Operational and Actuarial
Aspects of Takaful
 Risk Management in Takaful
Sub Topics
 Introduction
 Definition of Risk Management
 Enterprise Risk Management
 Risk Management in Takaful
 Overview
Introduction
‘The overall process that a financial
institution follows to define a business
strategy to identify the risk to which it is
exposed to, to quantify those risks and to
understand and control the nature of risk’
Coming and Hirtle 2001
Introduction
“ The essence of risk management lies in
maximizing the areas where we have
some control over the outcome while
minimizing the areas where we have
absolutely no control over the
outcome…”
Peter L. Bernstein
The Remarkable Story of Risk
Introduction
 What is Risk
 ‘Uncertainty of loss from an exposure’
 Loss-real loss or not making a gain,
usually negative in nature
 Real or Perceived
 Risk has no religion
Introduction

1.
2.
3.
4.
Culture, processes and structures to realize
potentials whilst managing adverse effects. Risk
management process:Identify
Asses and evaluate
Mitigate
Monitor and Review
Introduction
RISK MANAGEMENT
IDENTIFY
COMMUNICATE
ASSES AND
EVALUATE
MITAGATE
MONITOR
AND
REVIEW
Introduction
 Means to reduce Risk Exposure-
Risk Avoidance - eliminate, substitute and separate
Risk (Loss) Control – prevent and reduce/sharing
Risk Retention
Risk Transfer
Introduction


Terminology
Chance of loss -probability of an loss event
happening
 Peril -cause of loss
 Hazard -a condition that creates or increases chance
of loss
1. Physical Hazard
2. Moral Hazard
3. Morale Hazard
Introduction
 Physical Hazard –a condition that increases chance of
loss
 Moral Hazard –dishonesty or defective human
characteristics that increase the frequency or severity
of loss
 Morale Hazard –carelessness or indifference to a loss
Type of Risks
Basic Category of Risks:1. Pure Risks
2. Speculative Risks
3. Fundamental Risks
4. Particular Risks
5. Enterprise Risks
Types of Risk
 Pure Risk – a situation in which there are only the
possibilities of loss or no loss
 Speculative Risk – a situation in which either a
profit or loss is achievable
 Fundamental Risk – a risk that affects the entire
economy or groups within the economy
 Particular Risk – a risk which affect an individual
and not the group or community
Enterprise Risk Management
 Enterprise Risk – a term that encompasses all major
risks faced by a business organization. Such risks may
include pure risks, speculative risks, operational and
financial risks.
 Enterprise Risk Management (ERM) – combines into a
single unified treatment program all major risks the
organization is exposed to.
Enterprise Risk Management
 Yesterday
Internal Audit
CEO
Quality Assurance
Compliance Dept
 Today
Risk Philosophy
Risk Policy
Risk Framework and
guidelines
Risk awareness
training
Enterprise Risk Management in Takaful
Evolution of Risk Management
1990s
Pure Risk
Mgt
2000s
Speculative Risk
Mgt
Enterprise
Risk Mgt
Tillinghast ERM 2004 Survey-11% fully adopted ;38% partially adopted
ERM usage most prominent in Financial Services
Enterprise Risk Management in Takaful

1.
2.
3.
Objectives of ERM - Pre Loss
Prevent or reduce potential losses
Manage Anxiety
Meet legal obligations
Enterprise Risk Management in Takaful

1.
2.
3.
4.
Objectives of ERM – Post Loss
To survive
To continue existing
To stabilize earnings
To continue with growth
Enterprise Risk Management in Takaful

1.
2.
3.
4.
5.
6.
Benefits of ERM:Holistic treatment of Risk Exposure
Competitive advantage
Have a positive impact on Revenue
Reduces Earnings Volatility
Compliance
Good Corporate Governance
Enterprise Risk Management in Takaful

1.
2.
3.
4.
5.
6.
Barriers of ERM:Organization Culture
ERM is not a priority
ERM is costly
ERM is new
Lack of Intellectual Capital
Lack of Technology
Enterprise Risk Management in Takaful


1.
2.
3.

Who bears what risks-Participants, Operator or
Takaful Fund
Takaful Model a consideration?
Cooperative
Mudarabah
Wakalah
Solvency the name of the game otherwise a Qardrul
hasan is required.
Enterprise Risk Management in Takaful
 Cooperative-participants are jointly and severally
liable if assets are not sufficient to meet claims-akin to
aqilah
 Mudarabah-Operator required to maintain solvency
 Wakalah-Regulation requires Operator to maintain
solvency
Takaful Model - Cooperative
Participant
Contribution
(Premium)
100%
Investment
Profit
Participants
Account
(Personal)
Investment
Profit
Operator
100%
Policy Benefits
Participants
Special
Account
(Common)
Actual
Management
Expenses
Underwriting
Surplus
Takaful Model – Mudarabah on Investments
Participant
Contribution
(Premium)
(1 – x)%
Investment
Profit
Participant
Account
(Personal)
Investment
Profit
Policy Benefits
Participants
Special
Account
(Common)
x%
Operator
100%
Actual
Management
Expenses
Underwriting
Surplus
Takaful Model - Wakalah
Participant
100%
Contribution
(Premium)
Wakala Fee
(to operator)
Investment
Profit
Participants
Account
(Personal)
Investment
Profit
Operator
100%
Policy Benefits
Participants
Special
Account
(Common)
Actual
Management
Expenses
Underwriting
Surplus
Takaful Model – Modified Mudarabah
Participant
Contribution
(Premium)
(1-x)%
Investment
Profit
Participants
Account
(Personal)
Investment
Profit
(1-y)%
Policy Benefits
Participants
Special
Account
(Common)
Underwriting
Surplus
x%
Operator
Actual
Management
Expenses
y%
Takaful Model –Wakalah with Mudarabah
on Investments
Participant
Contribution
(Premium)
Wakala Fee
(to operator)
(1-x)%
Investment
Profit
Participants
Account
(Personal)
Investment
Profit
Policy Benefits
Participants
Special
Account
(Common)
x%
Operator
100%
Actual
Management
Expenses
Underwriting
Surplus
Takaful Model –Wakalah with Incentive
Compensation
Participant
Contribution
(Premium)
Wakala Fee
(to operator)
(1-x)%
Investment
Profit
Participants
Account
(Personal)
Investment
Profit
(1-y)%
Policy Benefits
Participants
Special
Account
(Common)
Underwriting
Surplus
x%
Operator
Actual
Management
Expenses
Fixed $y
if Surplus
Enterprise Risk Management in Takaful
Types of Enterprise Risks
1. Financial and pricing
2. Investments and Liquidity
3. Operational and Underwriting
4. Market
5. Regulatory and Legal
6. Shariah
7. Systemic
Enterprise Risk Management in Takaful

Financial and Pricing
1. Higher expenses
2. Higher mortality or incidence of contingencies
Enterprise Risk Management in Takaful

1.
2.
3.
4.
Investment and Liquidity
Lack of shariah based investments
instruments (esp. long term)
Asset liability matching
Poor yields
Market inefficiency
Enterprise Risk Management in Takaful

1.
2.
3.
4.
5.
6.
Operational and Underwriting
Processing delays- e.g. IT disruptions
Numerous customer complaints
Higher lapses
Collection difficulties
High claims
Lack of Retakaful capability
Enterprise Risk Management in Takaful

1.
2.
3.
4.
5.
Market
Takaful is still sold not bought
Takaful is only starting
Takaful Image is no difference from Insurance
and in some cases worst off
Savings and Insurance growth correlated to
economic growth
Inflation woes
Enterprise Risk Management in Takaful

1.
2.
3.
4.
Regulatory and Legal
Margin of Solvency
Risk Base Capital
Non compliance to regulations
Business Laws are conventional based
Enterprise Risk Management in Takaful

1.
2.
3.
4.
5.
6.
Shariah
Non consistency of Shariah Standards
Shariah v Conventional provisions
General Lack of Shariah understanding
Most operations are not fully shariah based
Shariah Scholars lack business and Insurance
acumen
SAC v Board
Enterprise Risk Management in Takaful
Measuring RisksYou cannot manage what you cannot measure
Use quantitative model and concept
Use qualitative approach at least
Enterprise Risk Management in Takaful
 Examples of Quantitative Models-
Actual Financial Loss
Trending (Regression Analysis)
Value At Risk (VAR)
Scenario Analysis
Stress Test
ERIC modeling
Enterprise Risk Management in Takaful
ERIC Modeling - Risk Scoping based on;
 Events Frequency or Probability of such uncertainties
 Risk Impact to the Organization
 Current Controls in placed
Enterprise Risk Management in Takaful
 Event Frequency –
Almost Certain=100%;Expected to occur most the
time
Likely=75%;Expected to occur in most
circumstances in the company or another
Possible=50%;Might occur at some time and have
occurred in the company or another
Unlikely=25%;Could occur at some time
Enterprise Risk Management in Takaful
 Risk Impact –
Catastrophic=50% and above; Devastating can
lead to closure
High=25%-50%; Effect is medium to long term
with substantial loss
Medium=5%-25%; Effect is not material but
recovery is medium term
Low=less than 5%; No negative impact with
sufficient reserves
Enterprise Risk Management in Takaful
 ControlExceptional=90% and above; Very good controls
Strong=70%; Good but still susceptible sometimes
Satisfactory=50%; Adequate but have occasional
lapses
Below Satisfactory=30%; Generally weak though
mitigate some risks
Weak=Below 5%; Absence of controls
Enterprise Risk Management in Takaful
 Example Expected Loss=%Gross Income (proxy)
 %age=E%xRI%x(1-C)%
Enterprise Risk Management in Takaful
% Gross Income
 0%-2%
 2%-5%
 5% and above
Severity of Risks
 Low Risk
 Medium Risk
 High Risk
Risk Assessment
RISK MATRIX
High
IMPACT $$$
Default
Medium
ALM
Low
Medium
LIKELIHOOD
High
Risk Assessment
RISK MATRIX
Overview
 Risk is viewed as a residual value
 A Risk Map is created
 The Risk Map is the organization’s risk dashboard
 The organization target is to convert the High Risk to
Low Risk by tightening controls on the higher risk
areas
Overview
 ERM is not just one person or one dept job
 Involved all functions, activities and depts.
 Addresses all facets of risks that are inter-related
 Rationale – In an organization nothing works in
isolation. Its value is a sum of its parts.
 A business process like any other
Overview
RISK PHILOSOPHY AND POLICY
RE CAP
RISK MANAGEMENT
IDENTIFY
COMMUNICATE
ASSES AND
EVALUATE
MITAGATE
MONITOR
AND
REVIEW
Governance Structure
??
SAC
BOARD
Audit/RM
Committee
CRO
CG/ERM is Best Practice ????
CEO
ERM In Takaful Operation Summary
Takaful
Key Risks
Operational
Market
Insurance
Credit
Liquidity
Evaluate and control
Key Business risks
Matching
Pricing
Reinsurance
Strategy
Cash Requirements
Risk/reward
Strategy
Expense Control
Place a value
On risk
Persistency
Corporate Stock
selection
Asset Liability
Matching
Systemic Risks
 In finance systemic risk is the risk of collapse of an entire financial
system or entire market, as opposed to risk associated with any one
individual entity, group or component of a system. It can be defined as
"financial system instability, potentially catastrophic, caused or
exacerbated by idiosyncratic events or conditions in financial
intermediaries“.
 It refers to the risks imposed by interlinkages and interdependencies in
a system or market, where the failure of a single entity or cluster of
entities can cause a cascading failure, which could potentially bankrupt
or bring down the entire system or market.
Systemic Risks
 A downturn in the economy and the market as a whole




sinks
The “life insurance or family takaful” business are subject to
loss of value of the underlying investments
A significant rise in surrender rates – inspired by
consumers’ needs for cash or because of rumored or real
failure of insurance companies – could be disastrous.
Many people would be unable to obtain the same insurance
from a competitor for the same price
Loss of employment (AIG has staff of 116,000)
The Contagion Effects of
Subprime Crisis
 The structure of the modern financial markets,
such as Securitization --the repackaging and
chopping up of loans and other assets into
tradable slices -- has allowed risks to be spread
across a more diverse set of investors around the
globe.
 When functioning normally, the system is
supposed to increase the availability of credit and
spread risk, reducing the chance that a major
financial institutional will collapse and cause a
financial meltdown.
The Contagion Effect of
Subprime Crisis
 Far-flung markets are tied more closely together. That
means a crisis in a niche market in one country can
contaminate lots of other markets that at first glance
have little to do with each other.
 Technology transfers information in seconds, giving
the infection a more potent scope.
The Contagion Effect of
Subprime Crisis
 Many foreign financial Institutions have invested in
highly rated securitized products that incorporated
the subprime loans as underlying assets. Ratings
downgrades have sent prices plunging hence effecting
solvency.
 Banks have become less willing to make loans among
themselves and to businesses, prompting a worldwide
squeeze on credit.
Impact on Insurance
Companies
 The subprime mortgage crisis has limited direct
impact on life insurers
 Insurers as major institutional investors are vulnerable
to contagion effects
 Insurers directly involved in this crisis because of their
own asset securitization and credit derivatives
activities are badly hit. E.g. AIG
Impact on Insurance
Companies
 Diversified insurers who provide credit guarantees
on debt instruments through credit default swaps
have reported multi-billion dollar reductions in
the fair value of these swaps
 Because insurer asset-backed-security investments
tend to be in tranches with the highest credit
ratings, insurers are less vulnerable to the crisis
than some investor
Impact on Insurance
Companies
 Credit market problems appear likely to grow
worse in the immediate future, with additional
possible negative effect on insurers. Insurers are
also vulnerable to the credit crunch resulting from
contagion effects
 The liquidity crisis in the banking industry could
easily morph into a solvency crisis because many
banks are now very likely undercapitalized,
insurers may follow
Impact on Insurance
Companies
 Credit market problems have resulted in moderate
stock price declines and rises in volatility,
developments that affect the profitability of insurers
variable products
 Insurers may see a drop in the demand for life
insurance and annuities and an increase in fraud
 The relative appeal of certain insurance products is
likely to change somewhat
Impact on Insurance Cos
 Some insurers may generate negative spreads on fixed-
rate products because the government has drastically
lowered interest rates in response to the credit market
crisis
 Inflation is rising in the wake of the subprime crisis, a
development that could prompt customer defections
from fixed-rate products
 Companies actively writing professional liability
coverage are likely to face higher claims activity due to
related bankruptcies and class-action lawsuits.
Impact on Insurance
Companies
 Fair value accounting and modern risk management
practices may serve as a mechanism through which
credit problems are amplified in the economy
 This crisis has exposed significant problems in the
current approach to financial regulation
Worldwide Impact on Insurance
Companies
 French insurance giant AXA reported a 32-percent
slump in net first-half profit.
Net profit was 2.16 billion euros, after allowance of 1.14
billion euros for a fall in asset values, much of it arising
on the bond market.
 AIG once the 18th-largest public company in the world
faced near collapse. The FED and the United States
Treasury by May 2009 had increased financial support
to AIG potentially to a tune of $182.5 billion
End