Overview of risk and

risk management
 

Chapter One: Noraziah Che Arshad

 Outline
 The Concept of Risk
o Conventional vs Islamic Perspectives

 Risk Management
o Definition and Process

 Types of Risk
 Risk vs Hazard
 Shariah Framework Relating to Risk and Risk
Management
 Takaful Practices Around The World
o Focusing on Malaysian Insurance and Takaful Industry
Introduction

 (Al-Quran 12:47-49).
 Introduction
Surah Yusuf Verse 67

‫اب‬ ٍ ‫اح ٍد َو ْاد ُخل ُوا ِم ْن أَبْ َو‬ ِ ‫اب َو‬ٍ َ‫اليَا بَ ِن ّ َي ل َا تَ ْد ُخل ُوا ِم ْن ب‬ َ ‫َو َق‬
‫عنْك ُْم ِم َن الل ّ َ ِه ِم ْن َش ْي ٍء ۖ ِإ ِن ال ُْحك ُْم ِإلَّا‬ َ ‫ي‬ ‫ن‬ِ ‫غ‬ْ ُ ‫ُمتَ َف ِ ّر َق ٍة ۖ َو َما أ‬
َ ‫عل َيْ ِه َفل ْيَتَ َوك َّ ِل ال ُْمتَ َو ِك ّل‬
‫ُون‬ ُ ‫عل َيْ ِه تَ َوكَّل‬
َ ‫ْت ۖ َو‬ َ ۖ ‫لِل َّ ِه‬
Meaning:
“O my sons, do not enter from one door; enter through separate doors. However, I
cannot save you from anything that is predetermined by Allah. To Allah belongs all
judgment. I trust in Him, and in Him shall all the trusting put their trust.”
 The Concept of Risk
 What is Risk?
Definition
Risk Chance Peril Hazard
: is an uncertainty : implies some : refers to the cause : refers to the
about financial loss doubt about the of a loss condition that
from an exposure outcome in a given increases the chance
: is an uncertainty of situation of loss.
an outcome of a : There are 4 types
future event - Physical
- Moral
- Morale
- Legal
The Concept of Risk from Shariah
perspectives

Non-
permissible
risk
Permissible Manageable
risk risk

Types of
risk as
identified by
the jurists
 The Concept of Risk from Shariah
perspectives
 Permissible risk

 Muslim jurists developed a legal maxim

“al-ghunm bil-ghurm” or “gain is justified with risk” or
“entitlement to profit is accompanied by responsibility for
attendant expenses and possible loss.”
 This maxim is extracted from several hadiths of Prophet (s.a.w):

 “[Entitlement to] profit is dependent on responsibility [for

attendant expenses and possible loss and defects].”
 The Concept of Risk from Shariah
perspectives
 Permissible risk

 Our Prophet (s.a.w) said, “Take advantage of five

opportunities before five other things: Your youth before your
old age, your health before your illness, your wealth before
your poverty, your leisure before your haste, and your life
before your death”.

 Leaving out the element of risk could lead to interest-based

transactions, which are prohibited in Islam. (Surah al-
baqarah:275-279).
The Concept of Risk from Shariah perspectives

 Based on principle: “al-ghurm bi al-ghunm” – no reward

without risk.
 The level of risk depends upon the nature of contract.
 The Concept of Risk from Shariah
perspectives
 Based on principle: “al-ghurm bi al-ghunm” – no reward
without risk.
 The level of risk depends upon the nature of contract.
 Avoiding risk with zero profit
 The Concept of Risk from Shariah
perspectives
 Based on principle: “al-ghurm bi al-ghunm” – no reward
without risk.
 The level of risk depends upon the nature of contract.
 Avoiding risk with zero profit is allowed
 The Concept of Risk from Shariah
perspectives
 Based on principle: “al-ghurm bi al-ghunm” – no reward
without risk.
 The level of risk depends upon the nature of contract.
 Avoiding risk with zero profit
 Avoiding risk with positive profit
The Concept of Risk from Shariah perspectives

 Based on principle: “al-ghurm bi al-ghunm” – no reward

without risk.
 The level of risk depends upon the nature of contract.
 Avoiding risk with zero profit
 Avoiding risk with positive profit is not allowed
 The Concept of Risk from Shariah
perspectives
 Based on principle: “al-ghurm bi al-ghunm” – no reward
without risk.
 The level of risk depends upon the nature of contract.
 Avoiding risk with zero profit is allowed
 Avoiding risk with positive profit is not allowed
 The Concept of Risk from Shariah
perspectives
 Non-Permissible risk

 "O you who believe! Eat not up your property among

yourselves unjustly except it be a trade amongst you, by
mutual consent. And do not kill yourselves (nor kill one
another). Surely, Allah is Most Merciful to you" (An-Nisa':29)

 Jurists link this risk to the element of excessive uncertainty,

gharar caused by elements of gambling (maysir), which is a
zero-sum game forbidden by the Shariah.
 The Concept of Risk from Shariah
perspectives
 Non-Permissible risk

 A number of aspects in which gharar may occur:

o a) Uncertainty or risk related to existence
o b) Uncertainty or risk related to taking ownership
o c) Uncertainty or risk related to quantity
o d) Uncertainty or risk related to quality
o e) Uncertainty or risk related to the time of payment
 The Concept of Risk from Shariah
perspectives
 Manageable risk

 Sheikh Dr Hussein Hamid Hassan outlined three Shariah pre-

conditions for managing this type of risk:

 a. The instrument or approach used to manage risk of this category

must not contravene the Shariah principle of al-ghunm bil-ghurm.
 b. The instrument employed to manage this risk does not involve
excessive ambiguity (gharar).
 c. The instrument or approach to be used must comply with Shariah
principles and only be used to avoid or manage risk allowed by
Shariah.
 What is Risk Management?

As a decision making
process involving the
identification and
assessment of risk

The key concepts in risk

A systematic approach in
setting the best way of
action under uncertainty Definition management are
identifying and
assessing risk

As all activities
performed within a
business or by an
individual to identify,
assess and control the
uncertainties
Risk management in Takaful
 Risk Management in Takaful Industry is a process
to identify LOSS EXPOSURES faced by an
Operator and to select the most appropriate
techniques for treating such exposures.

Key areas of risk management in Takaful:

 Shari’ah Compliance
 Investment Management
 Human Resources
 Key Objectives of Risk
Management Specific to
Takaful
Takaful
operator Why? How?
should
protect

Tabarru’ Fund Meet claims & Quality

expenses underwriting &
Shari’ah compliance

Grow lifelong Prudent investment

Participants management
Investment Acct savings

Generate profitable Quality human

Shareholder’ Fund resource-
returns
Key Objectives of Risk
Management Specific to
Takaful
 Key areas of risk
management in Takaful
 Shari’ah Compliance
 Continuous end-to-end process.
 Scope of Shari’ah compliance.
 Shari’ah Compliance in Investments -
Screening Criteria.
 Key areas of risk
management in Takaful
 Investment Management
 Asset Management Capabilities
 Limited availability - Lower Investment
Returns, Restricts Product Innovation,
Increases Liquidity Risk, Takaful products.
 Key areas of risk
management in Takaful
 Human Resources
 Qualified staff
 Trained
 Willingness to absorb candidates with
potential programme.
 Knowledge and Competency
 Talent and Technology
 Processes in Risk Management?

 Identification of risk
 Evaluation of risk
 Development of risk management plan
 Implementation of risk management plan
 Review and monitoring of risk management plan
 Processes in Risk Management?

 Identification of risk
 Evaluation of risk
 Development of risk management plan
 Implementation of risk management plan
 Review and monitoring of risk management plan
 Processes in Risk Management?

 Identification of risk
 There are 3 classes of risk or loss exposures:
Property Liability Personal
- Direct exposure - A condition that creates - Arise from the
• Physical damage the possibility that an possibilities of death,
individual’s financial illness or injury of an
- Indirect exposure resources may be individual.
• The individual diminished .
suffers a loss of
income due to
physical damage.
 Processes in Risk Management?

 Identification of risk
 Evaluation of risk
 Development of risk management plan
 Implementation of risk management plan
 Review and monitoring of risk management plan
 Processes in Risk Management?

 Identification of risk
 Evaluation of risk
 Development of risk management plan
 Implementation of risk management plan
 Review and monitoring of risk management plan
 Processes in Risk Management?

 Evaluation of risk
 Involves the estimation of frequency and severity of risk and
ranking them to their relative importance.
.

The number of potential Refers to the magnitude of

occurrence of loss within a the losses.
certain period of time
 Processes in Risk Management?

 Identification of risk
 Evaluation of risk
 Development of risk management plan
 Implementation of risk management plan
 Review and monitoring of risk management plan
 Processes in Risk Management?

 Identification of risk
 Evaluation of risk
 Development of risk management plan
 Implementation of risk management plan
 Review and monitoring of risk management plan
 Processes in Risk Management?

 Development of risk management plan

 The selection & application of the different techniques used in risk
management.
 There are 4 techniques involved:
 Risk Avoidance
 Risk Control
o Loss prevention
o Loss reduction
 Risk Retention
o Active retention
o Passive retention
 Risk Transfer
o Insurance transfer
o Non insurance transfer - often include indemnification provisions.
 Processes in Risk Management?

 Identification of risk
 Evaluation of risk
 Development of risk management plan
 Implementation of risk management plan
 Review and monitoring of risk management plan
 Processes in Risk Management?

 Identification of risk
 Evaluation of risk
 Development of risk management plan
 Implementation of risk management plan
 Review and monitoring of risk management plan
 Processes in Risk Management?

 Implementation of risk management plan

 Once the selection & application of suitable techniques been applied,
the plan is ready for implementation.
 Risk Avoidance
o : a mixture of actions can be used – elimination, substitution, separation &
rational planning
 Risk Control
o Is meant for risks that cannot be avoided and when the individual concerned
does not wish to transfer the risk
 Risk Retention
o This is the most pervasive move where an individual or organization is willing
to retain part of their risks rather than passing them on to others.
 Risk Transfer
o The idea of risk transfer is to plan how to finance those losses when they arise.
 Processes in Risk Management?

 Implementation of risk management plan

Risk Prevention Risk Avoidance

High
& Retention
Frequency

Risk Retention Risk Transfer

Low

Low High
Risk Management
Matrix Severity
 Processes in Risk Management?

 Identification of risk
 Evaluation of risk
 Development of risk management plan
 Implementation of risk management plan
 Review and monitoring of risk management plan
 Processes in Risk Management?

 Identification of risk
 Evaluation of risk
 Development of risk management plan
 Implementation of risk management plan
 Review and monitoring of risk management plan
 Processes in Risk Management?

 Review and monitoring of risk management plan

 To identify any necessary adjustments
 To ensure the objectives of the plan are being attained
 These activities involve:
 1) periodic reviews and monitoring the implementation
process
 2) progressive revision on the plan
 Approaches in Islamic Risk Management

 The processes must comply with shariah principles.

 The additional values of Islamic rules: Risk Sharing
 Risk Sharing: should be based on three elements
 1) Belief (I’tiqadiyyah)
o Is strongly based on the 5 pillars of Islam & 6 pillars of Iman.
 2) Dealings (‘Amaliyyah)
o Relationship between human and his creator (Ibadah)
o Relationship between human and human (Muamalah)
 3) Morality (Akhlaqiyyah)
o Relationship between human and his creator (Ibadah)
o Relationship between human and Allah creation (to achieve the ultimate
happiness in life and the hereafter).
 Categories of Risk

Pure Risk
vs Fundamental Risk
Speculative Risk vs
Particular Risk

Enterprise Risks
 Categories of Risk

 Pure Risk vs Speculative Risk

• e.g: Risk of damage to property

Pure and even human lives resulting
Risk from a fire, lightning, flood or
other natural disasters, death.
Loss No Loss

Speculative
Risk
• e.g: Investments in the stock
market, price movements of
Loss No Loss Profit/ Gain
foreign currencies,
agricultural & other
commodities.
 Categories of Risk

 Types of Pure Risk

Risk of
premature
death

Risk of poor
health
Personal
Risk of
unemployment
Pure Risk Property
Risk of
longevity
Liability
 Categories of Risk

• Fundamental Risk: • Particular Risk:

• A risk when it • A risk which when it

occurs, the whole occurs, only
society or a large individuals and not
number of people the entire
within the economy community are
is affected affected
 Categories of Risk
 Enterprise Risk
 Refer to all major risks faced by a company/firm.

Financial
StrategicRisk
OperationalRisk
Risk
 SHARIAH RISK MANAGEMENT
PROCESS IN THE CONTEXT OF
SHARIAH GOVERNANCE
FRAMEWORK
 Shariah Risk Management Process
 SHARIAH RISK MANAGEMENT
PROCESS IN THE CONTEXT OF
SHARIAH GOVERNANCE
FRAMEWORK
 Shariah Risk Management Process
 SHARIAH RISK MANAGEMENT
PROCESS IN THE CONTEXT OF
SHARIAH GOVERNANCE
FRAMEWORK
 Shariah Risk Management Process

Risk
Risk Monitoring/
Identification controlling

Risk
Measurement
 SHARIAH RISK MANAGEMENT
PROCESS IN THE CONTEXT OF
SHARIAH GOVERNANCE
 FRAMEWORK
Shariah Risk Management Process: Risk Identification

 Risk identification relates to process of understanding the nature and impact of

the risk to current and future activities of the institution.
 The main purpose of the identification process is to identify the main causal
factors that lead to the non-compliance events.
 Any weaknesses or shortcomings arising from the incompetency of people,
insufficiency of process or an ineffective system may lead to events that can
trigger Shariah non-compliance risk.
 SHARIAH RISK MANAGEMENT
PROCESS IN THE CONTEXT OF
SHARIAH GOVERNANCE
 FRAMEWORK
Shariah Risk Management Process: Risk Identification

Shariah non-compliance risk

People Process System External Event

• Fatwa risk • Lack & Unclear processes, • Process and system • Lack of supervision by
• Falsification of information, policies, procedures. accounting mismatched, regulator
fraud, misrepresentation, • Inadequate Internal Shariah inadequate product • Unclear law and regulations
negligence. Governance arrangements. modules, poor reporting,
• Guideline violations and • Insufficient disclosure and and unapproved software.
unapproved products, transparency. • Inexperienced vendors,
transactions, or legal non-timely support,
documentation. nonuser-friendly system,
• Insufficient resources, and system mistakes.
inadequate training and
negligence.
 SHARIAH RISK MANAGEMENT
PROCESS IN THE CONTEXT OF
SHARIAH GOVERNANCE
 FRAMEWORK
Shariah Risk Management Process: Risk Measurement

 This study suggests that Shariah non-compliance risk should be measured

according to the status of product.
 This is the fact that distinguishes IFIs from their conventional counterparts where
the latter do not base their business according to aqad.
 As such, any non-compliant events that occurrs is to be measured whether it
renders the aqad to be either void (batil), irregular (fasid) or permissible (sahih).
 SHARIAH RISK MANAGEMENT
PROCESS IN THE CONTEXT OF
SHARIAH GOVERNANCE
 FRAMEWORK
Shariah Risk Management Process: Risk Monitoring/ controlling

 Risk monitoring can be used to ensure that risk management practices are sound
and effective.
 Proper risk monitoring also helps IFIs to discover mistakes an early stage rather
than suffering the bad consequences from dormant untraceable
 risks.
 The risk monitoring mechanism must monitor the variables and factors that can
lead to Shariah non-compliance risk.
 The monitoring process utilizes data collected from the previous audit or
inspection.
 SHARIAH RISK MANAGEMENT
PROCESS IN THE CONTEXT OF
SHARIAH GOVERNANCE
 FRAMEWORK
Shariah Risk Management Process: Risk Monitoring/ controlling
Sources of Shariah Non- Events Some Key Risk Indicators
compliance risk

People •Fatwa risk •Staff turnover rates

•Fraud and misrepresentation •Staff training and experience level
•Incompetent staff •Number of approvals that are not
•Non-performance of obligation compliant to Shariah rules and
principles

Process •Unclear process and policies •Number of contracts that are

inconsistent with IFI’s policies
•Settlement failure rate
•Number of defaults
•Number of contracts that are not
Shariah compliant

System •It is not Shariah compliant •Number of contacts that are not
Shariah compliant
•System failure rate
•Number of failed operations
 SUPERVISORY ISSUES
 For any regulation to be effective it must fully appreciate the differences between
insurance and takaful. According to BNM, the following are among the
dimension of comparison that need to be examined:-
 General rulings
Takaful insurance

Sources of laws and - Al-Quran & sunnah - State

regulations - Man-made laws - Man-made laws

The contractual - Tabarru’ contract - Exchange contract

relationship - Agency
- Profit sharing

Investment treatments - No involvement of - Not involve policy

contributors. holders
- Islamic ethics and Shariah - Profit motive
principles. - Riba & maysir
 SUPERVISORY ISSUES
 For any regulation to be effective it must fully appreciate the differences between
insurance and takaful. According to BNM, the following are among the
dimension of comparison that need to be examined:-
 Business Operations
Takaful insurance

Motive of operation - Community well-being, - Profit motive, maximizing

optimizing operations, fair returns
profits
Sources of capital - Supplied by rabb al-mal - Supplied by shareholders.

Treatment of investment - Losses retained - Losses transferred among

insurance pools

Agency status - Agents are employees - Agents are independent

insurer
- The End -
 