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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.
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Takaful - Role of an Actuary in Takaful
An actuary plays an important role in ensuring that a Takaful operation is financially sound, properly priced, adequately provided for, and fair to participants.
Actuaries are specialists in:
Risk Management + Mathematics + Statistics + Financial Analysis
Their main task is to use information available today to understand uncertain events that may happen in the future and estimate their possible financial consequences.
In simple terms:
An actuary studies past and present data to estimate future risks and determine their possible financial impact.
1. What Is an Actuary?
An actuary is a professional who specialises in analysing and managing financial risk and uncertainty.
Future events are uncertain.
For example, a Takaful operator does not know exactly:
who will make a claim
when a claim will occur
how many claims will occur
or
how much those claims will cost.
The actuary uses mathematics, statistics and financial techniques to estimate these uncertain outcomes.
Therefore:
Past and Present Data
↓
Mathematical and Statistical Analysis
↓
Estimate Probability of Future Events
↓
Estimate Financial Impact
↓
Support Better Financial and Risk Decisions
2. Why Are Actuaries Important?
Many financial decisions must be made before the future is known.
For example, a participant pays a Takaful contribution today.
But the operator does not yet know whether that participant will make a:
RM1,000 claim
RM20,000 claim
or
no claim at all.
The actuary helps estimate the expected financial consequences of these uncertain future events.
Without appropriate actuarial analysis, a Takaful operator could:
charge inadequate contributions
underestimate future claims
overstate surplus
or
maintain insufficient financial resources.
3. Actuaries Are Experts in Risk Management
One of the most important ideas is:
Actuaries do not eliminate risk. They measure, estimate and help manage it.
Suppose 10,000 participants enter a medical Takaful pool.
The actuary cannot say exactly:
“Ahmad will make a RM15,000 claim next March.”
But by analysing a sufficiently relevant group, the actuary may be able to estimate:
expected number of claims
expected average claim size
and therefore:
expected total claims
This information helps the Takaful operator manage the PRF appropriately.
4. Actuaries Use Past and Present Data
Actuaries analyse information from:
The Past
For example:
historical claims
previous claim frequency
previous claim severity
historical mortality or morbidity experience
past expenses
and relevant financial experience.
The Present
They also consider current information such as:
current participant characteristics
current economic conditions
current medical costs
current portfolio composition
and other relevant information.
The purpose is to make reasonable estimates about:
The Future
5. Simple Example
Suppose historical data shows that among:
10,000 similar participants
approximately:
500 participants make claims each year.
Expected claim frequency:
500 ÷ 10,000 = 5%
Suppose the expected average claim is:
RM10,000
Then a simplified expected claim cost per participant is:
5% × RM10,000 = RM500
The actuary can use this information, together with other relevant assumptions and risk factors, when determining an appropriate risk contribution.
This illustrates how:
Historical Data → Probability Estimate → Financial Estimate
6. Actuaries Work in More Than Insurance
Actuaries are commonly associated with insurance because insurance involves significant uncertainty about future financial events.
However, actuarial work also extends to areas such as:
Takaful
pensions
social security
investments
and other areas involving long-term financial risk.
The common feature is:
There is uncertainty about future events that have financial consequences.
7. Traditional Role of an Actuary in Insurance and Takaful
Two traditional actuarial responsibilities are particularly important:
1. Pricing
and
2. Determining appropriate technical provisions
In Takaful, another important responsibility is:
3. Assessing and determining surplus
Therefore, three major areas are:
PRICING → PROVISIONS → SURPLUS
8. First Role - Pricing
The actuary helps determine how much should be charged for the risk being covered.
This is necessary because contributions are normally determined before the claims occur.
The actuary considers factors such as:
expected claim frequency
expected claim severity
risk characteristics
sum covered
historical experience
and other relevant assumptions.
A simplified starting point is:
Expected Claim Cost = Expected Claim Frequency × Expected Claim Amount
The objective is to ensure that the contribution appropriately reflects the expected risk.
9. Why Is Appropriate Pricing Important?
Suppose the PRF should actuarially receive:
RM1,000 per participant
to support a particular level of risk.
But participants are charged only:
RM700
Shortfall per participant:
RM300
For 10,000 participants:
RM300 × 10,000 = RM3 million
This can create significant financial pressure on the PRF.
Therefore:
Underpricing
↓
Insufficient Tabarru’
↓
PRF Underfunding
↓
Higher Risk of Deficit
The actuary helps reduce this risk by determining appropriate pricing.
10. Second Role - Calculating Technical Provisions
Another major actuarial responsibility is determining the appropriate technical provisions that should be recognised in the financial accounts.
Technical provisions reflect obligations associated with:
remaining coverage
and
claims that have already occurred.
Two important concepts are:
LRC - Liability for Remaining Coverage
and
LIC - Liability for Incurred Claims
LIC may include actuarial estimates associated with:
IBNR - Incurred But Not Reported
and
IBNER - Incurred But Not Enough Reported
11. Why Are Technical Provisions Important?
Suppose the PRF appears to have:
RM10 million surplus
before all relevant future and outstanding obligations are properly recognised.
The actuary determines that another:
RM6 million
of appropriate technical provisions must be recognised.
Simplified remaining surplus:
RM10m − RM6m = RM4m
Without the actuarial calculation, the Takaful operation might incorrectly believe it has RM10m available.
Therefore:
Technical provisions help prevent liabilities from being understated and surplus from being overstated.
12. Third Role - Determining Surplus
The actuary also plays an important role in determining whether a surplus exists and whether it is appropriate for that surplus to be distributed.
Suppose the PRF produces:
RM5 million surplus
This does not automatically mean:
RM5 million should be distributed.
The actuary needs to consider the future financial strength of the PRF.
13. Why Might the Actuary Recommend Retaining Surplus?
Suppose claims are highly volatile.
One year:
RM5m claims
Next year:
RM15m claims
Next year:
RM7m claims
Then:
RM20m claims
The large fluctuations create uncertainty.
The actuary may therefore recommend retaining some surplus within the PRF.
For example:
Total surplus = RM5m
Distribute = RM2m
Retain = RM3m
The retained RM3m can strengthen the PRF’s:
Financial Buffer
and help absorb unexpectedly high future claims.
14. Actuary and Fair Treatment of Participants
The actuary’s role can extend beyond calculations.
The actuary may also have an important professional and governance role in helping ensure that:
participants are treated fairly.
This is especially important because Takaful can involve an agent-principal relationship.
Under a Wakalah structure:
Participants = Principals
Takaful Operator = Agent/Wakil
The operator manages the Takaful arrangement on behalf of participants.
15. Why Can the Wakalah Relationship Create a Conflict?
The participants and operator do not necessarily have identical financial interests.
Participants want:
appropriate protection
fair contributions
proper management of the PRF
and
fair treatment.
The operator needs:
sufficient Wakalah fees
operating income
and
a sustainable return for shareholders.
These objectives can coexist, but poorly designed incentives can create conflicts.
16. Simple Agent-Principal Problem
Suppose:
Gross contribution = RM1,000
Wakalah fee = RM200
Tabarru’ available to PRF = RM800
Assume RM800 is actuarially adequate for the risk.
Now suppose the operator increases its fee to:
RM400
while the participant still pays:
RM1,000.
Only:
RM600
remains for the PRF in this simplified illustration.
But if the risk still requires:
RM800
then the PRF could be inadequately funded.
Therefore, an actuary may identify that the structure creates a problem for participants even though the operator itself receives more fee income.
17. The Actuary Can Advise Management
If the actuary identifies a problem that could adversely affect participants, the actuary may advise:
Management
For example, the actuary may identify:
inadequate pricing
insufficient technical provisions
inappropriate surplus distribution
or other actuarial matters that could weaken participants’ interests or the PRF.
The objective is not merely to perform calculations but also to communicate the implications of those calculations.
18. The Actuary and the Shari’ah Committee
The actuary may also provide relevant advice to the:
Shari’ah Committee
This is important because Shari’ah governance decisions can have financial and actuarial consequences.
The Shari’ah Committee specialises in assessing Shari’ah matters, while the actuary provides expertise regarding:
risk
pricing
financial sustainability
claims expectations
technical provisions
and other actuarial consequences.
Therefore, their expertise can complement each other.
19. The Actuary and the Regulator
In some regulatory frameworks, actuaries also have responsibilities connected directly to the regulator.
The material gives Malaysia as an illustration where an actuary may have reporting obligations if important actuarial advice is not acted upon and participants’ interests could be harmed.
The underlying governance principle is:
The actuary’s professional responsibility is not limited to helping management produce desirable financial figures.
The actuary must exercise appropriate professional judgment and comply with applicable regulatory and professional requirements.
20. Why Is Independence Important?
Imagine management wants to distribute:
RM10m surplus
because a large distribution may look attractive to participants.
But actuarial analysis indicates that:
RM8m should remain in the PRF
because future claims are highly uncertain.
If the actuary simply agrees with management despite the actuarial evidence, participants could be exposed to unnecessary financial risk.
Therefore, the actuary needs sufficient:
Professional Independence
to provide an objective assessment.
21. Why Must the Actuary Understand Takaful?
An actuary working in Takaful cannot simply understand mathematical calculations.
The actuary must also understand:
how the Takaful model operates
who bears the underwriting risk
how the PRF operates
how tabarru’ is allocated
how Wakalah fees work
how surplus and deficit are treated
and
how the contractual structure affects participants and the operator.
This is because the actuarial calculations depend on the actual economic and contractual structure.
22. Knowing the Model’s Name Is Not Enough
A Takaful operation may be described as:
Wakalah
But two operators using a Wakalah model may not operate in exactly the same way.
Differences may arise from:
Takaful certificate/contract terms
fee structures
fund arrangements
surplus arrangements
distribution methods
and
sales processes.
Therefore:
The actuary must understand how the model actually works in practice, not merely what the model is called.
23. Simple Illustration
Suppose:
Operator A
Uses a Wakalah model with:
20% Wakalah fee
and a particular surplus-sharing arrangement.
Operator B
Also calls its structure Wakalah but uses:
30% Wakalah fee
and a different surplus arrangement.
Although both are called:
Wakalah
their financial outcomes may differ.
Therefore, actuarial analysis must reflect:
The actual operational structure
rather than simply assuming all Wakalah models behave identically.
24. Why Does the Sales Process Matter?
How a Takaful product is sold can influence:
who joins the pool
what risks enter the pool
anti-selection
participant expectations
and
acquisition costs.
For example, if a product is marketed particularly strongly to people who already expect to make high claims, the actual risk composition may be worse than the actuary originally assumed.
Therefore:
Sales Process
↓
Type of Participants Entering Pool
↓
Risk Composition
↓
Claims Experience
↓
Financial Performance of PRF
This is another reason why the actuary needs to understand the Takaful operation as a whole.
25. The Actuary’s Three Major Responsibilities
The main actuarial responsibilities can be remembered as:
1. PRICE
Determine an appropriate contribution/tabarru’ based on expected risk.
2. PROVIDE
Calculate appropriate technical provisions for existing obligations.
3. PROTECT SURPLUS
Determine whether surplus exists and whether it can prudently be distributed without weakening the PRF’s ability to meet future claims.
26. How the Three Roles Work Together
These responsibilities are closely connected.
Step 1 - Pricing
The actuary estimates:
How much should participants contribute for the risks accepted?
↓
Step 2 - Technical Provisions
The actuary estimates:
How much liability must be recognised for remaining coverage and claims obligations?
↓
Step 3 - Surplus
The actuary considers:
After recognising the appropriate obligations, is there a genuine surplus, and can any of it prudently be distributed?
Therefore:
Pricing → Provisions → Surplus
27. Full Takaful Actuarial Cycle
The overall process can be understood as:
Analyse Historical and Current Data
↓
Estimate Future Risk
↓
Determine Appropriate Pricing
↓
Participants Pay Contributions
↓
PRF Accepts Risks
↓
Claims Occur
↓
Actuary Estimates Outstanding and Future Obligations
↓
Calculate Appropriate Technical Provisions
↓
Determine More Accurate Financial Position
↓
Surplus or Deficit
↓
If surplus:
Assess Whether Distribution Is Prudent
If deficit:
Assess financial implications and any required support under the applicable framework
Easy Way to Remember
ACTUARY = LOOK BACK → MEASURE TODAY → ESTIMATE TOMORROW
LOOK BACK
Analyse historical experience.
MEASURE TODAY
Understand the current risk pool and financial position.
ESTIMATE TOMORROW
Estimate future claims and financial obligations.
Then use these estimates to support:
Pricing + Provisions + Surplus Decisions
Simple Formula
The broad actuarial process is:
Past Data + Present Information + Mathematical/Statistical Analysis → Estimate Future Risk and Financial Impact
In Takaful:
Actuarial Analysis → Appropriate Pricing + Adequate Provisions + Prudent Surplus Assessment
One-Sentence Summary
An actuary in Takaful uses mathematical, statistical and financial analysis to estimate uncertain future risks and their financial impact, with major responsibilities including determining appropriate pricing, calculating adequate technical provisions, assessing surplus and its possible distribution, and providing independent professional advice that helps protect participants and maintain the financial sustainability of the Takaful arrangement.
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Takaful - Role of an Actuary in Pricing
Pricing is an important part of Takaful because participants normally pay their contributions in advance, at the beginning of the coverage period, before anyone knows exactly what claims will occur during that period.
This creates an important problem:
The contribution must be determined today, even though the actual claims will only be known in the future.
Therefore, the actuary uses available information and assumptions about future claims to determine an appropriate contribution.
Two broad approaches to determining the risk contribution are:
Collective pricing
and
Risk-weighted pricing.
1. Why Is Pricing Necessary in Takaful?
Suppose Ahmad purchases medical Takaful on:
1 January
He pays his contribution at the beginning of the year.
However, the Takaful operator does not know whether Ahmad will:
make no claim
make one small claim
or
make several large claims
during the year.
Therefore:
Contribution is collected first
↓
Claims occur later
This means the contribution has to be determined based on an estimate of future risk.
2. The Actuary Cannot Know Future Claims Exactly
The actuary cannot predict exactly:
who will become sick
who will make a claim
how many claims will occur
or
how much each claim will cost.
Instead, the actuary uses:
historical claims data
statistical information
claim frequency
claim severity
participant characteristics
and other relevant risk information
to estimate the expected cost of claims.
Therefore:
Actuarial pricing is based on expected future claims, not known future claims.
3. What Does the Actuary Try to Achieve?
The actuary tries to determine an appropriate amount of tabarru’ so that the PRF has sufficient resources to support the risks accepted into the pool.
In simple terms:
Expected Risk → Appropriate Tabarru’ → PRF → Future Claims
If tabarru’ is too low relative to the risk:
Insufficient Tabarru’
↓
Claims may exceed PRF resources
↓
Greater risk of PRF deficit
Therefore, appropriate pricing is important for the financial sustainability of the Takaful arrangement.
4. What Is Collective Pricing?
Under collective pricing, participants in the relevant group pay the same or common tabarru’ amount, even though their individual risk levels may be different.
In simple terms:
Different risks → Same tabarru’
The contribution is based on the collective or average characteristics of the group rather than being individually adjusted for each participant’s specific risk.
5. Medical Takaful Illustration
Suppose four people want medical Takaful protection.
Risk 1
A 30-year-old in good health
Risk 2
A 50-year-old with high blood pressure
Risk 3
A 60-year-old with diabetes
Risk 4
A 20-year-old in very good health
These four people do not necessarily have the same probability of making a medical claim.
Within this simplified illustration, Risk 3 is assumed to have the highest expected claims risk, while Risk 4 has a much lower expected claims risk.
6. Different Participants Bring Different Risks
The important idea is:
Risk 1
Relatively lower expected risk.
Risk 2
Higher expected risk because of the assumed health characteristics.
Risk 3
Highest expected risk in this illustration.
Risk 4
Lowest expected risk in this illustration.
Therefore:
The participants do not bring equal expected claims risk into the PRF.
However, collective pricing does not necessarily distinguish between these different individual risk levels.
7. Same Tabarru’ Under Collective Pricing
Suppose the common tabarru’ is:
RM100 per participant
Therefore:
Risk 1 pays = RM100
Risk 2 pays = RM100
Risk 3 pays = RM100
Risk 4 pays = RM100
Total tabarru’ collected:
RM100 × 4 = RM400
Therefore, the PRF receives:
RM400
8. But Their Risks Are Not the Same
Although everybody contributes:
RM100
their expected claims risks differ.
For instance, within this simplified illustration:
Risk 4 may have a relatively low probability of making a claim.
Risk 3 may have a considerably higher probability of making a claim.
Yet:
Risk 4 pays RM100
and
Risk 3 also pays RM100.
Therefore, the tabarru’ does not directly reflect the individual risk each participant brings into the pool.
9. Why Might RM400 Be Insufficient?
Suppose the RM100 common tabarru’ was determined based on an assumed mixture of:
lower-risk participants
medium-risk participants
and
higher-risk participants.
If the actual group develops exactly as expected, the pricing may be more likely to work as intended.
But suppose the actual participants who join are mostly:
higher-risk participants
.
Then:
Total expected claims may be much higher
while:
Each person still pays only RM100.
Therefore, the:
RM400 total tabarru’ may be insufficient to meet total claims.
10. Simple Numerical Illustration
Suppose the actuarial expected claims costs are:
Risk 1 = RM60
Risk 2 = RM120
Risk 3 = RM180
Risk 4 = RM40
Total expected claims:
RM60 + RM120 + RM180 + RM40 = RM400
If all four participate and each pays RM100:
Total tabarru’:
RM400
Expected claims:
RM400
So the collective price appears to work.
But this depends on the expected mixture of risks actually remaining in the pool.
11. What If the Healthy Participants Do Not Join?
Suppose Risk 4 is very healthy and believes:
“RM100 is too expensive for the amount of risk I bring.”
Risk 4 decides not to participate.
Risk 3, however, has much higher expected medical costs and may think:
“RM100 is attractive for the protection I receive.”
Risk 3 therefore remains in the pool.
This creates a serious problem because the actual pool begins to contain a larger proportion of:
Higher-risk participants
than the actuary originally assumed.
12. This Is Called Anti-Selection
This situation is called:
Anti-selection
or:
Adverse selection
It occurs when participants have information about their own risk and the pricing structure makes the Takaful arrangement relatively more attractive to higher-risk participants than to lower-risk participants.
In simple terms:
The people who expect to claim more are more attracted to the common price, while people who expect to claim less may find the same price unattractive.
13. Why Would a Healthy Participant Leave?
Suppose:
Healthy participant
Expected claim cost = RM40
Tabarru’ = RM100
The participant may feel RM100 is expensive relative to their expected risk.
But consider:
Higher-risk participant
Expected claim cost = RM180
Tabarru’ = RM100
The RM100 contribution appears relatively attractive.
Therefore:
Lower-risk participant
Expected cost RM40 → Pays RM100 → May not join
while:
Higher-risk participant
Expected cost RM180 → Pays RM100 → More likely to join
This is how common pricing can affect the composition of the risk pool.
14. Why Is Anti-Selection Dangerous?
The original RM100 contribution may have been calculated assuming a balanced mixture of:
low risk + medium risk + high risk
But if many lower-risk participants do not join, the pool changes.
The new pool may contain:
More high-risk participants
Therefore:
Average expected claims increase
but:
Tabarru’ remains RM100
This creates a mismatch.
15. The Anti-Selection Process
The process can be understood as:
Same Tabarru’ for Different Risks
↓
Low-Risk Participants Find Price Relatively Expensive
↓
Some Low-Risk Participants Do Not Join
↓
High-Risk Participants Find Price Relatively Attractive
↓
Higher-Risk Participants Become a Larger Proportion of the Pool
↓
Average Expected Claims Increase
↓
Original Tabarru’ Becomes Inadequate
↓
Greater Risk of PRF Deficit
16. Why Is the Actuary’s Original Assumption Important?
Actuarial pricing depends on assumptions.
Suppose the actuary expects:
40% low-risk participants
40% medium-risk participants
20% high-risk participants
The RM100 tabarru’ may have been determined based on this expected mixture.
But suppose the actual pool becomes:
10% low-risk
30% medium-risk
60% high-risk
The actual risk profile is now much worse than assumed.
Therefore:
A collective price calculated using one expected risk mixture may become inadequate if the actual participants have a significantly different risk profile.
17. Collective Pricing Depends on the Composition of the Pool
This is the key weakness of collective pricing.
The common contribution may be adequate only if the actual composition of participants is reasonably consistent with the assumptions used when determining the price.
If the actual pool becomes much riskier:
Expected Claims ↑
while:
Tabarru’ per Participant stays the same
Therefore:
Probability of insufficient PRF funding ↑
18. Why Does Voluntary Participation Matter?
If participation is compulsory, lower-risk participants cannot simply leave because they consider the common contribution too high.
Therefore, the expected mixture of:
low-risk
medium-risk
and
high-risk
participants may be easier to maintain.
But if participation is voluntary:
Participants can decide whether the common contribution represents good value for their own circumstances.
This creates greater potential for anti-selection.
19. Collective Pricing Can Create Cross-Subsidisation
When everyone pays the same tabarru’ despite having different expected risk:
Lower-risk participants may contribute more relative to their expected claims
while:
Higher-risk participants may contribute less relative to their expected claims.
This creates:
Cross-subsidisation
For example:
Low-risk expected cost = RM40
Contribution = RM100
Higher-risk expected cost = RM180
Contribution = RM100
The lower-risk participant is effectively contributing relatively more toward the collective risk cost.
20. Is Cross-Subsidisation the Same as Risk Sharing?
No.
This distinction is important.
Risk Sharing
Means participants contribute to a common PRF and the fund collectively pays valid covered losses.
Cross-Subsidisation
Means one category of participants is systematically paying relatively more compared with its expected risk while another category pays relatively less.
Therefore:
Risk sharing is the fundamental pooling mechanism, while cross-subsidisation concerns how the cost of that pool is allocated among participants.
21. The Alternative - Risk-Weighted Pricing
One way to address the problem is:
Risk-Weighted Pricing
Under this approach, the amount of tabarru’ depends more directly on the risk that each participant brings into the pool.
Therefore:
Lower expected risk → Lower tabarru’
Higher expected risk → Higher tabarru’
The objective is to make contributions better reflect expected claims costs.
22. Simple Risk-Weighted Illustration
Suppose actuarial assessment produces:
Risk 1 expected risk cost = RM60
Risk 2 = RM120
Risk 3 = RM180
Risk 4 = RM40
Instead of charging everyone RM100, a simplified risk-weighted structure could charge amounts more closely related to those risks.
Therefore:
Risk 1 → Lower tabarru’
Risk 2 → Higher tabarru’
Risk 3 → Highest tabarru’
Risk 4 → Lowest tabarru’
The total contributions can then respond more directly to the actual risk composition of the pool.
23. Why Can Risk-Weighted Pricing Reduce Anti-Selection?
Suppose a lower-risk participant has an expected risk cost of:
RM40
Instead of charging RM100, the contribution is priced closer to the participant’s actual expected risk.
The participant is therefore less likely to feel that they are paying excessively relative to their risk.
At the same time, a higher-risk participant with an expected cost of:
RM180
would pay a higher tabarru’.
Therefore, the higher-risk participant is less likely to be severely underpriced.
So:
Risk-Based Contribution
↓
Less Underpricing of High Risks
- ●
Less Overpricing of Low Risks
↓
Reduced Anti-Selection Pressure
24. Contributions Are Paid Before Claims Are Known
The most important timing issue is:
At the beginning of coverage
The participant pays the contribution.
But:
During the coverage period
Claims emerge.
Therefore:
Time 0
Contribution determined and collected.
↓
Future period
Claims occur.
↓
Actual claims become known
The actuary must therefore estimate future claims before they happen.
25. Why Can’t the Operator Wait Until Claims Occur?
Suppose the operator said:
“We will wait until the end of the year, see who claimed, and then decide how much everyone should contribute.”
That would undermine the normal advance-funding structure of the Takaful arrangement.
The PRF needs resources available to pay claims when they arise.
Therefore:
Contributions must be collected before the actual claims experience is fully known.
This is why actuarial pricing is necessary.
26. Expected Claims vs Actual Claims
The actuary determines contributions based on:
Expected claims
But the PRF eventually experiences:
Actual claims
These will not necessarily be identical.
For example:
Expected claims = RM1 million
Actual claims could be:
RM800,000
RM1 million
or
RM1.3 million
Therefore:
Pricing is based on expectations, while the eventual financial result depends on actual experience.
27. Why Is There Uncertainty?
Future claims are affected by:
how many participants make claims
how severe the claims are
unexpected illnesses or accidents
medical-cost inflation
changes in participant behaviour
and other uncertain events.
Therefore, even a well-calculated contribution cannot guarantee:
Total Tabarru’ = Total Actual Claims
The objective is to set contributions on a financially sound basis given the information available.
28. What Happens If Tabarru’ Is Too Low?
Suppose:
Total tabarru’ collected = RM1 million
Actual claims and relevant obligations = RM1.3 million
Simplified shortfall:
RM1.3m − RM1m = RM300,000
This creates financial pressure on the PRF and may contribute to:
PRF deficit
Therefore, underpricing can threaten the financial sustainability of the risk pool.
29. What Happens If Claims Are Lower Than Expected?
Suppose:
Total relevant PRF income = RM1 million
Relevant claims, expenses and provisions = RM800,000
Simplified positive result:
RM1m − RM800,000 = RM200,000
This may contribute to an:
Underwriting surplus
However, the existence of surplus does not automatically mean the entire RM200,000 should immediately be distributed.
The PRF’s future obligations and financial strength still need to be considered.
30. The Actuary’s Main Pricing Responsibility
The actuary needs to consider questions such as:
What risks are entering the pool?
How frequently are claims expected?
How severe are those claims expected to be?
What participant characteristics affect the risk?
What total claims are expected?
What tabarru’ should be collected?
and
Could the pricing structure create anti-selection?
Therefore, actuarial pricing is not simply:
“Choose a contribution amount.”
It is about ensuring that the contribution structure appropriately reflects the expected risk of the pool.
Easy Way to Remember
PRICE TODAY → CLAIMS TOMORROW
The contribution is determined:
Before claims occur
Therefore, the actuary must:
Estimate Risk
↓
Estimate Future Claims
↓
Determine Appropriate Tabarru’
↓
Collect Contributions
↓
PRF Pays Future Covered Claims
Collective Pricing - Easy Formula
Different Risks → Same/Common Tabarru’
For example:
Risk 1 → RM100
Risk 2 → RM100
Risk 3 → RM100
Risk 4 → RM100
Total:
RM400
The problem arises if the actual risk composition is worse than the assumptions used to determine RM100.
Anti-Selection - Easy Formula
Same Price + Voluntary Participation
↓
Low-Risk Participants May Find Price Too High
↓
High-Risk Participants May Find Price Attractive
↓
Pool Becomes Higher Risk
↓
Expected Claims Increase
↓
Original Contribution May Become Inadequate
Risk-Weighted Pricing - Easy Formula
Different Risks → Different Tabarru’
Therefore:
Lower Expected Risk → Lower Tabarru’
and:
Higher Expected Risk → Higher Tabarru’
The objective is:
Tabarru’ More Closely Reflects Expected Risk
Most Important Concept
The main problem is not simply that participants have different risks.
The real problem occurs when:
A common contribution is calculated using an assumed mixture of low-risk and high-risk participants, but voluntary participation causes the actual pool to contain disproportionately more high-risk participants.
Then:
Actual Pool Risk > Expected Pool Risk
while:
Tabarru’ remains based on the original assumptions
which can lead to:
Insufficient PRF Funding
One-Sentence Summary
The actuary determines Takaful pricing before actual claims are known by estimating the expected risk of participants; under collective pricing, participants with different risk levels pay a common tabarru’ amount, which can encourage anti-selection when lower-risk participants find the price unattractive while higher-risk participants are attracted to it, potentially making the actual risk pool more expensive than assumed and causing the tabarru’ collected to become insufficient for future claims.
- Published on
Takaful - Collective Pricing and Risk-Weighted Pricing of Tabarru’
The amount of tabarru’ collected from participants is important because it provides the financial resources for the Participants’ Risk Fund (PRF) to pay valid covered claims.
However, participants do not necessarily bring the same level of risk into the pool.
Some participants may have a relatively low expected claims risk, while others may have a higher expected claims risk.
This creates an important pricing question:
Should every participant pay the same tabarru’, or should the tabarru’ differ according to the risk each participant brings into the pool?
Two approaches can be considered:
Collective pricing
and
Risk-weighted pricing
1. What Is Collective Pricing?
Collective pricing means participants within a particular pool are charged a common or average tabarru’ rate, even though their individual risk levels may differ.
In simple terms:
Different levels of risk → Same or average tabarru’ rate
The tabarru’ is based on the average risk of the group rather than being individually adjusted for each participant’s specific risk.
2. Simple Collective Pricing Example
Suppose four participants have different expected claim costs:
Ahmad
Expected claim cost = RM200
Ali
Expected claim cost = RM400
Sarah
Expected claim cost = RM1,200
Fatimah
Expected claim cost = RM200
Total expected claims:
RM200 + RM400 + RM1,200 + RM200 = RM2,000
Average expected claim cost:
RM2,000 ÷ 4 = RM500
Under a simplified collective pricing approach, each participant could therefore contribute:
RM500 tabarru’
Total tabarru’ collected:
RM500 × 4 = RM2,000
3. What Happens Under Collective Pricing?
Although everyone pays RM500, their expected risks are different.
Ahmad
Expected risk cost = RM200
Tabarru’ = RM500
Ahmad contributes more than his individual expected risk cost.
Sarah
Expected risk cost = RM1,200
Tabarru’ = RM500
Sarah contributes substantially less than her individual expected risk cost.
Therefore, collective pricing can involve:
Cross-subsidisation
where lower-risk participants effectively contribute relatively more toward the overall cost of higher-risk participants.
4. Is Cross-Subsidisation Always a Problem?
Not necessarily.
Risk pooling itself involves participants collectively sharing losses.
However, a problem can arise when the common tabarru’ rate creates incentives for participants to decide whether to enter or remain in the pool based on their individual risk.
This becomes particularly important when participation is:
Voluntary
because participants can choose whether the common price is attractive to them.
5. Collective Pricing Works Better With Compulsory Membership
Suppose all four participants are required to remain in the pool.
Then:
Total tabarru’ collected = RM2,000
Total expected claims = RM2,000
The low-risk and high-risk participants remain together.
Therefore, the averaging mechanism can continue to function.
This is why collective pricing can work more effectively when membership in the relevant pool is compulsory.
The basic idea is:
Compulsory Membership → Low and High Risks Remain Together → Average Pricing More Sustainable
6. Problem With Voluntary Membership - Anti-Selection
When participation is voluntary, collective pricing can create:
Anti-selection
also commonly called:
Adverse selection
Anti-selection occurs when the pricing arrangement makes participation relatively more attractive to higher-risk participants and less attractive to lower-risk participants.
In simple terms:
The people most likely to claim may find the common price attractive, while people less likely to claim may find it too expensive.
7. Simple Anti-Selection Example
Suppose everyone must pay:
RM500 tabarru’
Ahmad has a relatively low expected risk:
RM200
Ahmad may think:
“My expected risk is much lower than RM500. This arrangement seems expensive for me.”
He may decide not to participate.
Sarah has a much higher expected risk:
RM1,200
but she only needs to contribute:
RM500.
The common rate may therefore appear relatively attractive to Sarah.
As a result:
Lower-risk participants → More likely to leave or not join
while:
Higher-risk participants → More likely to join or remain
This changes the risk composition of the pool.
8. Why Is Anti-Selection Dangerous?
Suppose the original tabarru’ rate was calculated assuming the pool contained:
many low-risk participants
and
some high-risk participants.
Now many low-risk participants leave.
The remaining pool contains a greater proportion of:
Higher-risk participants
Therefore:
Average expected claims increase.
But if the tabarru’ remains at the old average level, the PRF may no longer collect enough money to support the new risk profile.
The process becomes:
Common Average Tabarru’
↓
Low-Risk Participants Find It Relatively Expensive
↓
Some Low-Risk Participants Leave
↓
Higher-Risk Participants Become a Larger Part of Pool
↓
Average Expected Claims Increase
↓
Tabarru’ May Become Inadequate
↓
Greater Risk of PRF Deficit
9. What Is Risk-Weighted Pricing?
An alternative is:
Risk-Weighted Pricing
Under risk-weighted pricing:
The tabarru’ payable by each participant is linked to the amount of risk that participant brings into the risk pool.
Therefore:
Different Risk → Different Tabarru’
A participant presenting higher expected claims risk would generally contribute a higher tabarru’ than a participant presenting lower expected claims risk, subject to the applicable pricing framework.
10. Simple Risk-Weighted Pricing Example
Suppose actuarial analysis estimates:
Ahmad
Expected claim cost = RM200
Ali
Expected claim cost = RM400
Sarah
Expected claim cost = RM1,200
Fatimah
Expected claim cost = RM200
Under a very simplified risk-weighted approach:
Ahmad’s tabarru’ = RM200
Ali’s tabarru’ = RM400
Sarah’s tabarru’ = RM1,200
Fatimah’s tabarru’ = RM200
Total tabarru’:
RM200 + RM400 + RM1,200 + RM200
= RM2,000
Total expected claims:
RM2,000
The total amount collected reflects the total expected risk, while the amount contributed by each participant more closely reflects that participant’s individual expected risk.
11. Why Does a Higher-Risk Participant Pay More Tabarru’?
The purpose is not to punish the participant.
The objective is to ensure that the contribution reflects the expected financial cost of the risk being introduced into the PRF.
Suppose:
Participant A has expected claim cost = RM300
Participant B has expected claim cost = RM1,000
If both contribute only:
RM300
then Participant B’s expected risk is significantly underfunded.
If many participants similar to B enter the pool, the PRF may collect insufficient tabarru’ relative to its expected claims.
Therefore:
Higher Expected Risk → Higher Required Risk Contribution
12. Risk Factors Can Affect Tabarru’
The actuary may consider relevant risk characteristics when determining the expected claims cost.
Depending on the type of Takaful product, relevant factors can include matters such as:
age
health characteristics
occupation
type and value of property
claims history
sum covered
and other relevant factors permitted within the applicable regulatory and underwriting framework.
The purpose is to estimate:
How much expected claims risk does this participant bring into the pool?
13. Higher-Risk Participant Illustration
Suppose a particular participant is assessed as presenting a higher expected claims risk than other participants.
For example:
Expected claim frequency for lower-risk participant = 2%
Expected claim frequency for higher-risk participant = 6%
Suppose the expected amount payable if a claim occurs is:
RM20,000
For the lower-risk participant:
2% × RM20,000 = RM400
For the higher-risk participant:
6% × RM20,000 = RM1,200
Therefore:
Lower expected risk cost = RM400
Higher expected risk cost = RM1,200
This helps explain why the actuarially determined tabarru’ may differ between participants.
14. Claim Frequency and Claim Severity
Two important elements in determining expected claims are:
Claim Frequency
How often claims are expected to occur.
and
Claim Severity
How large the claims are expected to be when they occur.
A simplified formula is:
Expected Claim Cost = Expected Claim Frequency × Expected Claim Amount
For example:
Expected claim frequency = 5%
Expected claim amount = RM20,000
Therefore:
5% × RM20,000 = RM1,000
Simplified expected claim cost:
RM1,000
This provides an actuarial basis for determining an appropriate risk contribution.
15. Why Historical Claims Data Is Important
Actuaries cannot know exactly what will happen in the future.
Instead, they analyse relevant information such as:
historical claim frequency
historical claim severity
participant characteristics
sum covered
claims trends
and other relevant risk information.
The process can be understood as:
Historical Claims Information
↓
Identify Relevant Risk Characteristics
↓
Estimate Claim Frequency
↓
Estimate Claim Severity
↓
Estimate Expected Claim Cost
↓
Determine Appropriate Risk-Weighted Tabarru’
16. What Happens When More High-Risk Participants Enter the Pool?
Suppose a pool initially contains mostly lower-risk participants.
Expected total claims:
RM1 million
The required tabarru’ would be determined with reference to that risk profile and other relevant actuarial considerations.
Now suppose the same number of participants remains, but the pool contains many more higher-risk participants.
Expected claims might increase to:
RM2 million
Under risk-weighted pricing, the higher-risk participants would generally contribute higher tabarru’ amounts.
Therefore:
More High-Risk Participants
↓
Higher Total Expected Claims
↓
Higher Risk-Weighted Tabarru’ Requirements
↓
Higher Total Tabarru’ Collected
This helps the PRF’s funding respond to changes in the risk composition of the pool.
17. Why Is This Important for the PRF?
The PRF needs sufficient financial resources to meet valid covered claims.
Suppose the pool becomes significantly riskier, but tabarru’ remains unchanged.
Then:
Risk increases
but:
Tabarru’ does not increase
This creates a mismatch.
For example:
Total tabarru’ = RM10m
Expected claims increase to = RM14m
Potential expected funding gap:
RM4m
Therefore, risk-weighted pricing helps align:
Risk Accepted ↔ Tabarru’ Collected
18. Does Risk-Weighted Pricing Guarantee That Tabarru’ Will Be Enough?
No.
Risk-weighted pricing is based on expected claims, but actual claims remain uncertain.
Suppose:
Expected total claims = RM10m
Appropriate tabarru’ collected = RM10m, in a simplified illustration.
But unexpectedly severe claims result in:
Actual claims = RM15m
Then:
RM15m − RM10m = RM5m
Claims are RM5m higher than expected.
Therefore:
Risk-weighted pricing improves the relationship between expected risk and contributions, but it cannot eliminate uncertainty.
19. Why Can Actual Claims Differ From Expected Claims?
Claims can differ because of:
random fluctuations
unexpectedly large claims
changes in claim frequency
changes in claim severity
catastrophic events
inflation
and other unforeseen developments.
Therefore, appropriate pricing is only one part of sound Takaful risk management.
The PRF may also rely on:
appropriate margins
technical provisions
retained surplus
financial buffers
Retakaful
diversification
and sound:
risk management.
20. Expected Claims vs Actual Claims
This distinction is extremely important.
Expected Claims
An actuarial estimate made before the future claims are known.
For example:
Expected claims = RM10m
Actual Claims
The claims that actually emerge.
For example:
Actual claims = RM12m
Therefore:
Expected claims are an estimate; actual claims are the eventual experience.
This is why actuarial pricing can improve the probability of adequate funding but cannot guarantee the exact outcome.
21. Does Risk-Weighted Pricing Remove Risk Sharing?
No.
This is one of the most important concepts.
Suppose:
Ahmad contributes = RM300
Ali contributes = RM600
Sarah contributes = RM1,000
Fatimah contributes = RM500
They contribute different amounts because their risks differ.
But their tabarru’ still goes into:
The common Participants’ Risk Fund
If Ali subsequently suffers a valid covered loss of:
RM20,000
he does not simply receive his:
RM600
back.
His valid covered claim is paid from the collective PRF, according to the applicable terms.
Therefore:
Different contribution amounts do not eliminate mutual risk sharing.
22. Pricing and Risk Pooling Are Different Concepts
This distinction is very useful.
Pricing asks:
How much should each participant contribute to the risk pool?
Risk pooling asks:
How are the covered financial losses of participants shared?
Under risk-weighted Takaful:
Participants can pay different tabarru’ amounts
while:
their covered risks remain collectively pooled through the PRF.
Therefore:
Risk-Weighted Pricing ≠ Individual Self-Insurance
The participant is still part of a mutual risk-sharing arrangement.
23. Collective Pricing and Risk-Weighted Pricing Compared
Collective Pricing
The contribution is based on a:
common or average rate.
Therefore:
Low risk → Same/average tabarru’
Medium risk → Same/average tabarru’
High risk → Same/average tabarru’
This can create cross-subsidisation and may encourage anti-selection when participation is voluntary.
Risk-Weighted Pricing
The contribution is linked more closely to individual expected risk.
Therefore:
Lower risk → Lower tabarru’
Medium risk → Moderate tabarru’
Higher risk → Higher tabarru’
This helps the total contributions collected adjust when the overall risk profile of the pool changes.
24. Connection With PRF Deficit
Suppose many higher-risk participants enter the pool but continue paying a tabarru’ amount designed for a lower-risk population.
Then:
Higher-Risk Pool
↓
Expected Claims Increase
↓
Tabarru’ Remains Too Low
↓
Insufficient PRF Funding
↓
Claims May Exceed Available Resources
↓
Greater Risk of PRF Deficit
Risk-weighted pricing helps reduce this mismatch by adjusting contributions to reflect expected risk.
25. Connection With Solvency
Appropriate pricing also contributes to the financial sustainability of the Takaful arrangement.
The process is:
Proper Risk Assessment
↓
Appropriate Tabarru’
↓
Adequate PRF Funding
↓
Greater Ability to Meet Claims
↓
Stronger Financial Sustainability
However, pricing alone cannot guarantee solvency.
Financial strength also depends on:
actual claims experience
technical provisions
investment performance
Retakaful
liquidity
capital support
and other risk-management measures.
26. Connection With Surplus and Deficit
Suppose:
Total relevant PRF income = RM10m
Relevant claims, costs and provisions = RM8m
Simplified result:
RM10m − RM8m = RM2m surplus
However, if claims and relevant obligations instead become:
RM12m
then:
RM10m − RM12m = −RM2m
The PRF has a:
RM2m deficit
Therefore, appropriate risk-weighted pricing improves the starting financial position by aligning tabarru’ with expected risk, but the eventual result still depends on actual experience.
27. Why the Actuary Is Important
The actuary helps determine appropriate tabarru’ by assessing:
Who is entering the pool?
What level of risk do they bring?
How frequently are claims expected?
How severe could claims be?
What is the expected total claims cost?
and:
How much tabarru’ should be collected to support those risks?
Therefore, actuarial pricing helps prevent the PRF from accepting increasing amounts of risk without receiving an appropriate corresponding amount of tabarru’.
Easy Way to Remember
COLLECTIVE = AVERAGE
Participants with different risks pay a common or averaged tabarru’ rate.
Possible problem:
Low-risk participants pay relatively more
while:
High-risk participants pay relatively less
If participation is voluntary, this can contribute to:
Anti-selection
RISK-WEIGHTED = RISK-BASED
The tabarru’ reflects the expected risk each participant brings into the pool.
Therefore:
Lower Expected Risk → Lower Tabarru’
Higher Expected Risk → Higher Tabarru’
But all participants still share their risks through the:
Common PRF
Simple Formula
A simplified actuarial starting point is:
Expected Claim Cost = Expected Claim Frequency × Expected Claim Amount
For example:
5% × RM20,000 = RM1,000
Therefore, the expected claim cost is:
RM1,000
The actuary then considers the relevant risk characteristics and other actuarial factors when determining the appropriate tabarru’.
Anti-Selection Formula
Remember:
Common Average Tabarru’
- ●
Voluntary Participation
↓
Lower-Risk Participants May Find the Price Less Attractive
↓
Higher-Risk Participants May Find the Price More Attractive
↓
Pool Becomes Higher Risk
↓
Expected Claims Increase
↓
Greater Risk of Insufficient Tabarru’
Risk-Weighted Pricing Formula
Participant’s Risk ↑ → Expected Claims Cost ↑ → Required Tabarru’ ↑
At the pool level:
Higher Overall Risk → Higher Expected Claims → Higher Required Total Tabarru’
This helps keep the PRF’s contributions more closely aligned with the risks it is accepting.
One-Sentence Summary
Collective pricing applies a common or averaged tabarru’ rate to participants with different risk levels and can encourage anti-selection when participation is voluntary, whereas risk-weighted pricing links each participant’s tabarru’ more closely to the expected risk they bring into the pool, helping total contributions reflect total expected claims while preserving mutual risk sharing through the common Participants’ Risk Fund.
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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.
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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.
- Published on
Takaful - What Is a Financial Buffer?
A financial buffer is an amount of financial resources kept available to help a Takaful fund absorb unexpected losses, higher-than-expected claims, or other adverse financial events.
In very simple terms:
Financial buffer = extra financial strength kept for a bad day.
It is called a buffer because it creates a cushion between the fund’s normal expected financial needs and a situation in which the fund becomes financially distressed.
1. Why Do We Need a Financial Buffer?
Future claims cannot be predicted perfectly.
Suppose the actuary estimates:
Expected claims next year = RM10 million
But actual claims could be:
RM9m
RM10m
RM12m
or even:
RM15m
The RM10m is an estimate, not a guarantee.
If the PRF only has exactly enough resources for RM10m and actual claims become RM15m, the fund may face financial difficulty.
Therefore, it is prudent to maintain additional financial resources.
That additional protection is what we mean broadly by a:
Financial buffer
2. Simple Example
Suppose the PRF expects:
Claims and other relevant obligations = RM20 million
But it has:
RM25 million of appropriate financial resources
The additional:
RM5 million
provides a cushion against adverse experience.
You can think of:
RM20m → Expected requirements
RM5m → Additional financial protection
So, conceptually:
Financial Resources = Expected Requirements + Financial Buffer
This is simplified because actual regulatory and actuarial calculations are more complex.
3. Where Does the Financial Buffer Come From?
“Financial buffer” is a general concept, not necessarily one specific account called the “Financial Buffer Account.”
Depending on the context and regulatory framework, financial resilience can come from several sources, such as:
retained/accumulated surplus in the PRF, appropriate reserves or provisions, capital, Retakaful protection, and other required financial resources.
In the section you are currently studying, the particularly important buffer is:
Surplus retained in the PRF
Instead of distributing the entire surplus to participants, some may remain in the PRF to help absorb future claims fluctuations.
4. Example - Retained Surplus Becomes a Buffer
Suppose the PRF generates:
RM6 million surplus
The actuary considers future claims uncertainty and recommends:
Distribute = RM2m
Retain in PRF = RM4m
The retained:
RM4 million
strengthens the PRF and acts as a financial buffer against future adverse claims experience.
Suppose next year claims are unexpectedly:
RM3 million higher than expected.
The accumulated resources can help the PRF absorb that adverse experience.
So:
Surplus today → Retained in PRF → Financial buffer → Helps absorb future bad claims
5. What Happens Without the Buffer?
Suppose the entire:
RM6m surplus
was distributed.
The PRF therefore does not retain that RM6m as additional accumulated strength.
Next year:
Expected claims = RM20m
Actual claims = RM24m
Unexpected additional claims:
RM4m
The PRF may now be more vulnerable to a deficit.
Depending on the circumstances and applicable Takaful structure:
Unexpected Claims → PRF Deficit → Potential Qard Support
So retaining an appropriate buffer can reduce the PRF’s dependence on external support.
6. Why Does Claims Volatility Affect the Required Buffer?
Remember:
Claims volatility = claims fluctuate significantly from one period to another.
Suppose PRF A has claims:
RM10m → RM10.5m → RM9.8m → RM10.2m
These claims are relatively stable.
Now PRF B has:
RM5m → RM18m → RM7m → RM25m
PRF B has much greater claims volatility.
Therefore, the actuary may be more cautious about distributing PRF B’s surplus.
Why?
Because:
Greater volatility → Greater uncertainty → Greater possibility of unexpectedly high claims → Greater need for financial protection
So:
Higher Claims Volatility → Greater Need for Financial Buffer
7. Why Is It Called a “Buffer”?
Think about the bumper of a car.
A bumper helps absorb an impact.
A financial buffer performs a similar economic function:
Unexpected financial shock
↓
Buffer absorbs part/all of shock
↓
Core financial position is better protected
For Takaful:
Unexpectedly High Claims
↓
Financial Buffer
↓
PRF better able to absorb claims
↓
Lower risk of severe deficit
That is why the word buffer is used.
8. Financial Buffer Is Not the Same as Surplus
This distinction is important.
Surplus
A surplus is a positive financial result remaining in the PRF after relevant obligations and provisions have been accounted for.
For example:
PRF income RM20m − relevant claims/costs RM16m = RM4m surplus
Financial Buffer
A financial buffer describes financial resources available to absorb adverse future experience.
If the RM4m surplus is retained in the PRF, it can contribute to the PRF’s financial buffer.
Therefore:
Surplus can be a source of financial buffer, but “surplus” and “financial buffer” do not mean exactly the same thing.
9. Financial Buffer Is Also Not Exactly the Same as a Reserve
This is another useful distinction.
A reserve/provision generally represents amounts recognised for particular expected or incurred obligations, depending on the accounting/actuarial context.
For example, suppose the PRF knows that claims have already occurred but some have not yet been paid.
It may need to recognise:
RM5m claims provision
That RM5m is not simply “extra money available to distribute.”
It relates to obligations that need to be met.
A buffer, on the other hand, refers more broadly to additional financial capacity available to absorb unexpected adverse experience.
So conceptually:
Reserve/Provision → Expected or recognised obligations
Buffer → Protection against adverse/unexpected experience
The exact terminology and calculation depend on the regulatory and accounting framework.
10. Financial Buffer Is Also Different From Pricing Margin
You have now encountered three related terms:
Pricing Margin
Used when pricing the product.
Example:
Expected claims = RM700
Margin for uncertainty = RM100
Pricing requirement = RM800
It helps recognise uncertainty before future experience occurs.
Surplus
Arises from the actual financial performance of the PRF.
Example:
PRF underwriting income = RM20m
Relevant claims/costs = RM17m
Surplus = RM3m
Financial Buffer
Financial strength retained/available to help absorb future adverse experience.
Example:
Of the RM3m surplus:
RM2m retained
That RM2m strengthens the PRF’s buffer.
So:
Margin → built into assumptions/pricing for uncertainty
Surplus → positive result after experience
Buffer → financial protection maintained against future adverse experience
11. Connection With the Actuary
Now the previous section should make more sense.
Suppose:
PRF surplus = RM10m
Participants may naturally ask:
“Why don’t we distribute the whole RM10m?”
The actuary may respond:
“Because claims are volatile. If we distribute the entire RM10m, the PRF may not have enough financial strength if next year’s claims are unusually high.”
The actuary might therefore recommend:
RM3m → distribute
RM7m → retain
The RM7m strengthens the PRF’s financial buffer.
12. Connection With the “Next Big Claim”
This explains the statement you just studied about retaining surplus for the next “big claim.”
Suppose:
Year 1 retained surplus = RM2m
Year 2 retained surplus = RM3m
Year 3 retained surplus = RM2m
Accumulated retained surplus:
RM7 million
Then Year 4 has unexpectedly severe claims.
Additional adverse claims experience:
RM6 million
The PRF already has accumulated financial strength from earlier years.
Therefore:
Earlier Surpluses → Accumulated Buffer → Absorb Later Claims Volatility
This is also how risk sharing can extend across different years.
13. Connection With Qard
Suppose a PRF has:
No accumulated financial buffer
and unexpectedly experiences:
RM5m deficit
The shareholder/operator fund may need to provide qard, depending on the applicable Takaful framework.
Now suppose the PRF had accumulated sufficient surplus from previous years.
That accumulated financial strength may help absorb the adverse experience before the PRF needs external support.
Therefore:
Stronger PRF Buffer → Lower Potential Dependence on Qard
This is one reason why distributing every surplus immediately may not be prudent.
14. Connection With Solvency
A financial buffer also supports solvency.
Remember:
Solvency = ability to maintain sufficient financial resources to meet obligations.
If a PRF has very little financial cushion, a single adverse year can put it under severe pressure.
If it has an appropriate financial buffer, it has greater capacity to withstand:
unexpectedly high claims
claims volatility
catastrophes
and other adverse financial developments.
Therefore:
Financial Buffer → Greater Loss-Absorbing Capacity → Stronger Financial Resilience
Easy Example to Remember
Imagine Ahmad expects his monthly expenses to be:
RM4,000
But he keeps:
RM10,000 emergency savings
He does not expect to spend that RM10,000 every month.
It exists because unexpected things can happen:
car repair
home repair
or another unexpected expense.
That RM10,000 is Ahmad’s financial cushion or buffer.
The PRF follows a similar general principle:
Do not maintain resources only for what you expect to happen; maintain appropriate financial strength for the possibility that actual experience is worse than expected.
Easy Way to Remember
Think:
BUFFER = SHOCK ABSORBER
Normal expected claims
↓
Unexpected large claims occur
↓
Financial Buffer absorbs the shock
↓
PRF remains stronger
↓
Lower risk of deficit / qard dependence
Simple Formula
Conceptually:
Expected Financial Requirements + Additional Loss-Absorbing Capacity = Stronger Financial Position
And in the surplus context:
Surplus Generated → Part Distributed + Part Retained
The retained portion can contribute to:
Financial Buffer
Therefore:
Retained Surplus → Financial Buffer → Absorb Claims Volatility → Protect Future Claim-Paying Ability
One-Sentence Summary
A financial buffer is additional financial strength maintained to absorb unexpected losses or higher-than-expected claims; in Takaful, retaining part of the PRF’s surplus instead of distributing it can strengthen this buffer, helping the fund withstand claims volatility, protect future claim payments and reduce the likelihood of a deficit or reliance on qard.
- Published on
Takaful - Role of an Actuary in Determining Surplus
An important responsibility of the actuary in Takaful is not only to calculate whether the Participants’ Risk Fund (PRF) has generated an underwriting surplus, but also to determine:
whether that surplus is safe to distribute, how much can be distributed, and who is eligible to receive it.
The most important principle is:
The existence of a surplus does not automatically mean that the entire surplus should be distributed.
Some or all of the surplus may need to remain in the PRF as a financial buffer against future claims volatility.
1. First, What Is a Surplus?
Recall the basic concept.
Suppose the PRF receives:
Relevant PRF income = RM20 million
During the year:
Claims = RM12 million
Retakaful costs = RM2 million
Other relevant expenses/provisions = RM3 million
Simplified result:
RM20m − RM12m − RM2m − RM3m = RM3m
Therefore:
Underwriting surplus = RM3 million
There is a positive balance after the relevant obligations and provisions have been taken into account.
But the next question is:
Should the entire RM3 million now be distributed?
Not necessarily.
2. The Actuary Has to Assess the Surplus
The actuary considers whether distributing the surplus would leave the PRF financially strong enough to meet future obligations.
Therefore, the actuary is not simply asking:
“Is there a surplus?”
The more important question is:
“How much of this surplus, if any, can safely be distributed without jeopardising the PRF’s ability to pay future claims?”
This distinction is extremely important.
3. Surplus Does Not Automatically Mean Distribution
Suppose:
PRF surplus = RM10 million
It might seem attractive to distribute:
RM10 million
to eligible participants.
But suppose the actuary knows that claims are highly volatile.
Historical claims might have been:
Year 1 = RM10m
Year 2 = RM12m
Year 3 = RM25m
Year 4 = RM11m
Year 5 = RM30m
The PRF may have a surplus today, but another very large claims year could occur in the future.
Therefore, the actuary may recommend:
Retain part or all of the surplus in the PRF.
4. Why Retain Surplus?
One major reason is to create a margin or buffer against fluctuations in claims experience.
Remember:
Expected claims ≠ Actual claims
Suppose expected claims next year are:
RM15 million
But actual claims could become:
RM20 million
or:
RM25 million
because of unexpected adverse events.
If previous surpluses were retained, the PRF has additional resources to absorb the higher claims.
Therefore:
Retained Surplus → Stronger PRF → Greater Ability to Absorb Claims Volatility
5. Example - Distribute Everything vs Retain Surplus
Suppose the PRF has:
RM5 million surplus
Situation A - Distribute Everything
The entire:
RM5m
is distributed.
PRF retained surplus:
RM0
Next year an unexpectedly large claim produces an additional:
RM4m requirement
The PRF has no accumulated surplus available to absorb it.
This increases the possibility of:
PRF deficit → Qard requirement
Situation B - Retain RM4 Million
Suppose the actuary recommends:
Distribute RM1m
and
Retain RM4m
Next year there is an unexpected:
RM4m adverse claims experience
The accumulated RM4m can help absorb that adverse experience.
Therefore:
Retaining surplus today can protect participants against claims tomorrow.
6. What Does “Margin Against Fluctuation in Claims Experience” Mean?
This is closely related to your earlier question about margin.
Claims do not remain exactly the same every year.
For example:
Year 1 claims = RM5m
Year 2 = RM7m
Year 3 = RM6m
Year 4 = RM15m
Year 5 = RM8m
The sudden RM15m year illustrates claims volatility.
Therefore, the PRF needs some financial cushion.
Accumulated surplus can provide part of this cushion.
So:
Claims Volatility → Need for Financial Buffer → Retain Appropriate Surplus
7. Important - This Is Related to, but Different From, a Pricing Margin
You previously studied margin in pricing.
We should distinguish the two ideas.
Pricing Margin
Included when determining an appropriate contribution or risk price.
It is forward-looking.
For example:
Expected claims = RM700
Pricing margin = RM100
Required claims-related pricing allowance = RM800
Retained Surplus as a Buffer
This arises after actual experience has produced a surplus.
Instead of distributing the entire surplus, some is retained in the PRF to strengthen the fund against future adverse claims.
For example:
Actual underwriting surplus = RM5m
Actuary recommends retaining = RM4m
Distributable amount = RM1m
So both provide protection against uncertainty, but they arise at different stages.
8. The Actuary Must Protect Future Claim-Paying Ability
The most important consideration is:
Will the PRF still be capable of paying future claims after the surplus distribution?
Suppose:
PRF assets/resources = RM100m
Potential surplus = RM10m
The operator wants to distribute the entire RM10m.
But actuarial analysis indicates that the PRF needs approximately:
RM96m
to maintain an appropriate financial position for its future obligations and risks.
If RM10m were distributed:
RM100m − RM10m = RM90m
But the PRF needs:
RM96m
Therefore, distributing RM10m could weaken the PRF excessively.
The actuary may therefore conclude that the full RM10m should not be distributed.
9. The Actuary May Recommend Only Part of the Surplus
Suppose:
Total surplus = RM10m
Based on claims volatility and future obligations, the actuary determines that:
RM7m should remain in PRF
Therefore:
Potential distributable surplus:
RM10m − RM7m = RM3m
So:
Total Surplus ≠ Distributable Surplus
This is a very important distinction.
10. What Is “Distributable Surplus”?
Distributable surplus means the portion of the available surplus that can appropriately be distributed under the applicable rules without weakening the PRF’s ability to meet its obligations.
For example:
Total underwriting surplus = RM8m
Required amount to be retained = RM5m
Potential distributable amount = RM3m
Therefore:
RM8m surplus does not necessarily mean RM8m distribution.
The actuary’s assessment is crucial.
11. Malaysia - Actuarial Assessment Before Distribution
Under the Malaysian regulatory approach described here, surplus distribution is subject to an actuarial assessment.
The actuary needs to be satisfied that the proposed distribution will not jeopardise future claim payments from the risk fund.
In simple terms:
Participants should not receive a large surplus distribution today if doing so could leave insufficient resources to pay participants’ claims tomorrow.
This reflects the principle of financial prudence.
12. Why Must the Accounts Be Audited?
The accounts should also be audited before surplus is distributed.
Why?
Because before distributing money, there should be sufficient confidence that the reported financial position is reliable.
Suppose management calculates:
Surplus = RM10m
But after proper review, it is discovered that:
RM3m of claims had not been properly recognised.
The true position may be substantially different.
Therefore, auditing provides additional assurance over the financial information used in determining the surplus.
13. Actuary and Auditor Have Different Roles
Do not confuse the two.
Actuary
Focuses heavily on matters such as:
claims liabilities
future uncertainty
claims volatility
financial adequacy
and
whether surplus distribution is prudent.
Auditor
Examines whether the financial statements are appropriately prepared and presented according to the relevant financial reporting framework.
Therefore:
Actuarial Assessment + Audited Accounts → Stronger Basis for Surplus Distribution
14. Claims Volatility Is Extremely Important
The more volatile the claims experience, the more cautious the actuary is likely to be about surplus distribution.
Why?
Because:
High volatility = Greater uncertainty about future claims
Suppose two PRFs each have:
RM5m surplus
But their claims histories are very different.
PRF A
Claims:
RM10m → RM10.5m → RM9.8m → RM10.2m → RM10.4m
Claims are relatively stable.
PRF B
Claims:
RM5m → RM18m → RM7m → RM25m → RM6m
Claims are highly volatile.
Although both currently have RM5m surplus, the actuary may be much more cautious about distributing PRF B’s surplus.
15. Why?
Because PRF B has demonstrated that a:
“Big claim”
or bad claims year can arise unexpectedly.
If the entire RM5m is distributed today and a major claim occurs next year, the PRF could fall into deficit.
Therefore:
Greater Claims Volatility
↓
Greater Need for Buffer
↓
Greater Surplus Retention
↓
Less Likely/Less Amount to Be Distributed
16. What Does “Save It for the Next Big Claim” Mean?
Suppose:
Year 1 surplus retained = RM2m
Year 2 surplus retained = RM3m
Year 3 surplus retained = RM2m
Accumulated surplus:
RM2m + RM3m + RM2m = RM7m
Now in Year 4, an unexpectedly bad claims year creates an additional:
RM6m adverse claims experience
The PRF has:
RM7m accumulated surplus
available as a financial buffer.
Therefore, the fund is much better positioned to absorb the bad year.
This is the benefit of surplus accumulation.
17. Retaining Surplus Can Reduce Dependence on Qard
This connects directly with what you studied earlier.
Suppose the PRF has no accumulated surplus.
Unexpected adverse claims create:
RM5m deficit
The shareholder/operator fund may have to provide:
RM5m qard, depending on the applicable arrangement.
But suppose the PRF had previously accumulated:
RM6m retained surplus
The RM5m adverse experience may be absorbed by the PRF’s own accumulated resources.
Therefore:
Retained Surplus → Stronger PRF → Lower Reliance on Qard
This supports the mutual nature of Takaful.
18. Risk Sharing Is Not Only Between Participants in the Same Year
This is one of the most important ideas here.
Normally, when we think about Takaful risk sharing, we imagine:
Ahmad + Ali + Sarah + Fatimah
all contributing to the PRF in the same year.
If Ahmad suffers a covered loss, the common fund pays Ahmad’s claim.
That is:
Risk sharing among current participants.
But Takaful risk sharing can also extend across time through the accumulation of the PRF.
19. Risk Sharing Between Different Years
Imagine:
Year 1
10,000 participants contribute.
Claims are low.
Surplus retained:
RM3m
Year 2
Another group of participants contributes.
Claims are also relatively low.
Additional surplus retained:
RM2m
Accumulated surplus:
RM5m
Year 3
Participants experience unusually high claims.
The PRF needs an additional:
RM4m
The accumulated RM5m from earlier years can help absorb the Year 3 claims.
Therefore, resources built up when earlier participants experienced favourable claims can support the risk pool when later participants experience unfavourable claims.
This creates an intertemporal dimension of risk sharing.
20. What Is Intertemporal Risk Sharing?
Intertemporal simply means:
Across different periods of time.
So Takaful risk sharing can occur:
Horizontally
Among many participants within the same period.
and
Intertemporally
Through the PRF’s accumulated resources across different years.
For example:
Current Participants → Build PRF Surplus → Retain Surplus → Future Participants/Claims Benefit
This is why distributing every surplus immediately may weaken the long-term mutual risk-sharing function.
21. Important Clarification
This does not mean that every future participant personally owns the surplus generated by previous participants.
The exact ownership, eligibility for distribution and treatment of surplus depend on the applicable Takaful model, certificate terms and regulatory/Shari’ah framework.
The important economic concept is:
Retaining appropriate surplus allows the PRF to absorb fluctuations across different periods rather than treating each year as completely isolated.
22. Why This Makes the PRF Stronger
Suppose the PRF distributes every surplus immediately.
The pattern becomes:
Good year → Distribute everything
Bad year → Deficit
Good year → Distribute everything
Bad year → Deficit
This creates instability.
A more prudent approach may be:
Good year → Retain appropriate surplus
↓
Another good year → Build additional buffer
↓
Bad year → Use accumulated buffer
↓
PRF remains stronger.
Therefore:
Surplus Accumulation Smooths Claims Volatility Across Time
23. The Actuary’s Decision Process
The actuary essentially considers:
Is there an actual surplus?
↓
What future claims and liabilities exist?
↓
How volatile are claims?
↓
How strong is the PRF?
↓
How much financial buffer should remain?
↓
Would distribution jeopardise future claims?
↓
If safe:
Recommend an appropriate distributable amount
If not safe:
Retain surplus in PRF
24. Three Possible Outcomes
Suppose total surplus is:
RM10 million
The actuary might conclude:
Outcome 1 - Full Distribution
If financial conditions are sufficiently strong under the applicable rules:
Distribute RM10m
Outcome 2 - Partial Distribution
For example:
Distribute RM3m
Retain RM7m
Outcome 3 - No Distribution
If claims volatility and future obligations are too uncertain:
Distribute RM0
Retain RM10m
Therefore:
Having a surplus does not create an automatic right to immediate full distribution.
25. Connection With Solvency
Surplus distribution and solvency are directly connected.
If too much surplus is distributed:
PRF resources ↓
↓
Financial buffer ↓
↓
Ability to absorb unexpected claims ↓
↓
Probability of deficit ↑
↓
Potential qard dependence ↑
Therefore, actuarial oversight helps ensure that surplus distribution does not undermine the financial sustainability of the PRF.
Easy Way to Remember
Use:
SURPLUS → CHECK → RETAIN → DISTRIBUTE
SURPLUS
Determine whether a genuine surplus exists.
CHECK
Actuary assesses future claims, volatility and financial strength.
RETAIN
Keep enough surplus in the PRF as a buffer.
DISTRIBUTE
Only the amount that can prudently be distributed should be considered for distribution according to the applicable rules.
Simple Formula
A useful conceptual formula is:
Total Surplus − Required Retained Buffer = Potential Distributable Surplus
For example:
RM10m − RM7m = RM3m
Therefore:
Total surplus = RM10m
does not necessarily mean:
Distribution = RM10m
It could mean:
RM7m retained + RM3m distributed
depending on actuarial assessment and applicable requirements.
Relationship With Claims Volatility
The principle can be remembered as:
Higher Claims Volatility → Greater Need for Retained Surplus → Lower Likelihood/Amount of Distribution
Conversely, relatively stable claims may give the actuary greater confidence, although other financial factors still need to be considered.
Relationship With Risk Sharing
Within the Current Year
Many Current Participants → Common PRF → Claims of the Few
Across Different Years
Current Surpluses → Retained in PRF → Future Claims
Therefore:
Takaful risk sharing can operate both among participants in the same period and across different periods through the accumulation of the risk fund.
One-Sentence Summary
The actuary determines not only whether the Participants’ Risk Fund has a surplus but also whether any of that surplus can safely be distributed, how much should be retained as a buffer against future claims volatility, and the appropriate distribution under the applicable rules; greater claims volatility generally supports greater surplus retention because accumulated surplus strengthens the PRF, protects future claim-paying ability and enables risk sharing across different periods.
- Published on
Takaful - Regulation and Supervision of Takaful
Regulation and supervision of Takaful aim to ensure that Takaful operators understand the risks they are managing, maintain sufficient resources to manage those risks, treat participants fairly, remain financially sound, and operate in accordance with Shari’ah requirements.
The central regulatory principle is:
First identify and allocate the risks → then ensure sufficient resources are available to manage those risks.
Importantly, resources do not mean capital alone. They also include competent people, appropriate IT systems, governance and other operational capabilities.
1. First Principle - Determine Where the Risks Are
Before deciding how much capital or other resources are required, the regulator must understand:
What risks exist, and who bears those risks?
This is particularly important in Takaful because different risks may be borne by different parties or funds.
For example:
Participants’ Risk Fund (PRF) bears the participants’ underwriting risk.
The Takaful operator manages the Takaful operation and faces operational, management and other business risks.
The shareholder/operator fund provides the operator’s financial resources and may support the PRF through qard where applicable.
Therefore, regulation should recognise the fund structure and allocation of risks rather than treating every risk as if it belonged to the same party.
2. Example - Allocation of Underwriting Risk
Suppose:
PRF underwriting income/resources = RM20 million
Relevant claims and obligations = RM25 million
Therefore:
RM20m − RM25m = −RM5m
The PRF has:
RM5 million underwriting deficit
The underwriting risk belongs primarily to the participants collectively through the PRF, rather than automatically becoming an underwriting loss of the operator’s shareholders.
The regulator therefore needs to determine:
Who bears the risk?
before deciding:
What resources are required and where should those resources be maintained?
3. Regulation Is Not Only About Capital
When we hear:
“The Takaful operator must have sufficient resources.”
we might immediately think of:
Money or capital.
But regulatory resources are much broader.
They include:
Financial capital
Competent and appropriately trained employees
Actuaries
Underwriters
Claims personnel
Risk-management personnel
Shari’ah expertise
IT systems
Data and cybersecurity infrastructure
and
appropriate governance systems
Therefore:
Financial strength without operational capability is not sufficient.
4. Why Are Human Resources Important?
Suppose a Takaful operator has:
RM500 million capital
but its underwriters are poorly trained.
They repeatedly accept high-risk participants at inadequate contributions.
This could result in:
Poor underwriting
↓
Inadequate pricing
↓
Excessive claims
↓
PRF deficits
↓
Financial pressure
Therefore, having a large amount of capital does not compensate indefinitely for poor management.
A Takaful operation needs both:
Financial Resources + Competent Human Resources
5. Why Are IT Systems Important?
Modern Takaful operators may manage thousands or millions of:
participants
contributions
claims
certificates
investments
and
financial transactions.
Suppose an operator has adequate capital but a poor IT system that cannot accurately track:
participant contributions
claims
PRF balances
or
investment allocations.
This creates significant operational risk.
Therefore:
Capital + Skilled People + Reliable Systems = Stronger Risk Management
6. Risk-Based Capital
An important regulatory approach is Risk-Based Capital (RBC).
The basic principle is:
The amount of capital required should reflect the amount and nature of risk being taken.
Therefore:
Higher risk → Generally higher required capital
Lower risk → Generally lower required capital
This is more meaningful than requiring every Takaful operator to maintain exactly the same amount of capital regardless of its risk profile.
7. Simple Risk-Based Capital Example
Suppose:
Takaful Operator A
Required capital = RM100 million
Available capital = RM180 million
Takaful Operator B
Required capital = RM300 million
Available capital = RM320 million
At first, Operator B appears stronger because:
RM320m > RM180m
But this is misleading because Operator B also carries much greater risk.
We therefore compare:
Available Capital ÷ Required Capital
8. Risk-Based Capital Ratio
A simplified formula is:
Capital Adequacy Ratio = Available Capital ÷ Required Capital × 100%
For Operator A:
RM180m ÷ RM100m × 100 = 180%
For Operator B:
RM320m ÷ RM300m × 100 ≈ 107%
Therefore, even though Operator B has more capital in absolute terms, its capital position relative to its risks is much tighter.
This is the purpose of a risk-based approach.
Do not look only at how much capital exists. Compare the available capital with the amount of capital required for the risks being taken.
9. Why Does the Regulator Monitor This Ratio?
Suppose an operator’s capital ratio changes:
Year 1 = 200%
Year 2 = 175%
Year 3 = 145%
Year 4 = 120%
The ratio is progressively deteriorating.
The regulator should not necessarily wait until:
Capital = RM0
or until the operator becomes unable to meet its obligations.
Instead, if the ratio falls to a predetermined regulatory intervention level, this acts as an early warning.
The regulator may then take appropriate supervisory action.
10. Why Is Early Regulatory Intervention Important?
The objective of risk-based supervision is to detect financial weakness before it becomes a severe solvency problem.
The process is:
Risk increases
↓
Required capital increases or available capital falls
↓
Capital ratio decreases
↓
Predetermined regulatory level reached
↓
Regulatory intervention
↓
Corrective action
Therefore:
The regulator tries to identify problems early rather than waiting until the Takaful operation fails.
11. Regulation Also Protects Participants
Regulation is not only concerned with financial solvency.
It also aims to ensure that participants are treated fairly.
This can include:
appropriate product design
clear disclosure
fair pricing
proper sales practices
protection against mis-selling
fair claims handling
and
management of conflicts of interest.
This directly connects with the earlier issue of product mis-selling risk.
12. What Happens If the Operator Treats Participants Unfairly?
The regulator may impose appropriate supervisory measures or sanctions under the applicable regulatory framework.
For example, suppose an operator systematically allows intermediaries to tell participants:
“This Family Takaful product guarantees a particular investment return.”
But the return is actually non-guaranteed.
Participants may purchase the product based on incorrect information.
This creates:
Misrepresentation
↓
Participant misunderstanding
↓
Mis-selling
↓
Unfair customer treatment
The regulator may therefore take action against the operator.
13. But Regulation Can Become Excessive
There needs to be a balance.
Too little regulation can result in:
mis-selling
poor underwriting
inadequate capital
unfair fees
weak governance
and potentially:
financial failure.
However, excessively restrictive regulation can create another problem:
It may stifle innovation.
This means Takaful operators may find it difficult or uneconomic to develop new products, technologies, distribution methods or business models.
14. Example - Excessive Regulation and Innovation
Suppose a Takaful operator wants to introduce an innovative low-cost digital Takaful product.
The objective is to allow participants to:
join online
make contributions digitally
submit claims electronically
and
receive faster service.
But suppose the regulatory framework contains extremely rigid requirements designed only for traditional branch-based operations.
The cost of complying with those requirements may make the new digital product economically unattractive.
Therefore:
Excessive Regulation
↓
Higher Compliance Burden
↓
Reduced Innovation
The regulator therefore needs to achieve:
Participant Protection + Financial Stability + Room for Appropriate Innovation
15. Fair Treatment Does Not Mean Charging the Lowest Fee
This is a particularly important point.
The requirement to:
“Treat participants fairly”
should not automatically be interpreted as:
“The Takaful operator must charge the lowest possible fee.”
The operator needs sufficient income to operate sustainably.
The Wakalah fee may support activities such as:
staff salaries
underwriting
claims administration
IT systems
distribution
regulatory compliance
Shari’ah governance
and other operating expenses.
Therefore:
A low fee is not automatically a fair fee.
The appropriate question is whether the fee is reasonable, transparent and consistent with the services and responsibilities undertaken by the operator.
16. Example - Lowest Fee Is Not Necessarily Better
Suppose:
Operator A
Wakalah fee = RM200
This allows the operator to maintain:
competent staff
good claims service
strong IT systems
proper underwriting
and
appropriate governance.
Operator B
Wakalah fee = RM80
The fee appears more attractive to participants.
But suppose RM80 is insufficient to maintain proper operations.
As a result:
service deteriorates
staff quality falls
IT investment is inadequate
and
risk management weakens.
Therefore:
Fair treatment should focus on value and appropriate treatment, not simply the lowest possible fee.
17. Supply Side and Demand Side
A sustainable Takaful industry requires appropriate incentives on both the supply side and demand side.
Supply Side - Takaful Operator
The operator supplies the Takaful service.
It expects to earn a:
Reasonable return on the capital and resources employed.
Investors provide:
capital
technology
management expertise
and other resources.
If the business cannot generate a reasonable sustainable return, investors may become unwilling to provide those resources.
Demand Side - Participants
Participants demand Takaful products.
They expect to receive:
appropriate protection
reasonable costs
and, where applicable,
savings and investment benefits.
Therefore:
Operator wants reasonable return
while:
Participant wants cost-effective protection and savings
A successful Takaful structure should try to satisfy both objectives sustainably.
18. The Interests Must Be Balanced
Suppose the operator charges extremely high fees.
Then:
Operator return ↑
but:
Participant value ↓
Participants may stop purchasing the product.
Now consider the opposite situation.
Suppose fees are forced to extremely low levels.
Then:
Participant cost may initially ↓
but:
Operator sustainability ↓
The operator may eventually reduce:
staff
technology
service quality
or
product innovation.
Therefore:
Reasonable Operator Return + Cost-Effective Participant Protection = More Sustainable Takaful
This connects directly with the principle of alignment of stakeholder interests.
19. A Holistic Approach to Takaful
A holistic approach means looking at the entire Takaful system rather than concentrating on only one component.
The system includes:
Participants
Participants’ Risk Fund
Takaful operator
Shareholders
Management
Intermediaries
Shari’ah governance
Retakaful
Investments
Technology
and
Regulators.
For example, simply forcing contributions to be very low may appear beneficial to participants.
But if:
Contribution too low
↓
Insufficient tabarru’
↓
PRF deficit
↓
Greater qard dependence
↓
Financial weakness
then the low contribution was not necessarily beneficial in the long term.
Therefore:
Takaful regulation should consider the entire system and its long-term sustainability.
20. International Association of Insurance Supervisors (IAIS)
Insurance regulators can look to the International Association of Insurance Supervisors (IAIS) for an internationally recognised framework for insurance supervision.
An important part of this framework is the:
Insurance Core Principles (ICPs)
These provide principles, standards and guidance relating to the regulation and supervision of the insurance sector.
The broad idea is:
IAIS provides an internationally recognised foundation that regulators can consider when developing their insurance supervisory frameworks.
21. What Are Insurance Core Principles?
The Insurance Core Principles (ICPs) provide a broad international framework covering important areas of insurance regulation and supervision.
They help regulators establish appropriate standards concerning matters such as insurance supervision and risk management.
The important concept to remember is:
IAIS → General international insurance supervisory framework
However, Takaful has additional structural and Shari’ah considerations.
Therefore, conventional insurance supervisory principles alone may not address every Takaful-specific issue.
22. Role of the IFSB
The Islamic Financial Services Board (IFSB) provides standards and guidance relevant to Islamic financial services, including Takaful.
For Takaful, its guidance covers areas such as:
solvency
and
risk management.
Therefore, regulators can consider:
IAIS
for the broader insurance regulatory and supervisory framework,
together with:
IFSB
for guidance addressing Islamic financial services and Takaful-specific considerations.
So:
IAIS + IFSB → Useful regulatory guidance for Takaful supervision
23. Why Can’t One Country Simply Copy Another Country’s Takaful Regulations?
A regulatory framework that works successfully in one jurisdiction may not automatically work in another.
Countries can differ in:
legal systems
market size
financial development
Takaful industry maturity
available Islamic investment instruments
consumer behaviour
business structures
and
Shari’ah governance frameworks.
Therefore:
Regulation should be adapted to the local business environment rather than copied mechanically from another jurisdiction.
24. Example - Same Regulation, Different Business Environment
Suppose Country A has a highly developed Islamic capital market containing:
many Sukuk
Islamic money-market instruments
and
Shari’ah-compliant equities.
Its Takaful operators therefore have many investment choices.
Now suppose Country B has a much smaller Islamic capital market with very few suitable Shari’ah-compliant investment instruments.
If Country B simply copies Country A’s investment rules, Takaful operators in Country B may face:
excessive concentration
liquidity problems
or
difficulty complying with the requirements.
Therefore:
Same Regulation + Different Environment = Potentially Different Outcome
Regulations need to reflect local circumstances.
25. Local Shari’ah Interpretation Must Also Be Considered
Takaful regulation has an additional dimension:
Shari’ah interpretation
Different jurisdictions may adopt different Shari’ah governance approaches or interpretations regarding certain fiqh al-muʿāmalāt issues.
Fiqh al-muʿāmalāt broadly refers to Islamic jurisprudence concerning transactions and commercial dealings.
These issues can affect matters such as:
Wakalah
Mudarabah
tabarru’
qard
investment structures
surplus arrangements
and other financial transactions.
Therefore, when a regulatory approach is transferred from one jurisdiction to another, regulators need to consider whether it is compatible with the applicable local Shari’ah framework.
26. Does Shari’ah Compliance Mean Regulation Can Be Less Prudent?
No.
This is an extremely important point.
Shari’ah constraints should not be used as an excuse to reduce:
solvency standards
risk-management standards
participant protection
or
financial discipline.
Instead, Takaful regulation must achieve both objectives simultaneously:
Prudential Soundness
and
Shari’ah Compliance
Therefore:
Shari’ah Compliance ≠ Weaker Financial Regulation
Instead:
Prudent Regulation + Shari’ah Compliance = Sound Takaful Regulation
The Whole Regulatory Process
You can understand the entire topic as one chain:
Identify Risks
↓
Determine Who Bears Each Risk
↓
Require Appropriate Resources
↓
Capital + Skilled People + IT Systems + Governance
↓
Monitor Risk-Based Capital
↓
Early Intervention When Financial Position Weakens
↓
Protect Participants
↓
Require Fair Treatment
↓
Maintain Sustainable Operator Incentives
↓
Avoid Excessively Restrictive Regulation
↓
Use IAIS + IFSB Guidance
↓
Adapt Regulation to Local Business and Shari’ah Environment
↓
Sound and Sustainable Takaful Industry
Easy Way to Remember
RISK – RESOURCES – PROTECT – BALANCE – ADAPT
RISK
Identify the risks and determine who bears them.
RESOURCES
Ensure sufficient capital, skilled people, technology and systems.
PROTECT
Protect participants through fair-treatment and prudential requirements.
BALANCE
Protect participants while allowing the operator to remain sustainable and encouraging appropriate innovation.
ADAPT
Use international guidance but adapt regulation to the local business environment and applicable Shari’ah framework.
Simple Formula
The basic regulatory principle is:
Risk Exposure → Required Resources
For capital:
Greater Risk → Generally Greater Required Capital
A simplified capital monitoring ratio is:
Available Capital ÷ Required Capital × 100% = Capital Adequacy Ratio
If the ratio falls toward a predetermined regulatory intervention level:
Early Warning
↓
Regulatory Intervention
↓
Corrective Action
↓
Reduced Risk of Financial Failure
Most Important Concept
Takaful regulation should not focus only on:
“How much capital does the operator have?”
A sound Takaful operation requires:
Capital
- ●
Competent Human Resources
- ●
Strong IT Systems
- ●
Risk Management
- ●
Fair Participant Treatment
- ●
Appropriate Pricing
- ●
Good Governance
- ●
Shari’ah Compliance
Therefore:
Capital is only one part of the resources required for a safe and sustainable Takaful operation.
One-Sentence Summary
Regulation and supervision of Takaful begin by identifying and allocating risks and then ensuring sufficient financial, human and technological resources are available to manage those risks; regulators must also protect participants, monitor solvency, maintain appropriate incentives for operators, avoid unnecessarily restricting innovation, and use international guidance such as IAIS and IFSB in a way that is appropriate to the local business environment and applicable Shari’ah framework.
- Published on
Takaful - Regulatory Requirements Regarding Different Aspects of Takaful
The table compares several regulatory requirements for Takaful across six jurisdictions:
Malaysia, Bahrain, United Arab Emirates (UAE), Indonesia, Sudan, and Saudi Arabia.
The main idea is that although Takaful operates according to Shari’ah principles, different countries regulate Takaful differently. Some requirements are common across almost all jurisdictions, while others differ substantially.
1. Requirement to Treat Customers Fairly
All six jurisdictions in the table indicate Yes for the requirement to treat customers fairly.
This means Takaful operators and intermediaries are expected to ensure that participants are treated properly throughout the relationship.
This can include matters such as:
fair product design
proper disclosure
appropriate sales practices
fair pricing
proper handling of claims
and
protection against mis-selling
The table therefore shows:
Malaysia – Yes
Bahrain – Yes
UAE – Yes
Indonesia – Yes
Sudan – Yes
Saudi Arabia – Yes
Why Is Fair Treatment Important in Takaful?
Participants may not fully understand complicated Takaful products.
For example, Ahmad purchases a Family Takaful product.
The intermediary should properly explain:
what is covered
what is excluded
how much Ahmad contributes
how much is allocated as fees
how the savings/investment component works
and
what benefits are guaranteed or non-guaranteed
The intermediary should not exploit Ahmad’s lack of financial knowledge.
This connects directly with the product mis-selling risk you studied earlier.
Easy formula:
Clear Information + Fair Selling + Suitable Product + Fair Claims Handling = Fair Treatment of Participants
2. Certification of Takaful Pricing
Another regulatory issue is whether the pricing of Takaful products must be certified.
According to the table:
Malaysia – Yes
Bahrain – No
UAE – Yes
Indonesia – Yes
Sudan – No
Saudi Arabia – Yes
This requirement is important because Takaful contributions should be priced appropriately for the risks being accepted.
Why Is Pricing Certification Important?
Remember what you studied earlier:
If a Takaful product is underpriced, the contribution may be insufficient.
Suppose actuarial analysis indicates that the PRF requires:
Expected claims = RM700
Appropriate margin = RM100
Therefore:
Required PRF amount = RM800
But because the product is underpriced, only:
RM600
is allocated to the PRF.
There is potentially:
RM200 inadequate funding per participant.
If this happens across thousands of participants:
Underpricing → Insufficient Tabarru’ → PRF Deficit → Greater Solvency Pressure
Therefore, appropriate pricing requirements help protect the financial sustainability of the PRF.
3. Connection With the Agent-Principal Conflict
Pricing regulation is also important because of the Wakalah fee conflict you studied.
Suppose the operator receives:
20% of contributions as Wakalah fee.
The operator might benefit from:
More participants → More contributions → Higher total Wakalah fees
But if more participants are attracted through deliberately low pricing, the PRF may become underfunded.
Therefore:
Operator benefits from higher turnover
while:
Participants may suffer through PRF deficits.
Proper pricing governance helps reduce this conflict.
4. Requirement for Shari’ah Certification of Operations
Takaful is not merely conventional insurance with different terminology.
Its operations must comply with relevant Shari’ah requirements.
According to the table:
Malaysia – Yes
Bahrain – Yes
UAE – Yes
Indonesia – Yes
Sudan – Yes
Saudi Arabia – No
The table therefore shows that most of the jurisdictions examined expressly require Shari’ah certification of Takaful operations, although the regulatory structures differ.
What Does Shari’ah Certification Mean?
It means the Takaful operation needs appropriate Shari’ah oversight to ensure that its structure and activities comply with applicable Shari’ah principles.
This may concern matters such as:
Takaful contracts
tabarru’ arrangements
Wakalah arrangements
Mudarabah arrangements
investment activities
surplus treatment
qard
and
Retakaful arrangements.
5. Why Is Shari’ah Certification Important?
Imagine a Takaful operator collects participants’ savings and then invests them in prohibited interest-bearing instruments.
Even if the operator has:
good underwriting
good claims management
and
strong financial performance
there would still be a Shari’ah compliance problem.
Therefore, Takaful needs both:
Financial soundness
and
Shari’ah compliance.
A successful Takaful operation cannot focus on only one and ignore the other.
Easy formula:
Sound Takaful = Financial Sustainability + Shari’ah Compliance
6. Existence of a National Supreme Shari’ah Decision-Making Body
This requirement concerns whether the jurisdiction has a national-level Shari’ah authority or decision-making body relevant to the industry.
According to the table:
Malaysia – Yes
Bahrain – No
UAE – No
Indonesia – Yes
Sudan – Indirectly, Yes
Saudi Arabia – No
This shows an important difference in Shari’ah governance architecture between jurisdictions.
7. Why Have a National Shari’ah Body?
Suppose:
Takaful Operator A’s Shari’ah committee says a particular structure is permissible.
But:
Takaful Operator B’s Shari’ah committee says it is impermissible.
If every institution operates completely independently, inconsistent Shari’ah interpretations may arise.
A national-level Shari’ah authority can help provide greater:
consistency
standardisation
certainty
and
coordination
within the financial system, depending on the jurisdiction’s governance model.
8. Institutional Shari’ah Committee vs National Shari’ah Body
Do not confuse these two.
Institutional Shari’ah Committee
Operates at the level of the individual Takaful operator or financial institution.
Its role is to oversee the institution’s Shari’ah compliance according to the applicable framework.
National Shari’ah Body
Operates at a broader national or regulatory level.
It may provide centralised Shari’ah rulings, standards or guidance depending on the jurisdiction.
Therefore:
Institutional Shari’ah Governance = Individual institution
while:
National Shari’ah Governance = Broader financial system
9. Limitation on Commissions to Intermediaries
The table also considers whether there are limitations on commissions paid to Takaful intermediaries.
According to the table:
Malaysia – Yes
Bahrain – No
UAE – No
Indonesia – No
Sudan – No
Saudi Arabia – Yes
This issue is closely related to product mis-selling and conflicts of interest.
10. Why Can Intermediary Commission Be a Problem?
Suppose an agent can recommend either Product A or Product B.
Product A gives the agent:
RM200 commission
Product B gives:
RM1,000 commission
But Product A is more suitable for Ahmad.
The agent may nevertheless be tempted to recommend Product B because:
Product B → Higher commission
This creates a:
Conflict of interest
The intermediary’s interest becomes:
Maximise commission
while the participant’s interest is:
Obtain the most appropriate protection/product
These interests may conflict.
11. Connection With Mis-Selling
This connects directly with the previous topic.
A poorly designed commission structure can produce:
Higher Commission
↓
Agent incentive to sell particular product
↓
Customer needs potentially ignored
↓
Unsuitable product sold
↓
Mis-selling risk
Therefore, regulation of intermediary remuneration can form part of the broader framework for protecting participants.
12. Solvency Requirements
This is one of the most consistent requirements in the table.
All six jurisdictions are marked Yes:
Malaysia – Yes
Bahrain – Yes
UAE – Yes
Indonesia – Yes
Sudan – Yes
Saudi Arabia – Yes
This reflects the fundamental importance of financial strength.
13. What Does Solvency Mean?
Solvency broadly refers to having sufficient financial resources to meet financial obligations.
For Takaful, the arrangement must be capable of meeting valid participant claims and other relevant obligations.
For example:
Suppose the PRF has:
RM100 million
but expected claims and relevant obligations amount to:
RM130 million
There is potentially a serious financial problem.
Therefore, regulators impose financial requirements intended to reduce the risk that a Takaful operation cannot meet its obligations.
14. Why Is Solvency Especially Important?
Remember:
Participants pay contributions before many claims occur.
Ahmad might pay his contribution:
today
but make a claim:
six months later.
Therefore, the Takaful arrangement must remain financially sound between:
Contribution received → Claim eventually occurs
This is why Takaful operators cannot simply focus on today’s sales.
They need to ensure long-term financial sustainability.
15. Connection With Your Previous Capital Topic
You previously studied:
Risk pooling
PRF surplus
PRF deficit
qard
capital
Retakaful
and
solvency
They are all connected.
A financially strong Takaful arrangement may rely on:
Proper Pricing
- ●
Adequate Tabarru’
- ●
Good Underwriting
- ●
Diversification
- ●
Appropriate Reserves
- ●
Retakaful
- ●
Accumulated Surplus
- ●
Capital/Qard support where applicable
to maintain financial strength.
16. Regulation of Investment of Takaful Assets
The final requirement shown concerns the investment of Takaful assets.
According to the table:
Malaysia – Yes
Bahrain – Yes
UAE – Yes
Indonesia – Yes
Sudan – Yes
Saudi Arabia – Yes
So all six jurisdictions shown regulate investment of Takaful assets.
17. Why Must Takaful Investments Be Regulated?
Takaful operators manage significant amounts of money.
Depending on the Takaful structure, this can include:
Participants’ Risk Fund assets
participants’ savings/investment funds
and
shareholder/operator fund assets.
The operator should not simply invest these funds in extremely risky assets in an attempt to obtain very high returns.
Investment management needs to consider:
Shari’ah compliance
safety
liquidity
diversification
return
solvency
and
regulatory requirements.
18. Example - Why Investment Regulation Matters
Suppose a PRF has:
RM100 million
The operator invests the entire RM100m into one highly risky and illiquid investment.
Then suddenly:
RM30 million of claims
must be paid.
Even if the investment might eventually generate a good return, the PRF could face a serious liquidity problem because the money cannot easily be converted into cash.
Therefore:
A good investment is not judged only by its return.
It must also consider:
Risk + Liquidity + Shari’ah Compliance + Solvency
19. Connection With Claims
Remember your recent question:
“Where does an insurer get money to pay claims?”
Takaful funds also hold assets.
Therefore, investment management must ensure sufficient assets are available or sufficiently liquid to meet claims when they become due.
For example:
PRF assets = RM100m
Expected near-term claims = RM20m
The operator should not lock the entire RM100m into investments that cannot be converted into cash when those claims need to be paid.
This is called liquidity management.
20. The Major Pattern in the Table
There are two requirements for which all six jurisdictions are marked Yes:
Fair treatment of customers
and
Solvency requirements
and the table also shows all six as regulating:
Investment of Takaful assets.
Other areas show more variation, particularly:
pricing certification
national Shari’ah governance
and
intermediary commission limitations.
This demonstrates that:
The broad objectives of Takaful regulation may be similar, but the regulatory mechanisms used to achieve them can differ between jurisdictions.
Easy Way to Remember
Remember:
CUSTOMER – PRICE – SHARI’AH – AGENT – SOLVENCY – INVESTMENT
CUSTOMER
Treat participants fairly.
PRICE
Ensure Takaful is appropriately priced.
SHARI’AH
Ensure operations comply with applicable Shari’ah requirements.
AGENT
Control intermediary conduct and conflicts of interest.
SOLVENCY
Ensure sufficient financial strength to meet obligations.
INVESTMENT
Ensure Takaful assets are invested prudently and appropriately.
How All the Regulations Connect
Fair Customer Treatment
↓
Reduces mis-selling
↓
Proper Pricing
↓
Prevents insufficient tabarru’
↓
Good Underwriting
↓
Reduces unnecessary PRF deficits
↓
Shari’ah Governance
↓
Maintains Shari’ah compliance
↓
Intermediary Regulation
↓
Reduces conflicts of interest
↓
Investment Regulation
↓
Protects fund assets and liquidity
↓
Solvency Regulation
↓
Helps ensure claims can be paid
↓
Sustainable Takaful System
One-Sentence Summary
Takaful regulation aims to protect participants and maintain a financially and Shari’ah-sound system through fair customer treatment, appropriate product pricing, Shari’ah governance, control of intermediary incentives, solvency requirements and prudent regulation of Takaful investments, although the exact regulatory approach differs between jurisdictions.
