Operational and Actuarial Aspects of Takaful

Operational and Actuarial Aspects of Takaful Takaful Contracts and Underwriting

LEGAL DOCUMENTATION OF TAKAFUL CONTRACTS • Legal documentation of takaful contracts usually contain the following : • Provisions – parameters of the contract • Clauses – specific or special conditions of events • Warranties - preconditions • Exclusions – non-claimable contingencies

(a) Provisions : (i) General Provisions : • The contract • Incontestability • Modification • Freedom from Restrictions • Age and Sex • Proof of Age • Currency and Place of Payment

(ii) Contribution Provisions • Certificate Years and Anniversaries • Payment • Change • Grace period • Contribution Pause (iii) Fund Provisions • Shariah –Approved Funds • Valuation of Funds (iv) Ownership Provisions • The owner • Change of Ownership • Assignment • The Nominee • Revocation of Nomination

(b) Condition, Clauses, warranties and Exclusions • Conditions relates to what is not covered, what is covered and under what circumstances; there are numerous clauses contained in contracts of different kind; the following some of the important clauses that a takaful company should automatically incorporated : • Reinstatement Value Memorandum; • Special Provision (c) Types of Takaful Contracts • Different takaful companies in different countries use slightly different wordings for their contracts; in fact takaful companies in the same country use different contract wordings because these companies used different contract such as Mudharabah, Wakalah and others ;

A main contract is a contract that is a stand-alone and complete contract by itself; e.g. Takaful Education Certificate ; • A supplementary contract does not stand by itself, it is usually attached to the main contract; e.g accident Supplementary Certificate

PRINCIPLES OF TAKAFUL CONTRACT • The basic formalities in a commercial contract there must be : (i) The subject matter (al-Ma’qud ‘alaih); (ii) Contracting parties (al-Muta ‘aqidayn) (iii) Consideration (al-’Iwad al-Mutaqawwim) (iv) Terms and conditions (Shurut) (v) Ijab and Qabul

Other principles are: (i) Insurable Interest ; (ii) Utmost of Good faith ; (iii) Indemnity ; (iv) Subrogation ; (v) Contribution ; (vi) Proximate Cause ;

Insurable Interest : • In a broad sense an insurable interest implies some relationship between the insured and the event insured against, so that its occurrence would result in injury or loss; without this principle the contract can become a wagering agreement which is not in line with Shariah requirement ; generally, an insurable interest must exist when the certificate / policy is issued and at the time of loss except in the case of marine insurance when insurable interest is required only at the time of loss, and in life insurance when insurable interest is required only at the inception;

Utmost of good faith : • Utmost of good faith is an obligation of the insured to disclose material facts; a material fact is a fact that would influence the judgement of a prudent underwriter in deciding whether to accept a risk for insurance and on what term; the proposer has a duty to disclose material facts at inception, at renewal and at other instances when the status of the contract has changed ; a breach by the insured makes the contract null and void at the insurer’s option; breaches can happen through concealment, non-disclosure, misrepresentation; • From the Shariah viewpoint the principle of utmost of good faith is in line with Islamic teachings as contained in a hadith related by Hakim b. Hazimi;

Indemnity : • Simply stated, indemnity means reimbursement for actual loss sustained; it is a principle designed to place an insured in the same financial position after a loss that existed immediately before the loss; an exact financial compensation may be denied by an inadequate sum insured, indemnity limit, excess or franchise; this principle cannot be applied to valued policies such as life insurance or personal accident cover; • Subrogation : • The right of the company who has granted an indemnity to take over any recovery rights the insured may have against third parties liable for the same loss; a subrogation condition in the certificate / policy enables the company to take action in the insured’s name before paying the claim; subrogation may arise under contract, tort or statue;

Contribution : • Under the contribution principle, the insured may insure as many times as he wishes and with as many different insurers as he wishes, however, in the event of loss each company pays a suitable proportion of the loss either in proportion to the sum insured or in proportion to their respective independent liabilities; since under the indemnity principles, the insured cannot recover more than his/her financial loss, therefore, in the event that two or more insurers do face liability for the same loss, the paying company is entitled to recover from the other insurers by way of contribution, its share of the loss; • Proximate Cause : • Under this principle, there must be a cause and effect relationship between the peril insured against and the resulting loss; the insurer is liable only for loss proximately caused by an insured peril not loss caused by uninsured peril; the insurer will be liable if the sequence between an insured peril and the loss is unbroken;

PRINCIPLES OF UNDERWRITING • Underwriting is the process of assessing and classifying the degree of risk of an applicant and of selecting participants; by doing so, a takaful operator can controls the quality of new and renewal business that they write; • The purpose of underwriting is to develop and maintain a profitable portfolio of business and for underwriting to achieve its purpose, takaful operators must avoid adverse selection;

(a) FAMILY TAKAFUL UNDERWRITING • In family takaful the following are underwriting components and process that need to be addressed : (i) Agent’s report (ii) Preliminary processing (iii) Information gathering (iv) Underwriting factors (v) Underwriting manual (vi) The numerical rating system

(i) Agent’s Report : • Since agents are those who deal directly with potential clients, their opinion and judgement becomes an essential part of the underwriting process; • All takaful agents are provided with application forms from which pertinent information about the applicant can be gathered for the underwriter to make a decision; agents must make sure all questions are answered fully and the description of any health problems are described exactly and completely; when health problems are noted, additional information need to be furnished such as : • Medical illness; • Date and duration of an attack or episode; • Date of first attack; • Frequency of episodes; • Date of last attack;

Full names and addresses of doctors visited and dates of such visits; • Dates of hospitalizations and name of hospitals; • Effects and complication of the problem; • Type of treatment or medication; • Date of last treatment or medication; • Agents are expected to report to underwriters anything about the applicant that is not reported in the application form;

(ii) Preliminary Processing : • An application will be assigned a proposal number to be used for control purposes and also for the certificate / policy number ; • Make sure that the application and supporting documents are complete; if a national database is available, make a search about applicant from other company’s records; • Depending on the size of the operator, the underwriting decision can be made at a branch level or directly to the head office; • An underwriter will normally use the numerical rating process to rate the risk concerned ;

(iii) Information Gathering : • Primary source of underwriting is the takaful application form; however other information's are also required for additional information and verification and this include the Attending Doctor’s Statement (ADS) ; • The application form has two or three sections; section (I) contains questions pertaining to details of the applicant and the takaful plan applied; section (II) includes questions about the health history of the applicant which may include the applicant’s (a) height and weight; (b) current and past health problem; (c)recent visits to doctors; (d) reasons for the visits; • Based on the information, the underwriter can accept, reject or accept with modification or KIV of the application; a underwriter can classify an application as a non-medical case or call for a medical examination;

For a non-medical case, normally the participant ought to satisfy the following criteria : • Applicant is younger than a certain age; • Applicant is applying for less than a certain amount of sum covered; • Has indicated no health problem; • For a medical case, the applicant must undergo some kind of medical examination such as, pulse rate, blood pressure, blood sugar, heart size, heart sounds, blood tests, electrocardiogram; the type of medical examination required depends on the applicant’s age, amount of cover requested, the agent’s report and answers from the applicant’s form; the takaful underwriter obtained his request for information mostly from the ADS;

(iv) Underwriting Factors : • Apart from age, underwriting factors comprises of medical and non-medical risk factors; medical risk factors include (a) build, (b) other physical condition, (c) medical and family history; • As mentioned above an application can be accepted at standard rates, loaded-up, postponed or KIV; when the application is loaded-up the new rates, terms and conditions will be sent to the applicant for his acceptance;

The following are the medical risk factors : • Build - Takaful underwriters usually use the body mass index (BMI) method or the girth to buttock (GTB) ratio; BMI more than 25 or GTB more than 1 is considered obese; • Other physical condition - presence of cardiovascular diseases, high blood pressure, kidney disease, chest disorder, cancer or diabetes can result in above – average mortality; • Medical and family history - applicant’s health history may also signify an above – average mortality risk;

The following are some of the non-medical risk factors : • Occupation • Avocation or hobbies • Lifestyle • Environment • Foreign residence or travel • Insurable interest • Anti-selection • Personal finances

(v) Underwriting Manual • The underwriting manual provides underwriters with background information on underwriting impairments and serves as a guide to suggested underwriting actions when various impairments are present; the underwriting manual usually contains the following : • Anatomy and physiology – discusses the main body systems, their structure and interrelationship the main body systems includes body cells, the muscular-skeletal structure, the cardiovascular system, the respiratory system, the digestive system, the genitor-urinary system, the nervous system and the endocrine glands;

Disorders and Diseases – this section covers the nature and function of the heart, investigation of heart diseases, various diseases associated with the heart and their underwriting implications; this includes main causes of hypertension, diseases of the arteries, diseases of the respiratory system, treatment of metabolic disorders, and all other diseases of the various systems of the human body; • Assessment of Extra Risks – this section covers the nature of extra risks, methods of treating under-average lives, imposition of additional premiums or restrictions on cover provided and the mechanism of loading;

Financial Risk Assessment – here the main objectives of financial underwriting including anti-selection and fraud, the range and underwriting of personal covers, the range and underwriting of key person insurance and business loans cover and the evidence required; • Underwriting Life and Disability Risks – this section covers social and legislative constraints on underwriting practice; it covers the mechanic of application processing, structure of the underwriting department, role of the Chief Medical Officer, requirements for medical evidence and the like ;

Mechanics of underwriting – this section covers the structure of proposal forms, supporting medical evidence with particular reference to the ADR, medical examiner’s report, questionnaires, basic concepts of life underwriting; it also includes how anti-selection, numerical rating system, classification of risks, assessment and ratings as well as acceptance terms; • AIDS Risks : in this section the discussions involved HIV virus, modes of transmission, treatment and underwriting strategy and development of underwriting practices for HIV and AIDS ;

(vi) The Numerical Rating System – it is a quantitative method of classifying risks ; it assumes that (a) medical and non-medical factors affect the mortality of a risk, (b) the impact of each of the factors can be determined by a statistical study of people affected by these factors, and (c) a numerical value can be assigned to each factor according to its impact in mortality ; the principle of the numerical rating system is that a normal case is rated at 100 of the normal mortality and points are added or subtracted in accordance to information revealed by the participant in his / her application; once the case is fully rated, the participant can be accepted as a standard case, or a substandard case or an unacceptable case ;

(b) GENERAL TAKAFUL UNDERWRITING • For general takaful, the underwriting process will vary depending on the class of takaful being considered ; • Since the early days, underwriting for general insurance depended largely on gut feel; however, over the years a more accurate method had been developed and many of the takaful operators used these experience as their guidance ; many also resort to tariffs in order to prevent acute losses ; (i) Tariffs : • Due to the absence of sound scientific and mathematical basis for some general classes of takaful, there was a need to turn to tariff; takaful industry has adopted the use of tariffs just like their insurance counterpart; in Malaysia tariffs are applied to motor and fire coverage;

Underwriting guides are either structured along major lines of business or classes of business; it provide for properly structured decisions, ensure uniformity and consistency and incorporates claims experience; the underwriting guide can be for a single sub-class or for several classes; • Given the underwriting guides, underwriters should still follow a structured decision-making process to ensure that ultimately there is surplus in the takaful fund; the process are as follows : • Gathering information; • Analyzing and evaluating alternatives; • Selecting an alternative; • Implementing; • Monitoring;

Underwriting also refers to the process of selecting participants by recognizing and evaluating hazards; hazard can be physical, moral, morale and legal in nature; • The following factors will determine whether a risk should be accepted, the cover should be limited, the terms amended or the case rejected; • Types of cover – peril covered, basis of settlement; • Occupation • Protective factors • Identity • Claims experience

Takaful underwriter should limit the cover, if the sum covered is over the amount of potential liability; underwriters can amend the terms of contract by excluding certain risks or increasing deductibles; underwriters should try to make modifications so as to allow the submission to be acceptable; • Compared to insurance, takaful underwriters should also consider occupation of participant which are prohibited by Shariah, where the operator shall not underwrite these risks;

(VI) TAKAFUL CERTIFICATE / CONTRACT PROCESSING • General takaful underwriting slightly differs from family takaful underwriting in that the underwriting of the various classes of general takaful may be initiated either directly by the underwriter or through agents or brokers; they submit the application form, broking slip, quotation slip or tender documents as the initiating documents providing the relevant information and terms of the risk. • The content of the application documents with regard to the risk and the terms specified by the applicant or the broker are then subjected to the following checks : • Ensuring that the application form and related documents are complete; • Review the risk involved;

Whether a survey is required to determine the terms and clauses; • Whether special rating is required; • Checking underwriting guide, cession or treaty; • Past claim experience of the applicant / participant / broker; • From the review relevant facts are forwarded to Senior management for consent to proceed; if risk is rejected, a letter or a fax will be sent to the applicant; if accepted and risk need to be surveyed, the underwriter will request for a survey to be done either in-house or by professional surveyors; once survey performed, compare survey report with the information disclosed in the application;

When risk is accepted, issue a cover note; nowadays however, takaful operators issue takaful certificate immediately; for motor takaful cover note are issued electronically; • After the issuance of the takaful certificate, the underwriter must consider the necessity of facultative re-takaful, if this is required, the underwriter will request for the cover from the re-takaful department;

Application made through agents, brokers, direct or tender retakaful • Below is a typical general takaful certificate issuance procedure : Check the documents Yes Is a survey required No Is retakaful needed Can the risk be accepted Yes Yes Issue cover note Do a survey No Issue certificate No Decline letter Stop

The issuance procedure can be summarized as follows : • Job assignment • Review Document Submitted • Allocated work • Enter Data and Indicate Mode of Printing • Check for completeness and Correctness • Issue and Prepare Policy or Endorsement Documents • Sort and Dispatch

Examples : (a) Fire Takaful Rate : Risk : Menara Hang Tuah Risk Address : Jalan Arau, Taman Emas, Kuala Lumpur Sum covered : RM 30 million Occupation : Office-space Construction : Class 1 Rate : 0.1 % ( Issued by PIAM Technical Rating committee) Takaful Contribution : RM 30,000,000 x 0.1 % = RM 30,000

(b) Motor Takaful : For Motor Policy issued in west Malaysia the Tariff is : * RM 26 is added to every RM 1000 for values more than RM 1000

Sum insured : RM 50,0000 Made & Model : Proton wira 1.5 Age of car : 4 years Capacity : 1468 c.c NCD : 25% Comprehensive Cover : (a) First RM 1,000 RM 251.50 (b) Next RM 49,000 (26x49) RM 1,274.00 (c) Basic premium RM 1,525.00 (d) 25% NCD RM 381.37 (e) Premium Paid RM 1,144.13

Third Party Cover : (a) Basic Premium RM 81.00 (b) Loading 50% RM 40.50 (c) Gross Premium RM 121.50 (d) 25% RM 30.38 (e) Premium Paid RM 91.13

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Operational and Actuarial Aspects of Takaful