Risk Management in Takaful
Risks are at the heart of insurance, which may be divided into general or non-life insurance and life insurance. While the first of these is concerned with risks of losses arising from various kinds of hazards, the second was originally concerned with mortality risk but offers a variety of savings and investment products in connection with life insurance, including pensions. The economics of insurance depend crucially on the “law of large numbers” in underwriting risk, according to which, in the absence of high correlation, the larger the set of risks insured in an underwriting pool, the greater the degree of risk diversification in the pool, and hence, the smaller the (underwriting) risk of a large proportion of the insured losses occurring in a given time period, and hence, of claims on the pool exceeding premium payments from policyholders for the period.
Risk management in all insurance undertakings is concerned with underwriting risk, but life insurance, and to a lesser extent, non-life insurance are also concerned with risks similar to those faced by banks, namely: (a) investment risks arising from the investment of funds received from policyholders, the nature of which (market and credit risk) depends on the type of assets in which the funds are invested; (b) liquidity risk (inability to meet obligations because assets cannot be converted into cash quickly enough); and (c) operational ...