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Risk, Risk Management & Takaful


¢ Risk a major component of our environment; human is
surrounded by innumerable risks from birth to death;
human learned to improve after experiencing misfortunes;
quest for security evolved since the dawn of man’s
¢ According to Blaise Pascal :
“As each generation progressed they will learn at least a
part of what their earlier generations had learned”.
¢ Abraham Maslow’s hierarchy of needs:
¢ Physiological Needs
¢ Security Needs
¢ Social Needs
¢ Esteem Needs
¢ Self Actualizing Needs

2250 B.(II) EVOLUTION (a) Early Insurance Development : ◦  Introduction of the contract of Bottomry by the merchants of Babylon about 4000-3000 B..C.C.. ◦  Later adopted by the Romans. ◦  The Greeks adopted it around 4 B. ◦  Bottomry Contract adopted by the Phoenicians 1600-1000 B. ◦  Constitution of Madinah 622 A.C Chinese merchants have practiced the concept of risk separation.. ◦  Around 3000 B. formation of the Al-Kanz fund 3 . ◦  Code of Hammurabi. adoption the concept of al-aqilah.D.C..C.

4 . ◦  Lloyds of London established 1688. ◦  Life insurance first practiced in 1583. ◦  The Italian introduced first known “insurance agreement” on 13 October 1347 ◦  Thomas Gresham established the first Royal Exchange.◦  (912-961) A.D. 1570. Rahman III adopted some form of marine insurance to protect their merchants. Lloyds Act passed in 1871. Spain under Abd.

pre-islamic. —  Constitution of Medina. the Qasamah and the Muwalat systems. two situations: —  Dispute between the two women from the tribe of Huzail. names in the diwan owed one another mutual assistance. A fund known as ‘Al-Kanz’ was created to be used to pay compensation on behalf of members who are liable to pay diyat. ¢  During the time of Umar the second Caliph. ¢  Two other mutual systems also existed i.. aqilah system Adopted by Prophet. he ordered preparation of registers (diwan) in all parts of the Muslim State. between Muhajirin and Ansar.e. pagan Arabs. 5 .(b)  ¢  ¢  ¢  ¢  Takaful (early evolution) : Diyat. The aqilah system was utilized.

¢ Global takaful contributions grew by 31% in 2009 to USD 7 billion. ( c ) Takaful in the Modern Era ¢  The first modern Islamic insurance was formed in the Islamic State of Sudan in 1979.e. became the first Islamic Scholar to come up with the meaning. ¢  Currently. The Islamic Insurance Company of Sudan. business expected to grow to USD 12 billion by 2011. there were more than 250 takaful operators globally. 6 . concept and legal basis of an insurance contract. the company was based on the concept of cooperative i.¢ Ibn’ Abidin (1784-1836) a Hanafi lawyer..

000 employees. ¢  Net contribution exceeded RM1. ¢  Total Takaful Fund Asset exceeding RM7 billion.000 agents are utilized. (Before 1980s) ¢  Nurturing phase. (1980-1990) ¢  Consolidation phase. ¢  Twelve takaful operators in the market. ¢  Almost 3. ¢  More than 15. 7 .5 billion. (After 1990s) (e) Performance of the Malaysian takaful business: ¢  The industry is about 27 years in operation.(d) Development of Takaful in Malaysia : ¢  Evolutionary phase.

derived from the French word risque –  Risque’ (French) –  Risk (English) 8 . –  Risqum (Latin) - challenge a barrier reef presents to a sailor –  Greek derivative - 12th Century - 18th Century.(II) CONCEPT OF RISK a)  Origin of the word –  Risq (Arabic) - anything that has been endowed to human (by Allah) and from which you attain goodness.

which is often to mean uncertainty. 9 . (Vaughn & Vaughn) –  ‘risk. –  ‘a condition in which there is a possibility of adverse deviation from a desired outcome that is expected or hoped for’. Hoyt & Sommer) –  ‘uncertainty of financial loss’ (Bickelhaupt) –  Variability in future outcomes –  Chance of loss –  Possibility of an adverse deviation from desired outcome.b)  What is risk? –  No one single definition. creates both problems and opportunities for businesses and inviduals’ (Trieschmann.

Susceptibility to change or External Influence Severity of Impact (High/Low) RISK Probability of Occurrence (High/ Low) Degree of Interpendency with other factors of risk According to Allen risk is made of four essential components namely: •  •  •  •  Probability of occurrence Severity of impact Susceptibility to change Degree of interdependency with other factors 10 .

cause of loss .c)  Loss. –  Loss stemming from legal liabilities. fire. explosion impact damage –  Hazard – a condition that increases the likelihood of loss due to a particular peril. 11 .example. theft. –  Loss of income. –  Loss from unexpected expenses. peril and hazard –  Loss – unexpected reduction or disappearance of economic value. –  Four principle types of losses: –  Loss of property. –  Peril .

–  Moral hazard – character defect that increases the chance of loss. 12 . indifference attitude.—  There are four types of hazard: –  Physical hazard – tangible characteristics that increases the chance of loss. –  Legal hazard – arises when new laws are being enacted. –  Morale hazard – carelessness.

lives and crops.d)  Risk from an Islamic perspective –  ‘We will surely test you through some fear. hunger and loss of money. Give good news to the steadfast’ (Al-Baqarah verse 104) –  ‘Verily! Allah will not change the condition of a community if they do not change their state themselves’ (Ar-Rad. 13 . verse 11) –  Legal maxim ‘al-ghurm bil ghunm’ or ‘no reward without risk’ holds true. –  One cannot expect to achieve success or make profit without enduring some risks in his undertakings.

14 . When he asked if his camel would run astray. ‘O my Sons! Enter not all by one gate: enter ye by different gates. —  As narrated by Anas bin Malik: ‘The Holy Prophet (pbuh) told a Bedouin Arab who entered th emosque with his camel left outside untied. The Prophet then said: tie your camel first. he said ‘Insha Allah’. Not that I can profit you ought against Allah (with my advice): none can command except Allah: on Him do I put my trust: and let all that trust put their trust on Him. This can be inferred from acceptable contracts such as Kafalah.” this verse shows the attempt to reduce and manage risk and at the same time recognizing that everything happens with the will of Allah.—  The assumption of risk by a person and the transfer of risk from one person to another are allowed in Islam. then say ‘Insha Allah’. This hadith clearly indicates that the Prophet’s instruction is to manage the risk at hand well before leaving it to the will of Allah. Dhaman and Hiwalah. —  From Surah Yusuf (Verse 67). an advice of Prophet Yacob to his sons on their trip to Egypt to look for their brother Yusuf.

–  Religion –  Selves –  Minds –  Progney –  Wealth 15 . put forth the essence of Islam within the principle Maqasid Al-Shariah where he states: ‘The objective of the Shariah is to promote the welfare of human beings which lies in safeguarding their.—  Imam Al-Ghazali.

- inevitable. whether in the form of deceit or fraud or undue advantage or peril leading to uncertainty in the business or any dealing (6:151152) o  Permissible risk - could neither be accepted or avoided. 16 . - ‘al-kharaj bil daman. o .the Quran has explicitly forbidden all business transactions including injustice in any form to any parties. - attached to 2 legal maxim: - ‘al ghurm bil ghunm’. o Prohibited risk of excessive gharar - appears in the form (fahish). o  Essential risk - prevalent in all business undertakings.—  Hassan (2009) points out from an Islamic perspective there are three types of risk namely.

g. e. subprime mortgage crisis –  Particular risks are much more personal in their cause and effect.e)  Classifications of Risks –  Fundamental and particular risks: –  Fundamental risks are those which affect large segments of the population. could occur due to lack of knowledge as to the real facts. –  Speculative risks involve the situation of loss and gain. –  Subject risk refers to the mental condition or state of mind of individuals. –  Objective and subjective risks: –  Objective risk is also known as statistical risk. it can be measured (standard deviation). tsunami. 17 . –  Pure and speculative risks: –  Pure risks involve the situation of loss and no loss.

technology.–  Dynamic and static risks: –  Dynamic risks can be defined as those risks that cause financial losses of changes in the environment (economy. it involves three elements namely (i) objects exposed to risk. regulatory requirements). (iii) asset/property affected by the risk. it appears through the perils of nature. 18 . consumer tastes. –  Financial and non-financial risks: –  Financial risks exist in situations where exposures to adversity involving losses prevail. (ii) peril causing the risk. –  Non-financial risks involves adversities that posed no financial loss. –  Static risks are more predictable.

(iii) risk of poor health. (i) direct loss. it can be classified as: (i) risk of death. earthquake and others. –  Liability risks: –  Refers to risk inflicting bodily injury to another person or inflicting damage to someone else’s property. (ii) indirect or consequential loss. 19 . (ii) risk of insufficient income during retirement.f)  Types of pure risks –  Personal risks: –  Risks that directly affect individuals. (iv) risk of unemployment –  Property risks: –  The possibility of loss due to damage to properties from various causes such as flood. fire. there are two types of property loss.

speculative risk. –  To handle enterprise risk. operational risk. legal risk and strategic risk.e. through the adoption of the enterprise risk management approach. 20 . it includes pure risk. financial risk. organizations since the 1990s have adopted a more comprehensive approach to risk mitigation i.g)  Enterprise Risks –  Refers to all major risk faced by an organization or a business entity.

21 . –  To curb risk by providing material security for those who are suffering due to unexpected loss.(III) WHY MITIGATE RISK (a) Basic Human Instinct: ◦  Maslow’s hierarchy of need: –  Survival –  Safety and security –  Love and belongingness –  Self esteem –  Self actualization ◦  Doctrine of Maslaha al-Mursalah –  Catering to the well-being of people in the worldly life and also in the hereafter is the basic objective of the Shariah. damage is a necessity.

(b) Losses emanating from pure risks: –  Loss emerging from unexpected events such as. Libya and others. it may necessitate governments. –  These forms of risks will create economic burden to society. 22 . Egypt. –  Losses such as these can be mitigated through insurance or takaful. tsunami and earthquake from Fukushima Japan. floods in Thailand. organizations and individuals to set aside funds. Arab Springs uprising in Tunisia.

– Inefficient investment of assets. – worry 23 .(c) Other related reasons: –  Apart from the actual losses and other undesirable outcomes. there are also other factors that could inflate the costs of risk such as. – Misestimates of chance of loss.

–  The following are the various methods categorized as risk control methods: –  Risk avoidance –  Loss prevention –  Loss reduction –  Segregation and combination –  Salvage and contingency planning –  Noninsurance transfer of loss 24 . the method consists of activities to reduce both the frequency and severity of losses. –  Risk financing methods.(IV) RISK MITIGATION MEASURES ◦  According to Head (1978) methods to mitigate risk can be classified into two groups namely: –  Risk control methods. (a)  Risk Control Methods –  Risk control methods are focused towards avoiding. reducing and preventing risks.

b)  Risk Financing Measures –  Risk financing methods are focused towards reducing costs of those losses that do occur. –  Through the risk retention mechanism. (iii) creating a ‘self-takaful’ mechanism. 25 . –  Risk retention can be active (done intentionally) or passive (unintentionally). (iv) forming captive takaful companies. risk financing techniques are post-loss in nature and can be categorized into two namely: (i) risk retention. (ii) absorbing losses as expenses. active retention can be carried out by: (i) absorbing the losses into current operating expenses. different methods of funding can be established to pay losses such as (i) creating special reserves. (ii) creating earmarked liability accounts. and (iv) adopting a deductible arrangement. (ii) nontakaful transfers. (iii) risk sharing. (iii) creating earmarked asset accounts.

Hedging. this process is performed through the operations of takaful. the risk mitigation methods to treat risks in any particular organization should involve the combination of both the risk control and risk financing methods. the risks can be mitigated using the following approach: –  –  –  –  Transfer of risk through contracts. the risk is shared between related parties.Through nontakaful transfers. Incorporation of an organizational structure –  Through the mechanism of risk sharing. as Norman Baglini (1983) puts it in his definition of risk management: “risk management is an economic process of allocating a business firm’s financial resources in the optimum combination of loss control and loss financing methods to minimize the cost of pure risks”. in the event of loss. 26 . –  In a good risk management administration . then the losses will be shared accordingly. in Islam based on the principle of ta’awun and tabarru’.

–  Monitoring and reviewing the program. Measuring and analyzing the loss exposures. organizations that adopts the risk management mechanism would normally established a six steps process namely: Setting the risk management objectives and policies. Identifying the loss exposures. Selecting appropriate mitigation measures for treating the loss exposures.(V) THE RISK MANAGEMENT PROCESS ◦  As an effort to mitigate risk. –  Implementing the risk management program. –  –  –  –  27 .

The Risk Management Process Identify Risk Exposure Measure & Estimate Find instruments and facilities to shift or trade risks Assess effects of exposures Assess costs and benefits of instruments Form a risk mitigation strategy: • Avoid • Transfer • Mitigate • Retain Evaluate performance 28 .

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