In takaful, the surplus is defined
as an asset minus the liability of takaful risk fund. Surplus exists due to the
difference between actual experience and price assumptions. Total of surplus
depends on how assets and liabilities of the takaful fund are assessed. Surplus
can be split among participants (policyholders), to takaful operators
(shareholders), and keep in the fund for contingencies.
The surplus of the tabarru
‘account to be distributed between participants and takaful operators is based
on the fact that takaful contracts are generally built on tabarru’ (donation)
and ta’awun (help-assist) along with mutual consent between parties. Tabarru is
a key principle that underlies takaful products. Other shari’ah principles such
as mudarabah are wakalah are used to support the implementation of takaful
Surplus comes from many sources such
as excessive investment income, favourable experience in benefits such as
mortality benefits, fire etc. However, in family takaful, the surplus is
usually treated separately, namely underwriting surplus. This is due to that
there are often separate models used for investment, such as mudarabah while underwriting
surplus aspects are more likely to be considered under the wakala model.
From Shari’ah perspective of
surplus, underwriting surplus arise from risk funds which are actually an
excess of takaful contributions derived from claims incurred regardless of any
investment gains arising from the contributions accumulated in the fund.
Therefore, the operator does not contribute to any incremental growth or
increase in the value of the funds.
The Accounting and Auditing
Organization for Islamic Financial Institutions (AAOIFI) is an well-known Islamic
international autonomous non-for-profit corporate body that prepare and provide
standards for Islamic financial institutions and the industry, including
takaful. According to AAOIFI, there are relevant standards allocating for the
surplus, namely Financial Accounting Standards (FAS) No. 13 (Disclosure of
Bases for Determining and Allocating Surplus or Deficit in Islamic Insurance
Companies). FAS 13 is intentionally incorporated to determine and allocate
surplus or deficit in Islamic Insurance Companies. It is required in the
standards for takaful operators to provide a statement of surplus (or deficit)
of the policyholder. The takaful operators themselves should disclose the
method they use in allocating underwriting surplus and the shari’ah basis
applied in the notes.
For general takaful funds, the
underwriting surplus is determined for each takaful business class after taking
into account commissions, unearned contributions, retakaful, claiming incurred
and management expenses. Surplus can be distributed according to the terms and
conditions set by the company’s shari’ah committees and all takaful operators
have to disclose the amount of surplus in their takaful fund.
For family takaful, the surplus is
determined by the annual actuarial valuation of the family takaful fund. The
surplus that can be distributed to the participants is determined after
deducting the claims or benefits paid, retakaful provisions, commissions, management
expenses and reserves. It is distributed according to the terms and conditions
set by the company’s Shari’ah committees.
Takaful company may invest the insurance
surplus for the policyholder’s account, if there is a real provision for this
effect in the insurance policy. The consideration to be paid to the party in
such investment related with percentage of investment profit in mudarabah or
commission amount in the case of the agency, shall be stated in the insurance
Takaful company surplus usually distribute one time
per annum at the end of the financial year. Referring to the ultimate sum of
surplus, the surplus to be distributed should refer to the guidelines given by
appointed actuary and endorse by the board of directors. The guideline prepared
by appointed actuary are based on several factors such as expectations of
takaful participants, regulations has been established by financial regulators,
internal policy of takaful institutions and contracts that have been agreed
with the takaful participants and takaful company as well.
The actuarial principles of the desired
characteristics of the takaful surplus distribution method are stated as follow
with assumption the surplus belongs exclusively to the participants:
The element of equitable should be applicable in surplus distribution which means
only the participants who really contribute to profit entitled to get the surplus
distribution. For an equitable surplus distribution, takaful operators may
adopt one of the following three modes which are pro-rata, selective or
The surplus distribution method must be acceptable
by participants. Participants have no doubt towards the logic and fairness of
the surplus distribution method prepared by the actuary and adopted by the
The method of surplus distribution must
be simple and easy to govern by
takaful company. At the same time, easy for participants to understand and
accept the logic. It is important to avoid confusion that the participants may
encounter if the method used is too comprehensive.
The method of surplus distribution must
be flexible, easy to change or
modify by takaful companies if circumstances cause changes in the amount of
Distribution of surplus must be consistent and in line with the
actuarial basis for the provision of contributions and liabilities.
The determination of surplus
is essentially an actuarial process because it relies strongly on and sensitive
to the actuarial estimation of liability provisions for the business.
In the distribution of
surplus, the takaful company should prioritize the interests of takaful
participants as essentially the surplus is belonging them. When it comes to
issues of surplus, the distribution of the surplus must be carried out fairly
In implementing surplus administrative
process, the following factors need to be considered and taken into account:
The surplus is distributed on income and actual realized profit. This
mean the future participants will get more benefit than the previous generation
of participants as unrealized capital gains are not reflected in previous
Provision for bad investment
In takaful industry, provision for bad investment
which value has fallen from the value reflected on the purchase will reduce the
takaful surplus. Therefore, takaful company should rewrite corresponding to
that particular provisions to ensure it benefits the future participants.
The repayment of the loan, known as Qardhal Hasan should be given priority
over the distribution of surplus to the participants. This is because Qardhal
Hasan is considered as a loan injection into the takaful fund.
Determination of a fund-based
surplus or product portfolio
is a practical limitation to filter out surpluses to individual participants,
efforts must be made to distribute surpluses in a way that identifies the
particular experience of a cohort of participants who share the same
The surplus distribution
process needs to identify those who qualify for the surplus sharing. Among the
eligible participants are as follows:
a. takaful participants who have
never made a claim throughout the year.
b. takaful participants who claim
less than their risk contribution is paid into the risk pool.
takaful participants who have made maximum claims are definitely not
The mudarabah takaful model works on the
following basis: takaful operators (known as shareholders) bear all expenses
incurred in operating the business and as a reward, takaful operators are
entitled to share underwriting excess and investment profits. This is an
adjustment of mudarabah Islamic commercial contracts between takaful operator
and participants (or policyholders) who provide (contribute) the capital. The
biggest dissent of this model is underwriting excess is non-profit. It is
excess of premium over claims known as surplus. This business model is
difficult to manage where expenses are fixed but income (surplus) is not.
However, this is a very good model from the perspective of participants because
they do not directly contribute to the operator’s cost. All their contributions
are available to meet claims. Only when there is any excess of contribution to
the claim, the operator will be compensated for the expenses incurred, and even
if only to the extent that the surplus is sufficient to meet this expense.
Contribution into the takaful risk pool is
deemed as donation which under the Islamic contract of tabarru’, towards the
expected increase in claims. The adoption of tabarru’ and the risk-sharing
concept in this risk pool address the Shari’ah’s fundamental concerns about
conventional insurance. However, the tabarru’ will not be exactly equal with
the claim. If tabarru’is inadequate, there will be a deficit; if it is excessive,
there will be surplus. Surplus under the mudarabah takaful model is crucial for
companies to commercially viable. If take away the surplus sharing then the
whole model will collapse.
However, the mudarabah takaful model
is an unpopular choice. In Malaysia, only two of takaful operators practice
this mudarabah model.
Under wakalah model, the surplus is referred
to the surplus contributed by the participant into the Risk Fund based on
tabarru’ contract. Upon reaching a financial period, the sum of tabarru’ will
not be equal with the amount the claim. If the tabarru’ amount is less than the
sum of claims then the Risk Fund will be deficit, otherwise the tabarru’ amount
exceed the claim then the Risk Fund will have a surplus.
The wakala model is the default standard for
takaful. Operators charge and carry out takaful operations. For takaful
operators, he makes a profit if wakala fee exceed expenses.
The surplus is actually the excess premium
paid by the participants, so the surplus refund can be explained as a
experience refund. Once this is accepted, then the surplus is belongs of the
In Malaysia, several takaful companies
provide shareholders to share in experience refund. Given that the participants
are responsible for the deficit in the risk pool, it may seem odd that
participants should share any excessive contribution to the shareholders. Many
see this as an incentive compensation to the operator to manage the portfolio
well, as evidenced by the surplus. However, whether this incentive is necessary
given since the operators have already received a fee for underwriting
services. As practised in Malaysia, wakala models is a model where operators
only impose their management and distribution costs through wakala fees, while
the profits are from the sharing of any underwriting surplus. There is also a
wakala model where even management expenses and distribution costs are met from
underwriting surpluses and zero fees are charged. This last extreme wakala model
is similar to the mudarabah model. Even some Shari’ah scholars will also
describe mudarabah model as a wakala model with zero fees
We can explain this wakala model from the
perspective of both participants and operators. From a participant’s
perspective, the decision on the use of a wakala model whether operators share
in excessive premiums or not will depend on how much higher is the wakala fee
he has to pay. It is not always clear that having a share of the operator in
the the underwriting surplus gives the participants the best value proposition.
operator’s perpective, the wakala fee is determined as the sum of:
Distribution costs include commissions; and
Benefits to the operator
Given a scenario where the
surplus and deficit are in the participant’s account and where the operator’s
solvency requirements, hence the capital requirements are not excessive. It is
possible to impose a low wakala fee, thereby benefiting the participants. If
the operator’s profit depends solely on the underwriting surplus, then such as
the mudarabah model, this wakala model will not be commercially sustainable in
the long run.