Takaful - Conflict in an Agent-Principal Arrangement

This issue is about a possible conflict of interest between the Takaful operator and the participants under a Wakalah arrangement.

The basic relationship is:

Participants = Principal

Takaful Operator = Agent (Wakil)

The participants appoint the operator to manage the Takaful arrangement on their behalf. The operator receives a Wakalah fee for providing this service.

The potential problem arises when the way the Wakalah fee is calculated gives the operator an incentive to increase contribution volume, even when doing so may weaken the Participants’ Risk Fund (PRF).

1. What Is an Agent-Principal Relationship?

An agent-principal relationship exists when one party appoints another party to act on its behalf.

In Takaful:

Participants appoint the Takaful operator to manage the Takaful operation on their behalf.

Therefore:

Principal = Participants

Agent/Wakil = Takaful Operator

For example, participants are not personally going to:

underwrite every participant,

manage claims,

arrange Retakaful,

manage the PRF,

keep financial records,

and administer certificates.

Instead, they appoint the Takaful operator to perform these activities.

2. How Does the Operator Earn Money?

Under a Wakalah model, the operator receives a Wakalah fee.

Suppose participants collectively pay:

RM100 million contributions

and the Wakalah fee is:

20% of contributions

The operator receives:

RM100m × 20% = RM20 million Wakalah fee

If contributions increase to:

RM150 million

then:

RM150m × 20% = RM30 million Wakalah fee

Therefore:

Higher contribution volume → Higher absolute Wakalah fee

This creates an economic incentive for the operator to increase business volume.

3. What Does “Turnover” Mean Here?

Here, turnover basically refers to the volume of Takaful business/contributions generated.

For example:

Year 1 contributions:

RM100 million

Year 2 contributions:

RM150 million

Turnover has increased substantially.

Increasing turnover is not automatically bad.

If the operator attracts more participants through:

good products

good service

proper pricing

careful underwriting

and

effective distribution

then business growth can be healthy.

The problem arises when the operator increases turnover through underpricing or poor underwriting.

4. Where Does the Conflict of Interest Arise?

Suppose the Wakalah fee is:

20% of total contributions

The operator benefits financially when it sells more Takaful certificates.

This could create an incentive to think:

“If we reduce contributions, more people may join. If more people join, total contribution volume may increase. If contribution volume increases, our Wakalah fee increases.”

But lower prices can become dangerous if they are actuarially inadequate.

So the operator’s interest may become:

Increase sales → Increase contributions collected → Increase Wakalah fee

while the participants’ interest is:

Proper pricing → Adequate PRF → Sufficient money for claims → Financially sustainable risk pool

These interests are not necessarily automatically aligned.

5. Example - Properly Priced Product

Suppose the actuarially appropriate contribution is:

RM1,000 per participant

The Wakalah fee is:

20%

Therefore:

RM200 → Operator

RM800 → PRF as tabarru’

Suppose the RM800 allocation is actuarially adequate for the expected PRF obligations.

If:

10,000 participants join

total contributions are:

RM10 million

Operator Wakalah fees:

RM2 million

Tabarru’ into PRF:

RM8 million

If the risks were properly underwritten and priced, this may represent healthy growth.

6. Now Suppose the Operator Reduces the Price

Imagine the operator wants to attract many more participants.

Instead of charging:

RM1,000

it charges:

RM800

Because the price is cheaper, suppose:

20,000 participants join

Total contributions become:

20,000 × RM800 = RM16 million

The Wakalah fee remains 20%.

Therefore:

Operator Wakalah fee = RM3.2 million

The operator’s Wakalah fee has increased from:

RM2 million → RM3.2 million

So the operator benefits from the higher turnover.

But now look at the PRF.

7. The PRF May Become Underfunded

From each RM800 contribution:

20% Wakalah fee = RM160

Remaining tabarru’:

RM640

Suppose actuarial analysis indicates that approximately:

RM800 per participant

should actually have been allocated to the PRF to support the risk adequately.

But only:

RM640

is entering the PRF.

So:

Required = RM800

Actual = RM640

Shortfall = RM160 per participant

Across 20,000 participants:

RM160 × 20,000 = RM3.2 million potential funding shortfall

The operator has increased its Wakalah fee income through higher turnover, while the PRF may have become financially weaker.

That is the central conflict.

8. Poor Underwriting Can Create the Same Problem

The operator does not necessarily have to reduce prices to create this problem.

It could also accept too many high-risk participants without charging contributions appropriate to their risks.

Suppose a participant represents an expected risk cost of:

RM1,500

but is accepted at a contribution appropriate for someone whose risk cost is only:

RM800

This attracts more business but exposes the PRF to claims that are not adequately funded.

Therefore:

Poor Underwriting + Inadequate Pricing → More Business Today → Potential PRF Deficits Later

9. Why Is This an Agent-Principal Conflict?

Because the benefit and the cost can fall on different parties.

Operator

Benefits from:

higher Wakalah fee income

Participants / PRF

May suffer:

inadequate tabarru’

higher claims relative to contributions

lower surplus

or

PRF deficit

Therefore:

Operator receives more fee

while:

Participants’ risk fund bears the consequences of poor underwriting

This creates an agency problem.

10. Very Simple Example

Imagine Ahmad appoints Ali to manage a fund.

Ahmad tells Ali:

“I will pay you 20% of every RM1 you bring into the fund.”

Ali therefore has an incentive to bring as much money and business into the arrangement as possible.

But suppose Ali begins accepting very risky business simply because doing so increases the amount on which his 20% fee is calculated.

Ali receives:

more fees

while Ahmad’s fund bears:

more losses

That is a conflict between:

Agent’s financial incentive

and

Principal’s financial interest.

11. Why Is the Issue Different in Conventional Insurance?

The economic consequence is different because, in conventional insurance, the insurer generally bears the underwriting risk.

Suppose a conventional insurer deliberately underprices its products.

Proper premium should be:

RM1,000

but it charges:

RM700

It attracts many customers.

Initially:

Sales ↑

Premium volume ↑

But eventually:

Claims > adequate premiums

↓

Underwriting losses

↓

Shareholders’ financial resources are affected

Therefore, the conventional insurer and its shareholders have a strong direct financial reason not to underprice indefinitely.

12. Why Can the Conflict Be More Complicated in Takaful?

In Takaful:

PRF bears the participants’ underwriting risk

while:

Operator receives Wakalah fee for managing the arrangement.

Therefore, suppose the operator underprices aggressively.

It may initially experience:

More participants

↓

Higher contribution volume

↓

Higher Wakalah fee

But the consequences of inadequate underwriting may appear in:

PRF claims

↓

PRF underwriting deficit

The financial benefit and underwriting consequence may therefore fall into different funds.

This is the important structural issue.

13. Compare the Two Very Carefully

Conventional Insurance

Insurer underprices.

↓

More customers.

↓

Premium volume increases.

↓

Claims eventually exceed adequate premiums.

↓

Insurer/shareholder financial position suffers.

Takaful Under a Wakalah Structure

Operator underprices or accepts poor risks.

↓

More participants.

↓

Contribution volume increases.

↓

Operator’s Wakalah fee may increase.

↓

Insufficient tabarru’ may enter PRF relative to risk.

↓

Claims become excessive relative to PRF resources.

↓

PRF suffers deficit.

This is why simply saying:

“The operator is only an agent.”

does not solve the incentive problem.

14. Connection With Your Previous Topic - Wakalah Fee

This directly connects with the issue you studied earlier.

Suppose:

Total contribution = RM1,000

Wakalah fee = RM200

Tabarru’ = RM800

If RM800 is actuarially adequate, there may be no problem.

But suppose the operator reduces the total contribution to:

RM750

Wakalah fee at 20%:

RM150

Tabarru’:

RM600

Yet the PRF really needs:

RM800

Now:

RM600 < RM800

The participant sees a cheaper Takaful product.

The operator may gain more sales.

But the PRF becomes inadequately funded.

15. Connection With Surplus

Poor pricing also affects the possibility of generating a surplus.

Suppose:

PRF tabarru’ = RM10 million

Claims and relevant obligations = RM8 million

Simplified surplus:

RM2 million

Now suppose underpricing results in only:

RM7 million

entering the PRF.

But claims and obligations remain:

RM8 million

Then:

RM7m − RM8m = −RM1m

Instead of:

RM2m surplus

the PRF has:

RM1m deficit

So poor pricing can transform a potentially sustainable risk pool into a deficit situation.

16. What Is Fiduciary Responsibility?

This is another very important concept.

A fiduciary responsibility means the operator is entrusted to act responsibly, honestly and carefully in managing the interests and assets placed under its management.

In simple terms:

The operator should not exploit its position as agent to benefit itself at the unfair expense of participants.

Under Wakalah, the operator is not simply:

“Someone who collects a fee.”

It is a Wakil entrusted with managing the participants’ arrangement.

Therefore, the operator should exercise appropriate care in matters such as:

pricing

underwriting

claims management

investment

Retakaful

PRF management

and

conflicts of interest.

17. Fiduciary Character of Wakalah

The idea of Wakalah should therefore not be reduced to:

Participants pay fee → Operator performs service

There is also an element of trust and responsibility.

The operator is entrusted with managing funds and risks on behalf of participants.

Therefore:

Wakalah = Agency + Fee + Trust/Responsibility

The operator should not deliberately pursue a strategy that increases its fee while knowingly damaging the financial position of the participants’ risk fund.

18. Mudarabah Has a Similar Responsibility

Under Mudarabah:

Participants/capital providers provide the relevant funds

while:

Mudarib manages/invests them

according to the applicable arrangement.

The Mudarib is also expected to perform its role responsibly.

Therefore, whether acting as:

Wakil under Wakalah

or

Mudarib under Mudarabah

the operator’s role involves responsibilities toward the funds and participants it serves.

19. Normal PRF Deficit vs Deficit Caused by Operator Misconduct

This is a particularly important distinction.

Not every PRF deficit means the operator did something wrong.

A deficit could arise even with proper management because:

claims were unexpectedly high

a catastrophe occurred

claims severity exceeded reasonable expectations

or other adverse experience occurred.

For example:

Expected claims = RM10m

Actual claims after an unexpected catastrophe = RM15m

The operator may have priced and underwritten prudently, but the PRF still experiences a deficit.

Under the applicable structure, qard may be used to support the fund.

20. But What If the Operator Caused the Deficit Through Negligence or Misconduct?

Now imagine the deficit occurred because the operator:

deliberately underpriced products

ignored proper underwriting standards

accepted inappropriate risks

or otherwise failed to discharge its responsibilities properly.

The source argues that it would be problematic if the operator could simply say:

“The PRF has a deficit. We will lend the PRF money through qard, and the PRF will repay us later.”

Why?

Because ultimately the participants’ fund would still bear the financial consequences of the operator’s own failure.

21. Why an Outright Shareholder Transfer Is Different From Qard

This distinction is extremely important.

Qard

Suppose:

PRF deficit = RM5 million

Shareholders provide:

RM5 million qard

The PRF receives the money, but qard is an interest-free loan that may be repayable from future PRF surpluses according to the applicable rules.

So economically:

Shareholders support PRF now → PRF may repay shareholders later

Outright Transfer

Suppose the same RM5 million deficit resulted from the operator’s failure to discharge its responsibilities properly.

Under the regulatory approach being proposed here:

Shareholders transfer RM5 million to PRF

but it is not treated as qard repayable by the PRF.

Therefore:

Shareholders bear the financial consequence

rather than passing the eventual cost back to participants.

This creates stronger accountability.

22. Why Would This Better Align Interests?

Imagine management knows:

“If we deliberately underprice products to increase Wakalah fees, and this causes a PRF deficit, shareholders may have to cover the resulting deficit without repayment.”

Now shareholders and management have a much stronger incentive to ensure:

proper pricing

proper underwriting

adequate tabarru’

good governance

and

responsible management

Therefore:

Operator causes problem → Operator/shareholder side bears consequence

This helps reduce the conflict of interest.

23. Important - Do Not Assume Every Deficit Must Be Paid by Shareholders Outright

The distinction is:

Genuine adverse claims experience

Operator acted prudently, but unexpectedly bad claims occurred.

→ PRF deficit may be supported through qard, depending on the applicable Takaful framework.

Deficit caused by operator’s failure to properly discharge its responsibilities

For example, negligent or improper underwriting/pricing.

→ The regulatory approach described here argues that shareholders should make an outright transfer rather than qard.

So the principle is:

Participants should not ultimately have to repay shareholders for a deficit that arose because the operator failed in its own responsibilities.

24. Complete Numerical Example

Suppose:

Proper contribution = RM1,000

Wakalah fee = 20%

Adequate tabarru’ = RM800

There are:

10,000 participants

Proper structure:

Total contributions = RM10m

Operator Wakalah fee = RM2m

PRF tabarru’ = RM8m

Everything is actuarially appropriate.

Now suppose the operator aggressively reduces the price to:

RM800

This attracts:

20,000 participants

Total contributions:

RM16m

Operator Wakalah fee:

20% × RM16m = RM3.2m

So the operator’s fee has increased:

RM2m → RM3.2m

But PRF receives:

RM12.8m

Suppose the risks accepted actually require:

RM16m

of adequate risk funding.

The PRF is therefore substantially underfunded relative to the risks accepted.

Eventually, poor claims experience produces a deficit.

So:

Operator benefits from higher turnover

while

Participants suffer through weaker PRF

That is the agent-principal conflict.

Easy Way to Remember

Think of:

FEE vs FUND

The operator wants a sustainable:

FEE

Participants need a sustainable:

FUND

A badly designed incentive can encourage:

More Sales → More Wakalah Fee

while simultaneously causing:

Poor Pricing → Insufficient Tabarru’ → PRF Deficit

Good governance must align the two interests.

Simple Formula

Potential Conflict

Wakalah Fee % × Higher Contribution Turnover = Higher Operator Fee Income

But if growth comes from poor pricing:

Lower Price + Poor Underwriting → Insufficient Tabarru’ → PRF Deficit

Therefore:

Operator Benefit ↑ while Participant Fund Strength ↓

= Agent-Principal Conflict

How to Reduce the Conflict

The solution is not to prevent the operator from earning profit.

A commercially sustainable Takaful operator needs appropriate remuneration.

Instead, governance should ensure that:

Operator profitability

is compatible with:

PRF sustainability and participant interests

So:

Proper Pricing + Prudent Underwriting + Adequate Tabarru’ + Fiduciary Responsibility + Appropriate Accountability = Better Alignment of Operator and Participant Interests

One-Sentence Summary

The agent-principal conflict in Takaful arises because a Wakalah fee based on contribution volume may encourage the operator to maximise sales and fee income, while poor pricing or underwriting can leave insufficient tabarru’ in the Participants’ Risk Fund and cause deficits borne by participants; therefore, the operator’s fiduciary responsibilities and appropriate regulatory accountability are necessary to align the operator’s interests with those of the participants.