Takaful - Distribution of Underwriting Surplus to Participants and the Takaful Operator

An important issue in Takaful is determining who is entitled to receive the underwriting surplus that arises in the Participants’ Risk Fund (PRF).

One approach allows the surplus to be distributed to:

1. Eligible participants

and

2. The Takaful operator

However, allowing the Takaful operator to receive part of the PRF surplus is a Shari’ah issue on which different approaches exist.

In Malaysia, the Shariah Advisory Council of Bank Negara Malaysia (SAC-BNM) permits the operator to receive an agreed share under specified conditions.

1. First, What Is the Surplus?

The surplus being discussed is the underwriting surplus arising from the Takaful risk fund, rather than simply the operator’s own business profit.

In simplified form:

Underwriting Surplus = PRF Income − Claims − Relevant Expenses − Required Provisions/Obligations

Suppose:

PRF income = RM10 million

Claims and other relevant obligations = RM8 million

Simplified underwriting surplus:

RM10m − RM8m = RM2m

The question then becomes:

What should happen to this RM2 million?

Depending on the applicable Takaful framework, the surplus might be retained in the PRF, distributed to eligible participants, or dealt with through another permitted mechanism.

A more controversial question is:

Can some of the surplus also be given to the Takaful operator?

2. Malaysian SAC-BNM Position

The SAC-BNM permits surplus to be distributed to the Takaful operator provided the method of distribution has been clearly disclosed and agreed upon by the participants when entering into the Takaful contract.

This condition is very important.

The operator should not simply decide at the end of the year:

“There is a surplus, so we will take 30%.”

Instead, the surplus-sharing arrangement should already form part of the contractual arrangement agreed by the parties.

Therefore:

Clear Surplus-Sharing Method + Participant Agreement at Contract Formation → Operator May Receive Agreed Share under the Malaysian approach

3. Why Is Participant Agreement Important?

The reasoning refers to the importance of mutual consent between contracting parties.

The relevant fiqh principle can be understood as:

Contractual arrangements are fundamentally based on the consent of the contracting parties, provided the agreed terms do not contradict Shari’ah principles.

Therefore, if the participant knowingly enters a Takaful arrangement that clearly states how surplus will be allocated, that agreement provides the contractual basis for the agreed distribution under this approach.

However, consent does not mean:

“Anything agreed between the parties automatically becomes Shari’ah-compliant.”

The contractual term must still be consistent with applicable Shari’ah requirements.

4. Surplus Distribution Under the Wakalah Model

Under a Wakalah model:

Participants = Principals

Takaful Operator = Wakil/Agent

The operator manages the Takaful arrangement and normally receives a:

Wakalah fee

for performing its management role.

Under the Malaysian approach described here, the operator may additionally receive an agreed share of underwriting surplus as a:

Performance Fee

provided this arrangement has been appropriately agreed upon.

5. What Is a Performance Fee?

A performance fee is an additional reward linked to the financial performance of the Takaful risk fund.

The basic idea is:

If the operator manages the Takaful operation effectively and a surplus arises, the operator may receive an agreed percentage as an incentive or performance-related reward.

This is separate conceptually from the ordinary Wakalah fee.

6. Simple Wakalah Example

Suppose the PRF produces:

RM1 million underwriting surplus

The Takaful contract states that:

20% of distributable surplus → Operator as performance fee

80% → Eligible participants

Then:

Operator:

20% × RM1m = RM200,000

Participants:

80% × RM1m = RM800,000

Therefore:

Operator receives = RM200,000

Eligible participants collectively receive = RM800,000

This is only a simplified illustration. Before any distribution, applicable actuarial, regulatory, contractual and financial requirements would still need to be satisfied.

7. Wakalah Fee vs Performance Fee

Do not confuse these two.

Wakalah Fee

The normal fee paid to the operator for:

managing the Takaful business.

It is part of the operator’s remuneration for acting as the:

Wakil

Performance Fee

An additional amount that may be linked to:

the emergence of an underwriting surplus

under a structure that permits such an arrangement.

Therefore:

Wakalah Fee = Payment for management

while:

Performance Fee = Additional incentive linked to performance/surplus

8. Why Use a Performance Fee?

One possible objective is to align the interests of the operator with the participants.

If the operator benefits when the PRF performs well, the operator has an incentive to:

price appropriately

underwrite prudently

manage claims efficiently

control relevant costs

and

manage the PRF carefully.

The intended chain is:

Better PRF Management

↓

Better Financial Experience

↓

Surplus Emerges

↓

Participants and Operator May Both Benefit

However, this incentive structure must be carefully governed because it can also create conflicts of interest.

9. Potential Conflict of Interest

Suppose the operator receives:

20% of surplus

The operator now has a financial incentive to increase the amount of reported surplus.

That can be positive if surplus results from genuine:

efficient management

and

prudent underwriting.

But it could become problematic if the incentive encouraged inappropriate actions such as:

under-provisioning for future claims

or

excessive restriction of valid claim payments.

For example:

Proper technical provisions = RM10m

Suppose only RM7m were recognised.

Liabilities could appear:

RM3m lower

and surplus could appear:

RM3m higher.

That could improperly increase the operator’s performance fee.

This is one reason why:

Actuarial oversight + Shari’ah governance + regulatory supervision

are important.

10. Why the Actuary Is Important Here

The operator should not be able to create a larger distributable surplus simply by underestimating the PRF’s obligations.

The actuary assesses matters such as:

technical provisions

claims liabilities

claims volatility

future claim-paying capacity

and

whether surplus distribution is financially prudent.

Therefore:

Calculate Proper Liabilities

↓

Determine Genuine Surplus

↓

Assess Whether Distribution Is Safe

↓

Only Then Consider Surplus Allocation

This protects participants from excessive distributions that could weaken the PRF.

11. Surplus Sharing Under Mudarabah

A different arrangement may apply under a:

Mudarabah model

In Mudarabah:

one party provides capital/funds

while:

the Mudarib manages the activity

and profits are shared according to an agreed:

Profit-Sharing Ratio

The material describes an approach under which surplus may be shared with the Takaful operator according to an agreed percentage or profit-sharing ratio.

The important point for your notes is:

The contractual basis for the operator’s remuneration differs between Wakalah and Mudarabah structures.

12. Simple Mudarabah Illustration

Suppose the relevant amount available for sharing is:

RM1 million

and the agreed sharing ratio is:

Participants = 70%

Operator = 30%

Then:

Participants:

70% × RM1m = RM700,000

Operator:

30% × RM1m = RM300,000

The precise Shari’ah characterisation and permissible treatment of underwriting surplus under Mudarabah is one of the areas where standards and practices can differ, so this simplified illustration should not be treated as a universal rule for every Takaful operation.

13. Wakalah and Mudarabah - Easy Distinction

For study purposes:

Wakalah

Operator acts as:

Agent/Wakil

Normal remuneration:

Wakalah Fee

Where permitted and agreed, an additional:

Performance Fee

may be linked to surplus.

Mudarabah

Operator acts as:

Mudarib/Manager

Remuneration is associated with an agreed:

Profit-Sharing Ratio

The exact treatment must follow the applicable Shari’ah, contractual and regulatory framework.

14. Why Is Operator Sharing of Underwriting Surplus Controversial?

The key issue is:

Who does the underwriting surplus actually belong to?

The underwriting risk in Takaful is borne collectively through the:

Participants’ Risk Fund

The operator manages the arrangement but does not bear the underwriting risk in the same way that a conventional insurer does.

This leads to the argument:

If the participants collectively bear the underwriting risk, why should the operator receive part of the underwriting surplus?

This is one reason operator participation in underwriting surplus is debated from a Shari’ah perspective.

15. The Argument Against Operator Surplus Sharing

The reasoning can be understood as:

Participants contribute Tabarru’

↓

Participants collectively bear underwriting risk through PRF

↓

PRF pays participants’ covered claims

↓

Any underwriting surplus arises in PRF

Therefore, some Shari’ah approaches conclude that:

The operator should not share in the underwriting surplus merely because it manages the fund.

The operator already receives its agreed remuneration under the applicable management arrangement.

16. The Argument Permitting Operator Surplus Sharing

The alternative position allows an operator share where:

the arrangement is clearly disclosed

participants agree to it when entering the contract

and

the arrangement satisfies the applicable Shari’ah requirements.

Under this reasoning, an operator’s agreed share can function as a:

Performance incentive

The Malaysian SAC-BNM approach described here permits such an arrangement.

17. Different Shari’ah Approaches

This is therefore an area where there is not complete uniformity across Takaful jurisdictions and standard-setting approaches.

The material identifies Malaysia and Brunei as jurisdictions where operator surplus sharing has been practised.

By contrast, it reports that the Islamic Financial Services Board (IFSB) describes a “near-consensus” against sharing underwriting surplus with Takaful operators, including through performance-related or incentive fees.

Therefore, for study purposes, remember:

Malaysian SAC-BNM Approach

Operator surplus sharing can be permitted subject to the applicable contractual and Shari’ah conditions.

Broader IFSB Position Described

There is strong support for the view that underwriting surplus should not be shared with the operator.

18. Why Do These Views Differ?

The disagreement mainly concerns the nature and ownership of the underwriting surplus.

One approach emphasises:

Contractual Consent

If participants knowingly agree to an operator performance fee and it does not contradict Shari’ah requirements, it may be permissible.

The other approach emphasises:

Nature of the PRF

Because underwriting risk belongs collectively to the participants’ fund, the resulting underwriting surplus should remain associated with participants/the fund rather than becoming operator remuneration.

Therefore, the disagreement can be simplified as:

Contractual Consent and Incentive

versus

Ownership and Nature of Underwriting Surplus

19. Surplus Does Not Have to Be Distributed

There is another important distinction.

Even if the rules allow participants or an operator to receive surplus, it does not mean every surplus must be distributed.

Suppose:

PRF underwriting surplus = RM5m

The actuary determines that:

RM3m should be retained

to strengthen the PRF against future claims volatility.

Only:

RM2m

may be considered available for distribution, subject to applicable rules.

Therefore:

Surplus arising ≠ Surplus automatically distributable

20. Why Retain Surplus?

Retained surplus can strengthen the PRF’s:

Financial Buffer

For example:

Total surplus = RM5m

Retained = RM3m

Potentially distributable = RM2m

The RM3m remains available to strengthen the fund against:

unexpected claims

claims volatility

and other adverse financial experience.

Therefore:

Surplus

↓

Assess Financial Position

↓

Retain Necessary Amount

↓

Determine Distributable Surplus

↓

Apply Permitted Distribution Method

21. Full Surplus Distribution Process

The process can be understood as:

PRF Receives Tabarru’

↓

Covered Claims and Relevant Obligations Arise

↓

Technical Provisions Recognised

↓

Financial Result Determined

↓

Underwriting Surplus Exists

↓

Actuary Assesses Whether Distribution Is Prudent

↓

Necessary Amount Retained for Financial Strength

↓

Distributable Surplus Determined

↓

Depending on the applicable framework:

Participants

and, where permitted:

Operator

may receive the agreed allocation.

Easy Way to Remember

Use:

AGREE → EARN → ASSESS → DISTRIBUTE

AGREE

The surplus-sharing method must be properly established in the contractual arrangement where operator sharing is permitted.

EARN

A genuine underwriting surplus must actually arise.

ASSESS

The financial position and future claim-paying ability must be considered.

DISTRIBUTE

The distributable amount is allocated according to the applicable contractual, regulatory and Shari’ah requirements.

Key Shari’ah Issue to Remember

The debate can be reduced to one question:

Should an operator that manages the PRF but does not itself bear the participants’ underwriting risk be entitled to part of the PRF’s underwriting surplus?

Different Shari’ah and regulatory approaches have answered this differently.

Therefore, do not memorise:

“The operator always receives surplus.”

or:

“The operator can never receive surplus.”

Instead remember:

The treatment depends on the applicable Shari’ah standard, jurisdiction, Takaful model and contractual arrangement.

Simple Formula

If operator sharing is permitted and the distributable surplus is:

RM1,000,000

and the agreed performance fee is:

20%

then:

Operator Share = RM1,000,000 × 20% = RM200,000

Remaining amount:

RM800,000

would be dealt with according to the applicable surplus-distribution arrangement.

One-Sentence Summary

Under the Malaysian SAC-BNM approach, a Takaful operator may receive an agreed portion of distributable underwriting surplus where the arrangement is clearly established and accepted by participants—such as a performance fee under Wakalah—while other Shari’ah approaches, including the near-consensus described by the IFSB, oppose operator participation in underwriting surplus because the underwriting risk and resulting surplus are associated with the participants’ risk fund.