Mohammad Kamil bin Abu Talib, Nooraslinda abdul Aris and Roszana Tapsir (2012)

Risk and Management of Takaful Industry. Journal of Global and Economics,

Volume 4, Number 1(page: 29-39)

The article of Risk and Management of Takaful Industry by Mohammad Kamil bin Abu
Talib, Nooraslinda abdul Aris and Roszana Tapsir that appeared in journal of global and
economics can be said to be an argument about risk management that is important in Islam
which takaful provides a way to manage risks in business according to Shariah principles.
The argument will be developed through a critical review of their paper, discussing in turn its
conceptual bases, research methods, main findings and practical implications.
Kamil, Nooraslinda and Roszana made some clarification about risk of takaful company and
identifies the management of such risk by the takaful operator. Proper planning, control,
implementation and monitoring must be put in place to ensure the society interest is well
safeguard. The justice must exist for the benefit of the society as being commanded under the
maqasid shariah. The category of risk profile for Islamic finance have two which are generic
risks and unique risk. Islamic finance with its unique characteristics give rise to a set of risk
management challenges namely credit risk, liquidity risk, legal and fiduciary risk, financial
supervision and transparency and shariah supervision risk (Morisano 2009). Due to the rapid
growth in Islamic finance, there is a need for a unique risk framework for Islamic institutions,
particularly for takaful operators. The compliance of Shariah should have directs relationship
with the management of risks since the unique risk for Islamic institution lies in the shariah
supervision risk.

The research method is by secondary analysis when an analyse data which was collected by
another researcher. It allows the researcher to explore areas of interest without having to go
through the process of collecting data themselves in the field. The study utilised a survey
research strategy to understand about risk management essential for takaful company. The
research findings of risk management are to protect the safety of the takaful fund, to ensure
the fund is able to pay claims and obligations, to achieve a required rate of return on
investment if possible, ability to withstand and adverse conditions and to ensure continuity as
a going concern. Then, most of the takaful operators classified their risks into three headings
namely the takaful (business) risk, financial risk and operational risk. Identifying and
classifying the risk in takaful business is important as it will enable them to manage the risk
more effectively.

The articles first outlines is the meaning of takaful which derives from word kafalah
(guaranteeing each other or joint guarantee). In principle, Takaful system is based on mutual
co-operation, responsibility, assurance, protection and assistance between groups of
participants. It is a form of mutual insurance (S. Saaty & Ahmad Ansari, 2009). The central
idea of a Takaful contract is that it is a financial transaction of a mutual co-operation between
two parties to protect anyone of them from unexpected future material risk. In a Takaful
transaction, the participant (insured) pays a particular amount of money known as the
contribution (premium) to the Takaful operator (insurer) with a mutual agreement that the
insurer is under a legal responsibility to provide the participant with a financial protection
against unexpected loss, should it happen within the agreed period. However, in a case where
the loss does not occur against the insured within the specified period, the insured is entitled
for the whole amount of paid-premiums together with the share of profits made out of the
cumulated paid-premiums based on the principle of Mudharabah (profit sharing) financing
technique. In such a transaction, both the insurer and the insured are mutually helping each
other for financial protection (Khan, 2003).

Next, the article emphasized about the risk. Risk is the probability that a chosen action will
lead to a loss or undesirable outcome. Risk is also defined as uncertain future events which
could influence the achievement of the businesss objectives, including strategic, operational,
financial and compliance objectives. Potential losses themselves may also be called risks.
Any human endeavour and business carries some risk, but some are much riskier than others.
In a nutshell, risk denotes losses. The concept of risk has been associated with uncertainty of
events in future. The higher the uncertainty of events, the higher the risk. Shariah non-
compliance risk is the risk arising from failure to comply with shariah rules and principles as
determined by the shariah regulatory council. In Malaysia, the highest authority of shariah
lies with the national shariah advisory council of the Central Bank of Malaysia (Bank
Negara Malaysia or BNM) and the Security Commission. Shariah non-compliance risk is
considered paramount as it is the distinguishing factor between the Islamic and conventional
systems.

Islamic Financial Service Board (IFSB) classifies risk into six categories namely operational
risk, credit risk, equity investment risk, market risk, liquidity risk and rate of return risk.
Operational risk is defined as risk of losses resulting from inadequate of failed internal
process, people and system or from external events, which include legal risk and shariah
compliance risk, but exclude strategic and operational risk (IFSB, 2004). The shariah
compliance risk cuts across the six categories of risk and is considered as part of the
operational risk. Therefore, shariah compliance is an important feature in an Islamic
financial institution. The scope of shariah compliance includes includes the takaful model
(mudharabah, wakalah or hybrid), takaful products, investments, contract wordings,
marketing collateral, surplus sharing and fee structures.

One of the aspects under shariah compliance is to ensure acceptance, validity and
enforceability of contract according to the shariah law. Breeching any shariah element in a
contract will result in severe implications, both financial and non-financial. From financial
perspective, the contract may be invalid and result in obtaining illegal profit from such
transaction. Non-financial impacts include impediment from ALLAHs barakah (blessing),
against the command of ALLAH, contravening the provision of legislations (Takaful Act
1984 and Islamic Banking Act 1983) and jeopardising the reputation of the IFI. Thus, the
concpet of ibadah as promoted in islam will not materialise. This shows that shariah
noncompliance is a real risk which may lead to serious losses for the takaful operator.

The article showed that in Malaysia, the IFIs are guided by their internal Shariah
Supervisory Board which are established to advise and ensure their products comply and
adhere to the Shariah principles. This is a requirement by BNM to all IFIs including takaful
companies. To oversee the institutions compliance (products, services and operations), BNM
also has a Shariah Advisory Coucil (SAC). BNM is continuously enhancing the Shariah
framework to be in line with the developments in the takaful industry. This is crucial to
ensure uniformity of Shariah interpretations in its effort to strengthen the regulatory
framework of the Islamic finance industry. The strong Shariah framework enhances
consumer confidence and gives greater flexibility for takaful operators to be innovative
within the boundary of Shariah (BNM, 2005).

Besides, the article said that managing risk involves creating awareness of uncertainty,
qualifying the risks, managing the controllable risks, and minimizing the impact of
uncontrollable risks by risk allocation/apportionment. Ineffective risk management is often
caused by lack of formalized risk management procedures, including risk identification,
analysis and control (Tah and Carr, 2001); lack of continuity of risk management in the
different stages in the project life cycle; poor integration between risk management and other
key processes; and a lack of interaction among different parties. Risk management in takaful
industry is a process to identify potential losses of an operator and to select the most
appropriate techniques for treating such potential losses. To ensure the effectiveness of
overall management, takaful operators are required to observe the Guidelines on Directorship
for Takaful Operators, which govern the appointment of directors and chief executives and
the setting up of board committees, including risk management committee. In addition,
takaful operators are also required to observe prudential limits and conditions imposed on the
outsourcing of the management of takaful funds so as to ensure that the funds are properly
managed within the accepted risk management framework (BNM, 2005).

As conclusion, in line with shariah requirements and the concept of takaful, risk
management practice and management of a takaful operator should be better off than a
conventional insurance operator. Protection that is in accordance with maqasid shariah needs
to be integrated into the Islamic finance activities. Takaful operators need to be proactive in
managing their risks as part of good governance and best practice code. Self-regulatory is
needed rather than depending on regulatory requirements. As risk is an on-going process,
continuous development of knowledge is required in order to understand and manage the
risks effectively. Irrespective of the business model adopted by the takaful operators
(mudharabah or wakalah or hybrid), the risk management will be the same since the basis is
shariah.


REFERENCE

1. Abd Rahman, Z. (2010). Contracts & The Products of Islamic Banking. Kuala
Lumpur: CERT Publications Sdn Bhd.
2. Abdul Aris, N., & Othman, R. (2011). Takaful Industry: A Malaysian Experience.
Shah Alam: Universiti Teknologi MARA.
3. Abu-Tapanjeh, A. M. (2009). Corporate Governance from the Islamic Perspective: A
Comparative Analysis with OECD Principles. Critical Perspectives on Accounting 20,
556-567.
4. Ahmad K. (2000). Islamic finance and banking: the challenge and prospects. Review
of Islamic Economic 2000; 9:5782.
5. Ahmad, M. (1967, June 6). Semantic of Theory of Interest. Islamic Studies
(Rawalpindi) , 171-196.
6. Ahmed, P. (2010, April 12 & 13). Risk Management in Takaful: What Makes the
Differences? Fifth Annual World Takaful Conference . Dubai, UAE.
7. Abdul Majid, M. Z. (2009). "Pentakrifan Semula Konsep Pematuhan Syariah dalam
Urusan Perbankan Islam." In Visi.
8. Asyraf W. D. (2006). Stakeholders expectation toward corporate social responsibility
of Islamic Banks. In: IIUM International Accounting Conference (INTAC) III.


























Salder Jaffer, Farzana Ismail, Jabran Noor and Lindsay Unwin (2010) Takaful
(Islamic Insurance): Concept, Challenges and Opportunities. Milliam Research
Report.

The research report by Salder Jaffer, Farzana Ismail, Jabran Noor and Lindsay Unwin that
appeared in Milliam research report stated about principles and practices underlying takaful,
issues and challenges facing the takaful industry and the takaful operating models. The
argument will be developed through a critical review of their paper, discussing in turn its
conceptual bases, research methods, main findings and practical implications.
The research first stated about the background and market outlook of takaful which whilst
takaful started in 1979 in Sudan, and it only gained momentum in early 2000 when the
Malaysian government promoted it and significant growth was witnessed thereafter. Next the
research emphasized about principles and practices underlying takaful. Three elements that
prohibited in takaful are riba, maisir and gharar. The research paper also make comparison
between conventional insurance and takaful. The authors also make some clarification about
takaful operating model which are mudharabah model and wakala model. Some issues and
challenges facing the takaful industry in following section such as key issues and challenges
and technical issues and challenges.

The research method is by

The articles first outlines is described about principles and practices underlying takaful.
There are certain key issues within conventional insurance that Islam does not permit which
are riba, maisir, gharar and forbidden things. There is a further focus in takaful around the
importance of moral values and ethics as business meant to be conducted openly in
accordance with the utmost good faith, honesty, full disclosure, truthfulness and fairness in
all dealings. The pooling does eliminate Gharar, as the uncertainty about the future claims
events certaintly still exists but now is acceptable as the donation (tabarru) is meant for
mutual assistance and not for profit-taking or gambling. The article also make comparison
between conventional insurance and takaful such as conventional insurance contains three
element while takaful does not contain three element of it. In conventional insurance profit
belongs to shareholder and the with-profit policyholders. The insurer is covered during the
policy period but is not entitled to any return at end of such period. While in takaful, surplus
belongs to the participants and is accordingly returned to them.
The components and current practices in the takaful industry such as family takaful and
general takaful, Shariah-compliant assets, retakaful and retro-takaful. Family takaful
offerings provide access to life coverage in a manner which does not conflict with their
religious belief. Family takaful is designed to combine protection for the benefit of ones
dependents with a savings element and requires the distribution of surplus to participant.
Shariah-compliant asset is the avoidance of Riba, Gharar, Haram and Maisir in the design of
takaful products which has significant impact on decisions of takaful operation. On the point
of retakaful, it allows takaful fund to share risk among multiple takaful pools. Some retakaful
operators retrocede conventionally on the basic of necessity because currently there is
limited Retro-Takaful capacity available.

Next, the research emphasized on takaful operating model which are commonly structured
such as the Mudharabah model and the Wakala model. Then it found out that Mudharabah
model less acceptable globally but perhaps more attractive as profit is shared with the
policyholders. However, there is a strong opinion of scholars from especially the Middle East
that underwriting profit cannot be shared with the operator as it stem from donation. The
Wakala model is by far the most recognised and has the positive effect of providing a fixed
and steady income stream. However, in its purest form it has limited upside potential as the
only source of income is the Wakala fee. This could harm competitiveness as a high up-front
Wakala fee might look unattractive to participants and have adverse effects to new entrants
because of the high initial costs. There has been an increasing trends towards the hybrid
model which is the based on the application of the Wakala model for the underwriting portion
and the application of the Mudharabah model for the investment part. Considering that
investment income usually make up the bulk of the profits, this model is viewed by many
Takaful operators to be commercially viable. The AAOIFI has also endorsed hybrid versions
of Wakala model.

Besides, the authors also found out the issue and challenges facing the takaful industry
nowadays are lack of consumer awareness, scarcity of human resources with both insurance
and Shariah expertise, the shortage of Shariah scholars with appropriate experience, lack of
standardisation in the industry that is due to Shariah interpretation, solvency and capital
requirements, corporate governance and shortage of suitable assets. In addition, there are
various technical issues within the Takaful industry, which may be relevant in the valuation
and risk management of takaful business. Some of the key technical issues considered are
treatment of the interest-free loan (Qard Hasan), approach to underwriting and claim
management, determination and distribution of surplus, treatment of contingency reserves,
treatment of participants pools, issues around Retakaful and retrocession and treatment of
transfers of in-force business from conventional reinsurer to Retakaful.


































































REFERENCE

1. Wong, K. (2007). Risk-based capital framework for insurers in Malaysia
2. Bank Negara Malaysia. Guidelines on Takaful operational framework. Concept paper.
3. Ernst & Young (2008, 2009). World Takaful Report.
4. Usmani, Muhammad Taqi (2007). Introduction to Islamic Finance