Risk, Solvency and the Benefit Multiplier

Another key point of discussion is the claims benefit payout. The structure of the benefit payouts are designed to de-risk the DAO fund and ensure ongoing solvency by pegging the benefit payouts to contributions and fund performance. Adjusting for individual underwriting risk, the more an individual contributes, the larger his benefit payout. The better the fund performs, the higher the benefit payout and vice versa. The key point is that all risk and reward accrue to the DAO fund only and not the takaful operator. Hence the objective of all underwriting and risk management activities is to prolong the life of the DAO fund and ensure solvency.

In conventional life insurance, the policyholder is promised a sum assured regardless of how much he has paid in premiums. As long as the insurance policy is in force and his claim is approved, he is guaranteed to receive that amount no matter where in the lifecycle of the policy he is. He could have made only a single monthly premium payment and he will still receive the same benefit payout as if he had made 5 years of payments. This goes back to the concept of risk transfer as the insured has now effectively transferred all the risk to the insurer and hence the insured is not entitled to any of the benefit or underwriting surplus. In a risk-sharing model like Takasure, instead of a sum assured, we determine claims benefit payouts using a benefit multiplier.

At the time of underwriting prior to a policy being issued, an individual is first rated based on his individual risk. For life insurance, the rating will depend on age, residence, occupation and lifestyle, among other factors. The better the rating, the lower the risk and the higher the ensuing benefit multiplier. The rating schemes are determined by mortality rates and actuarial risk analyses.

As an example, a 25 year old non-smoker living in a Western country and working in a low stress office environment may be assigned a benefit multiplier of 150x.

In the event of death, the benefit amount will be determined by the total contributions paid by the insured multiplied by the benefit multiplier.

Continuing the example, the 25-year old insured makes monthly contributions of $15 for 2.5 years, totaling $450. He passes away and his family is entitled to a claim benefit of $450 x 150 = $67,500. If instead, he had made monthly contributions for 5 years, totaling $900, the benefit amount would raise to $900 x 150 = $135,000.

The primary reasons for using a benefit multiplier instead of a sum assured are to ensure equity among participants and to de-risk the fund to prolong solvency. Recall that all underwriting surplus is redistributed among the fund participants, so everyone benefits from a de-risked fund.

To further de-risk the fund, the benefit multiplier fluctuates within an expected range, according to the performance of the DAO fund. In any insurance-type product, there is an expected amount of losses that are incurred from claims, called the “loss ratio”. The loss ratio is based on the amount of risk that is taken on as a result of the underwriting process. In simple terms, if all of the policies are insuring senior citizens, the loss ratio is expected to be higher than if all the policies are insuring young healthy adults.

Benchmarking against historical data, we have underwriting models that project an expected loss ratio of the DAO fund. The assigned benefit multipliers are based on these expected loss ratios. In case reality does not match history, the benefit multipliers will be adjusted up or down within a given range.

In our example, the anticipated loss ratio for the DAO fund is 40%. In simple terms, that means we expect 40% of all contributions to be spent paying claims. Based on this loss ratio, our 25-year old insured is assigned a benefit multiplier of 150x. In the event that the loss ratio is increased significantly to 50%, an adjustment downward will be made to the benefit multipliers of all who are currently insured. The adjustment will be equivalent to the amount necessary to restore the financial outflows to expected amounts, in order to keep the DAO fund solvent. A deeper discussion of how these amounts are determined can be found in later sections of this whitepaper.

These adjustments are not arbitrary and are based on published financial models and also coded into smart contracts that are open source and publicly auditable. The solvency of the DAO fund (which results in the ability to honor all claims) is always the ultimate goal of all underwriting and financial decisions undertaken by the takaful operator. Furthermore, the actions of the takaful operator are overseen by the independent board of directors that represents the DAO fund. More on DAO governance can be found in later sections of this whitepaper.