Transcript Download attachment

Operational and Actuarial
Aspects of Takaful
 Retakaful
Sub Topics
 Basic Principles
 Retention Capacity
 Classes of Retakaful
 Retakaful v Reinsurance
 Certificate Issuance
 Methodology
Introduction
 Adverse Claims experience is influenced by:
Major losses of the individual risks
Major losses arising from a single event
High frequency of many small losses
Change in risk structure (technological, economic,
social and political)
Elements of Reinsurance
 Reinsurance is a type of insurance but is a distinct
and separate contract from the original insurance
and itself takes the form of a contract of insurance.
 Reinsurance may cover part of the ceding
company’s portion, but no more than that.
 The reinsurance contract must cover the same risk
as the original insurance.
 Both insurance and reinsurance policies are to be
in existence at the same time.
Elements of Reinsurance
 The co-existence rule seems to have been
dispensed as decided in General Accident Fire and
Life Assurance v. Tanter, The Zephyr (1984), where
the reinsurance had been placed before the
insurance. In both practice and law, The Zephyr
confirms that an undertaking to indemnify against
future liability is coherent with the objectives of
reinsurance.
Basic Principles
 Same as insurance; namely Indemnity, Utmost Good
Faith, Insurable Interest, Subrogation, Contribution
and Proximate Cause.
 In particular, the 3 principles apply directly in the case
of reinsurance; Indemnity, Utmost Good Faith and
Insurable Interest.
Indemnity
 Putting the insured in the same financial position
as he/she was, before the insured event.
 The real limit of indemnity is the extent of the
cedant’s insurable interest.
 The amount recoverable from reinsurance relates
to the corollary of indemnity, which is the average
clause
Why Retakaful
 Risk spreading
 Capacity boosting
 Financial advantage
 Financial stability
 Protection against catastrophic risks
Retention
 Defined as “the limit of liability, usually expressed
as a monetary amount, which the insurer retains
for its net account after reinsurance”.
 Also be defined as “the maximum amount that the
insurer is willing to pay for a loss affecting a policy,
risk or group of risks".
 The retention may apply to a single risk or a series
of risks, or to a single loss or series of losses.
Retention
 Retentions are usually fixed based on each class of business separately
(family, fire, accident, marine, aviation, etc.).
 There may also be an overall retention over the combined portfolios of
the various classes.
 There is only an optimal retention for each takaful operator. The
optimal retention will provide the takaful operator a framework in
which to achieve its particular corporate objectives.
 Takaful operators with similar portfolios but having different corporate
aims will likely to have different retention levels.
Retention

1.
2.
3.
4.
5.
6.
The factors for consideration:
Size of the operator
Contribution income, size of portfolio and
profitability
Financial strength of the operator
Reinsurance/retakaful type and cost
Claims experience
Corporate strategy
Classes of Retakaful/Reinsurance

Treaty

Proportional
1.
2.
3.

quota-share
surplus (above retention limits)
facultative obligatory
Non-proportional
1.
2.
3.
excess of loss
stop loss
Catastrophe loss
Classes of Retakaful/Reinsurance
 Facultative (individual basis)
 Proportional
1. quota-share
2. surplus
 Non-proportional
1. excess of loss
 Financial Re - focused more on capital
management than on risk transfer.
 Captive Re
Treaty
 Sufficient flow of retakaful
 The primary consideration that the portfolio may be
exposed to large individual losses
 More convenient as all risks accepted by the ceding
operator requiring retakaful falling within the scope of
contract will be automatically covered.
Treaty – Which Type?

Factors to consider :
1. Type of coverage
2. Administrative costs & ease of operation
3. The effect on net retained premium income
4. Whether to control exposures or ease the
financing of solvency
5. Whether to engage in reciprocal business
Treaty – Pro or Non Pro?
 Proportional
 A surplus treaty is technically the best arrangement to deal with
large individual risks on classes of business with fixed sums covered
and the ceding operator can retain part of the biz
 However, a surplus treaty requires considerable amount of skill and
time in its administration, and as such may induce a ceding
operator to place retakaful on a risk excess of loss basis.
 A quota share treaty usually will carry a higher rate of retakaful
commission than a surplus treaty.
Treaty – Pro or Non Pro?
 Non Proportional
 Excess of loss & quota share treaties are much cheaper
and easier to operate
 For added stability, stop loss retakaful may be
considered for the protection of classes of takaful
exposed to large-scale fluctuations in aggregate annual
claims.
Facultative

Generally, facultative placement is necessary in the following
circumstances:
1.
The risk falls outside the ceding operator’s treaties, such as outside
geographical area or an excluded class of risk
The sum covered exceeds the treaty limit
The ceding operator does not want to cede the risk to the treaty
The risk is unattractive to be offered on a treaty basis
The takaful operator wishes to accommodate a special case that may
fall outside the scope or limits of its treaties
The takaful operator does it for unique commercial, financial or
strategic reasons
2.
3.
4.
5.
6.
Facultative - Advantages
 Risks are considered individually;
 It increases the takaful operator’s competitive edge
in that particular line;
 There is freedom to offer any risk which may be
accepted or declined;
 A particular account may be further protected by
use of facultative retakaful
 Transfer of knowledge and technology
Facultative - Disadvantages




The takaful operator may not be able to place the
risk
The process is more complicated and involves more
administration
There could be errors in placement
Cover cannot be confirmed until placement is
effected
How much to Reinsure?
 Proportional
 Quota share
 Surplus treaty
 Non Proportional
 Excess of Loss
 Stop Loss
Quota Share
 A company may only be able to offer $1 million in
coverage, but by purchasing proportional
reinsurance it might double or triple that limit.
Premiums and losses are then shared on a pro rata
basis.
 For example, an insurance company might
purchase a 50% quota share treaty; in this case
they would share half of all premium and losses
with the reinsurer. In a 75% quota share, they
would share (cede) 3/4 of all premiums and losses.
Quota Share
 Advantages
 the relationship between cedant and the
reinsurer/retakaful operator is absolute - in such a
context the reinsurer/retakaful operator follows the
fortunes of the cedant almost identically
 the accounting and reporting of business is simple
 flexibility exists in increasing or decreasing the amount
of quota share ceded; i.e. the cedant may vary the quota
share
 unlimited cover is provided for aggregation of risk losses
in a single loss event
Quota Share
 Disadvantages
 since a quota share involves the cession of all business
within the retention pattern, large amounts of income
are ceded away - this could be to the detriment of the
cedant
 a quota share treaty is inflexible as the cedant has no
choice in selecting a retention limit.
Quota Share
 A quota share treaty is more appropriate new takaful
operators, or developing a new line or class of
business, or for experimental or special where the
reinsurer/retakaful operators' expertise is needed
Surplus Treaty
 The operator transfer the amount of risk above its retention
limit (defined as a ‘line’). Retakaful operator will accept the
part of every risk that exceeds the operator’s retention limit
automatically. The latter shares in contributions and losses
in the same proportion as it shares in the total limits of the
risk.
 E.g. An operator issues a cert for $20,000. It keeps $5000
(¼) and transfers the remaining $15,000 (¼) to its
Retakaful. This is called a three line surplus because the
amount transferred equals three times the retained line of
the operator. It keeps ¼ and transfers ¾ of the contribution
to the Retakaful.
Surplus Treaty
 In the event of total loss, the settlements between the two
operators would be effected on the identical ¼-¾ basis. If
there is a partial loss, the Retakaful must reimburse the
operator in the same proportion as the reinsurance
contribution received.
 E.g. In a 9 line surplus treaty where retention limit is
$100,000 the reinsurer would accept up to $900,000 (9
lines). So if the insurance company issues a policy for
$100,000, they would keep all of the premiums and losses
from that policy. If they issue a $200,000 policy, they would
cede half of the premiums and losses to the reinsurer (1 line
each). The maximum underwriting capacity of the cedant
would be $ 1,000,000 in this example.
Surplus Treaty
 The larger the number of lines, the higher the retakaful
operators obligation
 It reduces the retained loss cost on larger risks and limit the
loss on any one risk. It provides the cedant a larger retained
contribution for the same retention limit on any one risk,
therefore providing better balance.
 Main purpose is to attain automatic underwriting capacity
to enable the cedant to transact business in its chosen
market and compete with its peer operators.
 Surplus treaties are also known as variable quota shares.
Surplus Treaty
 Advantages:
 a surplus treaty allows the operator to vary its retention
upon a particular risk;
 there is automatic capacity available upon a particular
class and size of risk;
 the operator is allowed to retain a greater proportion of
its income – this aspect would be diluted if the cedant
chose to effect any quota share reinsurance/retakaful on
all or selected parts of its account.
Surplus Treaty
 Disadvantages:
 the operator stands or falls by its chosen retention - this
is a fundamental calculation for the cedant
 comparison of results between the cedant's net results
and those of its surplus reinsurer/retakaful operators
might be different - whichever way they fall might
influence the original construction between the cedant’s
net and gross accounts and the benefit which the cedant
should obtain from such arrangements.
Facultative Obligatory
 is used for a substantial number of individual
facultative cessions
 Treaty are concluded in advance and the cedant
has the option to cede risks to the treaty. The
obligatory element rests with the
reinsurer/retakaful operator, who must accept
such cessions once they are made
 Tend to generate small incomes for a large capacity
Facultative Obligatory
 Advantages
 Provides the cedant flexibility and complements existing
automatic treaty facilities, and such facilities follow the
cedant's gross retention pattern.
 The cedant also benefits from the knowledge that it
should be offered a risk larger that its capacity,
 Treaty would offer sufficient automatic underwriting
capacity hence the cedant would not have to resort to
the extensive administration required in making an
individual facultative placement.
Excess of Loss
 It will either limit the individual retained loss, or
the accumulation of retained losses from one
event, or the aggregation of retained losses over a
period
 The stop loss limits the total claims over a given
period of time, normally on an annual basis.
 Under aggregate excess of loss, it is normal if only
individual claims in excess of a certain figure will
be included in the deductible
Excess of Loss Example
 The insurer is prepared retain a loss of $1 million for
any loss which may occur and they purchase a layer of
reinsurance of $4 million in excess of $1 million.
 If a loss of $3 million occurs, the insurer pays the $3
million to the insured, and then recovers $2 million
from its reinsurer(s).
Excess of Loss
 Excess of loss reinsurance can have three forms –
 Per Risk XL (Working XL)
 Per Occurrence or Per Event XL (Catastrophe or Cat
XL)
 Aggregate XL
Per Risk XL
 For example, an insurance company might insure
commercial property risks with policy limits up to
$10 million, and then buy per risk reinsurance of $5
million in excess of $5 million. In this case a loss of
$6 million on that policy will result in the recovery
of $1 million from the reinsurer.
Per Event XL
 For example, an insurance company issues
homeowner's policies with limits of up to $500,000
and then buys catastrophe reinsurance of
$22,000,000 in excess of $3,000,000. In that case,
the insurance company would only recover from
reinsurers in the event of multiple policy losses in
one event (i.e., hurricane, earthquake, flood, etc.).
Aggregate XL
 Company retains $1 million net any one vessel, the
cover $10 million in the aggregate excess $5 million
in the aggregate would equate to 10 total losses in
excess of 5 total losses (or more partial losses).
 Aggregate covers can also be linked to the cedant's
gross premium income during a 12 month period,
with limit and deductible expressed as percentages
and amounts. Known as "Stop Loss" or annual
aggregate XL.
Retakaful v Reinsurance
 Reinsurance law derives largely from English law
whilst retakaful is based on the Shariah (the
retakaful contract between takaful operator and
the reinsurer/retakaful operator, must comply with
Shariah).
 The question now remains; which jurisdiction
does it fall under, especially if reinsurer/retakaful
operator is based in a foreign country),
Retakaful v Reinsurance
 Contracts between takaful operators and
reinsurers/retakaful operators just mirror exactly
the conventional reinsurance contract (non
shariah compliant)
 Issue of profit commission or experience refund do
not comply to shariah or follow the principles of
takaful.
 As for the solid financial standing and technical
advisory services, retakaful operators themselves
mostly retro-takaful to leading conventional
reinsurer.
Retakaful v Reinsurance

1.
2.
3.
4.
Retakaful with conventional reinsurer to be subjected to
the following conditions:
The retakaful has not enough capacity
Arrangement should be of a temporary nature and
agreement should be reviewed periodically.
As far as possible, contract between the takaful operator
and the reinsurer should comply with Shariah.
Inward retakaful from insurers can only be accepted if it is
conditional on outward retakaful subject to conditions (1)
and (2).
Contracting of Retakaful

1.
2.
3.
4.
5.
6.
Normal to use Brokers (in General Biz) whose services
include:
As an adviser to help construct the program
To identify the potential markets for the business and the
security of reinsurer/retakaful operators
Undertake the marketing & placement of the business
Prepare contract wordings
As arbiter in the event of disputes arising
Administer the program, including the collection &
transmission of contributions, and claims settlements
Challenges of Retakaful
 New – sometimes no/low security rating
 Services underdeveloped
 Different Models
 Lack of Expertise – Shariah, Actuarial and
Underwriting
Pricing Considerations
 In pricing for non-proportional retakaful, both general and family,












retakaful operators must take the following factors into consideration :
Claims experience
Original underwriting limits of the cedant
The basis of these limits
Nature of the account
Effect of inflation
Currency fluctuations
Risk profiles of the portfolio of business
Catastrophic perils
Underlying protections
Amount of cover
Relationship with the cedant
Quality of business
Financial Re
 'Financial reinsurance' were basically funded whereby the
reinsurer agreed to pay an agreed schedule of loss
payments in the future in return for the ceding operator
paying specified premiums based on the net present value
of the loss payments.
 Therefore, 'financial reinsurance' is not actually insurance
contracts but falls under the ambit of banking contracts.
 In this respect, authorities such as insurance regulators and
tax authorities decided that these contracts do not qualify
as insurance contracts as there was insufficient transfer of
risk.
Financial Re
 Finite risk reinsurance will resemble traditional insurance
if the elements of both timing risk and finite risk are
greater. Finite reinsurance contract should also have the
following characteristics :
 Make explicit allowance in the price for investment earnings;
 The cedant usually is allowed to share in any profit, but conversely
is required to contribute to any loss under the contract;
 A limit is usually placed on the aggregate loss payable by the
reinsurer operator.
 May be arranged on either pre-funded (prospective) or post-funded
(retrospective) basis.
Financial Re
 Retrospective covers - These address losses that have arisen
on contracts written in previous underwriting years. They
include Loss Portfolio Transfer, Adverse Development and
Retrospective Aggregate Excess of Loss covers.
 Prospective covers - These address losses arising on
business written in future years. They aim to smooth the
results of future underwriting tears by mitigating serious
increases in losses that may occur in the future. They
include Finite Quota Share and Spread Loss treaties.
Financial Re
 The Catastrophe Risk Exchange, also known as
CATEX, was established in 1996 in New York to
enable insurers, reinsurers and intermediaries to
trade tranches of insurance portfolio.
 It is an online system that enables insurers and
reinsurers exposed to catastrophic losses in one
geographical area to trade part of it with others
who are exposed in other areas. All Lloyds
syndicates have access to the system.
Financial Re
 A Catastrophe Bond is a form of corporate bond where the holder agree
to forgo or defer the payment of interest and/or of principal if a defined
loss event or experience occurs that exceeds a specified trigger.
 Catastrophe Swaps are a series of fixed, pre-defined payments in
exchanged for a series of floating payments whose values depend on
the occurrence of an insured event.
 An Industry Loss Warrant is similar but is structured as a reinsurance
transaction, which is activated by a double trigger of both industry
losses and losses incurred by the cedant, both exceeding pre-specified
thresholds.
Financial Re
 Finite reinsurance recognized as an appropriate
form of risk transfer but there is concern whether
they are properly accounted for in a manner that
reflects economic reality.
 Problems are when finite reinsurance is abused,
such as when it is used as a "low cost loan that flies
below the regulatory radar" and when its effect is
to transform a company's income statement and
balance sheet in a way that does not "reflect
economic reality."
Reinsurance Reserving
 The delay between the claim, intimation,
settlement and reporting dates necessitates that
the retakaful operator set up "reserves" in respect
of those claims still to be settled as in the case
above.
 The problems of loss reserving are further
compounded by a persistent upward development
of most claims reserves.
Reinsurance Reserving
Inherent problems:
 Claims data are limited, particularly for retrocession business;
 The numbers of claims and individual claims information are often not be available,
particularly for proportional business.
 It is difficult to develop a good loss development pattern as the data is heterogeneous and
sub-dividing the data into too small groups, to improve homogeneity, can give rise to
excessive volatility.
 The development of claims data is generally medium/long-tailed
 The length of tail also means that development factors to ultimate which too large and
sensitive to be reliable especially in the early periods of development.
 Different underlying currencies and inflation rates may distort aggregated data;