Product pricing is
one of the important aspect of financial management in a takaful operation. In
determining product pricing, both general takaful and family takaful products
are using the same method of calculations. In order to calculate the price of a
product, initially, we must identify the activities in the pricing step in
order to derived at the optimal price of the takaful product. In general, the
activities involve in the pricing step are the collection of relevant data,
assumptions and other inputs that eventually will be needed and analysed in
order to come up with the contribution rates for the takaful product.
There are five
(5) assumptions that needs to be consider by the actuaries in the pricing
step as listed below:
i. The mortality/
morbidity/ claims distribution pattern underlying the benefits covered under
the takaful plan.
ii. The investment
rate of return to be used in discounting the cash flows (particularly for
family takaful products).
iii. The management
expenses to be incurred in marketing (such as commissions and other incentives)
and processing the contracts issued under the new product.
iv. The withdrawal
pattern of participants which may affect the recoverability of initial expenses
incurred in marketing, underwriting and issuing new business contracts.
v. The level of
taxation and other external factors such as statutory reserve requirements,
which affect the takaful business.
On overall, the takaful product pricing is
heavily rely on the assumptions used and hence, choosing and applying the assumptions
for a particular product need to be done in a careful manner. In addition, some
of the data regarding the assumptions explained in the above mentioned have to
be outsource from bodies such as government agencies, retakaful operators and
conventional reinsurers due to current situation of the Takaful Operators (TOs)
that are relatively operate in a small scale and lack of experience or
expertise in the related field. The actuaries will take into the consideration the relative weightage to place on the
pricing factors obtained from internal as well as external sources.
Next, we will go
into detail matters. The activities in the pricing step can be identified by understands
what are the elements contributes to the calculation of gross contribution
(price of the takaful product). The takaful participants will be required to
pay gross contribution, normally monthly committed amount for their takaful
policy. The gross contribution is consisted of the risk coverage costs (net
rate), administration costs and provision for TO’s profits. The price structure
of which costs to be charged and how much profits to be made are customs to every
each of takaful product.
Listed below is a
generic gross contribution formula for takaful contracts regardless of which
takaful model is used that is whether wakalah model or mudarabah model (the ‘E’
GC = RC + ? + E
Where GC =
RC = Risk contribution
Safety loading (margin for inherent uncertainty)
Expense margin (including loadings for TO’s profits etc)
The first activity in the pricing step is to
calculate the value of risk contribution.
The risk contribution component is
defined as the expected ultimate cost in claims of the risk being covered. The
estimation of risk contribution may be done by taking the average claims amount
and the average number of claims. The formula of risk contribution derived as
Risk contribution = n x m
= Average or expected number of
m = Average or expected amount per claim
Then, the second activity is to identify the
safety loading amount. The safety
loading will act as a buffer to absorb higher than expected claims up to
some expected level of certainty. The level of the safety loading will depend
on the risk tolerance level acceptable to the takaful fund and the level and
availability of free unallocated capital (either sitting in the takaful fund or
available by way of loan from the operator) to absorb adverse fluctuations in
The third activity
in the pricing step is to calculate the margin of expenses including
calculations for TO’s profits, wakalah fee, marketing expenses, incentives etc.
An analysis should be conducted as proper as it should, in order to determine
management expenses incurred in
operating a takaful fund for a particular product. The analysis must be able to
identify and segregate between fixed costs and variable costs of administration
expenses as well. The analysis also should go deeper in order to identify all
types of expenses incurred in each and every stages of takaful operation for
the purpose of capturing the actual process that trigger the expenses. For
instance, new business acquisition, underwriting, contribution collection,
contract processing and claim handling expenses are example of different
expenses that may be incurred for a particular takaful contract, starting from
contract issuance to claims administrations and to contract expiration.
Last but not least, another activity involved
in the pricing step is the process of determine the investment yield or investment return to be used in pricing a
takaful product, especially for a long term takaful contracts. For example, Mortgage
Reducing Term Takaful (MRTT) needs cash flows for over a long time horizon. The
TOs need to achieve positive investment return of the takaful fund as it can be
an additional source of capital to TOs. The investment department of TOs will
provide the relevant data so that the actuary can calculate the potential
investment return that might be achieved for a desire future period.
In a nutshell,
based on the above mentioned explanations, the gross contribution rate
consisted of the following components as listed below:
contribution rate required to cover actual risk exposure only (also known as
the cost of goods sold), it is perhaps the most important component of the
takaful contribution amount.
(as explained in the above mentioned)
(as explained in the above mentioned)
Cost of capital
needed to support the risks covered in the proposed product.
Cost of temporary
qard (loan) required from the shareholders to top up anticipated takaful fund
deficits arising from the product.
of takaful operators.
expenses (if applicable).