Takaful operators are faced with two different and distinct sets of risks. The first is in relation to their fiduciary responsibility to their participants, while the second is in relation to their day-to-day business operations.
We currently have the IFSB outlining a risk management master document, due to be released in the near future. However, what are the main current differences between conventional insurers and Islamic insurers, from a risk management perspective?
There is one primary difference. In Takaful you have to contend with two regulatory bodies: you have the conventional regulatory arrangements (even if you have a regulatory body favorable towards Islam, such as Bank Negara Malaysia), and you have the Shariah board’s rulings. Both of these must be strictly adhered to. However the case must be determined as to whether an oversight body, regulator or Shariah board can involve themselves in commercial decisions.
Another element in risk management that is unique to Takaful is the underwriting of the risk pool: the operator does not participate in any deficit on the risk pool. The temptation is there to write new business in order to increase business based on premiums, knowing that the operator is not a participator in the deficit. If the operator is participating in the surplus (another issue in itself) this creates an enormous conflict in interest issue. In conventional insurance this is simply a risk transfer procedure, whereby the operator can take as much risk as he wants with his capital; unlike the Takaful operator, who is limited by the proxy nature of acting in the benefit of the risk pool.
Another issue that emerges is the fact that many Takaful operators are still not utilizing re-Takaful for their pooling. In terms of re-Takaful, the industry is currently ‘reinsurance in green’. This amounts to significant reputational risk. However, due to inherent commercial goals, significant amounts of capital were invested into re-Takaful in the heady pre-crisis years.
According to Wan Saifulrizal Wan Ismail, an associate director at Towers Watson: “Modern day Takaful operators are simply fund managers inviting participants to pool their risk. From a participant’s perspective they have very little say in day-to-day Takaful operations, whilst having to bear the risk, and can only assume that the Takaful operator will act in their best interests.”
Should participants be made aware of their risk exposure and that of the fund? Disclosures are mainly revealed only to analysts and investors. Is there a more meaningful way to communicate risk? Wan Saifulrizal suggests that there should be risk appetite statements or communications between the operator and the participant, highlighting the risks to which the fund is exposed as a cornerstone of the industry.
This risk appetite statement would be able to serve as an indication as to whether the client’s claims can be paid out in full or if the fund requires qard. It could also serve as the tenet for a Takaful operator to align themselves in relation to pricing, investment strategies and even if they are utilizing re-Takaful.
Wan Saifulrizal goes on to add that there are a number of side benefits that Takaful operators could also achieve from a risk appetite statement. For example: optimizing asset allocations, creating equality in pricing structures and ultimately deciding whether or not they undertake surplus distribution.
It also highlights how little representation participants actually have in what is supposed to be a cooperative business. Using a board of trustees under an actuary to communicate the actions of operators has been mooted: however, cost considerations make this unfeasible. This would be a likely outcome should a cooperative and non-commercial entity enter the Takaful market in the future, however, and it would also be useful in terms of transparency and disclosure. – SW