topic 2-concept of risks

 CONCEPT OF RISK IN ISLAM
 METHOD OF HANDLING RISKS
 RISK MANAGEMENT

 Risk traditionally means possibility of
harm, injury or loss.

 Risk is generally related to an
unfavourable outcome or unfortunate
event whereas a chance is something
which relates to a favourable outcome.

 Many Muslims misunderstood the
concept of fate (Qada’ and Qadar).

 Some Muslims believe that their future is
in the hand of Allah. Muslims are required
to be proactive in order to be able to
change their conditions as God says:

“Verily never will Allah change the
condition of a people until they change
it themselves” (Al-Quran, 13:11).

 Prophet Muhammad s.a.w once asked a
Bedouin who had left his camel untied,
“Why do you not tie your camel?”.

The Bedouin answered, I leave it to the
will of God”. The Prophet then said “Tie
up your camel first the put your trust in
God”.

 This conversation depicts not only how
Muslims should accept their fate but also
indicates how Muslims should make
efforts to reduce the risk of loss and
calamities.

 Risk management is a concept that is
not only accepted by Islam, but
embraced as one of the ways to ensure
the fulfillment of goals and objectives,
the ultimately should arrive at sa’adah
(happiness) in this world and the
hereafter.

TERM DESCRIPTION EXAMPLE
Peril
Peril is referred to as the main The insured vehicle

cause of a loss. Any accidental under a motor policy is

losses that are caused by a peril damaged in an accident,

may be subject to a claim under (accident is the insured

the respective policy. Example peril under a claim can be

of perils include fire, flood, made under the policy).

collision, accident, earthquakes,

sickness, premature death. If a restaurant is

destroyed in a fire, (fire is

the insured peril and a

claim can be made under

the fire policy).

TERM DESCRIPTION EXAMPLE
Hazard
Refers to the condition that increases the chance of loss.
There are two(2) types of hazard:

1. Physical Hazard Defective wiring in a

building that increases

Refers to the physical condition the chance of fire

of the subject matter that

increases the chance of loss

2. Moral Hazard Intentionally burning

unsold merchandise

Refers to the attitude of an that is insured to

individual that increases the collect from an insurer

chance of loss. Moral hazard is or a dishonest insured

difficult to determine. who exaggerates the

claim amount

RISK DESCRIPTION EXAMPLE
PURE
Possibilities that can result in Fire, lightning,

only a loss or breakeven. The flood, storm,

possible outcome can be premature

adverse (loss) or breakeven (no death, accident,

loss). Pure risks can generally be theft etc.

covered.

SPECULATIVE Possibilities that can result in loss, Investment in

no loss or profit (gain). It is an the stock

uncertainty about an event market, foreign

that could produce either a currency

profit, neutral (no change in fluctuations,

value) or a loss. Speculative risks venturing into a

generally cannot be covered. new business

RISK DESCRIPTION EXAMPLE

FUNDAMENTAL A fundamental risk will affect Damage to
the whole society or a large property due
number of people within the to earthquake,
economy. It is not within the war etc.
control of individuals.

PARTICULAR A particular risk will effect only Damage to

individuals and not the entire property from

community and is within the accident,

control of individuals. theft, robbery

 Pure risks are generally insurable.
 Pure risk can be categorized into three

(3) types that create financial insecurity,
namely:
i) Personal Risks
ii) Property Risks
iii) Liability Risks

Refers to risks that directly affect individuals. It will lead to the possibilities of loss
or reduction of income, extra expenses incurred and depletion of assets. Personal
risk can be further divided into the following four (4) types:

Description Example
Risk of Premature Death
The death of a breadwinner can cause financial
hardship to the dependants. This premature
death risk will cause financial problems for
dependents.

Risk of Insufficient Income Possibility of retirees losing their earned income of
during retirement they don’t have sufficient financial assets or other
sources of retirement income. The risk may cause
reduced standard of living.

Risk of poor health Possibility of having to pay catastrophic medical
Risk of unemployment bills and loss of income.

Major threat to financial security resulted from
business cycle down swings, technological and
economic changes etc.

Refers to the possibility of loss due to damage a property caused by fire, flood,
earthquakes and other natural disasters. There are two (2) types of risk related ro
property:

Description Example

Direct Loss A factory damaged due to fire (the physical
damage to the factory is a direct loss).
Financial loss that results from
the physical damage,
destruction or theft.

Indirect Loss or In addition to the physical damage to the factory,
the owner would lose his income due to reduction
Consequential Loss in turnover whilst the factory is being repaired. This
will cause a loss of income and would be
Financial loss that results consequential loss.

indirectly from the

occurrence of a direct

physical damage or theft.

Liability

Description Example

Refers to the risk of third party Business firms can be held legally liable for
bodily injury or property defective products that could cause bodily injury
damage. or property damage to consumers who use these
products.
In this case the court may
order you to pay substantial
damages to the person you
have injured.

 One risks have been identified and
assessed, all techniques to manage the risk
fall into one or more of these four major
categories:

1) Risk Avoidance
2) Risk Retention
3) Risk Transfer
4) Risk Sharing

 Avoid or eliminate the risk – If the risk is so
unacceptable then the individual or
organization may decide not to continue with
the activity or business that involves such a risk.

 If this decision adheres, then the individual or
organization will decide to avoid the risk
altogether.

 Avoiding risks means losing out on the potential
gains that may arise from it whilst retaining the
risk, it may have allowed.

 Not entering a business to avoid the risk of loss
also avoids the possibility of earning profits.

 An example would be not buying a property or
business in order not to take on the liability that
comes with it.

 If the current level of the risk is already at
an acceptable level, the individual or
organization may decide to retain the
risks. It involves accepting the loss when it
occurs.

 Risk retention is a viable strategy for small
risks where the cost of insuring against
the risk would greater over time than the
total losses sustained.

 This involves the transferring of risks to an
organization or individual.

 When a risk is transferred, losses will be
paid by the organization or individual to
whom the risk is transferred. There are
two ways of transferring risks:

i. Insurance contract:
Example: A house owner can transfer the risk of
loss incurred when his house is destroyed by fire
by entering into a fire insurance contract.

ii. Non insurance contract
Example: A supermarket can transfer potential
risk (liability) arising from the sale of defective
products by entering into agreement whereby
the manufacturer agrees to compensate the
supermarket from any liability arising from the
defective product.

 Islam does not allow risk to be exchanged
i.e. total transfer of financial consequence
of losses arising from risks.

 It is not recognized as being fair to each
party as it may lead to an ever-burden of
claims beyond the original intention of the
insurer, or otherwise may also result in
charges of unacceptable levels of premium
to the insured.

 As an alternative, individuals or organization
can share the risk with the others who have
a similar nature of risk. This practice is called
Takaful or mutual protection.

1) Risk Identification

2) Risk Screening and Evaluation

3) Development of a Risk
Management Plan

4) Implementation of Risk
Management Plan

5) Reviews and Monitoring of
Risk Management Plan

 Risk identification is the most important
step in risk management process.

 It is necessary to identify the risks that
could damage the financial soundness
of an individual or a firm before a
solution can be provided.

 Once the risks are identified, they must
be measured and evaluated individually
to determine the probability or chance
of loss and the financial impact it can
have on individual or a firm.

 Methods of Risk identification:

 Physical inspection
- A brief walk over the plant is essential to help in giving a ‘feel’
for the place which may later direct the formal risk identification.

 Organization chart
- A chart showing the organizational structure of the company
and the relationship between different personnel and
departments can highlight the weaknesses of an organizational
structure.

 Flow chart
- A chart showing materials or work ‘flowing’ through various
stages of process in which a weak link of the process can be
identified.

 Check list
- A list asking questions or a questionnaire relating to the main
areas of activity can highlight areas that present risks.

 Risk screening and evaluation is the
process of determining the risk impact or
potential losses so that appropriate
action can be taken, considering the
resources available.

 Risk evaluation involves the estimation of
frequency and severity of the risk
exposures and ranking them to their
relative importance.

 Those risks with high potential losses will
be given priority in the risk management
plan.

Risk Frequency The number of times a loss producing event will occur
Risk Severity during given time period (probability of its
occurrence).

The cost or amount of loss, in monetary terms, arising
from a loss producing event.

 Once the risks have been evaluated
completely, it is time to choose the
appropriate risk mitigation method.

 The selection of the methods should take
place in the early development stage.

 Selection must consider cost and
effectiveness.

 There are four methods of risk mitigation-
i) Risk Avoidance
ii) Risk Control
iii) Risk Retention
iv) Risk Transfer

 Once the selection of a suitable method
is made, the plan is ready for
implementation.

 In performing this step, the risk should be
prioritized and matched with the actions
to be taken.

 One of the action of course is to insure/
cover the risk.

 Reviews and monitoring is another
important step in the risk management
process.

 These activities involve periodical
reviews, monitoring the implementation
process as well as progressive revision on
the plan in light of any changes in the
business and economic environment.

 The monitoring and risk review stage
would include the production of risk
manuals, claims performance reports
and experience studies and audits.

 It is quite possible that different risks
would have different types of monitoring,
with insurance risks in particular
monitored on a more frequent basis and
reported directly to the management.

 Periodical reviews can help to identify
any deficiencies or adjustments and also
ensure the objectives of the plan are
met.

 Reviews should be done at least once a
year.