Risk risk 2. Operational risks 3. Credit risk

Risk
management is a process that identifies loss exposures faced by
anorganization and selects the most appropriate techniques for treating such
exposures (Rejda, 2006; p. 63). In general, risk
management can be defined as a systematic approach to managing risks that
threaten the assets and income of a business or entrepreneurship.

 

There are five
types of risks in business have been identified that are relevant to Takaful as follows:

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1.    
Underwriting risk

2.    
Operational risks

3.    
Credit risk

4.    
Liquidity risk

5.    
Market risk

 

Underwriting risk and
operational risk are directly related to the operations of the takaful company.
The remaining three risks are associated with the company’s investment
activities. All types of risk in takaful require specific risk management
strategies and need to be managed individually.

 

The effectively
manage the risks in takaful involves the following steps:

1.    
Identifying
risks

2.    
Managing
risks

3.    
Enhancing
risks management culture in takaful industry

 

The three
current practical challenges in risk management which is confronting takaful
operators as follows:

1.              
Shari’ah
Based Challenges

 

Most of the risk management
techniques do not apply to Islamic financial institutions due to Shari’ah
compliance requirements. It creates a Shari’ah-based challenge to risk
management for Takaful companies. These challenges emerge because Shari’ah
prohibits the use of certain instruments, but that instrument considered useful
in conventional risk management. For instance: derivatives (which involve futures,
options, swaps) and sales of debts.

 

2.              
Internal Controls

Internal controls are vital to
recognize and assess the risks faced by financial institutions including
Takaful companies. The existence of effective internal control has prevented
financial institutions from systemic crisis and enabled them to get early
detection of the problems and risks they might face in the future. This
experience highlights the crucial and need for internal control for Takaful
companies. The unique nature of these companies from conventional insurance
demands the fulfillment of Shari’ah aspects. To have an effective internal
control mechanism, the Takaful company must ensure that Shari’ah controls are
in addition to all statutory regulations. It urges the need for a Syariah audit
as part of an ongoing internal control system.

 

3. Corporate Governance

The structure of corporate
governance determines the distribution of rights and responsibilities of the
Board, managers, shareholders and other stakeholders, but effective corporate
governance ensures the independence of board of director(BOD) who subsequently
devise policies and executes strategies for risk management and hold management
accountable to shareholders. The lack of effective corporate governance
framework impedes the independence of the BOD and thereby poses a challenge to
risk management. It further increases the operational risk which may lead to
operational failures due to BOD’s inability to implement unbiased and
independent decisions for the best interests of all stakeholders. Takaful
companies are confronted with additional challenges related to the Shari’ah
Supervisory Board corporate governance. It requires more need to incorporate
corporate governance culture to address the issues related to the Takaful
industry.