FAQ #4

Is underwriting absolutely necessary for the takaful operator or is there any other way to manage the risk?

First and foremost, we need to understand what underwriting means in Takaful perspective as well as insurance.  In general, underwriting is a process of activities to assess the level of risk of the subject matter to be covered and subsequently making a decision on the acceptance of the proposal.  The final decision may involve acceptance at standard terms, acceptance with special terms and conditions or merely rejection.  For instance, a person goes to Etiqa Takaful to obtain a fire Takaful coverage to protect his home with  a market value of RM500,000.  After analyzing the information obtained, the underwriter of Etiqa decided to charge an additional contribution of say 50% of standard rate due to certain additional risk factors detected on the subject matter to be covered i.e. the house.  Thus, if the person agrees to the underwriting decision, he has to contribute an additional 50% higher than normal contribution rate on the same subject matter. 

The question now is whether it is acceptable from Shariah point of view to do the underwriting which may lead to different charges of contribution for different participants.  Universally, we require equality and fairness served in any form of risk sharing.  If a property has a 90% chance to catch fire while the other has only 10% chance, obviously the latter should contribute much lower amount of contribution into the pool as it is unlikely that the participant will benefit from the pool compared to the rest.  Similarly, a person aged 20 has lower probability to claim due to death in 5 years time compared to a person aged 75 therefore the latter fairly needs to contribute much higher amount to the pool compared to the earlier.  Assuming that there is no underwriting process imposed and everybody pays the same amount of contribution into the pool irrespective of their risk level, the Takaful pool will sooner or later be insufficient to cater for all claims needed by the participants.  As a result, future claimants may be unfairly treated due to the deficit in the pool.  Furthermore, the pool will naturally appeal predominantly to those with high risk who want to take advantage of the benefits.  Ultimately, the pool will be in serious shortfall which demand additional contributions or “qard” from shareholders to ensure viability of the takaful business.  Re-pricing or pricing with higher rate to recover the shortfall will only be imposed on new participants and not the earlier ones.  This is an issue of cross subsidizing between new participants and earlier participants.

Therefore, underwriting is absolutely required by the takaful operator as it can help to determine a fair contribution system into takaful fund by participants. The underwriting process will justify the appropriate contribution amount in tandem with the level of risk carried by the subject matter to be covered.  

FAQ #3

What is the difference between insurance underwriting method and takaful underwriting method?

In general, the underwriting methodology applied in insurance and takaful is quite similar in most activities.  However, underwriting process under takaful will also involve activities to evaluate whether the subject matter is acceptable to Shariah principles.  In other words, underwriter will ascertain whether there exist any elements which are against the Shariah principles related to the subject matter to be covered.  For instance, a customer applies to participate in fire takaful to cover his business premise.  If the premise is used for non-Shariah activities such as related to gambling, drugs, prostitution, or alcohol then the underwriter may decide to decline the risk.  Nevertheless, there are instances where the Shariah Committee may allow to accept the risk provided that the proportion of non-Shariah activities is insignificant say less than 5%.  This is applicable in the event that the subject matter is a hotel or an aircraft where alcohol is commonly served and constitute a small proportion of their business activities which is less than 5%.  

 

How about in a case where a person want to participate in a family  takaful covering her life while her profession involves in prostitution or alike?  There are two possible situation for this case.  If the applicant does not declare on her profession which is related to the non-Shariah activities, the underwriter will proceed to conduct the underwriting process without the knowledge on her profession.  On the other hand, if she declares her profession in detail, there are two different opinion by Shariah scholars.  Some scholars will agree to reject the risk due to the nature of her profession. However, there are some scholars who agree to accept the risk based on the fact that her sinful activities is her accountability with God.  Nevertheless, this kind of situation  shall be presented to the Shariah Committee for their deliberation and decision.

FAQ #2

What is an underwriting process in Takaful?

Wikipedia defines underwriting in insurance as a process to sign and accept liability and guaranteeing payment in case of loss or damage occurs. Underwriting, in general, is provided by a large financial service provider such as a bank, insurer, takaful or investment house to screen their potential customer.  However, underwriting can be further explained as a process to avoid any anti-selection or adverse selection for any particular event such as application for insurance or bank’s financing product.  For instance, when a customer applies for a bank’s loan or  financing, the credit officer will conduct a credit assessment process to determine whether he has the capacity to fulfil the monthly obligation to the bank.  Or, the officer is trying to determine the risk of default on the monthly payment subsequent to granting the financing. If the result of assessment is positive, he will be granted with the financing amount otherwise his application may be rejected or counter offered with different terms and conditions. 

 

Similarly, when a customer applies for an insurance or takaful product or coverage, the underwriter (person who handles the application) will conduct a thorough assessment on the subject matter to be covered to ensure that there is no adverse effect or higher risk of loss compared to the norms.  If there is evidence of higher risk involved then the underwriter may impose different terms and conditions such as higher rate (pricing) to the application. If the risk is extremely higher than the norm, the case may be rejected.  Both activities mentioned above are known as underwriting process.

In a nutshell, underwriting is a process of screening and filtering the subject matter to ensure that the case is within acceptable range of criteria. In Takaful, the same underwriting process is applied for all proposals to ensure that the risk to be shared in the takaful pool are within the acceptable level of risk.  This will help to minimize the probability of inadequacy of takaful pool to pay for future claims. 

Technically, the process of underwriting involves the following key activities:

1-       Assessment

2-       Selection

3-       Rating

Assessment

It is a process of assessing or evaluating the risk of the subject matter such as a house, a car, or a life to be covered. It evaluates the probability or chance of loss on the subject matter based on the information available. For example, if someone wants to participate in a fire takaful to cover his house, the underwriter will evaluate the probability that the house is exposed to the risk of fire and related perils.  The decision is derived from material facts given such as type of building, location, and purpose of the building whether for commercial or private.  Nevertheless, the underwriter may request for further information to ascertain the level of risk, if need be.  In certain circumstances, the potential customer may enjoy some discounts if there is evidence that there exist a good risk prevention measures within the premise such as fire extinguisher or water sprinkler.   In the case of family takaful product such as Medical Takaful, Investment linked Takaful, or Education Takaful, the underwriter will ascertain the health condition, life style, employment risk, etc. of the person to be covered.  Basically, the underwriter is trying to establish the level of risk with respect to the subject matter to be covered.

Selection

After a comprehensive process of assessment or evaluation done, the underwriter is ready to select the risk.  In other words, this selection process is basically a process of deciding which risk can be accepted, rejected or accepted with certain terms and conditions. The underwriter is bound under certain set of rules and guidelines endorsed by the management and board of directors of the company.  The underwriting guidelines are usually derived from underwriting guidelines imposed by the treaty with the retakaful companies.  In the past, the underwriting guidelines can be in a form of thick manual book or folder however most companies nowadays had already incorporated the details in their system to automate the process.  This underwriting guidelines has been converted into an online underwriting system by most retakaful companies. 

Going back to the example of fire takaful application mentioned above, the underwriter may accept the risk should he find no abnormality during the assessment process.  On the other hand, he may decline the case if he discover any potential higher risk threat, for instance, if the house is just next to a petrol station, which increases the risk of fire.  Under special circumstances, he may accept the risk as standard risk by excluding any losses arising from fire or related perils from the petrol station.

Rating

Once the proposal is accepted, the underwriter is ready to establish the relevant rating to the case.  With the advance of technology, the rating process is done automatically by the system provided that all the key information is captured in the system.  The system is designed to automatically rate the standard risk while any sub-standard cases will be manually handled by the underwriter by inserting the appropriate loadings in the system.  For a normal risk, the rating is called a standard rating while any deviation from the norms, it is considered a sub-standard rating where additional contribution is imposed to the standard rating.  The gross contribution to be paid by the participant is based on net contribution plus any loadings, and charges according to the takaful model adopted such as wakalah fees.