Retakaful

Retakaful is the Sharia-compliant equivalent of reinsurance. Just as a conventional insurer buys reinsurance to pass part of its risks to a reinsurer, a takaful operator uses retakaful to transfer part of the risks carried by its participants' risk fund to a retakaful fund. The arrangement protects the takaful fund against large single losses, catastrophes and unexpected accumulations of claims, so that it can continue paying the claims of its participants.

Retakaful follows the same principles as takaful itself. Instead of a sale of risk for a premium, which most scholars regard as involving excessive uncertainty (gharar) and an element of gambling (maysir), it is structured as mutual cooperation among takaful funds, which contribute to a common pool on the basis of donation and agree to help one another meet losses.

In takaful, participants contribute to a participants' risk fund on the basis of tabarru', a donation, and the fund pays claims. The takaful operator manages the fund for a fee or a profit share but does not own the risk. When the fund wants to limit its exposure, it cedes part of its risks and a corresponding share of its contributions to a retakaful operator. The retakaful operator in turn runs a retakaful risk fund, owned collectively by the ceding takaful funds, which pays the ceded share of claims.

The classic forms of reinsurance carry over:

• Proportional (quota share and surplus) retakaful: the ceding fund passes a fixed percentage of each risk, or the amount above a retained limit, and receives the same share of claims.
• Non-proportional (excess of loss) retakaful: the retakaful fund pays losses above an agreed threshold, protecting the takaful fund against catastrophic events.
• Treaty and facultative arrangements: a treaty covers a whole class of business automatically, while facultative retakaful is negotiated for an individual large risk.

Retakaful operators use the same contractual models as takaful operators:

• Wakalah model: the retakaful operator acts as agent of the retakaful fund and receives a fixed fee, or ujrah, often a percentage of contributions, and may also receive a performance incentive.
• Mudarabah model: the operator invests the fund's money as manager and shares in investment profits.
• Hybrid model: the most common in practice, combining a wakalah fee for underwriting management with a mudarabah share of investment returns.

Any surplus in the retakaful fund, after claims, reserves and costs, belongs to the participating takaful funds and may be distributed to them, which distinguishes retakaful from conventional reinsurance, where underwriting profit belongs to the reinsurer's shareholders. If the retakaful fund runs a deficit, the operator usually provides an interest-free loan, or qard, to be repaid from future surpluses.

The retakaful market is small relative to global reinsurance, and capacity has long been limited, particularly for large commercial and catastrophe risks. Many Sharia supervisory boards have therefore permitted takaful operators to place business with conventional reinsurers on grounds of necessity, usually with conditions: only the risk share that retakaful cannot absorb, a preference for reinsurers with Sharia-compliant windows, no interest-bearing elements in the arrangement, and a commitment to move business to retakaful as capacity becomes available. Several large international reinsurers have set up retakaful units or an Islamic window to meet this demand. The approach remains debated among scholars, and practice varies by jurisdiction.

Retakaful operators are regulated as reinsurers in their home jurisdictions, with major hubs in Malaysia, Bahrain, the United Arab Emirates and Saudi Arabia. Standard-setters such as the Islamic Financial Services Board (IFSB) and AAOIFI have issued standards on takaful and retakaful governance, solvency and accounting. Supervisors focus on the separation of the operator's shareholders' fund from the participants' and retakaful funds, the fairness of fees, the treatment of surplus and deficits, and Sharia non-compliance risk.

Economically, the protection a takaful fund receives looks similar to reinsurance. The differences lie in the structure. In retakaful, contributions are donations to a mutual fund rather than a price paid for risk; surplus belongs to the participating funds; the investments of the fund must avoid riba and prohibited sectors; and the operator earns a fee or profit share rather than underwriting profit. These features place retakaful within the wider system of Islamic finance, alongside Islamic banking and sukuk, guided by principles such as the maqasid al-Sharia, the objectives of Islamic law, which include the protection of wealth.

• Islamic Financial Services Board (IFSB)