Intakaful, the surplus is defined as an asset minus the liability of takaful riskfund. Surplus exists due to the difference between actual experience and priceassumptions. Total of surplus depends on how assets and liabilities of thetakaful fund are assessed.
Surplus can be split among participants(policyholders), to takaful operators (shareholders), and keep in the fund forcontingencies. The surplus of the tabarru’account to be distributed between participants and takaful operators is basedon the fact that takaful contracts are generally built on tabarru’ (donation)and ta’awun (help-assist) along with mutual consent between parties. Tabarru isa key principle that underlies takaful products. Other shari’ah principles suchas mudarabah are wakalah are used to support the implementation of takafuloperations. Surpluscomes from many sources such as excessive investment income, favourableexperience in benefits such as mortality benefits, fire etc.
However, in familytakaful, the surplus is usually treated separately, namely underwritingsurplus. This is due to that there are often separate models used forinvestment, such as mudarabah while underwriting surplus aspects are morelikely to be considered under the wakala model. FromShari’ah perspective of surplus, underwriting surplus arise from risk fundswhich are actually an excess of takaful contributions derived from claimsincurred regardless of any investment gains arising from the contributionsaccumulated in the fund. Therefore, the operator does not contribute to anyincremental growth or increase in the value of the funds.TheAccounting and Auditing Organization for Islamic Financial Institutions(AAOIFI) is an well-known Islamic international autonomous non-for-profitcorporate body that prepare and provide standards for Islamic financialinstitutions and the industry, including takaful.
According to AAOIFI, thereare relevant standards allocating for the surplus, namely Financial AccountingStandards (FAS) No. 13 (Disclosure of Bases for Determining and AllocatingSurplus or Deficit in Islamic Insurance Companies). FAS 13 is intentionallyincorporated to determine and allocate surplus or deficit in Islamic InsuranceCompanies. It is required in the standards for Takaful operators to provide astatement of surplus (or deficit) of the policyholder. The Takaful operatorsthemselves should disclose the method they use in allocating underwritingsurplus and the shari’ah basis applied in the notes. Forgeneral takaful funds, the underwriting surplus is determined for each takafulbusiness class after taking into account commissions, unearned contributions,retakaful, claiming incurred and management expenses.
Surplus can bedistributed according to the terms and conditions set by the company’s shari’ahcommittees and all takaful operators have to disclose the amount of surplus intheir takaful fund. Forfamily takaful, the surplus is determined by the annual actuarial valuation ofthe family takaful fund. The surplus that can be distributed to theparticipants is determined after deducting the claims or benefits paid, retakafulprovisions, commissions, management expenses and reserves. It is distributedaccording to the terms and conditions set by the company’s Shari’ah committees. Takafulcompany may invest the insurance surplus for the policyholder’s account, ifthere is a real provision for this effect in the insurance policy. Theconsideration to be paid to the party in such investment related with percentageof investment profit in mudarabah or commission amount in the case of theagency, shall be stated in the insurance policy. (ii) What is the Actuarial principles of surplusdistribution? Takafulcompany surplus usually distribute one time per annum at the end of thefinancial year. Referring to the ultimate sum of surplus, the surplus to bedistributed should refer to the guidelines given by appointed actuary andendorse by the board of directors.
The guideline prepared by appointed actuaryare based on several factors such as expectations of takaful participants,regulations has been established by financial regulators, internal policy oftakaful institutions and contracts that have been agreed with the takafulparticipants and takaful company as well. Theactuarial principles of the desired characteristics of the takaful surplusdistribution method are stated as follow with assumption the surplus belongsexclusively to the participants: a. The element of equitable should be applicable in surplus distribution which meansonly the participants who really contribute to profit entitled to get the surplusdistribution. For an equitable surplus distribution, takaful operators mayadopt one of the following three modes which are pro-rata, selective oroff-setting. b.
The surplus distribution method mustbe acceptable by participants. Participantshave no doubt towards the logic and fairness of the surplus distribution methodprepared by the actuary and adopted by the takaful company. c.
The method of surplus distribution must be simple and easy to govern by takafulcompany. 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 themethod used is too comprehensive. d. The method of surplus distribution must be flexible, easy to change or modify bytakaful companies if circumstances cause changes in the amount of surplusavailable. e. Distribution of surplus must be consistent and in line with theactuarial basis for the provision of contributions and liabilities.
The determination of surplusis essentially an actuarial process because it relies strongly on and sensitiveto the actuarial estimation of liability provisions for the business. iii. In your opinion, what are the factors thatneed to be taken into consideration when addressing the practical aspects ofsurplus distribution? In the distribution ofsurplus, the takaful company should prioritize the interests of takafulparticipants as essentially the surplus is belonging them. When it comes toissues of surplus, the distribution of the surplus must be carried out fairlyand transparent. In implementing surplus administrativeprocess, the following factors need to be considered and taken into account: a. Unrealized profitsThe surplus is distributed onincome and actual realized profit.
This mean the future participants will get morebenefit than the previous generation of participants as unrealized capitalgains are not reflected in previous surplus distributions. b. Provision for bad investment In takaful industry, provision for bad investmentwhich value has fallen from the value reflected on the purchase will reduce thetakaful surplus. Therefore, takaful company should rewrite corresponding tothat particular provisions to ensure it benefits the future participants. c. Qardhal HasanThe repayment of the loan, known asQardhal Hasan should be given priority over the distribution of surplus to theparticipants. This is because Qardhal Hasan is considered as a loan injectioninto the takaful fund.
d. Determination of a fund-basedsurplus or product portfolioWhile there is a practical limitation to filterout surpluses to individual participants, efforts must be made to distributesurpluses in a way that identifies the particular experience of a cohort ofparticipants who share the same characteristics. The surplus distributionprocess needs to identify those who qualify for the surplus sharing. Among theeligible participants are as follows:a. takaful participants who havenever made a claim throughout the year.b. takaful participants who claimless than their risk contribution is paid into the risk pool.
c. takaful participants who have made maximum claims are definitely notentitled. (i) Mudarabah Model Themudarabah takaful model works on the following basis: takaful operators (knownas shareholders) bear all expenses incurred in operating the business and as areward, takaful operators are entitled to share underwriting excess andinvestment profits. This is an adjustment of mudarabah Islamic commercialcontracts between takaful operator and participants (or policyholders) whoprovide (contribute) the capital. The biggest dissent of this model isunderwriting excess is non-profit.
It is excess of premium over claims known assurplus. This business model is difficult to manage where expenses are fixedbut income (surplus) is not. However, this is a very good model from the perspectiveof participants because they do not directly contribute to the operator’s cost.
All their contributions are available to meet claims. Only when there is anyexcess of contribution to the claim, the operator will be compensated for theexpenses incurred, and even if only to the extent that the surplus issufficient to meet this expense. Contributioninto the takaful risk pool is deemed as donation which under the Islamiccontract 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’sfundamental concerns about conventional insurance. However, the tabarru’ willnot be exactly equal with the claim. If tabarru’is inadequate, there will be adeficit; if it is excessive, there will be surplus. Surplus under the mudarabahtakaful model is crucial for companies to commercially viable. If take away thesurplus sharing then the whole model will collapse.
However, the mudarabah takaful model is an unpopular choice. InMalaysia, only two of takaful operators practice this mudarabah model. (ii) Wakalah Model Underwakalah model, the surplus is referred to the surplus contributed by theparticipant into the Risk Fund based on tabarru’ contract. Upon reaching afinancial period, the sum of tabarru’ will not be equal with the amount theclaim.
If the tabarru’ amount is less than the sum of claims then the Risk Fundwill be deficit, otherwise the tabarru’ amount exceed the claim then the RiskFund will have a surplus. Thewakala model is the default standard for takaful. Operators charge and carryout takaful operations. For takaful operators, he makes a profit if wakala feeexceed expenses. Thesurplus is actually the excess premium paid by the participants, so the surplusrefund can be explained as a experience refund. Once this is accepted, then thesurplus is belongs of the participants.
InMalaysia, several takaful companies provide shareholders to share in experiencerefund. Given that the participants are responsible for the deficit in the riskpool, it may seem odd that participants should share any excessive contributionto the shareholders. Many see this as an incentive compensation to the operatorto manage the portfolio well, as evidenced by the surplus. However, whetherthis incentive is necessary given since the operators have already received afee for underwriting services. As practised in Malaysia, wakala models is amodel where operators only impose their management and distribution coststhrough wakala fees, while the profits are from the sharing of any underwritingsurplus. There is also a wakala model where even management expenses anddistribution costs are met from underwriting surpluses and zero fees are charged.This last extreme wakala model is similar to the mudarabah model.
Even someShari’ah scholars will also describe mudarabah model as a wakala model withzero fees Wecan explain this wakala model from the perspective of both participants andoperators. From a participant’s perspective, the decision on the use of awakala model whether operators share in excessive premiums or not will dependon how much higher is the wakala fee he has to pay. It is not always clear thathaving a share of the operator in the the underwriting surplus gives theparticipants the best value proposition.
From operator’s perpective, the wakalafee is determined as the sum of:a. Management expenses;b. Distribution costs includecommissions; andc. Benefits to the operator Given ascenario where the surplus and deficit are in the participant’s account andwhere the operator’s solvency requirements, hence the capital requirements arenot excessive. It is possible to impose a low wakala fee, thereby benefitingthe participants.
If the operator’s profit depends solely on the underwritingsurplus, then such as the mudarabah model, this wakala model will not becommercially sustainable in the long run.