Takaful - Example of a Sufficiently Large Number of Risks

• A sufficiently large number of risks means having enough separate risks in the pool so that overall claims become more predictable and manageable.
• The idea is that one individual loss should not have too much impact on the whole fund.

Example 1 – Motor Takaful

Suppose a Motor Takaful operator covers only:

• 20 cars

If 5 cars are involved in serious accidents, the claims may be very large compared with the size of the pool.

Small Pool

• 20 cars covered
• 5 serious claims
• Very difficult to predict
• A few claims can heavily affect the fund

Larger Pool

Now suppose the operator covers:

• 100,000 cars

From past experience, it may estimate that:

• Around 5% will make claims
• Around 5,000 claims may occur
• Average claim may be approximately RM5,000

The operator still cannot predict exactly which cars will have accidents, but it can estimate the overall level of claims more reliably.

Simple Idea

20 risks → Very unstable

100,000 risks → More predictable

Example 2 – Retakaful

Retakaful needs an even larger and more diversified pool because each risk can be very large.

Suppose a Retakaful operator accepts risks from only:

• 3 Takaful operators

Each Takaful operator has large factory risks.

If one major earthquake affects all three, the Retakaful operator may face extremely large claims at the same time.

Small Retakaful Pool

• 3 Takaful operators
• Similar types of property risk
• Same geographical area
• One catastrophe can affect all of them

This is not a sufficiently large and diversified pool.

Better Retakaful Example

Suppose the Retakaful operator instead accepts business from:

• 50 Takaful operators
• 15 different countries
• Several types of risk:
• Motor
• Property
• Marine
• Family Takaful
• Engineering
• Agriculture

Now one event is less likely to affect the entire portfolio.

Example

A flood in Malaysia may affect:

• Malaysian property risks

But it may not affect:

• Motor risks in Saudi Arabia
• Marine risks in Indonesia
• Family Takaful risks in the UAE

Simple Idea

More risks + Different countries + Different types of risks = Better pooling

Why the Number Must Be Large

The larger the number of risks:

• The easier it is to estimate expected claims
• The less impact one individual claim has
• The more stable the financial results become
• The better the risk can be spread

Simple Example

If a fund contains only:

10 large risks

and one claim is RM100 million, that one claim may seriously damage the fund.

But if the fund contains:

10,000 diversified risks

the impact of one RM100 million loss may be more manageable relative to the entire pool.

Easy Way to Remember

Sufficiently large number of risks does not simply mean “many customers.”

It means having:

• Many risks
• Different types of risks
• Different geographical locations
• Enough financial volume
• Good diversification

Simple Formula

Large Number + Diversification = More Predictable Claims + More Stable Risk Pool