Takaful - Collective Pricing and Risk-Weighted Pricing of Tabarru’

The amount of tabarru’ collected from participants is important because it provides the financial resources for the Participants’ Risk Fund (PRF) to pay valid covered claims.

However, participants do not necessarily bring the same level of risk into the pool.

Some participants may have a relatively low expected claims risk, while others may have a higher expected claims risk.

This creates an important pricing question:

Should every participant pay the same tabarru’, or should the tabarru’ differ according to the risk each participant brings into the pool?

Two approaches can be considered:

Collective pricing

and

Risk-weighted pricing

1. What Is Collective Pricing?

Collective pricing means participants within a particular pool are charged a common or average tabarru’ rate, even though their individual risk levels may differ.

In simple terms:

Different levels of risk → Same or average tabarru’ rate

The tabarru’ is based on the average risk of the group rather than being individually adjusted for each participant’s specific risk.

2. Simple Collective Pricing Example

Suppose four participants have different expected claim costs:

Ahmad

Expected claim cost = RM200

Ali

Expected claim cost = RM400

Sarah

Expected claim cost = RM1,200

Fatimah

Expected claim cost = RM200

Total expected claims:

RM200 + RM400 + RM1,200 + RM200 = RM2,000

Average expected claim cost:

RM2,000 ÷ 4 = RM500

Under a simplified collective pricing approach, each participant could therefore contribute:

RM500 tabarru’

Total tabarru’ collected:

RM500 × 4 = RM2,000

3. What Happens Under Collective Pricing?

Although everyone pays RM500, their expected risks are different.

Ahmad

Expected risk cost = RM200

Tabarru’ = RM500

Ahmad contributes more than his individual expected risk cost.

Sarah

Expected risk cost = RM1,200

Tabarru’ = RM500

Sarah contributes substantially less than her individual expected risk cost.

Therefore, collective pricing can involve:

Cross-subsidisation

where lower-risk participants effectively contribute relatively more toward the overall cost of higher-risk participants.

4. Is Cross-Subsidisation Always a Problem?

Not necessarily.

Risk pooling itself involves participants collectively sharing losses.

However, a problem can arise when the common tabarru’ rate creates incentives for participants to decide whether to enter or remain in the pool based on their individual risk.

This becomes particularly important when participation is:

Voluntary

because participants can choose whether the common price is attractive to them.

5. Collective Pricing Works Better With Compulsory Membership

Suppose all four participants are required to remain in the pool.

Then:

Total tabarru’ collected = RM2,000

Total expected claims = RM2,000

The low-risk and high-risk participants remain together.

Therefore, the averaging mechanism can continue to function.

This is why collective pricing can work more effectively when membership in the relevant pool is compulsory.

The basic idea is:

Compulsory Membership → Low and High Risks Remain Together → Average Pricing More Sustainable

6. Problem With Voluntary Membership - Anti-Selection

When participation is voluntary, collective pricing can create:

Anti-selection

also commonly called:

Adverse selection

Anti-selection occurs when the pricing arrangement makes participation relatively more attractive to higher-risk participants and less attractive to lower-risk participants.

In simple terms:

The people most likely to claim may find the common price attractive, while people less likely to claim may find it too expensive.

7. Simple Anti-Selection Example

Suppose everyone must pay:

RM500 tabarru’

Ahmad has a relatively low expected risk:

RM200

Ahmad may think:

“My expected risk is much lower than RM500. This arrangement seems expensive for me.”

He may decide not to participate.

Sarah has a much higher expected risk:

RM1,200

but she only needs to contribute:

RM500.

The common rate may therefore appear relatively attractive to Sarah.

As a result:

Lower-risk participants → More likely to leave or not join

while:

Higher-risk participants → More likely to join or remain

This changes the risk composition of the pool.

8. Why Is Anti-Selection Dangerous?

Suppose the original tabarru’ rate was calculated assuming the pool contained:

many low-risk participants

and

some high-risk participants.

Now many low-risk participants leave.

The remaining pool contains a greater proportion of:

Higher-risk participants

Therefore:

Average expected claims increase.

But if the tabarru’ remains at the old average level, the PRF may no longer collect enough money to support the new risk profile.

The process becomes:

Common Average Tabarru’

↓

Low-Risk Participants Find It Relatively Expensive

↓

Some Low-Risk Participants Leave

↓

Higher-Risk Participants Become a Larger Part of Pool

↓

Average Expected Claims Increase

↓

Tabarru’ May Become Inadequate

↓

Greater Risk of PRF Deficit

9. What Is Risk-Weighted Pricing?

An alternative is:

Risk-Weighted Pricing

Under risk-weighted pricing:

The tabarru’ payable by each participant is linked to the amount of risk that participant brings into the risk pool.

Therefore:

Different Risk → Different Tabarru’

A participant presenting higher expected claims risk would generally contribute a higher tabarru’ than a participant presenting lower expected claims risk, subject to the applicable pricing framework.

10. Simple Risk-Weighted Pricing Example

Suppose actuarial analysis estimates:

Ahmad

Expected claim cost = RM200

Ali

Expected claim cost = RM400

Sarah

Expected claim cost = RM1,200

Fatimah

Expected claim cost = RM200

Under a very simplified risk-weighted approach:

Ahmad’s tabarru’ = RM200

Ali’s tabarru’ = RM400

Sarah’s tabarru’ = RM1,200

Fatimah’s tabarru’ = RM200

Total tabarru’:

RM200 + RM400 + RM1,200 + RM200

= RM2,000

Total expected claims:

RM2,000

The total amount collected reflects the total expected risk, while the amount contributed by each participant more closely reflects that participant’s individual expected risk.

11. Why Does a Higher-Risk Participant Pay More Tabarru’?

The purpose is not to punish the participant.

The objective is to ensure that the contribution reflects the expected financial cost of the risk being introduced into the PRF.

Suppose:

Participant A has expected claim cost = RM300

Participant B has expected claim cost = RM1,000

If both contribute only:

RM300

then Participant B’s expected risk is significantly underfunded.

If many participants similar to B enter the pool, the PRF may collect insufficient tabarru’ relative to its expected claims.

Therefore:

Higher Expected Risk → Higher Required Risk Contribution

12. Risk Factors Can Affect Tabarru’

The actuary may consider relevant risk characteristics when determining the expected claims cost.

Depending on the type of Takaful product, relevant factors can include matters such as:

age

health characteristics

occupation

type and value of property

claims history

sum covered

and other relevant factors permitted within the applicable regulatory and underwriting framework.

The purpose is to estimate:

How much expected claims risk does this participant bring into the pool?

13. Higher-Risk Participant Illustration

Suppose a particular participant is assessed as presenting a higher expected claims risk than other participants.

For example:

Expected claim frequency for lower-risk participant = 2%

Expected claim frequency for higher-risk participant = 6%

Suppose the expected amount payable if a claim occurs is:

RM20,000

For the lower-risk participant:

2% × RM20,000 = RM400

For the higher-risk participant:

6% × RM20,000 = RM1,200

Therefore:

Lower expected risk cost = RM400

Higher expected risk cost = RM1,200

This helps explain why the actuarially determined tabarru’ may differ between participants.

14. Claim Frequency and Claim Severity

Two important elements in determining expected claims are:

Claim Frequency

How often claims are expected to occur.

and

Claim Severity

How large the claims are expected to be when they occur.

A simplified formula is:

Expected Claim Cost = Expected Claim Frequency × Expected Claim Amount

For example:

Expected claim frequency = 5%

Expected claim amount = RM20,000

Therefore:

5% × RM20,000 = RM1,000

Simplified expected claim cost:

RM1,000

This provides an actuarial basis for determining an appropriate risk contribution.

15. Why Historical Claims Data Is Important

Actuaries cannot know exactly what will happen in the future.

Instead, they analyse relevant information such as:

historical claim frequency

historical claim severity

participant characteristics

sum covered

claims trends

and other relevant risk information.

The process can be understood as:

Historical Claims Information

↓

Identify Relevant Risk Characteristics

↓

Estimate Claim Frequency

↓

Estimate Claim Severity

↓

Estimate Expected Claim Cost

↓

Determine Appropriate Risk-Weighted Tabarru’

16. What Happens When More High-Risk Participants Enter the Pool?

Suppose a pool initially contains mostly lower-risk participants.

Expected total claims:

RM1 million

The required tabarru’ would be determined with reference to that risk profile and other relevant actuarial considerations.

Now suppose the same number of participants remains, but the pool contains many more higher-risk participants.

Expected claims might increase to:

RM2 million

Under risk-weighted pricing, the higher-risk participants would generally contribute higher tabarru’ amounts.

Therefore:

More High-Risk Participants

↓

Higher Total Expected Claims

↓

Higher Risk-Weighted Tabarru’ Requirements

↓

Higher Total Tabarru’ Collected

This helps the PRF’s funding respond to changes in the risk composition of the pool.

17. Why Is This Important for the PRF?

The PRF needs sufficient financial resources to meet valid covered claims.

Suppose the pool becomes significantly riskier, but tabarru’ remains unchanged.

Then:

Risk increases

but:

Tabarru’ does not increase

This creates a mismatch.

For example:

Total tabarru’ = RM10m

Expected claims increase to = RM14m

Potential expected funding gap:

RM4m

Therefore, risk-weighted pricing helps align:

Risk Accepted ↔ Tabarru’ Collected

18. Does Risk-Weighted Pricing Guarantee That Tabarru’ Will Be Enough?

No.

Risk-weighted pricing is based on expected claims, but actual claims remain uncertain.

Suppose:

Expected total claims = RM10m

Appropriate tabarru’ collected = RM10m, in a simplified illustration.

But unexpectedly severe claims result in:

Actual claims = RM15m

Then:

RM15m − RM10m = RM5m

Claims are RM5m higher than expected.

Therefore:

Risk-weighted pricing improves the relationship between expected risk and contributions, but it cannot eliminate uncertainty.

19. Why Can Actual Claims Differ From Expected Claims?

Claims can differ because of:

random fluctuations

unexpectedly large claims

changes in claim frequency

changes in claim severity

catastrophic events

inflation

and other unforeseen developments.

Therefore, appropriate pricing is only one part of sound Takaful risk management.

The PRF may also rely on:

appropriate margins

technical provisions

retained surplus

financial buffers

Retakaful

diversification

and sound:

risk management.

20. Expected Claims vs Actual Claims

This distinction is extremely important.

Expected Claims

An actuarial estimate made before the future claims are known.

For example:

Expected claims = RM10m

Actual Claims

The claims that actually emerge.

For example:

Actual claims = RM12m

Therefore:

Expected claims are an estimate; actual claims are the eventual experience.

This is why actuarial pricing can improve the probability of adequate funding but cannot guarantee the exact outcome.

21. Does Risk-Weighted Pricing Remove Risk Sharing?

No.

This is one of the most important concepts.

Suppose:

Ahmad contributes = RM300

Ali contributes = RM600

Sarah contributes = RM1,000

Fatimah contributes = RM500

They contribute different amounts because their risks differ.

But their tabarru’ still goes into:

The common Participants’ Risk Fund

If Ali subsequently suffers a valid covered loss of:

RM20,000

he does not simply receive his:

RM600

back.

His valid covered claim is paid from the collective PRF, according to the applicable terms.

Therefore:

Different contribution amounts do not eliminate mutual risk sharing.

22. Pricing and Risk Pooling Are Different Concepts

This distinction is very useful.

Pricing asks:

How much should each participant contribute to the risk pool?

Risk pooling asks:

How are the covered financial losses of participants shared?

Under risk-weighted Takaful:

Participants can pay different tabarru’ amounts

while:

their covered risks remain collectively pooled through the PRF.

Therefore:

Risk-Weighted Pricing ≠ Individual Self-Insurance

The participant is still part of a mutual risk-sharing arrangement.

23. Collective Pricing and Risk-Weighted Pricing Compared

Collective Pricing

The contribution is based on a:

common or average rate.

Therefore:

Low risk → Same/average tabarru’

Medium risk → Same/average tabarru’

High risk → Same/average tabarru’

This can create cross-subsidisation and may encourage anti-selection when participation is voluntary.

Risk-Weighted Pricing

The contribution is linked more closely to individual expected risk.

Therefore:

Lower risk → Lower tabarru’

Medium risk → Moderate tabarru’

Higher risk → Higher tabarru’

This helps the total contributions collected adjust when the overall risk profile of the pool changes.

24. Connection With PRF Deficit

Suppose many higher-risk participants enter the pool but continue paying a tabarru’ amount designed for a lower-risk population.

Then:

Higher-Risk Pool

↓

Expected Claims Increase

↓

Tabarru’ Remains Too Low

↓

Insufficient PRF Funding

↓

Claims May Exceed Available Resources

↓

Greater Risk of PRF Deficit

Risk-weighted pricing helps reduce this mismatch by adjusting contributions to reflect expected risk.

25. Connection With Solvency

Appropriate pricing also contributes to the financial sustainability of the Takaful arrangement.

The process is:

Proper Risk Assessment

↓

Appropriate Tabarru’

↓

Adequate PRF Funding

↓

Greater Ability to Meet Claims

↓

Stronger Financial Sustainability

However, pricing alone cannot guarantee solvency.

Financial strength also depends on:

actual claims experience

technical provisions

investment performance

Retakaful

liquidity

capital support

and other risk-management measures.

26. Connection With Surplus and Deficit

Suppose:

Total relevant PRF income = RM10m

Relevant claims, costs and provisions = RM8m

Simplified result:

RM10m − RM8m = RM2m surplus

However, if claims and relevant obligations instead become:

RM12m

then:

RM10m − RM12m = −RM2m

The PRF has a:

RM2m deficit

Therefore, appropriate risk-weighted pricing improves the starting financial position by aligning tabarru’ with expected risk, but the eventual result still depends on actual experience.

27. Why the Actuary Is Important

The actuary helps determine appropriate tabarru’ by assessing:

Who is entering the pool?

What level of risk do they bring?

How frequently are claims expected?

How severe could claims be?

What is the expected total claims cost?

and:

How much tabarru’ should be collected to support those risks?

Therefore, actuarial pricing helps prevent the PRF from accepting increasing amounts of risk without receiving an appropriate corresponding amount of tabarru’.

Easy Way to Remember

COLLECTIVE = AVERAGE

Participants with different risks pay a common or averaged tabarru’ rate.

Possible problem:

Low-risk participants pay relatively more

while:

High-risk participants pay relatively less

If participation is voluntary, this can contribute to:

Anti-selection

RISK-WEIGHTED = RISK-BASED

The tabarru’ reflects the expected risk each participant brings into the pool.

Therefore:

Lower Expected Risk → Lower Tabarru’

Higher Expected Risk → Higher Tabarru’

But all participants still share their risks through the:

Common PRF

Simple Formula

A simplified actuarial starting point is:

Expected Claim Cost = Expected Claim Frequency × Expected Claim Amount

For example:

5% × RM20,000 = RM1,000

Therefore, the expected claim cost is:

RM1,000

The actuary then considers the relevant risk characteristics and other actuarial factors when determining the appropriate tabarru’.

Anti-Selection Formula

Remember:

Common Average Tabarru’

• ●

Voluntary Participation

↓

Lower-Risk Participants May Find the Price Less Attractive

↓

Higher-Risk Participants May Find the Price More Attractive

↓

Pool Becomes Higher Risk

↓

Expected Claims Increase

↓

Greater Risk of Insufficient Tabarru’

Risk-Weighted Pricing Formula

Participant’s Risk ↑ → Expected Claims Cost ↑ → Required Tabarru’ ↑

At the pool level:

Higher Overall Risk → Higher Expected Claims → Higher Required Total Tabarru’

This helps keep the PRF’s contributions more closely aligned with the risks it is accepting.

One-Sentence Summary

Collective pricing applies a common or averaged tabarru’ rate to participants with different risk levels and can encourage anti-selection when participation is voluntary, whereas risk-weighted pricing links each participant’s tabarru’ more closely to the expected risk they bring into the pool, helping total contributions reflect total expected claims while preserving mutual risk sharing through the common Participants’ Risk Fund.