Dynamic Underwriting and Risk Management

Takasure represents a departure from existing Takaful products in the following ways.

• Absence of external capital providers

• Absence of retakaful or reinsurance providers

• Global fund with no historical data

Absence of capital providers

Because the DAO fund is fully community-owned, there are no external capital providers. Typically, external capital providers (such as the takaful operators and their investors) provide capital to an insurance fund not for the purposes of being insured, but as an investment that will yield a profit. Hence external capital providers will share in the underwriting surplus along with the takaful operator and participants. External capital providers are most important in the early years of the fund when the fund is small and contributions alone may not be sufficient to cover claims that have a defined benefit.

Imagine a scenario where in the first month of fund inception, there are 100 participants who have paid in $100 each. The fund will have total contributions of $10,000. Suppose one of the participants makes a successful claim for a sum assured (defined benefit) of $100,000, then the fund is wiped out. Having external capital at this time will be very useful to maintain the capital needed to keep the fund going.

The down side of introducing external capital is that it reintroduces the zero sum profit motive that pits insurance companies against their customers, the insured. In this case, capital providers will not look favorably upon claims being paid as this will directly reduce the underwriting surplus, and therefore reduce their profit.

The Takasure DAO fund is structured to operate without external capital providers. To avoid a scenario where the fund is wiped out by claims, Takadao will apply dynamic underwriting that adjusts the benefit multiplier (introduced in the previous section) according to the performance of the fund.

Back to the example of 100 participants in month 1 of the fund, who have paid in $100 each. The fund has a total contribution of $10,000. Participant Q makes a successful claim. Having a claim in month 1 in a fund with only 100 participants is highly unusual and generally not predicted in actuarial models, which means that the fund has performed poorly. Based on initial underwriting, Participant Q had an individual risk profile that allocated to him a Base Benefit Multiplier (B.BM) of 100x. However, due to the poor performance of the fund, the B.BM for all participants is adjusted downward. A Benefit Multiplier Adjuster (BM.A) of 0.5x* is therefore applied to all base benefit multipliers for all outstanding claims. Participant Q’s claim is therefore paid out at $100 (his initial contribution) x 100 (his B.BM) x 0.5 (portfolio BM.A) = $5,000.

*Important: the numbers in this example are used for illustrative purposes only and are not actual.

Note that such a scenario is extreme and is only likely in the early days of the fund when capital is low. As the fund matures and the number of participants increases, the risk is spread out among many more participants and hence the individual impact is lower. The older and larger the fund is, the lower the individual impact of poor fund performance.

On the flip side, if the fund performance is better than expected, the BM.A will be greater than 1x and individual claims payouts will increase. This goes back to the fundamental principle of risk sharing where both losses and rewards are shared.

Another important point to note is that claims payouts will not fluctuate wildly based on market conditions. Monies allocated for investments will make up a minority portion of the total capital in the fund, the majority of the fund being allocated to capital reserves that are maintained for claims payouts. The major factor that causes fluctuations in fund performance, and therefore claims payouts, are related to mortality rates, which tend to be stable over a long enough period of time. Outside of catastrophic events, mortality rates tend to be stable or slightly improve over time, which limits fluctuations.

Given the global nature of Takadao, catastrophic events in a single country or territory will affect the Takadao fund less than a national insurance fund. For example, an earthquake in a single country will likely wipe out the insurance funds in that country as all the risk is concentrated in that geographic location. With Takadao, risk is spread out globally, so a catastrophic event in a single country will have less impact on Takadao than a national insurance fund.