Operational and Actuarial Aspects of Takaful

1. Operational and Actuarial Aspects of Takaful Topic 9 Risk Management in Takaful

2. Sub Topics Introduction Islamic Perspective of Risk Management Definition of Risk Management Overview Risk Management in Takaful

3. 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

4. Introduction What is Risk? ‘Uncertainty of loss from an exposure’ Uncertainty-Probability Loss-real loss or not making a gain, usually negative in nature You can categorize as you please and depends on subject matter

5. Introduction Your view of Risk? Perceived v Real E.g. A drunken man driving a car or a student who do not study passing an examination. Degree of Risk Tolerance-Thrill seeker, indifference or Averter

6. Islamic Perspective The benefits that Syariah predicates to individual and community and laws to protect the benefits for improvement and perfection of life 3 main objectives: Daruriyah (“Essential”); Hajiah (“Complementary”); Tahsiniyah (“Desirable”).-Protect and promote Essentials; invalidate destructive affairs

7. Islamic Perspective Risk has no religion Muslims believe in the hereafter; life on this world is transitory You will be rewarded according to your intentions Risks cannot and should not be avoided Man are required to act diligently but Allah determines the final outcome.

8. Islamic Perspective Epic on the Hijrah Planning for Battles ‘Tie your camel, then say Isha’ Allah’-Hadith At Tarmidzi ‘O my sons! Do not enter by one gate, but enter ye by different gates. I cannot avail you against Allah at all. Verily! The decisions rest with Allah. In Him I put my trust, and let all those who trust put their trust on Him’(12:67)

9. Takaful Model - Cooperative Participant Contribution (Premium) 100% 100% Policy Benefits Investment Profit Participants Account (Personal) Participants Special Account (Common) Underwriting Surplus Investment Profit Actual Management Expenses Operator

10. Takaful Model - Mudarabah Participant Contribution (Premium) 100% (1 – x)% Policy Benefits Participant Account (Personal) Investment Profit Participants Special Account (Common) Underwriting Surplus Investment Profit x% Actual Management Expenses Operator

11. Takaful Model - Wakalah Participant Contribution (Premium) Wakala Fee (to operator) 100% 100% Policy Benefits Investment Profit Participants Account (Personal) Participants Special Account (Common) Underwriting Surplus Investment Profit Operator Actual Management Expenses

12. Takaful Model – Modified Mudarabah Participant Contribution (Premium) (1-y)% (1-x)% Policy Benefits Investment Profit Participants Account (Personal) Participants Special Account (Common) Underwriting Surplus Investment Profit x% Actual Management Expenses Operator y%

13. Takaful Model –Wakalah with Mudarabah Participant Contribution (Premium) Wakala Fee (to operator) 100% (1-x)% Policy Benefits Investment Profit Participants Account (Personal) Participants Special Account (Common) Underwriting Surplus Investment Profit x% Operator Actual Management Expenses

14. Takaful Model –Wakalah with Incentive Compensation Participant Contribution (Premium) Wakala Fee (to operator) (1-y)% (1-x)% Policy Benefits Investment Profit Participants Account (Personal) Participants Special Account (Common) Underwriting Surplus Investment Profit x% y% Operator Actual Management Expenses

15. Risk Management in Takaful 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.

16. 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

17. Defining Risk Management Culture, processes and structures to realize potentials whilst managing adverse effects. Risk management process:- Identify Asses and evaluate Mitigate Monitor and Review

18. Defining Risk Management RISK MANAGEMENT IDENTIFY COMMUNICATE MONITOR AND REVIEW ASSES AND EVALUATE MITAGATE

19. Defining Risk Management Means to reduce Risk Exposure- Risk Avoidance - eliminate, substitute and separate Risk (Loss) Control – prevent and reduce/sharing Risk Retention Risk Transfer

20. Defining Risk Management Chance of loss -probability of an loss event happening Peril -cause of loss Hazard -a condition that creates or increases chance of loss Physical Hazard Moral Hazard Morale Hazard

21. Defining Risk Management 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

22. Defining Risk Management 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

23. Defining Risk Management Basic Category of Risks:- Pure Risks Speculative Risks Fundamental Risks Particular Risks Enterprise Risks

24. Defining Risk Management 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

25. Defining 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. RISK MANAGEMENT IN TAKAFUL-TERMINOLOGY

26. Defining Risk Management Yesterday Internal Audit CEO Quality Assurance Compliance Dept Today Risk Philosophy Risk Policy Risk Framework and guidelines Risk awareness training

27. Enterprise Risk Management in Takaful Evolution of Risk Management 1990s 2000s Pure Risk Mgt Speculative Risk Mgt Enterprise Risk Mgt Tillinghast ERM 2004 Survey-11% fully adopted ;38% partially adopted ERM usage most prominent in Financial Services

28. Enterprise Risk Management in Takaful Objectives of ERM - Pre Loss Prevent or reduce potential losses Manage Anxiety Meet legal obligations

29. Enterprise Risk Management in Takaful Objectives of ERM – Post Loss To survive To continue existing To stabilize earnings To continue with growth

30. Enterprise Risk Management in Takaful Benefits of ERM:- Holistic treatment of Risk Exposure Competitive advantage Have a positive impact on Revenue Reduces Earnings Volatility Compliance Good Corporate Governance

31. Enterprise Risk Management in Takaful Barriers of ERM:- Organization Culture ERM is not a priority ERM is costly ERM is new Lack of Intellectual Capital Lack of Technology

32. 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 Enterprise Risk Management in Takaful

33. Enterprise Risk Management in Takaful Types of Enterprise Risks Financial and pricing Investments and Liquidity Operational and Underwriting Market Regulatory and Legal Shariah

34. Enterprise Risk Management in Takaful Financial and Pricing Higher expenses Higher mortality or incidence of contingencies

35. Enterprise Risk Management in Takaful Investment and Liquidity Lack of shariah based investments instruments (esp. long term) Asset liability matching Poor yields Market inefficiency

36. Enterprise Risk Management in Takaful Operational and Underwriting Processing delays- e.g. IT disruptions Numerous customer complaints Higher lapses Collection difficulties High claims Lack of Retakaful capability

37. Enterprise Risk Management in Takaful 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

38. Enterprise Risk Management in Takaful Regulatory and Legal Margin of Solvency Risk Base Capital Non compliance to regulations Business Laws are conventional based

39. Enterprise Risk Management in Takaful 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

40. Enterprise Risk Management in Takaful Measuring Risks- You cannot manage what you cannot measure Use quantitative model and concept Use qualitative approach at least

41. 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

42. 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

43. 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

44. 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

45. Enterprise Risk Management in Takaful Control- Exceptional=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

46. Enterprise Risk Management in Takaful Example- Expected Loss=%Gross Income (proxy) %age=E%xRI%x(1-C)%

47. Enterprise Risk Management in Takaful % Gross Income 0%-2% 2%-5% 5% and above Severity of Risks Low Risk Medium Risk High Risk

48. Enterprise Risk Management in Takaful 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

49. Enterprise Risk Management in Takaful RISK PHILOSOPHY AND POLICY RE CAP RISK MANAGEMENT IDENTIFY COMMUNICATE MONITOR AND REVIEW ASSES AND EVALUATE MITAGATE

50. ENTERPRISE RISK MANAGEMENT IN TAKAFUL • Governance Structure BOARD BARMC CRO CEO BNM Guideline; ERM is Best Practice