Operational and Actuarial Aspects of Takaful Distribution of Surplus

Sub Topics Definition And Sources Of Surplus Shariah Perspectives on Surplus Actuarial Principles of Surplus Distribution Practical Aspects of Surplus Distribution

Definition of Surplus In simple terms, the takaful fund surplus at any point in time t would be: Surplus at time t = Takaful Fund Asset at time t (-) Takaful Fund Liability at time t S (t) = A (t) – V (t)

Sources of Surplus The amount of surplus greatly depends on how takaful fund assets and liabilities are valued Statutory or regulatory definitions of assets have a bearing on the level of assets and consequently the surplus available. This rule is known as the rule on admitted or allowable assets may differ as to the type and percentage of assets disallowed from country to country. Takaful Fund Asset ↑ or Takaful Fund Liability ↓ then Surplus ↑ Takaful Fund Asset ↓ or Takaful Fund Liability ↑ then Surplus ↓

Sources of Surplus Surplus comes from the interaction of the takaful fund being more than that required for liability provision The sources of surplus can thus be traced to the differences in what has emerged in reality with that assumed (of claims, investment yields and expenses) in the liability calculation. Reserving basis (rules that prescribe a set of assumptions used in calculating or valuing the actuarial liability provisions or reserves) in calculating the reserves also affect the level of reserves and consequently the level of surplus

Sources of Surplus Generally, the more conservative the reserving basis, the higher the reserves and thus the lower is the surplus. The amount of surplus that would be revealed at any point in time is affected by the difference in the valuation basis and what has emerged in reality.

Sources of Surplus For takaful business, the obvious sources of surplus in a takaful risk fund would arise from: 1. Difference between mortality experienced and that assumed. 2. Difference between actual investment performance of the fund and that assumed. 3. Difference between actual expenses and the loading assumed. 4. Difference between funds paid (if any) to surrendering participants and the release (i.e. write back) in liability provisions/reserves on surrender [apparent or a real gain?]

Sources of Surplus Conclusion: Surplus arises due to the difference between actual experience and the pricing assumption Valuation surplus arises due to differences between the actual experience and assumption in actuarial reserving

Shariah Perspective of Surplus The underwriting surplus that arises from the risk fund (i.e.. surplus which is determined without consideration of any investment profit earned from the contributions accumulated in the fund) is really just an excess of takaful contributions earned over claims incurred. Thus the operator has not contributed to any incremental growth or increase in fund value.

Shariah Perspective of Surplus: AAOIFI Standard No. 13 Entitlement to the insurance surplus belongs only to the policyholders. Shareholders do not share in this surplus, because it belongs to policyholders collectively as defined by the insurance agreement. Several fatwas and shariah rulings have been issued confirming that policyholders have the existing right to the insurance surplus. The insurance company may invest the insurance surplus for the account of the policyholders, if there is an express provision to this effect in the insurance policy. The consideration payable to the party undertaking such investment (i.e. percentage of investment profit in the case of mudharabah or amount of commission in case of agency) should be specified in the insurance policy. The party undertaking the investment is entitled only to the consideration specified for this purpose, and should not appropriate any amount from the insurance surplus which is a residual from the premium contributions.

Actuarial Aspects of Surplus Distribution Desirable characteristics of a surplus distribution system for the takaful scheme (if distributable to participants ):- Equitable – participants who have contributed more to the surplus should be given more and vice versa Simple – easy to administer and simple for participants to understand and accept the logic Flexible – easily modified if circumstances cause a change in the amount of surplus available Consistent – distributes surplus in line with the actuarial basis for contribution and liability provisions Acceptable – participants need to accept the logic and fairness of the surplus distribution method otherwise there will be no takers in a competitive marketplace

Practical Aspects of Surplus Distribution Firstly, in arriving at the surplus, the surplus has to be fair and to be seen to be fair. In maintaining equity The particular accounting treatment of several financial items need to be addressed for consideration in the surplus administration process as follows: Unrealized gains – as surplus is distributed on income and actual realized gains, later generations of participants may benefit more than earlier generations of participants as unrealized capital gains profits are not reflected in earlier distributions of surplus. Provisions for bad investments – provisions for bad investments which value has fallen from the value reflected on purchase will reduce surplus. A corresponding write back of such provisions will benefit later generations of participants.

Practical Aspects of Surplus Distribution Qardhal Hasan – as qardhal hasan is considered a loan injection into the takaful fund, repayment of such loans should take precedence over distributing surplus to participants. Surplus determination on a fund or product portfolio basis – although there are practical limitations to refining surplus distribution to an individual participant level – an attempt should be made as far as is practicable to distribute surplus in a way that recognizes the particular experience of blocks or cohorts of participants sharing similar characteristics.

Practical Aspects of Surplus Distribution Risk Contribution Savings Contribution Risk PoolSavings Fund Claim benefits to participants Surplus may 1.not be shared and 100% is kept in fund 2.not be shared with operator (but ok to share with participants) 3.be shared with operator & participants Investment Profit shared with participants Different treatment of Surplus

Practical Aspects of Surplus Distribution Participants Eligibility to surplus sharing: Those who have not made a claim in the year, are entitled. Those that have claimed less than their risk contribution (i.e. Tabarru’ – donation) paid into the risk pool. Those who have claimed are not entitled at all.

Summary The opinion of shariah scholars is divided on the issue of the permissibility of sharing surplus with participants and the operator with many allowing its distribution to the operator. The determination of surplus is essentially an actuarial process as it is very dependent on and sensitive to the actuarial estimation of liability provisions for the business. The surplus distribution to different generations of participants is also affected by the accounting treatment of several financial items. Surplus distributed if any should be in proportion to the good experience contributed by the participants concerned.

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