How to Solve the Retakaful Dilemma

Islamic insurance seeks shariah compliance in risk coverage. But can retakaful actually enable loss sharing not transfer? Join the quest and piece together profit-mudharaba deals, fee waivers and moral wisdom ushering ethical finance into the digital age. #takaful #retakaful #islamicfinance

How to Solve the Retakaful Dilemma
Photo by Sigmund / Unsplash

Imagine you have a jigsaw puzzle but the pieces don't quite fit together. That's similar to the problem facing Islamic insurance, known as takaful. How can it provide coverage in a way that follows religious rules but still works financially? Let me walk you through this tricky situation.

Meet Ahmed, an artist who sells handmade pottery to support his family. One night, fire burns down Ahmed’s small workshop. Luckily, Ahmed had Islamic insurance, so his community pools money to help him rebuild.

But behind the scenes, the Islamic insurance company also needs backup coverage, called retakaful. This protects them during major claims that could bankrupt the company and community fund.

Here's the puzzle: Islamic rules ban interest and gambling. But reinsurance looks more like transferring risk instead of sharing it. So does that make even retakaful unacceptable?

Let’s examine why. Retakaful companies provide interest-free loans if claims exceed the pool's reserves. But what if those loans aren’t repaid? Does the company or community absorb that loss? No one agrees.

Also, conventional reinsurers keep all profits while Islamic ones share surplus with policyholders. This could put Islamic companies out of business long-term.

So how can retakaful firms solve this situation? Pioneering CEOs like Tobias Frenz suggest trying different solutions, just like the mathematician Andrew Wiles finally resolved a 350-year-old math riddle after wrestling with it for 7 years.

Retakaful Models

Frenz proposes four structures so retakaful firms can compete with conventional ones:

  1. Pure Wakala Model

The retakaful operator charges close to a 100% fee for services while leaving negligible funds for participants in underlying pools like Ali's. This mirrors mainstream insurers retaining maximum earnings. But such an approach likely contravenes guidance from financial regulators, Shariah authorities, governance committees and accounting standards.

  1. Pure Mudharaba Agreement

Here the retakaful firm essentially plays role of the 'silent partner' or entrepreneur in an Islamic profit-and-loss-sharing arrangement. The operator takes 100% profits as the business manager while losses fall entirely on the capital provided by participants. This aligns incentives around underwriting discipline. However, some Islamic scholars contest whether such a lopsided distribution fulfills mudharaba principles.

  1. Hybrid Wakala-Ju’ala Model

This combines a flat administration fee with a performance bonus for the retakaful operator based on underwriting results. But critics contend this resembles conventional insurance reserving and disguises interest payments still forbidden under Shariah law.

  1. Wakala-Wa'd Model

The operator receives a fair fee for services while voluntarily relinquishing rights to surplus funds from the underlying pool. These are shared among member participants instead. This aligns more closely with cooperative ethics. While waiving rights is not legally enforceable, the retakaful company's board makes a moral promise (wa’d) to participants and faces reputational consequences for breaching this pledge.

Each model has pros and cons. No approach provides a neat all-round fit for the Islamic risk transfer puzzle. But progressive explorers like Frenz edge the industry closer by chipping away constraints to reveal the coherent ethics below the legalistic surface: risk management founded on cooperation and honored bonds of trust rather than individual profit maximization.

Creative Problem Solving

Rather than see conflicting rules as an obstacle, innovators spot underlying unity. Like how geometric shapes seem disconnected but contain repeating patterns.

As Islamic finance grows quickly, exploring models like cooperative insurance fosters practical innovation. Problem solvers combine tools in new ways and appeal to moral wisdom. Bit by bit, progress happens.

Let’s apply this lesson wider too. Creative solutions can serve individual needs but also benefit whole communities when structured thoughtfully.

Smart long-term solutions often mix different elements:

• Math - Expert risk models and financial engineering

• Law - Navigating regulations while respecting ethics

• Tech - Efficient online administration of community-run coverage

• Culture - Interpreting universal principles within local customs

This enables retakaful to sustain ethical financial structures supporting each other. The profits shared become social too.

Some critics argue ideals just hide business motives. But cooperation champions counter that we have innate skills for teamwork and group harmony that provide evolutionary advantages. Whether we structure insurance pools or repair boats stranded on an island!

Looking broader still, the boom in ride-sharing and home-renting shows how aligning individual interests around common standards and community development can unlock major social value.

No perfect setup exists. But just like legendary quests lead explorers to discover new territory while seeking fairy tale cities, this creative problem-solving helps us find more inclusive financial patterns. That better serve dignity and justice for all.

The Growth of Islamic Finance

This is why searching for solutions matters. Growth is fueled by rising income in Muslim communities seeking financing and services aligning with faith values. This appeals wider too, for people seeking alternative banking supporting fairness and environment.

Mainstream banks now develop Islamic offerings to tap this market. But critics argue these just replicate the inequality issues of conventional banking under another guise. Then again, other experts highlight in-built stability factors in Islamic finance, such as reduced speculation.

Verdict on Aligning Business and Wisdom?

In summary, matching ancient wisdom and modern commerce remains tricky with gaps everywhere. We’re learning bit by bit how ideals and practice connect. It takes humility seeing today’s financial structures as work-in-progress.

But pioneers navigate towards fairness goals, given the strong growth in Islamic finance and its potential to rebalance extremes in our interconnected economy.

We all have pieces of the puzzle. Combining ethical business and social impact promises wide payoffs if structured appropriately. The next generation may stretch solutions even further, like young mathematicians proving new theorems.

For now, innovators show possibilities to integrate social good and fiscal discipline. Let’s gain inspiration from their step-by-step journey. The key is remembering our shared risk and supporting each other through uncertainty, however we build the mechanics behind that.

Piece by piece, progress often happens. With some creative problem-solving, we can find solutions that leave no one behind - whether an individual artisan or an emerging industry trying to operate by higher balanced ideals.

Disclaimer: The views expressed in this blog are not necessarily those of the blog writer and his affiliations and are for informational purposes only.
Read my other posts here: Conventional Finance - FinFormed, Islamic Finance - FinFormed, Takaful - FinFormed, Career - FinFormed and Randow Writings - FinFormed

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