Abstract

Family Takaful in Pakistan is built on a promise of mutual assistance, transcending regulatory compliance. Any favourable residual balance in the participant fund is attributable to participants collectively. However, surplus ownership at fund level does not automatically create an individual right to immediate distribution. Surplus may be retained, utilised for strengthening reserves, used to repay qard, transferred for participant benefit, or distributed amongst participants, depending on fund condition and the approved surplus policy (IFSB, 2023b, paras. 52–57). The real governance question is more nuanced than the existence of a distributable surplus. It is whether participants can understand why the chosen surplus outcome is equitable.

This article argues that Pakistan’s Family Takaful framework does not yet translate Shari’ah, regulatory, accounting and actuarial controls, into an explicit participant-equity assurance mechanism. Drawing on Pakistan’s Takaful Rules 2012, Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) standards, Islamic Financial Services Board (IFSB) guidance and the functional analogy of UK with-profits governance from their Financial Conduct Authority (FCA), it proposes a Pakistan-specific framework led by the Securities Exchange Commission of Pakistan (SECP), comprising an Actuarial Participant Equity Reasonableness Opinion and a Participant Surplus Statement, so that surplus discretion is made credible to participants.

Introduction

The word Takaful comes from the Arabic root kafala, meaning to support or guarantee. In financial practice, it refers to a system in which participants contribute to a common fund that supports members who suffer covered losses. Takaful even uses a different vocabulary from conventional insurance to reinforce its ideals: policyholders are “participants”, premiums are “contributions”, and the risk-pooling element is commonly structured around tabarru, or “donation”. These terms matter because they express the moral claim of Takaful: that it is cooperative, participant-oriented and Shari’ah-compliant.

Surplus is central to that claim. In conventional insurance, favourable underwriting experience generally belongs to shareholders whereas in Takaful, favourable experience within the participant risk fund is not shareholder profit. AAOIFI Shari’ah Standard No. 26 recognises underwriting surplus as distinct from operator profit and permits several methods for surplus treatment and distribution, subject to Shari’ah approval (AAOIFI, n.d., SS 26). Pakistan’s Takaful Rules 2012, particularly items 17-21, similarly establish the regulatory structure for Participant Takaful Funds (PTF) and surplus management. Yet this creates a difficult question: what does fairness require? A participant may reasonably ask why surplus is distributed in one year but retained in another, why one cohort benefits more than another, or why no payment is made despite a positive accumulated surplus. Existing governance can usually answer whether the calculation was permitted, approved and reported. It does not always answer the more important participant question, which is whether a particular decision regarding the surplus in the participants’ risk fund, any given participant’s right, is equitable or not.

This article focuses on Family Takaful. General Takaful also raises surplus fairness issues, but Family Takaful is the more appropriate starting point because long-term contracts, savings elements, mortality risk, persistency, surrender behaviour and intergenerational participation make cohort equity more complex (SOA Research Institute, 2024, sec. 1.8; IFSB, 2018, sec. 3.4). It is also the area where Pakistan’s existing Appointed Actuary framework¹ can be extended most naturally (SECP, 2012, rr. 10(1)(r), 20(4), 21(2)–(3)). Pertinent to note is that the argument is not that international standards have ignored fairness. IFSB guidance already recognises surplus allocation, qard and cohort fairness as conduct concerns (IFSB, 2023, paras. 52–57, 81–84). The argument is narrower and more practical: Pakistan has not yet converted those principles into a clear local assurance design for participants.

---

¹ Assumes that the Insurance Bill 2026 has not been passed. ↩

The Technical Nature of Surplus

A Family Takaful structure may include both a participant risk fund and participant investment-related balances. Contributions, investment income, claims, retakaful costs, expenses, reserves, operator remuneration, qard movements and surplus distributions interact over time. What remains after meeting fund obligations may be described as surplus, part of the participant fund’s financial estate. This estate may need to absorb adverse mortality or morbidity experience, strengthen reserves, support persistency risk, repay qard, smooth future contribution requirements or protect the fund against volatility. IFSB-29 states that long-term sustainability of the participant risk fund should be the main consideration for surplus distribution and that surplus may be retained to cushion future volatilities (IFSB, 2023b, paras. 52–53). It also states that supervisors should prohibit surplus distribution where the fund has qard payable, since surplus should first be used to repay outstanding qard ((IFSB, 2023b, para. 54; para. 84)).

This distinction between collective fund interest and individual entitlement is crucial to understand how the PTF is treated. Participants may collectively have an interest in the PTF, but an individual participant does not automatically have a vested right to a particular surplus amount until the approved rules allocate it (IFSB, 2023b, para. 50; SECP, 2012, rr. 13(1)(d)–(e), 21(2)–(3)). This is especially important in Family Takaful due to its long-term nature, where a participant entering the fund today may benefit from surplus accumulated by earlier participants, while an exiting participant may leave before retained surplus is ever distributed.

Participant equity should therefore be defined more precisely than “fairness”. For this article, participant equity refers to how surplus distribution and retention decisions are materially consistent with the approved surplus policy, the financial condition of the participant fund, the reasonable interests of current and exiting cohorts, and the need to avoid material unjustified cross-subsidies. It also means that retained surplus remains demonstrably for participant benefit, rather than becoming an indirect convenience for the operator. This extends the discussion of participant equity to beyond how much surplus was distributed in a particular period. A low distribution ratio may be fair if retention is needed for solvency, volatility, qard repayment or reserve strengthening, whereas a high distribution ratio may be unfair if it allows one cohort to extract surplus built by earlier participants or weakens the fund for future claimants. Thus, the actuarial question aims to look beyond the surface of mere material distribution and calls for a higher standard of reasonableness considering the fund’s risks, liabilities and participant cohorts.

The Assurance Gap in Pakistan

Pakistan’s Takaful Rules 2012 already contain important safeguards. In Family Takaful, the appointed actuary plays a role in determining whether the PTF is in surplus or deficit, while the Board and Shari’ah governance structure oversee policy and compliance. This is a strong foundation, but the gap in it has been identified above as well; surplus determination is not the same as surplus equity assurance.

Public financial statements may disclose contributions, claims, accumulated surplus, surplus distribution and fund balances, arguably easy to spot for a technically informed audience. But participants generally cannot see the decision logic. They cannot easily determine whether retained surplus was necessary, whether qard repayment took priority, whether cohorts were treated consistently, whether exiting participants were disadvantaged, or whether a cross-subsidy was justified by the mutual nature of the fund. This matters in Pakistan because insurance remains underdeveloped and trust-sensitive. The Competition Commission of Pakistan reported that Pakistan’s insurance penetration was only 0.87% of GDP in 2022, compared with a global average of 6.7% (CCP, 2025). In such a market, Takaful’s value proposition cannot rest only on being Shari’ah-compliant in form. It must also be seen as fair in operation.

The gap is that no formal mechanism presently translates actuarial analysis, Shari’ah approval and board discretion into a participant-facing explanation of equity. Participants can often see what happened without being able to ascertain whether it was fair.

Existing Standards Already Support the Reform

The proposed framework draws some inspiration from other aspects of Islamic financial governance. AAOIFI’s Takaful accounting framework has moved towards more specific presentation, disclosure, recognition and measurement requirements. FAS 42 addresses presentation and disclosures in the financial statements of Takaful institutions, while FAS 43 addresses recognition and measurement and supersedes earlier standards including FAS 13 on surplus and deficit allocation disclosure (AAOIFI, 2022). The principle dictates that where participants and operators have different interests in the same arrangement, reporting should make those interests understandable.

IFSB guidance is even more direct. IFSB-27 states that where Takaful undertakings distribute surplus from a segregated fund, the supervisor should require the board and senior management to consider whether the basis of allocation is fair between and within participant cohorts (IFSB, 2022). IFSB-29 further states that supervisors may require an actuary to assess risk perspectives and recommend surplus distribution, and that surplus distribution methods can create unfair treatment if, for example, only full-period participants share in surplus while others are excluded without proper justification (IFSB, 2023b).

A useful analogy also exists in UK with-profits insurance. In making this claim though, the author recognises fully well that Takaful is not with-profits business, and Pakistan should not import UK rules mechanically. The analogy, however, is being drawn because both systems involve pooled funds, discretion, intergenerational fairness and beneficiaries who cannot independently verify whether discretion has been exercised fairly. The Financial Conduct Authority of the UK requires firms to take reasonable care to ensure that operating practices are fair to with-profits policyholders and do not create undisclosed or unfair benefits for shareholders or others (FCA, n.d., COBS 20.2.1A R, COBS 20.2.1D G). To prevent any confusion, again, it is not that Takaful should become with-profits insurance, but that pooled financial discretion requires a fairness architecture. Pakistan already has the ingredients: SECP supervision, Takaful Rules, Shari’ah governance and Appointed Actuaries. What is missing is a local assurance design that joins these ingredients together.

A Pakistan-Specific Participant Equity Framework

SECP should act first. The most practical route is an SECP circular or guideline requiring Family Takaful operators to strengthen surplus governance through two linked documents: an Actuarial Participant Equity Reasonableness Opinion and a Participant Surplus Statement. PSOA could then support implementation through professional guidance for actuaries, while operators could incorporate the requirements into their approved PTF policies.

The first document should be an Actuarial Participant Equity Reasonableness Opinion. The name is deliberately cautious, as Actuaries should not certify fairness in an absolute moral or Shari’ah sense. That would exceed the actuarial role and blur the responsibilities of the Board and Shari’ah Advisor. Instead, the actuary should opine on whether the surplus decision is reasonable from an actuarial perspective, considering fund condition, risk, liabilities and participant cohorts. Currently, the Appointed Actuary is required to review and approve various policies and policy documents which do essentially imply an actuarial opinion. However, there is no detailed guidance on what should be covered, for which the following structure may prove useful:

The opinion should test at least seven matters. First, reserve adequacy: whether surplus is measured after appropriate technical provisions and margins. Second, solvency and volatility: whether the retained surplus is justified by mortality, morbidity, lapse, expense, investment or catastrophe stress. Third, qard priority: whether outstanding qard has been appropriately recognised and repaid before distribution. Fourth, experience attribution: which cohorts or product groups generated the surplus. Fifth, cross-subsidy: whether any material subsidy is inherent, immaterial or justified. Sixth, exit fairness: whether surrendering, maturing or terminating participants are treated reasonably. Seventh, policy consistency: whether the decision follows the approved surplus policy, precedent, or clearly explains any change.

This framework would make the proposal actuarial rather than merely rhetorical. For example, suppose a Family Takaful risk fund has accumulated surplus but has also experienced deteriorating persistency and higher-than-expected mortality claims. A low distribution may be equitable if the actuary demonstrates that surplus retention is needed under a reasonable adverse scenario. Conversely, where the fund is mature, well-capitalised, free of qard and has stable claims experience, continued retention without a clear cohort or solvency rationale should require stronger justification. The opinion should be addressed to the Board and Shari’ah governance function, submitted to SECP or made available on request, and summarised for participants. It should include materiality thresholds, data limitations, reliance on management information and escalation procedures where the actuary disagrees with management’s proposed treatment. This protects the exercise from becoming a rubber stamp and gives SECP a supervisory basis for challenge.

The second document should be a Participant Surplus Statement. This should be issued when surplus is distributed and also when material surplus is retained despite no distribution, along with the rationale for it. A notice only when a payout or reinvestment into the Participant Investment Account (PIA) is done misses the real fairness problem, because participants usually need explanation most when they receive nothing. The statement should show, in layman language, opening accumulated surplus, current-year surplus or deficit, investment income allocated to the fund, reserve strengthening or release, qard received or repaid, surplus retained, surplus distributed and closing accumulated surplus. It should also show the participant’s credited amount, if any, and clearly state that retained surplus remains within the PIA and is not an individually vested entitlement.

This statement must not become boilerplate. “Surplus was retained for prudential reasons” should not be enough. The operator should identify the actual reason: reserve strengthening, qard repayment, adverse claims volatility, solvency buffer, contribution stability, cohort fairness or another approved basis. At the same time, it should be kept in mind that the audience is mostly non-technical, which is why the rationale laid out should be clear and simple to understand, since this is in line with the objective of participant equity assurance.

The framework would also serve different stakeholders in different ways. Operators would gain a clearer basis for defending prudent retention decisions, while Shari’ah Advisors would receive actuarial support for assessing whether approved surplus methods are being applied fairly in practice. Actuaries would move beyond valuation into a more explicit participant-equity role, and SECP would gain a conduct-of-business mechanism that improves accountability without imposing a uniform distribution ratio. For participants, the benefit is simpler but more important: their trust would have a more substantive basis since it now depends on an understandable explanation of how their fund has been managed.

Conclusion

It has to be recognised that technical compliance is not the only measure of credibility for Family Takaful. Participants are asked to join a system based on mutual assistance, shared responsibility and Shari’ah legitimacy. Pakistan’s current framework provides meaningful protections through regulation, Shari’ah oversight, accounting disclosure and actuarial valuation. But it still leaves a gap between surplus outcomes and participant understanding.

That gap should be closed through participant-equity assurance. An Actuarial Participant Equity Reasonableness Opinion would test whether surplus decisions are supportable from the perspective of reserves, solvency, qard, volatility, cohort attribution and cross-subsidy. Furthermore, a Participant Surplus Statement would explain those decisions in language participants can understand. Together, these reforms are not meant to create guaranteed surplus entitlements or force operators to distribute surplus imprudently. Rather, they would simply require Operator discretion to be justified.

In a system as value oriented as Takaful, participants deserve to know the why behind every retention/distribution outcome and also whether it was the fair decision to make given the circumstances. Trust remains fragile in the Pakistani market, therefore, SECP-led participant-equity assurance could lead to bolstering the moral and commercial credibility of Family Takaful in Pakistan.

 

Works Referenced:

 

• (n.d.). Shari’ah Standard No. 26: Islamic insurance. Accounting and Auditing Organization for Islamic Financial Institutions.
• (2022a). Financial Accounting Standard No. 42: Presentation and disclosures in the financial statements of Takaful institutions. Accounting and Auditing Organization for Islamic Financial Institutions.
• (2022b). Financial Accounting Standard No. 43: Accounting for Takaful: Recognition and measurement. Accounting and Auditing Organization for Islamic Financial Institutions.
• (2024). State of competition in the key markets with significant SOE’s presence in Pakistan: Insurance industry. Competition Commission of Pakistan.
• (2025, April 17). Competition Commission launches comprehensive report on insurance industry, proposes reforms. Competition Commission of Pakistan.
• (n.d.). COBS 20: With-profits. FCA Handbook. Financial Conduct Authority.
• (2021). Consolidated guidance note on Islamic finance(BOPCOM—21/10). International Monetary Fund.
• (2009). IFSB-8: Guiding principles on governance for Takaful undertakings (Islamic insurance). Islamic Financial Services Board.
• (2018). Issues arising from changes in Takāful capital requirements(Working Paper WP-08). Islamic Financial Services Board.
• (2022). IFSB-27: Core principles for Islamic finance regulation: Takāful segment. Islamic Financial Services Board.
• (2023). IFSB-29: Conduct of business supervision for Takāful undertakings. Islamic Financial Services Board.
• (2012). Takaful Rules, 2012(S.R.O. 29(I)/2012; updated as of October 22, 2015). Securities and Exchange Commission of Pakistan.
• SOA Research Institute. (2024). Takaful: An alternative approach to insurance. Society of Actuaries Research Institute.