Issue: Imposition of Management Fee on Takaful Participants’ Contribution

The SAC was referred to on the issue as to whether a takaful company may impose
management fee on contribution paid by takaful participants to finance operational
expenses of takaful business which mainly consists of management expenses and
commission.

Resolution

The SAC, in its 62nd meeting dated 4 October 2006, has resolved the following:

i. For takaful model based on Wakalah contract, takaful company is allowed

to charge management fee on contribution paid by takaful participants.
The amount of management fee shall consider the responsibilities of
takaful company towards takaful participants and shall be agreed upon by
the contracting parties. The imposition of management fee shall be clearly
stated in takaful agreement contract and,

ii. For takaful model based on Mudarabah contract, takaful company is not
allowed to charge any management fee on contribution paid by takaful
participants. On the other hand, all operational expenses shall be borne by
the shareholders fund whereby its income is derived from its share of
investment profits or surplus of the takaful fund.

Basis of the Ruling

The aforesaid SAC’s resolution is based on the following considerations:

i. A Wakalah contract is permissible in Shariah, either with imposition of fee

or voluntarily (without fee). Remuneration or fee in Wakalah contract shall
be expressly determined and agreed upon by the contracting parties,
either in amount or at a certain ratio. It may be paid at the time of contract
or within the agreed period of time; and

ii. In Mudarabah contract, the mudarib’s remuneration is his portion as

agreed in the profit sharing ratio with the rabbul mal. Thus, the mudarib is
not entitled to charge any management fee on the takaful participants’
contributions.
Issue: Agency Problem

In addition to the issues above, the agency problem can be another issue that might
arise in the modified Wakalah model. According to the agency theory relationship, the
Takaful operators (as agents), are delegated the authority by the participants (as
principals) to manage the Takaful fund. Therefore, the Takaful operators are supposed
to perform according to the interests of the participants. However, due to the separation
of ownership and control, agency problems, i.e. moral hazard and adverse selection
could occur and Takaful operators might maximize their own interests at the expense of
the participants (Millson & Ward, 2005). Thus, the main issue from the agency theory is

i) Existence of agency cost,

For example, the difference in value of the firms between hundred percent
owners managed and not hundred percent owner managed firms
(Mueller, 2006; Williams et al., 2006).

ii) In the case of the agent considers his commission to be more important
that the needs of the client, or that the agent is not well versed with the
other products of the operator.

Resolution

i) Based on the above, the Takaful operator can only earn the fees for
services rendered. From the Shari’ah perspective, the Wakil (agent)
cannot share the profit and is not responsible for any losses, except in
cases of negligence and misconduct. Thus the agent might not be
motivated to perform better since he cannot share the profit. In some
cases, however, the agent is promised performance fee for any sound
management of the fund, this leads to another problem of personal
aggrandizement. This promise makes him place his personal interest over
any other interest. Thus, in this situation, the agent might try to maximise
profit at minimum expenses by denying the participant who suffers loss
from being adequately indemnified. It will result in unethical practice and it
is not permissible in Islam.

ii) In this kind of situation, Takaful operators should have their own Shari’ah
advisory board at the company level. Compliance is essential regardless
of where Takaful operators are operating. It is believed that strict
enforcement from the regulators is the most effective mechanism to
 ensure that they are operating in line with Shari’ah. In addition, board of
directors and the person-in-charge should be regularly updated the
knowledge by sending them to the training. There should be some clauses
in the Acts to penalize the Takaful operators if they do not comply with the
regulatory requirement. Takaful agents need to be trained in the
fundamentals of sales, shariah, technical & product knowledge.

Issue: Information asymmetry in Wakalah contract

The agent usually has more information and uses it to his advantage. The agent, i.e. the
Takaful operator receives an upfront fee which is a percentage of the contribution or
premium and solely determined by him. He does the underwriting, determines the
contribution rates, hires and trains sales agent, if any, and sets the fee structure with the
participant. The situation becomes worse when the participants do not have
representation in the board of directors and do not have any legal right to retain and fire
a director. All of these are ethically unfair to the participants who have little or no
information about the Takaful operator, The Holy Prophet Peace be upon him has not
only disapproved of certain forms of business transactions, but has also stipulated
certain conditions that must be fulfilled in every transaction to make it lawful. Islam tries
to be fair to both parties to a transaction. Any step on the part of one, that is
advantageous to him and disadvantageous to the other, is not permissible.

Issue: Unearned Wakalah fee arises when a participant withdraws his contract at
the mid of Takaful period

Wakalah fee (agents' commission) is usually charged in advance as upfront charge

when participant pays contribution amount. According to accrual principle of accounting,
Wakalah fee will be earned at the end of Takaful period for a particular year. Takaful
operators claim that participant's contribution will be refunded whenever he wants to
withdraw the contract. Only Wakalah fee is deducted from the contribution amount. The
question arises if any participant withdraws his contract at the mid of Takaful period, has
Takaful operator any right on unearned Wakalah fee? If not then how should unearned
Wakalah fee be returned to the participant when Takaful operator deducts it in advance
and pays to Takaful agents as commission? Thus, issue of unearned Wakalah fee
arises when a participant withdraws his contract at the mid of Takaful period, as fee is
usually charged in advance as upfront charge when participant pays contribution
amount.