minimum
human involvement.
Conclusion
Both MTA initiatives are still in progress. However, once they
have been finalised, they can help to bring retakaful to the
next level so that it is considered to being truly different
from the conventional reinsurance and an important part
of the Shariah-compliant value chain.
Mr Marcel Papp is Head Retakaful and Mr Delil Khairat is Client Manager,
at Swiss Re Retakaful.