Risk management can be defined as asystematic approach to managing risks that threaten the assets and income of abusiness or entrepreneurship. There are five types of risks in business have beenidentified that are relevant to takafulas follows:1. Underwriting risk2. Operational risks3. Credit risk4. Liquidity risk5. Market risk Underwriting risk andoperational risk are directly related to the operations of the takaful company.
The remaining three risks are associated with the company’s investmentactivities. All types of risk in takaful require specific risk managementstrategies and need to be managed individually. The effectivelymanage the risks in takaful involves the following steps:1.
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Identifyingrisks2. Managingrisks3. Enhancingrisks management culture in takaful industry The threecurrent practical challenges in risk management which is confronting takafuloperators as follows: 1. Shari’ahBased ChallengesPractically, most of the risk management techniquesare not applicable to Islamic financial institutions due to Shariah compliancerequirements.
Therefore, Shari’ah-based challenge to risk management wascreated for takaful companies. These challenges arise because Shari’ahprohibits the use of certain instruments such as derivatives involving futures,options, swaps; and debt sales, but these instruments are considered beneficialin conventional risk management. 2. Internal ControlsInternal controls areimportant to recognize and assess the risks faced by financial institutionsincluding Takaful companies.
The existence of effective internal controls canprevent financial institutions from systemic crises and enable them to be awareof the possible problems and risks they may face in the future. This emphasizethe importance and need of internal control for Takaful companies. To have aneffective internal control mechanism, the Takaful company must ensure thatShariah controls are in addition to all statutory regulations. It urges Syariahaudit requirements as part of an on-going system of internal control.
3. Corporate GovernanceThe structure of corporategovernance determines the distribution of rights and responsibilities of theBoard, managers, shareholders and other stakeholders, but effective corporategovernance will ensure the independence of the board of director (BOD) which willdevelops policies and implements strategies for risk management. The lack ofeffective corporate governance framework prevents the independence of the BODand thereby poses a challenge to risk management. It continues to increaseoperating risks which may lead to operational failures due to BOD’s inabilityto implement unbiased and independent decisions for the best interests of allstakeholders. Takaful companies are faced with additional challenges related tothe Shariah Supervisory Board’s corporate governance where it requires moreneed to incorporate corporate governance culture to address issues related tothe Takaful industry.