Module 3 Risk Management in Takaful

Module 3

Risk Management in Takaful

Module 3: Risk Management in Takaful

LEARNING OUTCOMES 2
At the end of the program, the participants will be able to:
• Explain risk management from Shariah perspectives
• Identify the risks arising from Takaful operation
• List the types of non-compliance to Shariah principles
• Describe regulatory requirements on Shariah compliance

Module 3: Risk Management in Takaful

LEARNING TOPICS: 4

1 Regulatory
Requirements on
Risk Management from Compliance to Shariah
Perspective of Shariah
Principles
2
3
Risks Arising from
Takaful Operation Types of Non-
Compliance to Shariah

Principles

Module 3: Risk Management in Takaful 3

RISK MANAGEMENT FROM PERSPECTIVE
OF SHARIAH

Module 3: Risk Management in Takaful

RISK MANAGEMENT FROM PERSPECTIVE OF SHARIAH 5

Risk as Defined by Shariah

Module 3: Risk Management in Takaful

RISK MANAGEMENT FROM PERSPECTIVE OF SHARIAH

Types of Risks Faced by Participants of Takaful

Individuals face various kinds of Personal Risk Risk of Old Age / Sickness
losses at any point of their lifetime. Risk of Unemployment
Losses of this nature impact the Risk of
individuals not only mentally and Premature Death
physically, and more often than not,
these losses impact the individuals Property Risk
and their family financially. These
are pure risk that no individuals
could escape from. The following are
examples of such losses:

Liability Risk

Module 3: Risk Management in Takaful 6

RISK MANAGEMENT FROM PERSPECTIVE OF SHARIAH 7

Takaful as a Form of Risk Sharing Among Participants

The mutual cooperation concept of
Takaful allows individuals to come
together, through consistent
donation into a common fund, i.e.
Participants’ Risk Fund (PRF), to help
any individual who faces hardship
when misfortune occurs. All
individuals agree to appoint the TO
to facilitate the payment of claims to
the deserving participants.

Module 3: Risk Management in Takaful

RISKS ARISING FROM TAKAFUL OPERATION

Module 3: Risk Management in Takaful

RISKS ARISING FROM TAKAFUL OPERATION

Types of Risks Faced by Takaful Operators

The Takaful Operator, under its capacity as the manager of the operation, ensures all the three (3) funds perform
according to its respective objective.

Most of the risks that Takaful Operator is exposed to are similar to the ones faced by conventional insurer.

There are six (6) major and common risks that potentially threaten the survival of a Takaful Operator and which have
been identified as relevant to most Takaful Operators.

Module 3: Risk Management in Takaful 9

RISKS ARISING FROM TAKAFUL OPERATION

Types of Risks Faced by Takaful Operators

There are six (6) major and COMMON risks that potentially threaten the survival of a Takaful Operator:

IFSB – 14: Standard on Risk Management for Takaful (Islamic Insurance) Undertakings 10

Module 3: Risk Management in Takaful

RISKS ARISING FROM TAKAFUL OPERATION

Types of Risks Faced by Takaful Operators

There are six (6) major and COMMON risks that potentially threaten the survival of a Takaful Operator:

IFSB – 14: Standard on Risk Management for Takaful (Islamic Insurance) Undertakings 11

Module 3: Risk Management in Takaful

RISKS ARISING FROM TAKAFUL OPERATION

Types of Risks Faced by Takaful Operators

Certain risks are SPECIFIC to Takaful Operators: (1) Shariah non-compliance risks, (2) Risks arising from segregation of
funds, and (3) Risks relating to the use of Retakaful
1. Shariah Non-Compliance Risk

Shariah non-compliance risk is unique to TOs compared to their conventional counterparts. Breach of Shariah principles may
render contracts invalid under Shariah.

This risk is relevant to the product development process of a TO. TOs could inadvertently introduce Shariah non-compliance in
its products in its attempt to meet market’s demand for innovative products.

Limitations in investment instruments may also expose TOs to an investment product whose Shariah compliance is
questionable.

IFSB – 14: Standard on Risk Management for Takaful (Islamic Insurance) Undertakings

“Shariah non-compliance risk” refers to the risk of legal or regulatory sanctions, financial loss or non-financial implications
including reputational damage, which an IFI may suffer arising from failure to comply with the rulings of the Shariah Advisory
Council of Bank Negara Malaysia (SAC), standards on Shariah matters issued by the Bank pursuant to section 29(1) of the IFSA
and section 33E(1) of the DFIA, or decisions or advice of the Shariah committee.

Module 3: Risk Management in Takaful Shariah Governance BNM / RH / PD 028-100
12

RISKS ARISING FROM TAKAFUL OPERATION

Types of Risks Faced by Takaful Operators

1. Shariah Non-Compliance Risk

An IFI must ensure effective management of Shariah non-compliance risk which requires the following functions to be
performed on an ongoing basis:
(a) Shariah risk management;
(b) Shariah review; and
(c) Shariah audit.

The Shariah committee has the responsibility to provide objective and sound advice to the IFI to ensure that its aims and
operations, business, affairs and activities are in compliance with Shariah. This includes;

(a) Providing a decision or advice on the operations, business, affairs and activities of the IFI which may trigger a
Shariah non-compliance event;

(b) Deliberating and affirming a Shariah non-compliance finding by any relevant functions; and

(c) Endorsing a rectification measure to address a Shariah non-compliance event.

Module 3: Risk Management in Takaful 13

RISKS ARISING FROM TAKAFUL OPERATION

Types of Risks Faced by Takaful Operators

2. Risk from Segregation of Funds
The segregation of PRF, PIF and SHF brings with it a set of agency risks that differ from a conventional insurer and require
separate consideration in the TO’s risk management framework.
The risks that arise from this may include those associated with the provision of support from SHF to PRF to meet its solvency
or liquidity needs.
There may also a risk of incorrect attribution of transactions to a fund, resulting in expenses being borne or income being
received by the wrong fund.

IFSB – 14: Standard on Risk Management for Takaful (Islamic Insurance) Undertakings

Module 3: Risk Management in Takaful 14

RISKS ARISING FROM TAKAFUL OPERATION

Types of Risks Faced by Takaful Operators

3. Risk Arising from Retakaful Activities

The development of the Takaful industry has raised concerns among the practitioners and Shariah scholars as to the validity
under Shariah of the use of conventional reinsurance by Takaful and Retakaful operators.
TO needs to also consider the credit risk exposure to Retakaful providers, if the principle adopted under the Retakaful
contracts is one of risk sharing with other cedant TOs, rather than risk transfer as used by reinsurance.

IFSB – 14: Standard on Risk Management for Takaful (Islamic Insurance) Undertakings

Module 3: Risk Management in Takaful 15

RISKS ARISING FROM TAKAFUL OPERATION

Risk Management Framework for Takaful Operators

Given the exposure to the common and specific risks, Takaful Operators should establish and regularly review a
framework for managing the different risks of the organisation.

Module 3: Risk Management in Takaful IFSB – 14: Standard on Risk Management for Takaful (Islamic Insurance) Undertakings
16

TYPES OF NON-COMPLIANCE TO
SHARIAH PRINCIPLES

Module 3: Risk Management in Takaful

TYPES OF NON-COMPLIANCE TO SHARIAH PRINCIPLES

Illustration of Various Types of Shariah Non-Compliant Activities of Takaful Operator

Invalidation of Takaful Contract

A Takaful contract is deemed Shariah non-compliant if it breaches the basic principles of Takaful such as non-existence
of permissible Takaful interest (PTI).

 Ali participates in a Takaful plan, with Abu
being the person covered. This contract is
not valid since Ali has no permissible Takaful
interest in Abu.

 The contract is hence non-compliant to
Shariah principles.

Module 3: Risk Management in Takaful 18

TYPES OF NON-COMPLIANCE TO SHARIAH PRINCIPLES

Illustration of Various Types of Shariah Non-Compliant Activities of Takaful Operator

Tainted Income

A Takaful contract is deemed Shariah non-compliant if it breaches the investment policy of the Takaful Operator, by
investing in Shariah non-compliant investment instruments.

 The investment returns contain tainted
income since the fund of the Takaful
Operator was invested in Shariah non-
compliant securities, albeit by mistake.

 The investment activities are deemed non-
compliant to Shariah principles.

Module 3: Risk Management in Takaful 19

TYPES OF NON-COMPLIANCE TO SHARIAH PRINCIPLES

Illustration of Various Types of Shariah Non-Compliant Activities of Takaful Operator

Non-Halal Product

A Takaful contract cannot provide coverage for non-halal products such as “Alcohol X” or any other Shariah non-
compliant products. So, any vehicle or property used to transport or store such products will not be accepted in a
Takaful contract.

 Wrongly approved Takaful certificate for
Shariah non-compliant application will result
in the contract being null and void.

 Cleansing of income received from Alcohol X
will need to be conducted by the Takaful
Operator.

Module 3: Risk Management in Takaful 20

TYPES OF NON-COMPLIANCE TO SHARIAH PRINCIPLES

Illustration of Various Types of Shariah Non-Compliant Activities of Takaful Operator

Non-Halal Activities

A Takaful contract cannot provide coverage for properties operating non-halal activities such as alcohol-serving pubs or
any other entertainment activities which are Shariah non-compliant. So, any vehicle or property used to operate such
activities will not be accepted in a Takaful contract.

 Wrongly approved Takaful certificate for
Shariah non-compliant application will result
in the contract being null and void.

 Cleansing of income received from Pub X will
need to be conducted by the Takaful
Operator.

Module 3: Risk Management in Takaful 21

TYPES OF NON-COMPLIANCE TO SHARIAH PRINCIPLES

Illustration of Various Types of Shariah Non-Compliant Activities of Takaful Operator

Other Activities

A Takaful Operator’s product development process requires approval from the Shariah Committee. An oversight on crucial process might
render the products Shariah non-compliant.
Example: the ‘Aqd wording does not meet the requirement of Shariah principles.

Module 3: Risk Management in Takaful 22

TYPES OF NON-COMPLIANCE TO SHARIAH PRINCIPLES

Illustration of Various Types of Shariah Non-Compliant Activities of Takaful Operator

Other Types of Risks That Are Shariah Non-Compliant

Module 3: Risk Management in Takaful 23

REGULATORY REQUIREMENTS ON
COMPLIANCE TO SHARIAH PRINCIPLES

Module 3: Risk Management in Takaful

REGULATORY REQUIREMENTS ON COMPLIANCE TO SHARIAH PRINCIPLES

Regulatory Requirements on Risk Management

Takaful Operational Framework (TOF) 2019, which substance is derived from IFSA 2013 emphasizes on the BOARD’S
OVERARCHING ROLE TO OVERSEE and ensure that Takaful Operator’s business and RISK STRATEGIES COMPLY TO
SHARIAH PRINCIPLES.

Module 3: Risk Management in Takaful 25

REGULATORY REQUIREMENTS ON COMPLIANCE TO SHARIAH PRINCIPLES

Regulatory Requirements on Risk Management

Takaful Operational Framework (TOF) 2019 subsequently highlights the SENIOR MANAGEMENT’s role in ensuring that
the operational framework is commensurate with the nature and complexity of the Takaful business and considers the
types of funds being managed and RELEVANT SHARIAH CONTRACTS adopted in managing the Takaful business. The
senior management must ensure that the Shariah contracts and Shariah matters in relation to the operational
framework are endorsed by the SHARIAH COMMITTEE.

Module 3: Risk Management in Takaful 26

REGULATORY REQUIREMENTS ON COMPLIANCE TO SHARIAH PRINCIPLES

Shariah Risk Management

Shariah risk management refers to a function that systematically identifies, measures, monitors and reports Shariah
non-compliance risks in the operations, business, affairs and activities of the IFI.

The Shariah risk management function, at minimum, must:-

• Integrate Shariah non-compliance risk considerations with enterprisewide risk
management;

• Identify Shariah non-compliance risk exposures in the business operations and activities
of the IFI;

• Assess Shariah non-compliance risk and measure the potential impact of the risk
exposures to the IFI;

• Establish appropriate risk mitigation measures;
• Monitor Shariah non-compliance risk exposures and effectiveness of the risk mitigation

measures;
• Report to the board, Shariah committee and senior management on the Shariah non-

compliance risk exposures in relation to (b) to (e); and
• Constructively challenge decisions that may give rise to Shariah noncompliance risks.

Module 3: Risk Management in Takaful 27

REGULATORY REQUIREMENTS ON COMPLIANCE TO SHARIAH PRINCIPLES

Shariah Risk Management

The senior officer principally accountable and An IFI shall ensure that its risk officers who
responsible for risk management shall be perform the Shariah risk management function

responsible for Shariah risk management which have the requisite knowledge on Shariah
forms part of the IFI’s integrated risk requirements applicable to Islamic financial
management framework.
business.

Module 3: Risk Management in Takaful 28

REGULATORY REQUIREMENTS ON COMPLIANCE TO SHARIAH PRINCIPLES

Shariah Non-Compliant Risk Assessment

In assisting the industry to identify the types of Shariah non-compliance activities, the MTA together with the industry players
developed a set of Shariah Non-Compliance (SNC) Parameters to guide its members in reporting Shariah non-compliance activities to
the regulators. The TOs should be mindful of the following breaches when assessing its compliance to Shariah principles.

Module 3: Risk Management in Takaful 29

REGULATORY REQUIREMENTS ON COMPLIANCE TO SHARIAH PRINCIPLES

Shariah Non-Compliant Risk Assessment

Keeping in mind the SNC parameters, TOs should have in place a risk assessment process of estimating the probability
of occurrence of a risk, and the various means of avoiding, mitigating or transferring the risk.

Module 3: Risk Management in Takaful 30

REGULATORY REQUIREMENTS ON COMPLIANCE TO SHARIAH PRINCIPLES

Shariah Non-Compliant Risk Mitigation

Risk mitigation will be conducted subsequent to risk assessment, by which a control mechanism is put in place to
ensure that the probability of occurrence of the identified risk is minimized.

Module 3: Risk Management in Takaful 31

REGULATORY REQUIREMENTS ON COMPLIANCE TO SHARIAH PRINCIPLES

Duty of Institution to Ensure Compliance with Shariah

An institution shall at all times ensure that its aims and operations, business, affairs and activities are in compliance
with Shariah.
Where an institution becomes aware that it is carrying on any of its business, affair or activity in a manner which is not
in compliance with Shariah or the advice of its Shariah committee or the advice or ruling of the Shariah Advisory
Council, the institution shall—

(a) Immediately notify the Bank and its Shariah committee of the fact;

(b) Immediately cease from carrying on such business, affair or activity and from taking 32
on any other similar business, affair or activity; and

(c) Within thirty days of becoming aware of such non-compliance or such further period
as may be specified by the Bank, submit to the Bank a plan on the rectification of the
non-compliance.

Module 3: Risk Management in Takaful

REGULATORY REQUIREMENTS ON COMPLIANCE TO SHARIAH PRINCIPLES

Duty of Institution to Ensure Compliance with Shariah

The Bank may carry out an assessment as it thinks necessary to determine whether the institution has rectified the non-
compliance.
Any person who contravenes or commits an offence, on conviction, be liable to imprisonment for a term not exceeding
eight years or to a fine not exceeding twenty-five million ringgit or to both.

Module 3: Risk Management in Takaful 33

ENTDHOFEMEODNULDE 3:

RISK MANAGEMENT IN TAKAFUL