TAKAFUL OPERATIONS

Risk, Risk Management & Takaful

(I) INTRODUCTION
Risk a major component of our environment; human is
surrounded by innumerable risks from birth to death;
human learned to improve after experiencing misfortunes;
quest for security evolved since the dawn of mans
existence;
According to Blaise Pascal :
As each generation progressed they will learn at least a
part of what their earlier generations had learned.
Abraham Maslows hierarchy of needs:
Physiological Needs
Security Needs
Social Needs
Esteem Needs
Self Actualizing Needs
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(II) EVOLUTION
(a) Early Insurance Development :
Introduction of the contract of Bottomry by the merchants of Babylon
about 4000-3000 B.C.;
Around 3000 B.C Chinese merchants have practiced the concept of
risk separation;
Code of Hammurabi, 2250 B.C.;
Bottomry Contract adopted by the Phoenicians 1600-1000 B.C.;
The Greeks adopted it around 4 B.C;
Later adopted by the Romans;
Constitution of Madinah 622 A.D., adoption the concept of al-aqilah;
formation of the Al-Kanz fund
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 (912-961) A.D. Spain under Abd. Rahman III adopted some

form of marine insurance to protect their merchants.
The Italian introduced first known insurance agreement on
13 October 1347
Thomas Gresham established the first Royal Exchange, 1570;
Life insurance first practiced in 1583;
Lloyds of London established 1688; Lloyds Act passed in
1871;

(b)

Takaful (early evolution) :

Diyat; pre-islamic; pagan Arabs; aqilah system

Adopted by Prophet; two situations:
Dispute between the two women from the tribe of Huzail;
Constitution of Medina, between Muhajirin and Ansar;
The aqilah system was utilized;
A fund known as Al-Kanz was created to be used to pay
compensation on behalf of members who are liable to pay diyat;

Two other mutual systems also existed i.e., the Qasamah and
the Muwalat systems.

During the time of Umar the second Caliph, he ordered

preparation of registers (diwan) in all parts of the Muslim State;
names in the diwan owed one another mutual assistance;
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Ibn Abidin (1784-1836) a Hanafi lawyer, became the first

Islamic Scholar to come up with the meaning, concept and
legal basis of an insurance contract;

( c ) Takaful in the Modern Era

The first modern Islamic insurance was formed in the
Islamic State of Sudan in 1979; the company was
based on the concept of cooperative i.e., The Islamic
Insurance Company of Sudan;
Currently, there were more than 250 takaful operators
globally;
Global takaful contributions grew by 31% in 2009 to USD
7 billion, business expected to grow to USD 12 billion by
2011;
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(d) Development of Takaful in Malaysia :

Evolutionary phase; (Before 1980s)
Nurturing phase; (1980-1990)
Consolidation phase; (After 1990s)
(e) Performance of the Malaysian takaful business:
The industry is about 27 years in operation;
Twelve takaful operators in the market;
More than 15,000 agents are utilized;
Net contribution exceeded RM1.5 billion;
Total Takaful Fund Asset exceeding RM7 billion;
Almost 3,000 employees.
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(II) CONCEPT OF RISK

a) Origin of the word
Risq (Arabic) -

anything that has been

endowed to human (by
Allah) and from which you
attain goodness.

Risqum (Latin)

challenge a barrier reef

presents to a sailor

Greek derivative

12th Century

18th Century, derived from the

French word risque

Risque (French)
Risk (English)

b)

What is risk?
No one single definition.
a condition in which there is a possibility of adverse
deviation from a desired outcome that is expected or
hoped for; (Vaughn & Vaughn)
risk, which is often to mean uncertainty, creates both
problems and opportunities for businesses and
inviduals (Trieschmann, Hoyt & Sommer)
uncertainty of financial loss (Bickelhaupt)
Variability in future outcomes
Chance of loss
Possibility of an adverse deviation from desired
outcome.
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Susceptibility to
change or External
Influence

Severity of Impact
(High/Low)

RISK

Probability of
Occurrence (High/
Low)

Degree of
Interpendency with
other factors of risk

According to Allen risk is made of four essential components namely:

Probability of occurrence
Severity of impact
Susceptibility to change
Degree of interdependency with other factors
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c)

Loss, peril and hazard

Loss unexpected reduction or disappearance of
economic value;
Four principle types of losses:
Loss of property;
Loss of income;
Loss stemming from legal liabilities;
Loss from unexpected expenses.

Peril

- cause of loss

- example, fire, theft, explosion impact

damage
Hazard a condition that increases the likelihood of
loss due to a particular peril;
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There are four types of hazard:

Physical hazard tangible characteristics
that increases the chance of loss;
Moral hazard character defect that
increases the chance of loss;
Morale hazard carelessness, indifference
attitude;
Legal hazard arises when new laws are
being enacted;

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d)

Risk from an Islamic perspective

We will surely test you through some fear, hunger and
loss of money, lives and crops. Give good news to the
steadfast (Al-Baqarah verse 104)
Verily! Allah will not change the condition of a
community if they do not change their state
themselves (Ar-Rad, verse 11)
Legal maxim al-ghurm bil ghunm or no reward
without risk holds true;
One cannot expect to achieve success or make profit
without enduring some risks in his undertakings;
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The assumption of risk by a person and the transfer of risk from one
person to another are allowed in Islam. This can be inferred from
acceptable contracts such as Kafalah, Dhaman and Hiwalah.

As narrated by Anas bin Malik: The Holy Prophet (pbuh) told a Bedouin
Arab who entered th emosque with his camel left outside untied. When
he asked if his camel would run astray, he said Insha Allah. The
Prophet then said: tie your camel first, then say Insha Allah. This
hadith clearly indicates that the Prophets instruction is to manage the
risk at hand well before leaving it to the will of Allah.

From Surah Yusuf (Verse 67), an advice of Prophet Yacob to his sons
on their trip to Egypt to look for their brother Yusuf, O my Sons! Enter
not all by one gate: enter ye by different gates. Not that I can profit you
ought against Allah (with my advice): none can command except Allah:
on Him do I put my trust: and let all that trust put their trust on Him.
this verse shows the attempt to reduce and manage risk and at the
same time recognizing that everything happens with the will of Allah.

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Imam Al-Ghazali, put forth the essence of Islam

within the principle Maqasid Al-Shariah where he
states: The objective of the Shariah is to promote
the welfare of human beings which lies in
safeguarding their,

Religion
Selves
Minds
Progney
Wealth

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Hassan (2009) points out from an Islamic perspective there are three
types of risk namely,
o Essential risk

prevalent in all business undertakings;

inevitable;

attached to 2 legal maxim:

-

al ghurm bil ghunm;

al-kharaj bil daman,

oProhibited risk
of excessive gharar

appears in the form

(fahish);

o- the Quran has explicitly forbidden all

business transactions including
injustice in
any form to any
parties, whether in the form
of deceit
or fraud or undue advantage or
peril leading to
uncertainty in the
business or any dealing (6:151152)
o

Permissible risk

could neither be accepted or avoided.

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e)

Classifications of Risks
Fundamental and particular risks:
Fundamental risks are those which affect large
segments of the population; e.g. tsunami, subprime
mortgage crisis
Particular risks are much more personal in their cause
and effect;
Pure and speculative risks:
Pure risks involve the situation of loss and no loss;
Speculative risks involve the situation of loss and gain;
Objective and subjective risks:
Objective risk is also known as statistical risk; it can be
measured (standard deviation);
Subject risk refers to the mental condition or state of
mind of individuals; could occur due to lack of knowledge
as to the real facts;
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 Dynamic and static risks:

Dynamic risks can be defined as those risks that
cause financial losses of changes in the
environment (economy, technology, consumer
tastes, regulatory requirements);
Static risks are more predictable; it appears through
the perils of nature;

Financial and non-financial risks:

Financial risks exist in situations where exposures
to adversity involving losses prevail; it involves three
elements namely (i) objects exposed to risk; (ii) peril
causing the risk, (iii) asset/property affected by the
risk.
Non-financial risks involves adversities that posed
no financial loss;
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f)

Types of pure risks

Personal risks:
Risks that directly affect individuals; it can be
classified as: (i) risk of death; (ii) risk of insufficient
income during retirement; (iii) risk of poor health; (iv)
risk of unemployment
Property risks:
The possibility of loss due to damage to properties
from various causes such as flood, fire, earthquake
and others; there are two types of property loss; (i)
direct loss; (ii) indirect or consequential loss;
Liability risks:
Refers to risk inflicting bodily injury to another person
or inflicting damage to someone elses property;
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g)

Enterprise Risks
Refers to all major risk faced by an
organization or a business entity; it includes
pure risk, speculative risk, operational risk,
financial risk, legal risk and strategic risk;
To handle enterprise risk, organizations
since the 1990s have adopted a more
comprehensive approach to risk mitigation
i.e. through the adoption of the enterprise
risk management approach.

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(III) WHY MITIGATE RISK

(a) Basic Human Instinct:
Maslows hierarchy of need:
Survival
Safety and security
Love and belongingness
Self esteem
Self actualization
Doctrine of Maslaha al-Mursalah
Catering to the well-being of people in the worldly life and
also in the hereafter is the basic objective of the Shariah;
To curb risk by providing material security for those who
are suffering due to unexpected loss, damage is a
necessity;

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(b) Losses emanating from pure risks:

Loss emerging from unexpected events such
as, tsunami and earthquake from Fukushima
Japan; floods in Thailand; Arab Springs uprising
in Tunisia, Egypt, Libya and others.
These forms of risks will create economic
burden to society; it may necessitate
governments, organizations and individuals to
set aside funds;
Losses such as these can be mitigated through
insurance or takaful.
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(c) Other related reasons:

Apart from the actual losses and other
undesirable outcomes, there are also other
factors that could inflate the costs of risk such
as,
Inefficient investment of assets;
Misestimates of chance of loss;
worry

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(IV) RISK MITIGATION MEASURES

According to Head (1978) methods to mitigate risk can be
classified into two groups namely:
Risk control methods;
Risk financing methods;

(a) Risk Control Methods

Risk control methods are focused towards avoiding, reducing

and preventing risks; the method consists of activities to reduce
both the frequency and severity of losses;

The following are the various methods categorized as risk

control methods:
Risk avoidance
Loss prevention
Loss reduction
Segregation and combination
Salvage and contingency planning
Noninsurance transfer of loss
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b) Risk Financing Measures

Risk financing methods are focused towards reducing
costs of those losses that do occur; risk financing
techniques are post-loss in nature and can be
categorized into two namely: (i) risk retention, (ii) nontakaful transfers, (iii) risk sharing;
Through the risk retention mechanism, different methods
of funding can be established to pay losses such as (i)
creating special reserves; (ii) absorbing losses as
expenses; (iii) creating a self-takaful mechanism; and
(iv) adopting a deductible arrangement.
Risk retention can be active (done intentionally) or
passive (unintentionally); active retention can be carried
out by: (i) absorbing the losses into current operating
expenses; (ii) creating earmarked liability accounts; (iii)
creating earmarked asset accounts; (iv) forming captive
takaful companies.
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Through nontakaful transfers, the risks can be mitigated using

the following approach:

Transfer of risk through contracts;

Hedging;
Incorporation of an organizational structure

Through the mechanism of risk sharing, the risk is shared

between related parties; in the event of loss, then the losses will
be shared accordingly; in Islam based on the principle of
taawun and tabarru, this process is performed through the
operations of takaful.

In a good risk management administration , the risk mitigation

methods to treat risks in any particular organization should
involve the combination of both the risk control and risk financing
methods; as Norman Baglini (1983) puts it in his definition of risk
management: risk management is an economic process of
allocating a business firms financial resources in the optimum
combination of loss control and loss financing methods to
minimize the cost of pure risks.
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(V) THE RISK MANAGEMENT PROCESS

As an effort to mitigate risk, organizations that
adopts the risk management mechanism would
normally established a six steps process namely:
Setting the risk management objectives and policies;
Identifying the loss exposures;
Measuring and analyzing the loss exposures;
Selecting appropriate mitigation measures for treating the
loss exposures;
Implementing the risk management program;
Monitoring and reviewing the program.

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The Risk Management Process

Identify Risk
Exposure

Measure &
Estimate

Find instruments and

facilities to shift or
trade risks

Assess effects of
exposures

Assess costs and

benefits of
instruments

Form a risk mitigation strategy:

Avoid
Transfer
Mitigate
Retain

Evaluate
performance

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THE END

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