Takaful - Elements Determining Gross Contribution

The gross contribution is the total amount that a participant pays into a Takaful plan.

The image explains that the actuary first determines the appropriate tabarru’ amount/rate based on the risk being covered. After that, other components are added to determine the total or gross contribution payable by the participant.

The basic structure is:

Gross Contribution = Tabarru’ Rate + Wakalah Fee + Surplus Loading (Optional)

Each component serves a different purpose and should not be confused with the others.

1. Role of the Actuary in Determining Tabarru’

One important actuarial responsibility is determining how much tabarru’ should be charged for the risk.

Remember:

Tabarru’ = contribution allocated to the common risk fund for mutual protection.

The amount should not simply be guessed.

The actuary estimates it based on the expected cost of claims.

A simplified approach is:

Expected Claim Cost = Expected Claim Frequency × Expected Amount Payable Per Claim

The image refers to the expected sum payable should a claim arise, which is essentially the expected claim amount/severity used in the calculation.

2. What Is Expected Claim Frequency?

Claim frequency means how often claims are expected to occur.

For example, suppose historical data shows that among:

1,000 similar participants

approximately:

50 claims

occur each year.

Then:

Expected Claim Frequency = 50 ÷ 1,000 = 5%

This means the actuary expects approximately 5 claims for every 100 similar risks, on average.

It does not mean the actuary knows exactly which participants will claim.

3. What Is the Expected Sum Payable?

This refers to the amount the fund expects to pay when a covered claim occurs.

Suppose historical claims data indicates that the average covered claim is:

RM20,000

The actuary can combine this with the expected claim frequency.

If:

Expected claim frequency = 5%

Expected claim payment = RM20,000

Then:

5% × RM20,000 = RM1,000

So the simplified expected claims cost per similar risk is:

RM1,000

This provides a starting point for determining the appropriate risk-related tabarru’ amount.

4. Why Does the Actuary Use Historical Claims Data?

The actuary needs evidence to estimate future claims.

Historical claims data from similar risks can provide information about:

how frequently claims occur

and

how large those claims tend to be.

For example, when pricing Motor Takaful, the actuary may analyse past claims for participants with similar relevant risk characteristics.

The basic process is:

Historical Claims Data

↓

Estimate Claim Frequency

• ●

Estimate Claim Severity/Amount

↓

Estimate Expected Claims Cost

↓

Determine appropriate risk-based Tabarru’ rate

5. Tabarru’ Should Reflect Risk

The image states that the tabarru’ rate is determined actuarially based on:

Risk factors of participants

and

Sum covered

This means participants with different risk exposures may require different tabarru’ amounts.

This is called risk-based pricing.

6. Example - Different Risks, Different Tabarru’

Suppose Ahmad and Ali both purchase Motor Takaful.

Ahmad

Lower expected risk based on the relevant rating factors.

Expected claims cost = RM700

Ali

Higher expected risk based on the relevant rating factors.

Expected claims cost = RM1,200

It would not necessarily be financially appropriate to charge both exactly the same risk contribution.

The actuarial calculation may therefore produce different tabarru’ rates.

The principle is:

Higher Expected Risk → Higher Required Risk Contribution

7. Why Does the Sum Covered Matter?

The sum covered represents the amount of protection provided, subject to the certificate terms.

Generally, a greater amount of exposure can result in a greater potential financial obligation for the PRF.

For example, consider two similar covered properties:

Property A sum covered = RM500,000

Property B sum covered = RM2 million

All else equal, the potential financial exposure associated with Property B can be greater.

Therefore, the sum covered is an important factor in actuarial pricing.

8. First Component - Tabarru’ Rate

The first component of gross contribution is therefore:

Tabarru’ Rate

This is the risk-related contribution determined actuarially.

The money allocated as tabarru’ goes into the:

Participants’ Risk Fund (PRF)

The PRF is then used collectively to pay valid covered claims.

Therefore:

Participant pays Tabarru’

↓

Tabarru’ enters PRF

↓

Risks are pooled

↓

PRF pays covered claims of participants

9. Why Must the Tabarru’ Rate Be Adequate?

This connects directly with your previous topic on pricing adequacy.

Suppose the actuarially appropriate tabarru’ is:

RM800 per participant

But only:

RM500

is actually allocated.

Shortfall:

RM800 − RM500 = RM300 per participant

For 10,000 participants:

RM300 × 10,000 = RM3 million

The PRF could be underfunded by approximately RM3m relative to that simplified requirement.

Therefore:

Inadequate Tabarru’ → Insufficient PRF Funding → Greater Deficit Risk

10. Second Component - Wakalah Fee

The second component is the:

Wakalah Fee

Remember:

Wakalah = agency arrangement

The Takaful operator acts as:

Wakil = Agent

while participants are:

Principals

The operator manages the Takaful operation on behalf of the participants and receives a fee for performing that role.

Therefore:

Wakalah fee = remuneration paid to the Takaful operator for managing the Takaful business.

11. What Does the Wakalah Fee Cover?

According to the image, the Wakalah fee can include amounts relating to:

Administrative expenses

For example:

employee salaries

office expenses

IT systems

claims administration

customer service

compliance

and other operational costs.

12. Return/Cost Associated With Shareholders’ Capital

The image also identifies a portion relating to the cost of shareholders’ capital, described there as their profit margin.

Shareholders provide financial capital to establish and support the Takaful operator.

They generally expect a reasonable return for providing that capital and taking the associated business risk.

Therefore, the operator cannot necessarily operate indefinitely by charging fees that merely cover its immediate administrative expenses.

It also needs a sustainable business model.

This connects with what you studied earlier:

Treating participants fairly does not necessarily mean charging the lowest possible Wakalah fee.

The fee should be reasonable while allowing the operator to operate sustainably.

13. Sales Intermediary Commission

Part of the gross contribution may also support commissions paid to:

agents

brokers

or other:

sales intermediaries

For example, an agent introduces Ahmad to a Family Takaful product and completes the sale.

The intermediary may receive a commission according to the applicable remuneration arrangement.

This forms part of the distribution/acquisition cost of selling Takaful.

14. Why Must Wakalah Fees Be Carefully Managed?

Suppose:

Gross contribution = RM1,000

Wakalah fee = RM200

Then, in a very simplified example:

RM800 remains for tabarru’/risk funding.

If the PRF actuarially requires RM800:

Adequate

But suppose Wakalah fee becomes:

RM400

Then:

RM1,000 − RM400 = RM600

If the PRF still actuarially requires:

RM800

there is a:

RM200 funding gap

Therefore, the operator’s fee structure should not undermine the actuarial adequacy of the PRF.

15. Important - Wakalah Fee and Tabarru’ Have Different Purposes

Do not mix them up.

Tabarru’

Purpose:

Fund the participants’ risk pool and covered claims.

Goes to:

PRF

Wakalah Fee

Purpose:

Compensate the operator for managing the Takaful operation and cover relevant operator costs/remuneration.

Goes to:

Takaful operator/shareholder fund according to the structure

Therefore:

Tabarru’ funds the risk; Wakalah fee funds/remunerates the management of the arrangement.

16. Third Component - Surplus Loading

The third component shown is:

Surplus Loading

But importantly, the image states that this is:

OPTIONAL

This means it is not necessarily included in every Takaful contribution.

A surplus loading is an additional amount built into the contribution where there is an intention to build up surplus that may support future surplus refunds/distributions, subject to the applicable structure and rules.

17. Why Include a Surplus Loading?

Suppose a Takaful arrangement intends to return/distribute surplus to eligible participants when experience is favourable.

If the pricing is designed only to cover the central expected cost with no additional allowance, there may be less room for a surplus to emerge.

Therefore, the pricing structure may include an additional:

Surplus Loading

This can help create additional financial strength and increase the possibility of surplus emerging if actual experience is favourable.

However:

Surplus loading does NOT guarantee that participants will receive a surplus distribution.

18. Example of Surplus Loading

Suppose the contribution is constructed as:

Tabarru’ = RM800

Wakalah fee = RM200

Optional surplus loading = RM100

Therefore:

Gross Contribution = RM800 + RM200 + RM100

Gross Contribution = RM1,100

The participant therefore pays:

RM1,100

But this does not mean the participant is guaranteed to receive the RM100 back later.

19. Why Isn’t the Surplus Loading Guaranteed to Come Back?

Because actual claims experience could be worse than expected.

Suppose the additional RM100 is included, but during the year the PRF experiences unexpectedly high claims.

That additional financial amount may contribute to absorbing those adverse claims.

Therefore:

Surplus Loading Included

does not mean:

Guaranteed Surplus Distribution

Actual surplus still depends on the fund’s financial experience and applicable provisions, expenses, liabilities and regulatory requirements.

20. Connection With the Actuary’s Role in Surplus Distribution

This connects directly with the previous topic.

Suppose a surplus eventually emerges.

The actuary still needs to assess:

Is the surplus genuine?

What technical provisions are required?

How volatile are claims?

Does the PRF need a financial buffer?

Would distribution jeopardise future claim payments?

Only after these considerations can an appropriate surplus distribution be considered.

Therefore:

Surplus loading may help create the potential for surplus, but it does not create an automatic right to receive a surplus refund.

21. Surplus Loading vs Financial Buffer

These concepts are related but different.

Surplus Loading

An additional pricing component included when determining the gross contribution.

It is established:

Before actual claims experience is known.

Financial Buffer

Financial resources maintained to absorb adverse future experience.

It may be strengthened by:

retaining actual surplus in the PRF.

So:

Surplus Loading → Pricing stage

while:

Financial Buffer → Financial strength/risk absorption

22. Surplus Loading vs Actual Surplus

Also do not confuse:

Surplus Loading

An amount deliberately incorporated into the pricing structure.

with:

Actual Underwriting Surplus

A positive result that actually emerges from the PRF’s experience after relevant claims, costs, provisions and obligations are taken into account.

Therefore:

Loading is planned in pricing; surplus is an actual financial outcome.

23. Surplus Loading vs Pricing Margin

This is another important distinction because you previously studied margin.

Pricing Margin

An allowance for uncertainty/adverse deviation in expected claims.

Purpose:

Protect against claims being worse than the central estimate.

Surplus Loading

An optional additional pricing component associated with an intention to provide for a potential surplus refund/distribution.

Purpose:

Build additional amount into pricing where surplus refund is intended.

They should therefore not automatically be treated as the same thing.

24. Bringing the Three Components Together

Suppose Ahmad purchases a Takaful plan.

The actuarial and pricing process determines:

Tabarru’ Rate = RM700

This reflects Ahmad’s risk and contributes to the PRF.

Wakalah Fee = RM200

This compensates/supports the operator in managing the Takaful operation.

Optional Surplus Loading = RM100

This is included because the structure intends to provide for potential surplus refund/distribution.

Therefore:

Gross Contribution = RM700 + RM200 + RM100

Gross Contribution = RM1,000

Ahmad pays:

RM1,000 total gross contribution

25. What Happens to Ahmad’s RM1,000?

Conceptually:

RM700

→ Tabarru’ / PRF

→ Used collectively for covered risks and claims.

RM200

→ Wakalah fee

→ Supports/remunerates management of the Takaful operation.

RM100

→ Optional surplus loading

→ Additional pricing component associated with the intended surplus arrangement.

The precise accounting/fund treatment depends on the particular Takaful model and regulatory framework.

26. The Actuary’s Overall Pricing Process

The process can be understood as:

Analyse Historical Claims

↓

Estimate:

Claim Frequency

↓

Estimate:

Expected Claim Amount / Severity

↓

Calculate:

Expected Claims Cost

↓

Adjust for:

Participant Risk Factors + Sum Covered

↓

Determine:

Tabarru’ Rate

↓

Add:

Wakalah Fee

↓

Add, if applicable:

Optional Surplus Loading

↓

Determine:

Gross Takaful Contribution

Easy Way to Remember

Use:

RISK + MANAGEMENT + OPTIONAL SURPLUS

RISK = Tabarru’

Money required to fund the risk pool and covered claims.

MANAGEMENT = Wakalah Fee

Money used to compensate/support the operator for managing the Takaful business.

OPTIONAL SURPLUS = Surplus Loading

Additional pricing component where the arrangement intends to provide for potential surplus refund/distribution.

Therefore:

Gross Contribution = Risk + Management + Optional Surplus

Simple Formula

From the exhibit:

Gross Contribution = Tabarru’ Rate + Wakalah Fee + Optional Surplus Loading

And the simplified actuarial starting point for the risk cost is:

Expected Claims Cost = Expected Claim Frequency × Expected Claim Amount

For example:

5% × RM20,000 = RM1,000

The actuary then considers the relevant risk characteristics, sum covered and other pricing considerations in determining the appropriate tabarru’ rate.

One-Sentence Summary

The gross contribution paid for a Takaful plan can be viewed as consisting of an actuarially determined tabarru’ rate reflecting the participant’s risk and sum covered, a Wakalah fee for managing and distributing the Takaful business, and, where applicable, an optional surplus loading intended to provide for potential surplus refunds; the actuary uses historical claims frequency and claim amounts together with relevant risk factors to determine an appropriate risk-based tabarru’ rate.