Takaful - Role of an Actuary in Calculating Appropriate Technical Provisions

Another important role of an actuary in Takaful is to calculate the appropriate technical provisions that must be recognised in the financial accounts at the end of the financial year.

Technical provisions are important because a Takaful entity may have financial obligations relating to:

future coverage that has already been provided for under existing certificates, and

claims from events that have already happened but have not yet been fully reported or settled.

Therefore, the financial accounts cannot simply look at how much cash was received and how much cash was paid during the year.

The key principle is:

Recognise the financial obligations that belong to the reporting period, even when the actual cash payment may happen later.

This is necessary to avoid overstating the financial strength, profitability or surplus of the Takaful operation.

1. What Is a Technical Provision?

A technical provision is an amount recognised in the accounts for obligations arising from Takaful coverage and claims.

In simple terms:

Technical provision = an accounting amount recognised today for Takaful obligations that still need to be fulfilled.

It does not necessarily mean that the operator takes that exact amount of cash and puts it into a separate bank account.

Instead, it represents a liability recognised in the financial accounts.

2. Why Are Technical Provisions Necessary?

Imagine the PRF has:

RM20 million income

and only:

RM10 million claims paid in cash during the year.

It might initially appear that:

RM20m − RM10m = RM10m

is available as surplus.

But suppose another:

RM6 million of valid claim obligations

relate to events that have already occurred but have not yet been paid.

If we ignore the RM6m simply because the cash has not yet left the fund, we could seriously overstate the surplus.

Therefore, appropriate liabilities must be recognised.

Conceptually:

Income = RM20m

Claims paid = RM10m

Additional claim obligations = RM6m

So the financial position cannot be assessed merely as:

RM20m − RM10m = RM10m

The outstanding obligations must also be considered.

3. The Actuary’s Role

The actuary estimates the appropriate amount of technical provisions that should be maintained in the accounts.

The actuary normally considers factors such as:

historical claims experience

claim frequency

claim severity

claims development patterns

outstanding claims

future obligations

uncertainty

and other relevant actuarial assumptions.

The actuary would normally provide an actuarial assessment or sign-off concerning the adequacy of the provisions.

In simple terms, the actuary asks:

“Have we recognised enough liability for the Takaful obligations that still exist?”

4. Why Does the Actuary Need to “Sign Off” on Adequacy?

Suppose management wants to recognise:

Technical provisions = RM5 million

But actuarial analysis indicates that:

RM9 million

would be required to appropriately reflect the relevant obligations.

If only RM5m were recognised, liabilities could be understated by:

RM4 million

This could make the financial position look stronger than it really is.

For example:

Reported surplus might appear to be:

RM7m

when a more appropriate provision could reduce it to:

RM3m.

Therefore, actuarial assessment provides an important safeguard against underestimating liabilities and overstating surplus.

5. Two Important Types of Liability

Under the IFRS 17 terminology in your material, two important liabilities are:

1. Liability for Remaining Coverage - LRC

and

2. Liability for Incurred Claims - LIC

The easiest way to distinguish them is:

LRC = the covered event has NOT happened yet.

LIC = the covered event HAS already happened.

That distinction is extremely important.

6. Liability for Remaining Coverage - LRC

Liability for Remaining Coverage (LRC) relates to the entity’s obligations under the unexpired portion of existing coverage.

In simple terms:

The participant is already covered, but part of the coverage period is still in the future.

The covered event has not yet occurred, but the Takaful fund still has an obligation to provide coverage during the remaining period.

7. Simple LRC Example

Suppose Ahmad obtains a one-year General Takaful certificate:

Coverage period: 1 January to 31 December

At:

30 June

only six months have passed.

Coverage has already been provided for:

January → June

But coverage is still required for:

July → December

The second half of the coverage period is still unexpired.

Therefore, there is still an obligation relating to the:

Remaining coverage

This is the basic idea behind LRC.

8. Why Can’t the Entire Contribution Immediately Be Treated as Earned?

Suppose Ahmad pays:

RM1,200

for one year of coverage.

For a simple illustration, assume the coverage is spread evenly over 12 months.

That works out to:

RM1,200 ÷ 12 = RM100 per month

After six months, conceptually:

Coverage already provided = 6 months

Coverage remaining = 6 months

The Takaful arrangement still owes Ahmad another six months of coverage.

Therefore, it would be misleading to treat the entire RM1,200 as if all the coverage obligations had already been completed.

The exact IFRS 17 measurement is more sophisticated than simply dividing the contribution equally by months, but this example helps explain the concept.

9. Easy Way to Understand LRC

Think:

LRC = “We still owe you COVERAGE.”

The participant has an existing certificate.

The future insured event has not happened.

But the Takaful arrangement still has an obligation to provide protection for the unexpired coverage period.

So:

Existing Certificate + Future Coverage Remaining = LRC

10. Liability for Incurred Claims - LIC

The second important liability is:

Liability for Incurred Claims (LIC)

This relates to covered events that have already occurred.

The Takaful fund may still need to:

investigate

assess

process

and

pay

the resulting valid claims.

Therefore:

LIC = the insured event has already happened, but the resulting claim obligations have not necessarily been fully settled.

11. Simple LIC Example

Suppose Sarah has Motor Takaful.

On:

20 December

she is involved in a covered accident.

The financial year ends:

31 December

But the claim is only fully settled:

15 February of the following year.

At 31 December:

Has the insured event happened?

Yes.

Has the claim been completely paid?

No.

Therefore, an obligation already exists at year-end.

The Takaful fund cannot say:

“We haven’t paid Sarah yet, so there is no liability.”

The event occurred before the reporting date.

Therefore, the relevant claim obligation needs to be recognised.

This falls under:

LIC

12. Easy Difference Between LRC and LIC

Remember these two questions:

LRC

Has the insured event happened yet?

No.

There is still future coverage to provide.

LIC

Has the insured event happened?

Yes.

There is now a claim-related obligation to investigate and/or pay.

So:

LRC = Coverage remaining

LIC = Claims already incurred

13. LIC Includes Claims That Have Not Yet Been Reported

This is where actuarial estimation becomes especially important.

Not every claim that has occurred will be reported immediately.

For example:

An accident happens on:

29 December

The financial year ends:

31 December

The participant reports the claim:

5 January

At 31 December, management may not even know about this particular claim.

But economically:

The event has already happened.

Therefore, an appropriate actuarial provision needs to allow for claims that have occurred but have not yet been reported.

This leads to:

IBNR

14. What Is IBNR?

IBNR = Incurred But Not Reported

It means:

The insured event has already occurred, but the claim has not yet been reported to the Takaful operator by the reporting date.

Example:

Accident occurs = 28 December 2026

Financial year-end = 31 December 2026

Claim reported = 5 January 2027

At 31 December:

Event occurred? → Yes

Claim reported? → No

Therefore:

IBNR

15. Why Is IBNR Necessary?

Suppose the operator only counts claims that have already been reported.

Reported outstanding claims:

RM5 million

But based on historical experience, the actuary estimates that another:

RM2 million

of claims have probably already occurred but have not yet been reported.

Without IBNR:

Claim liability recognised = RM5m

With the actuarial estimate:

RM5m + RM2m = RM7m

Therefore, ignoring IBNR would understate the claim liability by:

RM2 million

and potentially overstate the surplus by the same amount, all else equal.

16. What Is IBNER?

The material also refers to:

IBNER = Incurred But Not Enough Reported

This means the claim has already been reported, but the amount currently recorded is not sufficient to represent the eventual expected claim cost.

In simple terms:

The operator knows about the claim, but the claim is expected to cost more than currently estimated.

17. Simple IBNER Example

Suppose Ali has a serious accident.

He reports the claim before year-end.

Initially, the estimated claim amount is:

RM100,000

Therefore, the operator records:

RM100,000

But the actuary reviews claims development and concludes that the eventual cost is more likely to be:

RM150,000

Therefore, an additional:

RM50,000

needs to be allowed for.

That additional development is an example of the concept behind:

IBNER

So:

Claim already reported = Yes

Current estimate sufficient = No

Therefore:

IBNER

18. IBNR vs IBNER

This is very easy to remember:

IBNR

Claim event happened

BUT

Claim not reported yet

Example:

Accident happened on 30 December, reported on 5 January.

IBNER

Claim already reported

BUT

Not enough has been recognised for its eventual cost

Example:

Initially estimated at RM100,000, but expected ultimate cost becomes RM150,000.

19. Why Is an Actuary Needed for IBNR and IBNER?

If a claim has not yet been reported, management cannot simply look at the claims register and find it.

The actuary therefore uses:

historical claims patterns

reporting delays

claims development

frequency

severity

statistical methods

and other relevant information

to estimate these obligations.

For example, historical experience might show that at every year-end, approximately 10% of certain claims are reported after the reporting date.

The actuary can use historical and current information to estimate the expected liability.

Therefore:

Actuarial work helps recognise obligations that may not yet be fully visible in the accounting records.

20. Why Technical Provisions Affect Surplus

This is one of the most important connections.

Suppose before technical provisions:

PRF appears to have:

RM10 million surplus

But the actuary determines that additional claim obligations of:

RM6 million

need to be recognised.

Then, in a simplified illustration:

RM10m − RM6m = RM4m

The more realistic surplus is:

RM4 million

rather than:

RM10 million

Therefore:

Technical provisions prevent the PRF from appearing more profitable or having more distributable surplus than is actually justified.

21. Why This Matters for Surplus Distribution

This connects directly with the previous topic.

Imagine the operator says:

“We have RM10m surplus. Let’s distribute it.”

But the actuary identifies:

IBNR = RM2m

IBNER = RM1m

and other relevant liabilities.

After recognising appropriate technical provisions, the surplus may be much smaller.

If the operator distributed the original RM10m without recognising these obligations, the PRF could later discover that it does not have enough resources to pay valid claims.

Therefore:

Calculate Technical Provisions

↓

Determine More Accurate Financial Position

↓

Determine Genuine Surplus/Deficit

↓

Then Consider Surplus Distribution

22. Accrual Basis of Accounting

Technical provisions are necessary because financial accounts are generally prepared on an accrual basis.

The basic idea of accrual accounting is:

Recognise income and expenses/obligations in the period to which they relate, rather than looking only at when cash is received or paid.

This is extremely important in insurance and Takaful because claims can occur in one year but be paid in another year.

23. Cash Basis vs Accrual Basis Example

Suppose:

Accident occurs = December 2026

Claim amount = RM500,000

Claim paid = February 2027

If we looked only at cash:

2026 claim payment = RM0

2027 claim payment = RM500,000

But this could give a misleading picture because the insured event actually occurred in:

2026

Under accrual-based financial reporting, the relevant liability should be recognised in connection with the period in which the obligation arose, according to the applicable accounting requirements.

Therefore:

No cash payment yet does not mean no liability exists.

24. Technical Provisions Prevent Overstatement of Surplus

Without adequate technical provisions:

Liabilities appear too low

↓

Financial position appears too strong

↓

Surplus/profit appears too high

↓

Too much surplus might be distributed

↓

Future claim-paying ability could be weakened

Therefore:

Adequate Technical Provisions = More Accurate Financial Position

25. Technical Provisions Also Affect Solvency

Remember:

Solvency concerns whether sufficient financial resources are available to meet obligations.

Suppose:

PRF assets = RM100m

Initially recognised liabilities = RM70m

The position may look strong.

But the actuary discovers that appropriate technical provisions should actually make total relevant liabilities:

RM95m

Now the financial position looks very different.

Therefore, accurate technical provisions are necessary when assessing:

Solvency

If liabilities are underestimated, solvency may appear stronger than it actually is.

26. Technical Provisions Can Reveal a PRF Deficit

Technical provisions may also determine whether the PRF actually has a:

surplus

or

deficit.

Suppose before additional actuarial provisions:

PRF financial result = +RM3m

The actuary determines additional appropriate provisions of:

RM5m

Simplified adjusted result:

RM3m − RM5m = −RM2m

The PRF now shows:

RM2 million deficit

Therefore, what initially looked like a surplus can become a deficit after appropriate obligations are recognised.

27. Connection With Qard

This is why technical provisions can affect whether qard support is required.

Suppose the year-end accounts show:

PRF deficit = RM5 million

Under the applicable Takaful framework, the shareholder/operator fund may need to provide:

Qard

to support the PRF.

Remember:

Qard is an interest-free loan, not a donation.

It is generally recoverable from future PRF surpluses according to the applicable rules.

Therefore:

Actuary calculates provisions

↓

Liabilities properly recognised

↓

True PRF financial position determined

↓

If positive → Surplus

If negative → Deficit

↓

If deficit → Qard support may be required under the applicable framework

28. Connection With Financial Buffer

This also connects with the financial buffer you just studied.

These concepts should not be confused.

Technical Provision

Recognises obligations that need to be reflected in the accounts.

Financial Buffer

Provides additional financial strength against adverse or unexpected experience.

For example:

Expected/recognised claim obligations = RM10m

Technical provisions appropriately reflect those obligations.

An additional financial buffer may then help protect against claims experience becoming worse than expected.

So:

Technical provision = recognise the obligation

Financial buffer = help absorb adverse uncertainty beyond expected/recognised experience

Both contribute to financial soundness, but they perform different functions.

29. The Whole Process

The easiest way to understand the actuary’s role is:

Financial Year Ends

↓

Identify Remaining Coverage

↓

Calculate LRC

↓

Identify Claims Already Incurred

↓

Calculate LIC

↓

Include estimates such as:

IBNR + IBNER

↓

Recognise Appropriate Technical Provisions

↓

Determine More Accurate Liabilities

↓

Determine Financial Position

↓

Surplus or Deficit

↓

Assess:

Solvency

↓

If PRF deficit exists:

Qard may be required under applicable framework

Easy Way to Remember

Use:

LRC = LATER EVENT

The insured event has not happened yet.

There is still remaining coverage.

LIC = EVENT ALREADY HAPPENED

The insured event has already occurred.

There is now a claim-related obligation.

IBNR = HAPPENED, NOT REPORTED

Incurred But Not Reported

Event happened, but the operator does not yet have the claim report.

IBNER = REPORTED, BUT NOT ENOUGH

Incurred But Not Enough Reported

The claim is known, but the current recognised estimate is insufficient for the expected ultimate cost.

Simple Example Bringing Everything Together

Suppose the financial year ends on:

31 December 2026

Ahmad

His certificate runs until June 2027.

No insured event has occurred.

There is still future coverage to provide.

→ LRC

Ali

Accident happened on 20 December 2026.

Claim reported on 22 December.

Still unpaid at year-end.

→ LIC

Sarah

Accident happened on 30 December.

She reports it on 5 January 2027.

At year-end the event had occurred, but the claim had not been reported.

→ LIC including IBNR

Fatimah

Accident happened and was reported before year-end.

Initial estimate = RM50,000

Actuarial assessment indicates ultimate cost = RM80,000

Additional expected development = RM30,000

→ LIC including IBNER concept

Most Important Distinction

Remember these four questions:

Has coverage not yet expired?

→ LRC

Has the insured event already occurred?

→ LIC

Has it occurred but not been reported?

→ IBNR

Has it been reported but the current amount is insufficient?

→ IBNER

Simple Formula

Conceptually:

Appropriate Technical Provisions = Obligations for Remaining Coverage + Obligations for Incurred Claims

or:

Technical Provisions → LRC + LIC

with LIC including appropriate estimates for claims such as:

IBNR and IBNER

The exact measurement under IFRS 17 is more detailed than this simplified formula.

One-Sentence Summary

The actuary calculates and assesses the adequacy of technical provisions so that the Takaful accounts properly recognise obligations relating to remaining coverage (LRC) and claims that have already occurred (LIC), including estimates such as IBNR and IBNER; this prevents surplus from being overstated, provides a more accurate assessment of solvency and financial performance, and can help determine whether a PRF deficit exists that may require qard support under the applicable Takaful framework.