June 30 2009
Can Takaful / Re-Takaful be Shariah Sealed?
Zainal Abidin Mohd. Kassim, BSc., FIA, ASA Takaful Summit Masterclass, London
www.mercer.com
Takaful – Ethical Insurance redefined
Ethical issues with conventional insurance Is the contract between the insurer and the insured made with
both parties having the same level of information? Is the insured fully aware of; – How much the insurer is taking for his expenses? – Has the insurer “priced” the risk fairly? – To what extent does the insured understand the financial strength of the insurer? There is clearly an asymmetry of information between the
insured and the insurer which would question the fairness of the transaction.
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Fiqh Muamalat – Jurisprudence as it relates to transactions Whether it be in Islamic Finance or Takaful/ ReTakaful the same basic principles are applied Transparency Risk sharing rather than risk transfer
Concept of partnership, principally the various arrangement of sharing profit or loss i.e. equity financing, defines Islamic Finance. Similarly in Takaful/Retakaful the mutuality of the risk pool is fundamental to ensuring fairness in the enterprise. From the shariah perspective risk management in commerce is not about the sale of risk (this requires the pricing of risk – as evidenced by interest in finance and premium in insurance) but more the mitigation of risk and solidarity of the Ummah. 4
Takaful/Retakaful Modern takaful/retakaful is a hybrid of proprietary management
company and a mutual risk pool. Takaful participants pay a predetermined fee or agrees to share in
profits in a predetermined proportion with the Takaful/retakaful operator at the outset of the contract. In theory this fee should be negotiable so that both parties can assess the fairness of the transaction (fees versus quality and timeliness of service). The mutual risk pool pays all contingent benefits. This pool is
financed by contributions from the participants. The pool may or may not be sufficient to meet all liabilities. Participants should be aware that the pool would meet its obligation to the extent of its financial resources. The contributions (defined as tabarru’ for the purpose of Shariah compliance) are an estimate of what the pool requires to meet future claims. 5
Attraction of Takaful/Retakaful to participants Management cost overruns in the initial set up phase are borne by shareholders Policyholder can choose the better managed Takaful fund with a good surplus refund track record There is complete transparency as the Takaful Operator (TO) should disclose its wakala fee structure and surplus distribution policy in the takaful contract. The investments of the Takaful funds would be Sharia compliant. Sharia compliant investments are compatible with Socially Responsible Investments.
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Takaful/Retakaful – Can it succeed without capital to guarantee its solvency?
Takaful – limitations as to its ability to carry risk Being a mutual risk pool, there would be limited ability to absorb
volatility in claims experience. Any deficit in the risk pool will be temporarily funded by an
interest free loan from the Takaful Operator Such a loan to be recovered from future underwriting surpluses.
There is thus a spreading of volatility over time. Personal lines are well suited for Takaful as; – Larger number of claims – Less volatility in the size of emerging claims Resulting in relative stability in the surplus/deficit arising year on
year
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Distribution of Claims Cost Short-Tail Class
Long-Tail Class
Rare Event
Frequency Distribution
Poisson (λ = 0.05)
Poisson (λ = 0.05)
Poisson (λ = 0.5)
Claim Size Distribution
Normal (µ = 3600, σ = 250)
LogNormal (µ = 3600, σ = 7200)
LogNormal (µ = 36000, σ = 72000)
Total Risk Premium = Mean Claim amount
72,000
72,000
72,000
Standard Deviation of Claim amount
16,137
35,825
116,334
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Distribution of Claims Cost
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Distribution of Claims Cost
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Distribution of Claims Cost
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Distribution of Claims Cost Short-Tail Class
Long-Tail Class
Rare Event
Frequency Distribution
Poisson (λ = 0.05)
Poisson (λ = 0.05)
Poisson (λ = 0.5)
Claim Size Distribution
Normal (µ = 3600, σ = 250)
LogNormal (µ = 3600, σ = 7200)
LogNormal (µ = 36000, σ = 72000)
Total Risk Premium = Mean Claim amount
72,000
72,000
72,000
Standard Deviation of Claim amount
16,137
35,825
116,334
1 in a 4 year event - surplus
11,117
23,800
61,880
1 in a 4 year event - deficit
-10,651
-15,950
-18,439
1 in a 100 year event - deficit
-40,151
-119,839
-438,288
1 in a 4 year event - surplus
15%
33%
86%
1 in a 4 year event - deficit
-15%
-22%
-26%
1 in a 100 year event - deficit
-56%
-166%
-609%
Surplus / (Deficit)
Surplus / (Deficit) As a % of Risk Premium
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Takaful dependence on reinsurance and ReTakaful on retroinsurance At this stage of its development large risk, catastrophe cover
and seriously volatile claims experience are not recommended for Takaful funds without reinsurance support Retakaful capacity is growing very fast but suffer from the lack
of volume to manage large and specialised risk as Takaful companies are not that many as yet to cede such risks. Retakaful companies require retro cover to manage its own
claims volatility Until these capacity issues are sorted out, likely that only
personal lines are shariah sealed….
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Guarantees are overrated and can be dangerous Ultimately there are no guarantees in life notwithstanding what
the rating agencies may choose to say… Look at AIG and the experience with variable annuities in the
US with the likes of Ameriprise Financial Inc., Prudential Financial Inc., Allstate Corp., Hartford Financial Group and Lincoln National Corp. all may have to be bailed out by the US government. Guarantees can be dangerous, the Corporate Default Swap
market was a prime cause of the Global Financial Crisis. Takaful needs product differentiation to compete with
conventional insurer, it should not compete on guarantees.
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Zainal Abidin Mohd Kassim, FIA Mercer Zainal Consulting Suite 17.02 Kenanga International Jalan Sultan Ismail 50250 Kuala Lumpur Tel:+603 21610433 Zainal.kassim@mercer.com
www.mercer.com