Takaful - Pricing, Solvency Risk and Adequacy of Tabarru’

Pricing in Takaful is slightly different from pricing in conventional insurance because the initial contribution paid by a participant may not necessarily represent the participant’s ultimate net cost of protection.

This is because a Takaful risk fund may generate an underwriting surplus, and depending on the applicable Takaful model, regulations and certificate terms, some surplus may eventually be distributed to eligible participants.

Therefore, when considering Takaful pricing, we need to understand three important issues:

1. Initial contribution versus ultimate cost of cover

2. Adequate pricing and solvency

3. Adequacy of the tabarru’ remaining after the Wakalah fee

1. The Takaful Contribution Is the Initial Amount Paid

Suppose Ahmad purchases a Takaful certificate and pays:

RM1,000 contribution

At the beginning, Ahmad pays the full:

RM1,000

However, depending on the structure of the Takaful arrangement, Ahmad may later become eligible for a distribution from the underwriting surplus.

For example:

Initial contribution = RM1,000

Later surplus distribution = RM100

Simplified ultimate net cost:

RM1,000 − RM100 = RM900

This is why the contribution paid at the beginning is not necessarily the ultimate economic cost of the cover.

2. Similarity With a Mutual Insurer

This idea is similar to insurance provided by a mutual insurer.

In a mutual structure, policyholders collectively participate in the mutual arrangement, and depending on financial performance and the applicable rules, they may receive a dividend or similar distribution.

For example:

Initial payment = RM1,000

Eventual dividend = RM80

Simplified ultimate cost:

RM1,000 − RM80 = RM920

Similarly, in Takaful:

Initial contribution − eventual eligible surplus distribution = simplified ultimate net cost

However, a surplus distribution is not guaranteed. It depends on the actual performance of the risk fund and the applicable surplus policy.

3. Why Takaful Operators Should Not Focus Only on Price Competition

If two Takaful operators compete only by offering the lowest initial contribution, they may create financial problems.

Suppose:

Operator A contribution = RM1,000

Operator B contribution = RM850

Customers may immediately think:

“Operator B is cheaper, so it must be better.”

But this does not tell us whether RM850 is sufficient to support the underlying risk.

Operator A may have:

proper pricing

adequate tabarru’

strong claims reserves

appropriate Retakaful

and

a financially healthy PRF

Operator B may simply have reduced its price aggressively to attract customers.

Therefore:

Lower contribution ≠ automatically better Takaful

The contribution must first be financially sustainable.

4. Why Regulation Is Necessary

Takaful participants pay contributions before they know whether they will make a claim.

For example, Sarah buys a Family Takaful certificate today.

She may not make a claim for:

5 years, 10 years, 20 years or even longer, depending on the nature of the certificate.

Therefore, it is important that the Takaful operation remains financially sound and capable of meeting its obligations when covered claims eventually arise.

This is why regulators need to pay attention to:

pricing adequacy

capital and solvency

claims reserves

risk management

and

adequacy of the PRF

5. What Is Insolvency Risk?

Insolvency risk is the risk that the Takaful arrangement becomes financially unable to meet its obligations, including paying valid claims when they fall due.

In simple words:

The participant has a valid claim, but insufficient financial resources are available to meet the obligation.

Suppose a PRF has:

RM20 million available

but its claims and other obligations amount to:

RM30 million

If the deficit cannot be adequately addressed through the available financial mechanisms, serious solvency problems may arise.

Therefore, insolvency risk must be kept as low as reasonably possible.

6. Appropriate Product Pricing Is Essential

A Takaful operator must have a proper product pricing mechanism.

This means the contribution should be calculated carefully based on the underlying risks and expected costs.

For example, actuaries may consider:

expected frequency of claims

expected severity of claims

participant characteristics

historical claims experience

expenses

Retakaful costs

risk margins

reserves and capital requirements

and other relevant factors.

The objective is not simply:

“What is the lowest contribution we can charge?”

Instead:

“What contribution is sufficient and sustainable for the risks being covered?”

7. Example of Proper Pricing

Suppose the expected financial requirements associated with a particular risk are estimated as:

Expected claims = RM700

Relevant costs = RM150

Required margin/buffer = RM100

Simplified required total:

RM950

If the operator charges:

RM1,000

the pricing may provide an adequate margin based on those assumptions.

But if intense price competition causes the operator to charge:

RM750

while expected claims alone are RM700, there may be very little room for the other necessary costs and financial buffers.

Repeated underpricing can weaken the financial sustainability of the Takaful arrangement.

8. Prudent Claims Reserving Is Also Important

Correct pricing alone is not enough.

The Takaful operation also needs prudent claims reserves.

A claims reserve is money or a financial provision set aside for claims that the fund expects it will need to pay.

For example, a participant has already suffered a covered accident.

The final claim has not yet been settled, but the operator estimates that it will cost:

RM500,000

The PRF should recognise an appropriate provision for that expected obligation.

It should not treat the RM500,000 as freely available surplus merely because the claim has not yet been physically paid.

9. Example of Why Claims Reserving Matters

Suppose the PRF has:

RM10 million

It has already paid:

RM6 million claims

At first, someone might think:

RM10m − RM6m = RM4m remaining

But suppose there are outstanding valid claims expected to cost:

RM3 million

Then the fund cannot simply treat the entire RM4 million as surplus.

It needs to provide for those outstanding claims.

Simplified:

RM10m − RM6m paid claims − RM3m claims provision = RM1m

This is why prudent claims reserving protects solvency.

10. A Risk Specific to the Takaful Structure

There is another important pricing issue in Takaful.

Even if the total Takaful contribution is actuarially sound, the amount actually entering the Participants’ Risk Fund may still be inadequate.

Why?

Because under the Wakalah model, part of the contribution may be deducted as a:

Wakalah fee

The remaining amount is allocated as tabarru’ to the PRF.

So we must distinguish:

Total Takaful Contribution

from

Amount Actually Entering the PRF

11. Example - Total Contribution Is Adequate, But Tabarru’ Is Not

Suppose an actuary determines that:

Total Takaful contribution = RM1,000

At first, RM1,000 appears actuarially reasonable.

Now suppose:

Wakalah fee = RM300

Therefore:

RM1,000 − RM300 = RM700

Only:

RM700

is allocated to the PRF as tabarru’ in this simplified example.

Now suppose the expected claims burden allocated to the PRF is:

RM800

There is a problem:

Tabarru’ = RM700

Expected claims requirement = RM800

Shortfall:

RM100

Therefore:

The total contribution may be adequate overall, but the amount allocated to the risk fund is inadequate to support the risks borne by that fund.

12. Why Is This Particularly Important in Takaful?

Because the PRF is the fund that bears the participants’ underwriting risk.

Remember:

Participant → pays total contribution

Then, under a simplified Wakalah structure:

Total Contribution

↓

Wakalah Fee → Operator Fund

• ●

Tabarru’ → Participants’ Risk Fund

The PRF then pays covered claims.

Therefore, it is not enough to ask:

“Is the total contribution adequate?”

We must also ask:

“After deducting the Wakalah fee, is the amount entering the PRF adequate for the risks borne by the PRF?”

This is the crucial distinction.

13. Large-Scale Example

Suppose there are:

10,000 participants

Each pays:

RM1,000

Total contributions:

RM10 million

Suppose:

Wakalah fee = 30%

Therefore:

RM3 million → operator

and:

RM7 million → PRF

Now suppose expected claims and relevant PRF obligations are:

RM8 million

The PRF receives:

RM7 million

but needs approximately:

RM8 million

Expected shortfall:

RM1 million

So:

RM7m − RM8m = −RM1m

This creates a risk of a PRF deficit.

14. Why Regulation Should Consider the Tabarru’ Amount Separately

This leads to an important regulatory principle.

It is not sufficient for regulation to check only whether:

Total contribution = actuarially adequate

Regulation should also ensure that:

Contribution actually allocated to the Takaful risk fund = actuarially adequate for the risks and obligations borne by that fund.

Otherwise, an operator could theoretically charge a reasonable total contribution but allocate too much to the Wakalah fee, leaving the PRF financially weak.

15. Connection With Qard

Suppose excessive Wakalah deductions contribute to repeated PRF deficits.

The pattern could become:

Participants pay contributions

↓

Large Wakalah fee deducted

↓

Insufficient tabarru’ enters PRF

↓

Claims exceed PRF resources

↓

PRF deficit

↓

Qard required from shareholder/operator fund

This is not a desirable long-term financial structure.

Qard can provide important support when genuine adverse claims experience creates a deficit, but the PRF should not be systematically underfunded because its contribution allocation was inadequate from the beginning.

16. Connection With Surplus

Now we can connect this to your previous question about surplus.

Suppose:

Tabarru’ entering PRF = RM10 million

Claims and relevant obligations = RM8 million

Simplified surplus:

RM2 million

But suppose a larger Wakalah fee means only:

RM7 million

enters the PRF while obligations remain:

RM8 million

Then:

RM7m − RM8m = −RM1m

Instead of having a surplus, the PRF has a:

RM1 million deficit

Therefore, the allocation of the total contribution between the operator and the PRF can have a major effect on the financial health of the risk fund.

17. Does This Mean Wakalah Fees Should Always Be Low?

Not necessarily.

The Takaful operator has genuine operating expenses.

It needs resources for activities such as:

staff

underwriting

claims administration

technology

distribution

regulatory compliance

Shari’ah governance

and other management functions.

Therefore, the objective is not:

“Make the Wakalah fee as small as possible.”

Instead, the objective is to achieve a sustainable balance:

Adequate Wakalah Fee → Sustainable Operator

and

Adequate Tabarru’ → Sustainable PRF

Both sides need to be financially viable.

Easy Way to Remember

There are three pricing questions in Takaful:

1. Is the total contribution reasonable?

RM1,000 total contribution

↓

2. Is the Wakalah fee reasonable?

Suppose:

RM300 Wakalah fee

↓

3. Is the remaining tabarru’ sufficient for the PRF?

RM1,000 − RM300 = RM700 tabarru’

If the PRF requires approximately RM800 to support the expected risk:

RM700 < RM800

Then there is an adequacy problem.

Simple Formula

Participant’s Initial Contribution

Total Takaful Contribution = Wakalah Fee + Tabarru’ + Other Applicable Allocations

Then:

PRF Adequacy

Tabarru’ allocated to PRF ≥ Expected Claims + Relevant PRF Costs + Required Provisions/Margins

If this condition is not reasonably satisfied:

Insufficient Tabarru’ → Greater Deficit Risk → Greater Qard/Solvency Pressure

Connection of All the Concepts

You can now connect the topics you have been studying:

Correct Pricing

↓

Participants pay an adequate contribution

↓

Reasonable Wakalah Fee

↓

Adequate tabarru’ enters the PRF

↓

Good Risk Pooling + Proper Underwriting + Retakaful

↓

Claims are managed effectively

↓

Possible Underwriting Surplus

↓

Surplus can strengthen the PRF

↓

Stronger PRF

↓

Less reliance on shareholder qard

↓

Lower Insolvency Risk

One-Sentence Summary

Takaful pricing should not focus merely on offering the lowest contribution; both the total contribution and, importantly, the tabarru’ actually allocated to the Participants’ Risk Fund after deducting the Wakalah fee must be actuarially adequate, supported by prudent claims reserving and sound risk management, so that the PRF can meet future claims and minimise the risk of insolvency.

1. The Takaful Contribution Is the Initial Amount Paid Suppose Ahmad purchases a Takaful certificate and pays: RM1,000 contribution At the beginning, Ahmad pays the full: RM1,000 However, depending on the structure of the Takaful arrangement, Ahmad may later become eligible for a distribution from the underwriting surplus. For example: Initial contribution = RM1,000 Later surplus distribution = RM100 Simplified ultimate net cost: RM1,000 − RM100 = RM900 This is why the contribution paid at the beginning is not necessarily the ultimate economic cost of the cover. 

2. Similarity With a Mutual Insurer This idea is similar to insurance provided by a mutual insurer. In a mutual structure, policyholders collectively participate in the mutual arrangement, and depending on financial performance and the applicable rules, they may receive a dividend or similar distribution. For example: Initial payment = RM1,000 Eventual dividend = RM80 Simplified ultimate cost: RM1,000 − RM80 = RM920 Similarly, in Takaful: Initial contribution − eventual eligible surplus distribution = simplified ultimate net cost However, a surplus distribution is not guaranteed. It depends on the actual performance of the risk fund and the applicable surplus policy. 

3. Why Takaful Operators Should Not Focus Only on Price Competition If two Takaful operators compete only by offering the lowest initial contribution, they may create financial problems. Suppose: Operator A contribution = RM1,000 Operator B contribution = RM850 Customers may immediately think: “Operator B is cheaper, so it must be better.” But this does not tell us whether RM850 is sufficient to support the underlying risk. Operator A may have: proper pricing adequate tabarru’ strong claims reserves appropriate Retakaful and a financially healthy PRF Operator B may simply have reduced its price aggressively to attract customers. Therefore: Lower contribution ≠ automatically better Takaful The contribution must first be financially sustainable. 

4. Why Regulation Is Necessary Takaful participants pay contributions before they know whether they will make a claim. For example, Sarah buys a Family Takaful certificate today. She may not make a claim for: 5 years, 10 years, 20 years or even longer, depending on the nature of the certificate. Therefore, it is important that the Takaful operation remains financially sound and capable of meeting its obligations when covered claims eventually arise. This is why regulators need to pay attention to: pricing adequacy capital and solvency claims reserves risk management and adequacy of the PRF 

5. What Is Insolvency Risk? Insolvency risk is the risk that the Takaful arrangement becomes financially unable to meet its obligations, including paying valid claims when they fall due. In simple words: The participant has a valid claim, but insufficient financial resources are available to meet the obligation. Suppose a PRF has: RM20 million available but its claims and other obligations amount to: RM30 million If the deficit cannot be adequately addressed through the available financial mechanisms, serious solvency problems may arise. Therefore, insolvency risk must be kept as low as reasonably possible. 

6. Appropriate Product Pricing Is Essential A Takaful operator must have a proper product pricing mechanism. This means the contribution should be calculated carefully based on the underlying risks and expected costs. For example, actuaries may consider: expected frequency of claims expected severity of claims participant characteristics historical claims experience expenses Retakaful costs risk margins reserves and capital requirements and other relevant factors. The objective is not simply: “What is the lowest contribution we can charge?” Instead: “What contribution is sufficient and sustainable for the risks being covered?” 

7. Example of Proper Pricing Suppose the expected financial requirements associated with a particular risk are estimated as: Expected claims = RM700 Relevant costs = RM150 Required margin/buffer = RM100 Simplified required total: RM950 If the operator charges: RM1,000 the pricing may provide an adequate margin based on those assumptions. But if intense price competition causes the operator to charge: RM750 while expected claims alone are RM700, there may be very little room for the other necessary costs and financial buffers. Repeated underpricing can weaken the financial sustainability of the Takaful arrangement. 

8. Prudent Claims Reserving Is Also Important Correct pricing alone is not enough. The Takaful operation also needs prudent claims reserves. A claims reserve is money or a financial provision set aside for claims that the fund expects it will need to pay. For example, a participant has already suffered a covered accident. The final claim has not yet been settled, but the operator estimates that it will cost: RM500,000 The PRF should recognise an appropriate provision for that expected obligation. It should not treat the RM500,000 as freely available surplus merely because the claim has not yet been physically paid. 

9. Example of Why Claims Reserving Matters Suppose the PRF has: RM10 million It has already paid: RM6 million claims At first, someone might think: RM10m − RM6m = RM4m remaining But suppose there are outstanding valid claims expected to cost: RM3 million Then the fund cannot simply treat the entire RM4 million as surplus. It needs to provide for those outstanding claims. Simplified: RM10m − RM6m paid claims − RM3m claims provision = RM1m This is why prudent claims reserving protects solvency. 

10. A Risk Specific to the Takaful Structure There is another important pricing issue in Takaful. Even if the total Takaful contribution is actuarially sound, the amount actually entering the Participants’ Risk Fund may still be inadequate. Why? Because under the Wakalah model, part of the contribution may be deducted as a: Wakalah fee The remaining amount is allocated as tabarru’ to the PRF. So we must distinguish: Total Takaful Contribution from Amount Actually Entering the PRF 

11. Example - Total Contribution Is Adequate, But Tabarru’ Is Not Suppose an actuary determines that: Total Takaful contribution = RM1,000 At first, RM1,000 appears actuarially reasonable. Now suppose: Wakalah fee = RM300 Therefore: RM1,000 − RM300 = RM700 Only: RM700 is allocated to the PRF as tabarru’ in this simplified example. Now suppose the expected claims burden allocated to the PRF is: RM800 There is a problem: Tabarru’ = RM700 Expected claims requirement = RM800 Shortfall: RM100 Therefore: The total contribution may be adequate overall, but the amount allocated to the risk fund is inadequate to support the risks borne by that fund. 

12. Why Is This Particularly Important in Takaful? Because the PRF is the fund that bears the participants’ underwriting risk. Remember: Participant → pays total contribution Then, under a simplified Wakalah structure: Total Contribution ↓ Wakalah Fee → Operator Fund  ●  Tabarru’ → Participants’ Risk Fund The PRF then pays covered claims. Therefore, it is not enough to ask: “Is the total contribution adequate?” We must also ask: “After deducting the Wakalah fee, is the amount entering the PRF adequate for the risks borne by the PRF?” This is the crucial distinction. 

13. Large-Scale Example Suppose there are: 10,000 participants Each pays: RM1,000 Total contributions: RM10 million Suppose: Wakalah fee = 30% Therefore: RM3 million → operator and: RM7 million → PRF Now suppose expected claims and relevant PRF obligations are: RM8 million The PRF receives: RM7 million but needs approximately: RM8 million Expected shortfall: RM1 million So: RM7m − RM8m = −RM1m This creates a risk of a PRF deficit. 

14. Why Regulation Should Consider the Tabarru’ Amount Separately This leads to an important regulatory principle. It is not sufficient for regulation to check only whether: Total contribution = actuarially adequate Regulation should also ensure that: Contribution actually allocated to the Takaful risk fund = actuarially adequate for the risks and obligations borne by that fund. Otherwise, an operator could theoretically charge a reasonable total contribution but allocate too much to the Wakalah fee, leaving the PRF financially weak. 

15. Connection With Qard Suppose excessive Wakalah deductions contribute to repeated PRF deficits. The pattern could become: Participants pay contributions ↓ Large Wakalah fee deducted ↓ Insufficient tabarru’ enters PRF ↓ Claims exceed PRF resources ↓ PRF deficit ↓ Qard required from shareholder/operator fund This is not a desirable long-term financial structure. Qard can provide important support when genuine adverse claims experience creates a deficit, but the PRF should not be systematically underfunded because its contribution allocation was inadequate from the beginning. 

16. Connection With Surplus Now we can connect this to your previous question about surplus. Suppose: Tabarru’ entering PRF = RM10 million Claims and relevant obligations = RM8 million Simplified surplus: RM2 million But suppose a larger Wakalah fee means only: RM7 million enters the PRF while obligations remain: RM8 million Then: RM7m − RM8m = −RM1m Instead of having a surplus, the PRF has a: RM1 million deficit Therefore, the allocation of the total contribution between the operator and the PRF can have a major effect on the financial health of the risk fund. 

17. Does This Mean Wakalah Fees Should Always Be Low? Not necessarily. The Takaful operator has genuine operating expenses. It needs resources for activities such as: staff underwriting claims administration technology distribution regulatory compliance Shari’ah governance and other management functions. Therefore, the objective is not: “Make the Wakalah fee as small as possible.” Instead, the objective is to achieve a sustainable balance: Adequate Wakalah Fee → Sustainable Operator and Adequate Tabarru’ → Sustainable PRF Both sides need to be financially viable. 

Easy Way to Remember There are three pricing questions in Takaful: 1. Is the total contribution reasonable? RM1,000 total contribution ↓ 2. Is the Wakalah fee reasonable? Suppose: RM300 Wakalah fee ↓ 3. Is the remaining tabarru’ sufficient for the PRF? RM1,000 − RM300 = RM700 tabarru’ If the PRF requires approximately RM800 to support the expected risk: RM700 < RM800 Then there is an adequacy problem. 

Simple Formula Participant’s Initial Contribution Total Takaful Contribution = Wakalah Fee + Tabarru’ + Other Applicable Allocations Then: PRF Adequacy Tabarru’ allocated to PRF ≥ Expected Claims + Relevant PRF Costs + Required Provisions/Margins If this condition is not reasonably satisfied: Insufficient Tabarru’ → Greater Deficit Risk → Greater Qard/Solvency Pressure 

Connection of All the Concepts You can now connect the topics you have been studying: Correct Pricing ↓ Participants pay an adequate contribution ↓ Reasonable Wakalah Fee ↓ Adequate tabarru’ enters the PRF ↓ Good Risk Pooling + Proper Underwriting + Retakaful ↓ Claims are managed effectively ↓ Possible Underwriting Surplus ↓ Surplus can strengthen the PRF ↓ Stronger PRF ↓ Less reliance on shareholder qard ↓ Lower Insolvency Risk 

One-Sentence Summary Takaful pricing should not focus merely on offering the lowest contribution; both the total contribution and, importantly, the tabarru’ actually allocated to the Participants’ Risk Fund after deducting the Wakalah fee must be actuarially adequate, supported by prudent claims reserving and sound risk management, so that the PRF can meet future claims and minimise the risk of insolvency.