Takaful - Product Mis-Selling Risk

Product mis-selling risk arises when a participant is sold or recommended a Takaful product that is unsuitable for their actual needs, financial circumstances, risk profile or objectives, or when the product is not properly explained to them.

Mis-selling does not necessarily mean that the Takaful product itself is bad or non-Shari’ah-compliant.

A product can be:

Shari’ah-compliant

but still be:

unsuitable for a particular participant.

This is the most important distinction.

Shari’ah compliance tells us whether the product complies with Shari’ah requirements. Suitability tells us whether the product is appropriate for that particular customer.

1. What Is Product Mis-Selling?

Suppose Ahmad is 55 years old.

He wants:

simple medical protection

and tells the intermediary:

“My main concern is paying my hospital bills if I become sick.”

Instead, the intermediary recommends a long-term Family Takaful product with a substantial savings/investment component that does not appropriately match Ahmad’s objective.

The product itself may be perfectly legitimate and Shari’ah-compliant.

However, if it does not meet Ahmad’s actual needs and was recommended without proper assessment or explanation, there is a mis-selling risk.

So:

Good product + Wrong participant = Potential mis-selling

2. Mis-Selling Can Begin at the Product Design Stage

Mis-selling is not only a problem caused by an agent at the moment of sale.

The risk can begin much earlier, when the product is being designed.

Therefore, good product governance should start by asking:

Who needs this product, why do they need it, what risks does it create, and how should it be sold?

A badly designed product can make appropriate selling much more difficult.

3. First Question - Do Participants Actually Need This Product?

Before developing a new Takaful product, the operator should determine whether the product addresses a real customer need.

For example, suppose an operator wants to introduce a Family Takaful product requiring:

RM1,000 monthly contribution

with a long-term savings component.

The operator should ask:

“Do our intended participants actually need and have the financial ability to maintain this type of product?”

If the intended customers are low-income households earning RM2,500 per month, a RM1,000 monthly commitment may obviously create affordability and sustainability concerns.

The product might be Shari’ah-compliant, but it may be unsuitable for that target market.

4. Second Question - Who Is the Target Market?

Every product should have an appropriate target market.

This means identifying the type of participant for whom the product was designed.

For example:

A basic Motor Takaful product might target:

vehicle owners requiring motor protection

A Family Takaful protection product might target:

people with dependants who need financial protection against death or disability

A long-term savings-oriented Family Takaful product might target:

participants with long-term savings objectives and the financial ability to maintain contributions

Therefore:

Product Design → Identify Customer Need → Identify Appropriate Target Market

5. Example - Right Product, Wrong Target Market

Suppose Sarah has:

RM3,000 monthly income

and very limited emergency savings.

Her main concern is obtaining affordable medical protection.

An intermediary recommends a Family Takaful savings product requiring:

RM1,200 every month for 20 years.

Even if the product is well designed for wealthier customers seeking long-term savings, it may not be appropriate for Sarah.

The problem is not necessarily:

“This is a bad Takaful product.”

The problem is:

“This product may have been sold to the wrong customer.”

That is why identifying the target market is an important part of preventing mis-selling.

6. Availability of Shari’ah-Compliant Investment Instruments

This becomes particularly important when a Takaful product contains a savings or investment component.

Suppose a Family Takaful product promises or illustrates long-term investment benefits.

The operator must consider whether sufficient suitable Shari’ah-compliant investment instruments are available to invest participants’ funds appropriately.

These might include, depending on the applicable investment mandate:

Sukuk

Shari’ah-compliant equities

Islamic money-market instruments

and other permissible investments.

The operator should not design an investment-oriented product based on unrealistic assumptions about investment opportunities or returns.

7. Example - Savings Component

Suppose Fatimah contributes:

RM500 per month

to a Family Takaful arrangement.

Part provides protection and part is allocated toward savings/investment according to the product structure.

If the sales illustration creates the impression that her savings will grow to a very large amount, she may make her decision based on that expectation.

If the investment return is not guaranteed, this must be properly communicated.

The intermediary should not make a non-guaranteed illustration sound like a guaranteed future benefit.

Otherwise:

Unrealistic investment expectation → Participant misunderstanding → Mis-selling risk

8. What Risks Does the Product Create?

Before launching a product, the operator should identify risks to both sides:

Risks to the Participant

For example:

insufficient protection

investment losses or lower-than-expected returns

inability to maintain future contributions

loss of certain benefits after early termination

exclusions or limitations

misunderstanding of guarantees and non-guaranteed benefits

Risks to the Takaful Operator / Funds

For example:

underpricing

unexpectedly high claims

investment risk

liquidity risk

operational risk

mis-selling and conduct risk

reputational risk

The appropriate risks depend on the particular product.

9. Both Parties Should Understand the Risks

It is not enough for the operator to understand the product.

The participant also needs to understand the material features and risks relevant to their decision.

Suppose Ali buys a Family Takaful product believing:

“If I contribute RM500 every month, I am guaranteed RM500,000 after 20 years.”

But the RM500,000 was merely an illustration based on assumptions rather than a guaranteed amount.

Ali has misunderstood an important feature of the product.

A proper sales process should clearly distinguish:

Guaranteed benefits

from

Non-guaranteed benefits or illustrations

where relevant.

10. Why Are Participants Particularly Vulnerable?

Many participants may not have specialist knowledge of:

Takaful

investments

risk

financial planning

tabarru’

Wakalah fees

investment returns

exclusions

or

surplus arrangements

This creates an information imbalance.

The intermediary may understand the product much better than the participant.

Therefore, the participant often depends heavily on the intermediary’s explanation and advice.

That creates a responsibility for the intermediary to communicate accurately and appropriately.

11. What Is an Intermediary?

An intermediary is the person or organisation between the Takaful operator and the customer in the distribution or sales process.

Depending on the distribution structure, this could include an:

agent

broker

financial adviser

or other authorised distributor.

The intermediary helps connect:

Takaful Operator → Participant

But their role should not simply be:

“Sell as many certificates as possible.”

Where advice is being provided, the intermediary should appropriately understand the participant’s needs and the product being recommended.

12. Protection and Savings Must Both Be Explained

This is particularly important for Family Takaful products containing both protection and savings/investment elements.

Suppose Ahmad contributes:

RM1,000

In a simplified illustration, the money may be allocated between different purposes according to the product structure.

Ahmad needs to understand matters such as:

How much protection am I receiving?

What benefits are guaranteed?

What benefits are not guaranteed?

What fees am I paying?

How does the savings/investment component work?

What happens if I stop contributing early?

What risks am I taking?

A participant should not simply be told:

“This is a good Islamic savings plan.”

That explanation is insufficient for an informed financial decision.

13. “One Size Does Not Fit All”

This phrase means that the same financial product is not appropriate for every person.

Consider three participants.

Ahmad

Age: 25

Single, stable income, wants long-term savings and protection.

His needs may favour one type of Family Takaful structure.

Ali

Age: 40

Married with three children and a housing loan.

His priority may be substantial family protection if he dies or becomes disabled.

Fatimah

Age: 65

Retired and mainly concerned with medical expenses and preserving her existing savings.

Her needs may be completely different.

Therefore:

Same product + Different people ≠ Same suitability

Financial advice should consider the circumstances and objectives of the individual participant.

14. Intermediaries May Lack Sufficient Competence

Another source of mis-selling is insufficient knowledge or competence.

Suppose an agent does not properly understand:

Family Takaful investment risks

fees

exclusions

benefit structure

or

early termination consequences

If the agent does not understand the product properly, it becomes difficult to explain it accurately to the participant.

Therefore:

Poor intermediary knowledge → Poor explanation → Participant misunderstanding → Mis-selling risk

This is why training and competency requirements are important.

15. Intermediaries May Also Be Biased

An even more serious problem can arise when the intermediary’s incentives conflict with the participant’s interests.

Suppose:

Product A commission = RM200

Product B commission = RM800

Product A is more appropriate for Sarah.

But the intermediary recommends Product B primarily because it generates the larger commission.

The participant may believe:

“The adviser recommended Product B because it is best suited to me.”

But the recommendation may actually have been influenced by the intermediary’s financial incentive.

This is an example of a conflict of interest and creates significant mis-selling risk.

16. Why Can Mis-Selling Be Particularly Serious in Takaful?

Takaful has an additional issue: trust based on Shari’ah compliance.

A Muslim participant may think:

“It is Shari’ah-compliant, therefore it must be suitable for me.”

But those are two different questions.

Question 1

Is the product Shari’ah-compliant?

This concerns whether the product and its structure comply with applicable Shari’ah requirements.

Question 2

Is this product suitable for Ahmad?

This concerns Ahmad’s:

income

financial obligations

protection needs

savings objectives

risk tolerance

age

and other relevant circumstances.

A product can satisfy Question 1 but fail Question 2.

17. Shari’ah Compliance Should Not Become a Substitute for Understanding

This is one of the most important lessons.

A participant should not purchase a product merely because:

“It is Islamic, so I trust it.”

Shari’ah compliance is important, but the participant should still understand:

What am I buying?

What does it cover?

What does it exclude?

How much will I pay?

How long must I contribute?

What are the risks?

What happens if I terminate early?

Which benefits are guaranteed?

Which returns are uncertain?

Therefore:

Shari’ah Compliance + Product Understanding + Suitability = Better Participant Protection

18. Example - Misplaced Trust

Suppose Ahmad tells an intermediary:

“I don’t really understand this product, but because it is Takaful and Shari’ah-compliant, I trust that it is suitable.”

The intermediary should not exploit this trust.

Instead, the intermediary should explain the product clearly and assess whether it is appropriate for Ahmad.

If Ahmad later discovers that:

the investment return was not guaranteed

the protection was lower than he expected

or

early termination significantly affects the value he receives

he may feel that he was misled.

The fact that the product was Shari’ah-compliant would not remove the mis-selling concern.

19. Why Regulation of Intermediaries Is Important

Because participants rely heavily on intermediaries, regulators need appropriate rules governing their conduct.

Depending on the regulatory framework, these can address matters such as:

competence and training

clear disclosure

product knowledge

suitability or needs assessment

fair presentation of benefits and risks

management of conflicts of interest

sales incentives

documentation

and

customer complaints

The objective is to reduce the possibility that participants purchase unsuitable products because of poor advice, inadequate information or biased recommendations.

20. Product Governance Is the First Line of Defence

Mis-selling should ideally be prevented before the product reaches the customer.

The process can be understood as:

Identify participant need

↓

Define target market

↓

Design suitable product

↓

Identify participant and operator risks

↓

Ensure adequate Shari’ah-compliant investment opportunities where relevant

↓

Train intermediaries

↓

Explain product clearly

↓

Assess customer needs/suitability where required

↓

Sell to appropriate participant

This is much stronger than waiting until customers complain after purchasing the product.

21. Clear Example of Proper Selling vs Mis-Selling

Suppose Sarah earns:

RM4,000 per month

She tells the intermediary:

“I mainly need affordable protection for my children if I die. I cannot afford a very high monthly commitment.”

Proper approach

The intermediary assesses Sarah’s:

income

dependants

existing protection

financial commitments

and

objectives

The intermediary explains an appropriate Takaful option, including its contribution, benefits, exclusions, fees and risks.

Sarah understands what she is buying.

That is closer to appropriate selling.

Potential mis-selling

The intermediary ignores Sarah’s needs and sells her an expensive savings-oriented product requiring:

RM1,500 per month

because it produces a larger commission.

Sarah cannot sustainably maintain the contributions and did not understand the product.

That is a clear example of mis-selling risk.

Easy Way to Remember

Use:

NEED → TARGET → EXPLAIN → SUITABILITY → SELL

NEED

Does the customer actually need the product?

TARGET

Is the customer part of the appropriate target market?

EXPLAIN

Have the benefits, costs, risks and limitations been properly explained?

SUITABILITY

Does the product fit the participant’s circumstances and objectives?

SELL

Only then should the product be recommended or sold through the appropriate process.

Important Distinction

Shari’ah-compliant does not automatically mean suitable for everyone.

And:

Good investment potential does not automatically mean suitable product.

And:

Good product does not automatically mean good advice.

The product, customer and sales process must all fit together.

Simple Formula

Mis-Selling Risk = Unsuitable Product/Customer Match + Poor Explanation + Inadequate Advice + Intermediary Bias/Conflict

To reduce it:

Good Product Governance + Correct Target Market + Competent Intermediaries + Clear Disclosure + Appropriate Advice = Lower Mis-Selling Risk

One-Sentence Summary

Product mis-selling risk in Takaful arises when participants are sold products that do not appropriately match their needs or circumstances, or when benefits, costs and risks are inadequately explained; because participants may place additional trust in a product simply because it is Shari’ah-compliant, strong product governance, competent and unbiased intermediaries, clear disclosure and appropriate customer assessment are essential.