Operational and Actuarial Aspects of Takaful

Operational and Actuarial Operational and Actuarial Aspects of TakafulAspects of Takaful

Topic 9Topic 9

Risk Management in TakafulRisk Management in Takaful

Sub TopicsSub Topics

IntroductionIntroduction Islamic Perspective of Risk Islamic Perspective of Risk

ManagementManagement Definition of Risk ManagementDefinition of Risk Management OverviewOverview Risk Management in TakafulRisk Management in Takaful

IntroductionIntroduction

‘‘The overall process that a financial The overall process that a financial institution follows to define a institution follows to define a business strategy to identify the risk business strategy to identify the risk to which it is exposed to, to quantify to which it is exposed to, to quantify those risks and to understand and those risks and to understand and control the nature of risk’control the nature of risk’

Coming and Hirtle 2001Coming and Hirtle 2001


What is Risk?What is Risk? ‘‘Uncertainty of loss from an Uncertainty of loss from an

exposure’exposure’ Uncertainty-ProbabilityUncertainty-Probability Loss-real loss or not making a gain, Loss-real loss or not making a gain,

usually negative in natureusually negative in nature You can categorize as you please and You can categorize as you please and

depends on subject matterdepends on subject matter


Your view of Risk?Your view of Risk? Perceived v RealPerceived v Real E.g. A drunken man driving a car or a E.g. A drunken man driving a car or a

student who do not study passing an student who do not study passing an examination.examination.

Degree of Risk Tolerance-Thrill Degree of Risk Tolerance-Thrill seeker, indifference or Averterseeker, indifference or Averter

Islamic PerspectiveIslamic Perspective

• The benefits that Syariah predicates to The benefits that Syariah predicates to individual and community and laws to individual and community and laws to protect the benefits for improvement protect the benefits for improvement and perfection of lifeand perfection of life

• 3 3 main objectives: Daruriyah main objectives: Daruriyah (“Essential”); Hajiah (“Complementary”); (“Essential”); Hajiah (“Complementary”); Tahsiniyah (“Desirable”).-Tahsiniyah (“Desirable”).-Protect and Protect and promote Essentials; invalidate promote Essentials; invalidate destructive affairsdestructive affairs


Risk has no religionRisk has no religion Muslims believe in the hereafter; life Muslims believe in the hereafter; life

on this world is transitoryon this world is transitory You will be rewarded according to your You will be rewarded according to your

intentionsintentions Risks cannot and should not be Risks cannot and should not be

avoidedavoided Man are required to act diligently but Man are required to act diligently but

Allah determines the final outcome.Allah determines the final outcome.


Epic on the HijrahEpic on the Hijrah Planning for BattlesPlanning for Battles ‘‘Tie your camel, then say Isha’ Allah’-Tie your camel, then say Isha’ Allah’-

Hadith At TarmidziHadith At Tarmidzi ‘‘O my sons! Do not enter by one gate, but O my sons! Do not enter by one gate, but

enter ye by different gates. I cannot avail enter ye by different gates. I cannot avail you against Allah at all. Verily! The you against Allah at all. Verily! The decisions rest with Allah. In Him I put my decisions rest with Allah. In Him I put my trust, and let all those who trust put their trust, and let all those who trust put their trust on Him’(12:67)trust on Him’(12:67)

Takaful Model - CooperativeTakaful Model - Cooperative

Participant

Contribution (Premium)

Investment Profit

Participants Account

(Personal)Participants

Special Account

(Common)

Policy Benefits

Underwriting Surplus

Actual Management

Expenses

Operator

Investment Profit

100% 100%

Takaful Model - MudarabahTakaful Model - MudarabahParticipant


Investment Profit Participants

Special Account

(Common)

Policy Benefits


Actual Management

Expenses

Operator

Investment Profit

(1 – x)% 100%

x%

Participant Account

(Personal)

Takaful Model - WakalahTakaful Model - Wakalah

Participant


Investment Profit



Special Account

(Common)

Policy Benefits


Operator

Investment Profit

100% 100%Wakala Fee (to operator)

Actual Management

Expenses

Takaful Model – Modified Takaful Model – Modified MudarabahMudarabah

Participant


Investment Profit



Special Account

(Common)

Policy Benefits


Actual Management

Expenses

Operator

Investment Profit

(1-x)% (1-y)%

x%

y%

Takaful Model –Wakalah with Takaful Model –Wakalah with MudarabahMudarabah

Participant


Investment Profit



Special Account

(Common)

Policy Benefits


Operator

Investment Profit

(1-x)% 100%

x%

Wakala Fee (to operator)

Actual Management

Expenses

Takaful Model –Wakalah with Takaful Model –Wakalah with Incentive CompensationIncentive Compensation

Participant


Investment Profit



Special Account

(Common)

Policy Benefits


Operator

Investment Profit

(1-x)% (1-y)%

x%

Wakala Fee (to operator)

y%

Actual Management

Expenses


Who bears what risks-Participants, Who bears what risks-Participants, Operator or Takaful FundOperator or Takaful Fund

Takaful Model a consideration? Takaful Model a consideration? 1.1. CooperativeCooperative2.2. MudarabahMudarabah3.3. WakalahWakalah Solvency the name of the game Solvency the name of the game

otherwise a Qardrul hasan is otherwise a Qardrul hasan is required.required.


Cooperative-participants are jointly Cooperative-participants are jointly and severally liable if assets are not and severally liable if assets are not sufficient to meet claims-akin to sufficient to meet claims-akin to aqilahaqilah

Mudarabah-Operator required to Mudarabah-Operator required to maintain solvencymaintain solvency

Wakalah-Regulation requires Wakalah-Regulation requires Operator to maintain solvencyOperator to maintain solvency

Defining Risk ManagementDefining Risk Management

Culture, processes and structures to Culture, processes and structures to realize potentials whilst managing realize potentials whilst managing adverse effects. Risk management adverse effects. Risk management process:-process:-

1.1. IdentifyIdentify

2.2. Asses and evaluateAsses and evaluate

3.3. Mitigate Mitigate

4.4. Monitor and ReviewMonitor and Review


RISK MANAGEMENT

IDENTIFY

COMMUNICATEMONITOR

AND REVIEWASSES AND

EVALUATE

MITAGATE


Means to reduce Risk Exposure-Means to reduce Risk Exposure-

Risk Avoidance - eliminate, substitute Risk Avoidance - eliminate, substitute and separate and separate

Risk (Loss) Control – prevent and Risk (Loss) Control – prevent and reduce/sharingreduce/sharing

Risk Retention Risk Retention

Risk TransferRisk Transfer


Chance of lossChance of loss -probability of an loss -probability of an loss event happeningevent happening

PerilPeril -cause of loss -cause of loss HazardHazard -a condition that creates or -a condition that creates or

increases chance of lossincreases chance of loss1.1. Physical HazardPhysical Hazard2.2. Moral HazardMoral Hazard3.3. Morale HazardMorale Hazard


Physical HazardPhysical Hazard –a condition that –a condition that increases chance of lossincreases chance of loss

Moral HazardMoral Hazard –dishonesty or –dishonesty or defective human characteristics that defective human characteristics that increase the frequency or severity of increase the frequency or severity of lossloss

Morale HazardMorale Hazard –carelessness or –carelessness or indifference to a lossindifference to a loss


Physical HazardPhysical Hazard –a condition that –a condition that increases chance of lossincreases chance of loss

Moral HazardMoral Hazard –dishonesty or –dishonesty or defective human characteristics that defective human characteristics that increase the frequency or severity of increase the frequency or severity of lossloss

Morale HazardMorale Hazard –carelessness or –carelessness or indifference to a lossindifference to a loss


Basic Category of Risks:-Basic Category of Risks:-

1.1. Pure RisksPure Risks

2.2. Speculative RisksSpeculative Risks

3.3. Fundamental RisksFundamental Risks

4.4. Particular RisksParticular Risks

5.5. Enterprise RisksEnterprise Risks


Pure Risk – a situation in which there are Pure Risk – a situation in which there are only the possibilities of loss or no lossonly the possibilities of loss or no loss

Speculative Risk – a situation in which Speculative Risk – a situation in which either a profit or loss is achievableeither a profit or loss is achievable

Fundamental Risk – a risk that affects the Fundamental Risk – a risk that affects the entire economy or groups within the entire economy or groups within the economyeconomy

Particular Risk – a risk which affect an Particular Risk – a risk which affect an individual and not the group or communityindividual and not the group or community


Enterprise Risk – a term that Enterprise Risk – a term that encompasses all major risks faced by encompasses all major risks faced by a business organization. Such risks a business organization. Such risks may include pure risks, speculative may include pure risks, speculative risks, operational and financial risks.risks, operational and financial risks.

Enterprise Risk Management (ERM) – Enterprise Risk Management (ERM) – combines into a single unified combines into a single unified treatment program all major risks the treatment program all major risks the organization is exposed to.organization is exposed to.

RISK MANAGEMENT IN TAKAFUL-TERMINOLOGY


YesterdayYesterday

Internal AuditInternal Audit

CEOCEO

Quality AssuranceQuality Assurance

Compliance DeptCompliance Dept

TodayToday

Risk PhilosophyRisk Philosophy

Risk PolicyRisk Policy

Risk Framework Risk Framework and guidelinesand guidelines

Risk awareness Risk awareness trainingtraining

Enterprise Risk Management in Enterprise Risk Management in TakafulTakaful

Evolution of Risk ManagementEvolution of Risk Management

Pure RiskMgt

Speculative RiskMgt

EnterpriseRisk Mgt

1990s 2000s

Tillinghast ERM 2004 Survey-11% fully adopted ;38% partially adoptedERM usage most prominent in Financial Services


Objectives of ERM - Objectives of ERM - Pre LossPre Loss

1.1. Prevent or reduce potential lossesPrevent or reduce potential losses

2.2. Manage AnxietyManage Anxiety

3.3. Meet legal obligationsMeet legal obligations


Objectives of ERM – Objectives of ERM – Post LossPost Loss

1.1. To surviveTo survive

2.2. To continue existingTo continue existing

3.3. To stabilize earningsTo stabilize earnings

4.4. To continue with growthTo continue with growth


Benefits of ERM:-Benefits of ERM:-

1.1. Holistic treatment of Risk ExposureHolistic treatment of Risk Exposure

2.2. Competitive advantageCompetitive advantage

3.3. Have a positive impact on RevenueHave a positive impact on Revenue

4.4. Reduces Earnings VolatilityReduces Earnings Volatility

5.5. ComplianceCompliance

6.6. Good Corporate GovernanceGood Corporate Governance


Barriers of ERM:-Barriers of ERM:-

1.1. Organization CultureOrganization Culture

2.2. ERM is not a priorityERM is not a priority

3.3. ERM is costlyERM is costly

4.4. ERM is newERM is new

5.5. Lack of Intellectual Capital Lack of Intellectual Capital

6.6. Lack of Technology Lack of Technology

ERM is not just one person or one dept jobERM is not just one person or one dept job Involved all functions, activities and depts.Involved all functions, activities and depts. Addresses all facets of risks that are inter-Addresses all facets of risks that are inter-

relatedrelated Rationale – In an organization nothing Rationale – In an organization nothing

works in isolation. Its value is a sum of its works in isolation. Its value is a sum of its parts.parts.

A business process like any otherA business process like any other



Types of Enterprise RisksTypes of Enterprise Risks

1.1. Financial and pricing Financial and pricing

2.2. Investments and LiquidityInvestments and Liquidity

3.3. Operational and UnderwritingOperational and Underwriting

4.4. Market Market

5.5. Regulatory and LegalRegulatory and Legal

6.6. ShariahShariah


Financial and PricingFinancial and Pricing

1.1. Higher expensesHigher expenses

2.2. Higher mortality or incidence of Higher mortality or incidence of contingenciescontingencies


Investment and LiquidityInvestment and Liquidity

1.1. Lack of shariah based investments Lack of shariah based investments instruments (esp. long term)instruments (esp. long term)

2.2. Asset liability matchingAsset liability matching

3.3. Poor yieldsPoor yields

4.4. Market inefficiencyMarket inefficiency


Operational and UnderwritingOperational and Underwriting

1.1. Processing delays- e.g. IT disruptionsProcessing delays- e.g. IT disruptions

2.2. Numerous customer complaintsNumerous customer complaints

3.3. Higher lapsesHigher lapses

4.4. Collection difficulties Collection difficulties

5.5. High claimsHigh claims

6.6. Lack of Retakaful capabilityLack of Retakaful capability


MarketMarket

1.1. Takaful is still sold not boughtTakaful is still sold not bought

2.2. Takaful is only startingTakaful is only starting

3.3. Takaful Image is no difference from Takaful Image is no difference from Insurance and in some cases worst offInsurance and in some cases worst off

4.4. Savings and Insurance growth Savings and Insurance growth correlated to economic growthcorrelated to economic growth

5.5. Inflation woesInflation woes


Regulatory and LegalRegulatory and Legal

1.1. Margin of SolvencyMargin of Solvency

2.2. Risk Base CapitalRisk Base Capital

3.3. Non compliance to regulations Non compliance to regulations

4.4. Business Laws are conventional basedBusiness Laws are conventional based


ShariahShariah

1.1. Non consistency of Shariah StandardsNon consistency of Shariah Standards

2.2. Shariah v Conventional provisionsShariah v Conventional provisions

3.3. General Lack of Shariah understandingGeneral Lack of Shariah understanding

4.4. Most operations are not fully shariah Most operations are not fully shariah basedbased

5.5. Shariah Scholars lack business and Shariah Scholars lack business and Insurance acumenInsurance acumen

6.6. SAC v BoardSAC v Board


Measuring Risks-Measuring Risks-

You cannot manage what you cannot You cannot manage what you cannot measuremeasure

Use quantitative model and conceptUse quantitative model and concept

Use qualitative approach at leastUse qualitative approach at least


Examples of Quantitative Models-Examples of Quantitative Models-

Actual Financial LossActual Financial Loss

Trending (Regression Analysis)Trending (Regression Analysis)

Value At Risk (VAR)Value At Risk (VAR)

Scenario AnalysisScenario Analysis

Stress TestStress Test

ERIC modelingERIC modeling


ERIC Modeling - Risk Scoping based on;ERIC Modeling - Risk Scoping based on; EventsEvents Frequency or Probability of Frequency or Probability of

such uncertaintiessuch uncertainties Risk ImpactRisk Impact to the Organization to the Organization Current Current ControlsControls in placed in placed


Event Frequency –Event Frequency –

Almost Certain=100%;Expected to occur Almost Certain=100%;Expected to occur most the timemost the time

Likely=75%;Expected to occur in most Likely=75%;Expected to occur in most circumstances in the company or anothercircumstances in the company or another

Possible=50%;Might occur at some time Possible=50%;Might occur at some time and have occurred in the company or and have occurred in the company or anotheranother

Unlikely=25%;Could occur at some time Unlikely=25%;Could occur at some time


Risk Impact –Risk Impact –

Catastrophic=50% and above; Catastrophic=50% and above; Devastating can lead to closureDevastating can lead to closure

High=25%-50%; Effect is medium to long High=25%-50%; Effect is medium to long term with substantial lossterm with substantial loss

Medium=5%-25%; Effect is not material Medium=5%-25%; Effect is not material but recovery is medium termbut recovery is medium term

Low=less than 5%; No negative impact Low=less than 5%; No negative impact with sufficient reserveswith sufficient reserves


Control-Control-Exceptional=90% and above; Very good Exceptional=90% and above; Very good controlscontrolsStrong=70%; Good but still susceptible Strong=70%; Good but still susceptible sometimessometimesSatisfactory=50%; Adequate but have Satisfactory=50%; Adequate but have occasional lapsesoccasional lapsesBelow Satisfactory=30%; Generally weak Below Satisfactory=30%; Generally weak though mitigate some risksthough mitigate some risksWeak=Below 5%; Absence of controlsWeak=Below 5%; Absence of controls


Example-Example- Expected Loss=%Gross Income Expected Loss=%Gross Income

(proxy)(proxy) %age=E%xRI%x(1-C)%%age=E%xRI%x(1-C)%


% Gross Income% Gross Income 0%-2%0%-2% 2%-5%2%-5% 5% and above5% and above

Severity of RisksSeverity of Risks Low RiskLow Risk Medium RiskMedium Risk High RiskHigh Risk


Risk is viewed as a residual valueRisk is viewed as a residual value A Risk Map is createdA Risk Map is created The Risk Map is the organization’s The Risk Map is the organization’s

risk dashboardrisk dashboard The organization target is to convert The organization target is to convert

the High Risk to Low Risk by the High Risk to Low Risk by tightening controls on the higher risk tightening controls on the higher risk areasareas


RISK MANAGEMENT

IDENTIFY

COMMUNICATEMONITOR

AND REVIEWASSES AND

EVALUATE

MITAGATE

RE CAP RISK PHILOSOPHY AND POLICY

ENTERPRISE RISK ENTERPRISE RISK MANAGEMENT IN TAKAFULMANAGEMENT IN TAKAFUL

Governance StructureGovernance Structure

BOARD

BARMC

CRO CEO

BNM Guideline; ERM is Best Practice


“ “ The essence of risk management lies in The essence of risk management lies in maximizing the areas where we have maximizing the areas where we have some control over the outcome while some control over the outcome while minimizing the areas where we have minimizing the areas where we have absolutely no control over the absolutely no control over the outcome…”outcome…”

Peter L. BernsteinPeter L. Bernstein

The Remarkable Story of RiskThe Remarkable Story of Risk

EndEnd

Thank youThank you

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Operational and Actuarial Aspects of Takaful