RISK & INSURANCE

Hatim Abbas Mudawi (Dip CII)

Head of Operations & Training
Jaiz Takaful Insurance Plc
 THE CONCEPT OF RISK

The word Risk is used in several ways in the insurance marketplace

The conventional concept of Risk does not alter if applied from a Shariaa
perspective
 THE CONCEPT OF RISK

Consider the following statements:

Risk is the chance of a loss

Risk is the possibility of a loss
Risk is uncertainty
Risk is the dispersion of actual from the expected results
Risk is the probability of any outcome different from the
one expected (unfavorable)

UNCERTAINT
Y
 THE DEFINITION OF RISK

Risk
Uncertainty about the outcome of a situation
The possibility of outcome will be unfavorable

Risk is the probability of any outcome different

from the one expected (unfavorable)

Risk Vs.
Chance!!!
 COMPONENTS OF RISK

RIS
K
CAUSE OF LEVELS OF
LOSS RISK

UNCERTAINT
Y
 UNCERTAINTY

Uncertainty refers to a state of mind characterized by doubt what

will or will not happen in future (Certainty is opposite mental state).
Uncertainty is a psychological reaction to the absence of knowledge
about the future
An asset shall depreciate in value with its use and time is certain
but it will be damaged in an accidental fire is uncertain
 LEVELS OF RISK

Which house is Risky and why?

 LEVELS OF RISK

Which house is Risky and why?

 CAUSE OF LOSS

PERIL is a cause of a loss

HAZARD is condition that may create or

increase the chance of a loss arising
from a given peril.
 CAUSE OF LOSS

Peril or Hazard?
 CAUSE OF LOSS

Peril or Hazard?
CAUSE OF LOSS

Peril or
Hazard?
 HAZARDS

HAZARD
S

PHYSICAL MORAL

CARELESSNE
SS

DISHONESTY

SOCIAL
ATTITUDE
 CLASSIFICATION OF RISK

PARTICULAR
FINANCIAL PURE &
& & FUNDAMENTA
NON- SPECULATIVE L
FINANCIAL
CLASSIFICATION OF RISK

Financial Risk
The outcome capable of financial measurement

Non- Financial Risk

The outcome is not measurable financially
 CLASSIFICATION OF RISK

Financial risk What is insurable?

Accidental damage to a The financial value of the risk is the cost of repairing
motor car or replacing the vehicle.
Theft of property The financial value of the risk of theft of an item of
jewelry is its current market value. This is
measurable in financial terms. It would not include
sentimental value because, as we have seen, this is
not precisely measurable in financial terms.
Loss of business profits This risk is measurable since comparisons can be
following a fire made to similar trading periods to devise a fair
estimate of the loss to be paid by the insurer as
compensation.
Legal liability to pay The courts measure the value of damages applicable
compensation for personal for the loss of a leg, for example, against
injury to others compensations payments made previously by the
courts. The courts calculate the damages that will
take account of financial circumstances as well as the
injury itself, for example covered future medical
payments or special equipment.
 CLASSIFICATION OF RISK

Fundamental risk:
Those that arise from
social, economic, political
or natural causes
It occurs on vast scale

Particular risk

Those are localized or even

personal in their cause and
effect.
Sometimes the cause may be
more widespread but the
effect is localized or even
 CLASSIFICATION OF RISK

Particular Risk Information

Factory fire This would cause localized damage to
the factory and possibly to its
surroundings, but would not affect
the whole community.

Car Collusion Damage to the Vehicle and any third-

party liability are localized events
affecting relatively few individuals.
Theft of Personal An event that only affects an
Possession from a home individual or family
 CLASSIFICATION OF RISK

Speculative risk:
There is a situation in which there is
possibility of loss and also there is possibility
of gain

Pure risk
There may be a situation in which there is
possibility of loss or no loss. A motor car may
face and accidental damage or may not be
damaged.
 CLASSIFICATION OF RISK

Pure risk Information

Risk of Fire This could damage or destroy property or cause

an interruption to the running of the business,
both risks are measurable in financial times
Risk of machinery This could lead to actual damage or business
breakdown interruption and is measurable in financial
terms
Risk of injury to If such injury is caused by the negligence of the
employees at work Company, a court may award damages and
costs. These risks are measurable in financial
terms
 CLASSIFICATION OF RISK

Personal Risks-
Premature death
Old age or risk of insufficient income during retirement
Accident
Sickness or disability or poor health

Property Risks-
Direct loss or physical loss to the property- Fire damage to a
house
Indirect or consequential loss- additional expenses for
alternative accommodation

Liability Risks-
Legal liability arising out of Negligently causing bodily injury
or loss/damage to others or their property; Legal defense cost
TYPES OF INSURABLE RISK

Sharia
h
Not-be Compl
a one y
off

Fortuit
Insura ous
ble event
Interes
t

Public
Policy

INSURABLE RISK
 TYPES OF INSURABLE RISK

Fortuitous event:
- Accidental or unexpected
- Not inevitable

by the insured
 TYPES OF INSURABLE RISK

Insurable Interest:
The legal right to insure arising out of a
financial relationship recognized at law,
between the insured and the subject
matter of insurance.

What are the examples of Insurable Interest not necessary

based on ownership?
 TYPES OF INSURABLE RISK
FEATURE DETAILS
Subject matter Subject matter of insurance is the item or
event insured. For example, cars and factories,
or the potential to be held legally liable for loss
or damage to someone else or their property.
Subject-matter of the contract is the name
given to the financial interest the insured has in
the subject-matter of insurance. For example,
Tom owns car. The ownership is the financial
interest, the subject-matter of the contract.
Legal relationship The relationship between the insured and the
subject-matter of insurance must be recognized by
law. For example, ownership is a legal relationship.
Financial value The insurable interest in the subject matter of
insurance must have a financial value.
Insurers insurable Insurers have insurable interest in the risks that
interest they have assumed. They reinsure part or all of the
risk with other insurers; the subject-matter of the
contract being the insurers financial interest in the
original insurance.
Timing of insurable When must insurable interest exist? The answer
interest depends on the class of insurance business.
However, the expectation of acquiring an insurable
interest in the future is not enough to create
 TYPES OF INSURABLE RISK

Public Policy:
It is commonly recognized in law that
the contracts must not be against public
policy or go against what society
considers to be the right or moral thing
to do.

What is against public policy what is not from the

followings:
Paying fines?
Paying compensations for un intentional road accidents?
Insure the criminal offenses?
TYPES OF INSURABLE RISK

Shariah Compliance:
In Takaful there is additional requirement for the
Risk to be insurable: the risk must not in nature be
something which is prohibited or forbidden
according to Shariah.

Examples of prohibited
Risks
 TYPES OF INSURABLE RISK

Homogeneous Exposure:
Sufficient number of exposure to similar
Risks, historical patterns and trends
enable an insurer to forecast the
expected extent of future losses

Law of Large Numbers

A statistical axiom states that the larger
the number of exposure units
independently exposed to loss, the
greater the probability that actual loss
experience will equal expected loss
experience. In other words, the
credibility of data increases with the
size of the data pool under
consideration
Exceptions:
- A completely new Risk (e.g. new technology)
- Risk in part of the world not previously open to that insurer
 TYPES OF INSURABLE RISK

Summary Of Insurable
Risks
Insurable Uninsurable
Financial Non- Financial

Pure Speculative

Particular Fundamental

Fortuitous event Deliberate Act

Insurable interest No insurable Interest
Not against public policy Against Public Policy

Shariah Compliant Not Shariah Compliant

Homogenous Exposures One-offs(generally)

 RISK MANAGEMENT

Definition:
A systematic approach to identifying, measuring and controlling
risks that can threaten assets and earnings of oneself, a business
or the organization.

Identificat
Measure Control
ion

The purpose of risk management:

To enable the organization to progress toward its goal and
objectives (mission) in the most direct, efficient, and effective path
OBJECTIVES OF RISK MANAGEMENT

Objectives prior to a loss

Reduce impact of loss
Reduce fear and worry
Required by law

Objectives post loss

Survival of organization organization still
able to continue operations
Stability of earnings business operations
do not have to stop and the organizations
can concentrate on their business
activities as usual.
Reduce impact of losses to organization
and society when a loss occurs not only
will the organization suffer but the loss
has to be burdened by society as well.
Employees may have to be retrenched and
some departments may have to be closed
 RISK MANAGEMENT PROCESS

1. Identifying potential losses

2. Evaluating potential losses
3. Examining alternative risk
management techniques
4. Implementing the risk
management program
5. Controlling/monitoring the
program
IDENTIFYING POTENTIAL LOSSES

Risk identification is the process by which an organization is able to

learn of the areas in which it is exposed to risk.
Identification techniques are designed to develop information on
sources of risk, hazards, risk factors, perils and exposures to loss.
It is everybodys task to identify the loss exposures in one
organization.

How to identify risk?

Questionnaires
Interviews
Financial Statements
Flow Charts
Personal inspection / Observation
 EVALUATING POTENTIAL LOSSES

Risk measurement evaluates the likelihood of loss and the value of

loss in terms of frequency and severity.
The measurement process may take the form of a qualitative
assessment (using %)
This step involves two important aspects of loss exposures
Frequency
Severity
 EXAMINING RISK MANAGEMENT
TECHNIQUES

risk management
techniques
Risk avoidance
Risk Control
Loss prevention
Loss reduction
Risk Separation

Risk Finance
Risk Transfer/ Share
 Risk Avoidance

Risk is proactively avoided or abandoned after rational consideration.

If someone is afraid of risks, the best way to deal with it is to avoid it
completely.
Example; a manufacturer may stop production of a defective products to
avoid a lawsuit.
However, some risks are unavoidable although risk avoidance may be
chosen as an option in handling certain risks, the exposures of losses
cannot be eliminated entirely.
 Loss Control

Loss control is designed to reduce both the frequency and severity of

losses by changing the characteristics of the exposure so that it is more
acceptable to the firm. Divided into:
Loss prevention
Loss reduction
Risk separation
 Loss Control
Loss Prevention
Seek to reduce the number of losses (frequency) of losses
Is used when the benefits outweigh the costs involved.
Either imposed by law or imposed by companies and factories to fence
dangerous machinery to reduce the chances of employees being
injured.
Loss Reduction
Designed to reduce or lower the severity of losses, should it occur.
Since some risks are unavoidable, the other alternative is to reduce its
impact.
Can be used in two circumstances: before a loss, e.g. installation of fire
alarm or after a loss e.g. salvage efforts in the restoration of a building
burnt down by fire.

Risk separation
- Involves the dispersal of the firms assets in several locations instead
of confining it to one major area.
- This measure will reduce the impact of losses should a major disaster
occurs.
- Example, separation of head quarters and assembly plant in
automobile industry.
RISK FINANCING
 RISK FINANCING

Methods involving generating funds to pay for losses

Retention:
- The company will bear the consequences of the loss
- Risk or loss exposed are normally assumed or retained when their impact and
consequences are not too great or in cases when or other methods seem
feasible.
- In an organization, the ability to assume a risk depends on ones financial
ability

Self Insurance
- Self insurance implies tat the organization sets up a pool of fund to retain its
loss exposures.
- Adequate financial agreement has to be made in advance of the occurrence of
losses.
- The number of loss exposures must be large enough to ensure the mechanism
of insurance to be operative.
 Risk Transfer

Refers to the various methods by which a pure risk and its potential
financial consequences can be transferred to other party.

Contractual
Insurance
 Insurance

Risk transfer mechanism for the financial consequences of potential accidental

losses from an insured firm or family to an insurer
Transferring the risks to another party involves a contractual agreement
whereby the other party assumes the risks and is liable for the loss in the
event of loss.
In an insurance contract, the party exposed to the risks (the proposer/insured)
pays the premium to the insurance company.
In return, the insurance company agrees to pay a stated sum on the happening
of certain risks specified in the contract.