Takaful - Distribution of Underwriting Surplus Is Not Allowed

Another approach to the treatment of underwriting surplus is that the surplus should not be distributed at all.

Under this approach, neither the participants nor the Takaful operator receives the underwriting surplus as a distribution.

Instead:

The entire surplus remains within the Participants’ Risk Fund (PRF) and strengthens the fund for the benefit of the risk-sharing arrangement.

The main reasoning is based on the nature of tabarru’. Once participants contribute their tabarru’ to the risk pool, they are considered to have relinquished their individual rights to the amount donated.

1. What Does “Distribution Is Not Allowed in Totality” Mean?

It means:

No underwriting surplus is distributed out of the PRF.

Therefore:

Participants → No surplus distribution

and

Takaful operator → No surplus distribution

Instead:

Surplus → Remains in the PRF

The accumulated surplus can then be used to strengthen the fund and support future claims.

2. Why Is the Surplus Not Distributed?

The reasoning begins with the concept of:

Tabarru’

Tabarru’ means a contribution made on a donation basis for the purpose of mutual assistance.

When participants contribute tabarru’ into the PRF, they are not simply depositing personal savings into an individual account.

Instead, they relinquish their individual ownership claim over the donated amount so that it can be used collectively to help participants who suffer covered losses.

Therefore:

Participant makes Tabarru’

↓

Money enters PRF

↓

Individual right over donated amount is relinquished

↓

Money becomes available for collective risk sharing

This leads to the argument that participants cannot later automatically claim:

“There is money left in the PRF, so part of it must be returned to me.”

3. What Does “Relinquished Any Rights” Mean?

To relinquish means to:

give up or surrender a right or claim.

Suppose Ahmad contributes:

RM1,000 tabarru’

into the PRF.

Once the contribution is made on a genuine tabarru’ basis, Ahmad cannot treat that RM1,000 as though it remains his personal savings.

For example, he cannot normally say:

“I made no claim this year, so return my RM1,000.”

The contribution has already been committed to the collective risk-sharing arrangement.

Therefore:

Tabarru’ ≠ Personal Savings Deposit

4. Legal Right and Beneficial Right

The reasoning goes further by saying participants hold neither a:

Legal right

nor a:

Beneficial right

over the amounts they donated.

A legal right would mean the participant has an enforceable ownership claim over that donated amount.

A beneficial right, in this context, would mean the participant continues to have an individual economic ownership interest in that particular donated amount.

Under the non-distribution approach, the argument is:

Once tabarru’ has been donated to the risk fund, the participant no longer individually owns or controls that donated amount.

5. But Participants Can Still Receive Claims

This distinction is extremely important.

Saying that Ahmad no longer owns his RM1,000 tabarru’ does not mean Ahmad loses his Takaful protection.

Ahmad can still receive a valid covered claim according to the Takaful certificate.

For example:

Ahmad contributes:

RM1,000 tabarru’

Later, Ahmad suffers a valid covered loss:

RM50,000

The PRF may pay the RM50,000 according to the certificate terms.

Therefore:

The participant gives up individual ownership of the tabarru’ contribution but receives the benefit of mutual protection from the collective risk pool.

6. Why Is the Donation Nature Important in Takaful?

The tabarru’ structure supports the mutual assistance nature of Takaful.

Participants are effectively saying:

“I contribute this amount to the common fund so that it can be used to assist participants who suffer covered losses, including myself if I later suffer such a loss.”

Therefore:

Individual Contribution

↓

Donation to Common Fund

↓

Collective Risk Pool

↓

Mutual Financial Protection

The contribution is not simply:

“My money waiting for me to take it back.”

7. Why Does This Lead to No Surplus Distribution?

Suppose:

Participants collectively contribute = RM10 million

Relevant claims and obligations = RM8 million

Simplified surplus:

RM2 million

Under the non-distribution approach, participants cannot simply say:

“The RM2 million came from our contributions, so give it back to us.”

The argument is that participants already relinquished their individual rights over the tabarru’ contributions.

Therefore:

RM2 million remains within the PRF

rather than being distributed.

8. What Happens to the Surplus?

The surplus is retained as part of the financial resources of the risk fund.

For example:

Year 1 surplus retained = RM2m

Year 2 surplus retained = RM3m

Year 3 surplus retained = RM1m

Simplified accumulated amount:

RM2m + RM3m + RM1m = RM6m

The PRF now has additional accumulated financial strength that can help support future claims.

9. First Benefit - Strengthens the PRF

One major benefit of retaining the surplus is that it:

Consolidates and strengthens the risk fund.

Instead of distributing the money and removing it from the PRF, the surplus remains available to support the fund.

Therefore:

Underwriting Surplus

↓

Not Distributed

↓

Retained in PRF

↓

PRF Financial Strength Increases

This creates a stronger fund for future periods.

10. Second Benefit - Helps Pay Claims in Future Years

Claims do not necessarily remain stable every year.

For example:

Year 1

Claims = RM5m

Year 2

Claims = RM6m

Year 3

Claims = RM12m

Year 3 may experience unexpectedly high claims.

If the surplus from Years 1 and 2 was retained, the accumulated amount can help the PRF absorb the higher claims in Year 3.

Therefore:

Good Years Help Support Bad Years

This extends risk sharing across different periods.

11. Simple Multi-Year Example

Suppose:

Year 1

PRF surplus = RM2m

The entire RM2m is retained.

Year 2

PRF surplus = RM3m

Again, it is retained.

Accumulated surplus:

RM5m

Then in Year 3, claims are unexpectedly:

RM4m higher than expected

The accumulated financial strength from earlier years can help absorb the adverse claims experience.

So:

Earlier Surplus

↓

Accumulated Reserve/Financial Strength

↓

Later High Claims

↓

PRF Better Able to Absorb the Loss

12. Connection With Financial Buffer

The retained surplus effectively strengthens the PRF’s:

Financial Buffer

Remember:

A financial buffer is additional financial strength available to absorb unexpected adverse experience.

Therefore:

Surplus Retained

↓

Financial Buffer Becomes Stronger

↓

Unexpected Claims Occur

↓

PRF Has Greater Loss-Absorbing Capacity

This can reduce the likelihood that a bad claims year immediately creates severe financial difficulty.

13. Connection With Qard

A stronger PRF may also reduce reliance on:

Qard

Suppose the PRF has no accumulated surplus.

Unexpected claims produce:

RM3m deficit

Depending on the applicable Takaful framework, the shareholder/operator fund may need to provide qard.

Now suppose the PRF had accumulated:

RM5m

from earlier surpluses.

That accumulated financial strength may help absorb the adverse experience before external financial support becomes necessary.

Therefore:

Retained Surplus → Stronger PRF → Lower Potential Dependence on Qard

14. Third Benefit - Future Contributions May Be Lower

Another potential benefit is that accumulated reserves can reduce the amount of new funding that needs to be collected from participants in future periods, if actuarially and regulatorily appropriate.

Suppose the PRF has:

No accumulated surplus

The actuary estimates that the fund needs:

RM10m

from participants to support the coming year’s risk.

Now suppose the PRF already has substantial accumulated financial strength.

Depending on the pricing framework and the risks being accepted, this may allow the required future contribution burden to be reduced.

Therefore:

Accumulated Surplus

↓

Stronger Existing PRF Resources

↓

Potentially Less Need for Additional Funding

↓

Potentially Lower Future Contributions

This is not automatic: contributions still need to remain actuarially adequate for the risks and obligations of the fund.

15. Simple Contribution Example

Suppose 10,000 participants are expected to enter the pool.

Without sufficient accumulated reserves, assume the required contribution is:

RM1,000 each

Total:

10,000 × RM1,000 = RM10m

Now suppose the PRF has built substantial accumulated financial strength from previous years.

After actuarial assessment, assume the required new contribution can prudently be reduced to:

RM900 each

Participants now pay:

RM100 less each

For 10,000 participants:

RM100 × 10,000 = RM1m

less in new contributions.

This illustrates how retaining surplus today can potentially benefit participants indirectly through lower future funding requirements.

16. Participants Can Benefit Without Receiving Cash Surplus

This is an important concept.

A participant might think:

“If the surplus isn’t distributed to me, I receive no benefit.”

That is not necessarily true.

Participants can benefit indirectly through:

a financially stronger PRF

greater ability to pay future claims

lower likelihood of financial distress

less potential reliance on qard

and potentially:

lower future contributions

Therefore:

No Cash Distribution ≠ No Participant Benefit

The benefit can remain inside the collective arrangement.

17. Fourth Benefit - Takaful Can Become More Competitive

If accumulated surplus allows future contributions to be priced lower while remaining financially adequate, the Takaful product may become more attractive.

Suppose:

Takaful contribution = RM1,200

After sufficient accumulated financial strength and actuarial assessment:

New contribution = RM1,000

The participant saves:

RM200

A lower but still financially sound contribution can make the product more competitive in the market.

Therefore:

Retained Surplus

↓

Stronger PRF

↓

Potential for Lower Future Contribution Requirements

↓

More Attractive Pricing

↓

Greater Competitiveness

18. Lower Pricing Must Still Be Actuarially Sound

This qualification is very important.

The operator should not reduce contributions merely because the PRF has accumulated some surplus.

Suppose expected future claims require:

RM900 per participant

but the operator reduces tabarru’ to:

RM500

simply to attract more customers.

The PRF could become underpriced.

Therefore:

Accumulated surplus may support lower future contributions, but pricing must still reflect the expected risks and maintain the financial soundness of the PRF.

The objective is:

Lower but Adequate Pricing

not:

Unsustainably Cheap Pricing

19. Why Not Distribute Surplus and Then Charge More Next Year?

Suppose the PRF distributes:

RM5m

to participants this year.

Next year, the fund needs more financial resources and therefore increases contributions.

Participants receive money today but may have to pay more later.

Under the non-distribution approach, the argument is that it can be more sustainable to:

retain the RM5m inside the PRF

so that the money continues supporting the collective risk-sharing arrangement.

Therefore:

Retain Surplus Today

↓

Build Long-Term PRF Strength

↓

Support Future Claims

↓

Potentially Stabilise Future Contributions

This emphasises the long-term sustainability of the fund rather than immediate cash distribution.

20. Risk Sharing Across Different Years

This approach also highlights an important idea:

Risk sharing does not have to occur only among participants in the same year.

Surplus accumulated from participants in earlier periods can strengthen the PRF for participants in later periods.

For example:

Year 1 participants generate surplus

↓

Surplus remains in PRF

↓

Year 2 fund remains strong

↓

Year 3 experiences unexpectedly high claims

↓

Accumulated resources help meet those claims

Therefore, the PRF creates a form of:

Intergenerational / Interperiod Risk Sharing

meaning financial strength built in one period can help support the risk pool in later periods.

21. Non-Distribution vs Participants-Only Distribution

It is useful to distinguish the two approaches.

Participants-Only Distribution

A distributable surplus may be paid to:

Eligible participants

but:

not the operator.

No Distribution at All

Surplus is paid to:

Participants → No

Operator → No

Instead:

100% remains in the PRF

Therefore:

Participants-only distribution gives participants a direct cash benefit, while non-distribution seeks to provide participants with an indirect long-term benefit through a stronger PRF.

22. Non-Distribution vs Operator-Sharing Approach

There are therefore three broad approaches you have studied:

Approach 1 - Participants and Operator

Where permitted, distributable surplus may be shared between:

participants + operator

according to the applicable arrangement.

Approach 2 - Participants Only

Distributable surplus goes to:

eligible participants

and:

operator receives no underwriting-surplus share.

Approach 3 - No Distribution

Surplus goes to:

neither participants nor operator.

Instead:

Surplus remains in PRF

The third approach prioritises accumulation and long-term financial strength.

23. Why the Actuary Is Still Important

Even under a policy of retaining surplus, the actuary remains important.

The actuary can assess:

expected future claims

claims volatility

technical provisions

financial strength

appropriate contribution levels

and the effect of accumulated resources on future pricing.

Therefore, the actuary can help answer:

“Given the financial strength already accumulated in the PRF, what level of future contribution remains actuarially appropriate?”

24. Full Process

The whole idea can be understood as:

Participants Pay Tabarru’

↓

Tabarru’ Enters PRF

↓

Participants Relinquish Individual Rights to Donated Amount

↓

PRF Pays Covered Claims

↓

Underwriting Surplus Arises

↓

Do Not Distribute Surplus

↓

Retain It in PRF

↓

Build Financial Strength

↓

Support Claims in Future Years

↓

Reduce Potential Dependence on Qard

↓

Potentially Reduce Future Contribution Requirements

↓

Potentially Improve Takaful Competitiveness

Easy Way to Remember

Use:

RETAIN → STRENGTHEN → SUPPORT → REDUCE

RETAIN

Do not distribute the underwriting surplus.

STRENGTHEN

Keep it inside the PRF to build financial strength.

SUPPORT

Use the stronger fund to support claims in future years.

REDUCE

A stronger reserve position may allow future contributions to be reduced where actuarially appropriate.

Simple Example

Suppose:

PRF underwriting surplus = RM5m

Under the non-distribution approach:

Participants receive = RM0

Operator receives = RM0

PRF retains = RM5m

The RM5m then strengthens the fund.

If a later year produces unexpectedly high claims of:

RM3m above expectation

the accumulated resources can help absorb the additional claims.

Therefore:

RM5m Retained Surplus → Absorb RM3m Adverse Experience → PRF Remains Stronger

Key Concept to Remember

The argument is not:

“Participants should receive no benefit from the surplus.”

Rather, it is:

“The benefit should remain collective within the PRF instead of being individually distributed.”

Participants may therefore benefit through:

Stronger Claims-Paying Capacity + Greater Stability + Potentially Lower Future Contributions

One-Sentence Summary

Under the non-distribution approach, participants are regarded as having relinquished their individual rights to the tabarru’ donated to the risk pool, so any underwriting surplus is retained entirely within the PRF rather than distributed to participants or the operator; this strengthens the fund for future claims, builds financial resilience, may reduce dependence on qard, and can potentially support lower future contributions and greater Takaful competitiveness.