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Governance Challenge in Takaful-Is there a solution to the Principal (participant) - Agent (Operator) Conundrum

13 November 2012

Zainal Abidin Mohd Kassim, FIA

Istanbul 2012

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The Conundrum(Isn’t the Agent supposed to act in the best interests of its Principal)

PrincipalPrincipal AgentAgent

Asym

metric

Information

Self interest

hires

performs

Self Interest

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Examples of this relationship

Agent Principal

Management Shareholders

Politicians Voters

Brokers Purchasers

Trader Investment Bank

Rating Agency Company to be rated

Issues of Moral hazard and conflicts of interest as the agent usually has more information than the principal.

Agent Principal

InsuranceInsurance Agent

Policyholder

TakafulTakaful Operator /Shareholder

Participants/Policyholders

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The Wakala Model

Operator receives a fee as a percentage of the contribution or premium.

Participants is responsible for all underwriting and investment losses– Operator

does the underwriting sets the contribution rates hire and trains the sales agents sets the fee structure with the participant

Participants do not have representation on the Board and cannot ‘fire’ the Operator!

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Managing the Agent-Principal problem

Encouraging good underwriting and profitable rating structure through allowing the Operator to share in underwriting surplus and investment profits– Effective only if underwriting surplus and investment profit is a

significant percentage of the Operator’s total income.

However…

As Operator does not share in losses, this asymmetry can result in the Operator taking excessive risk.

Thus…

There should be a cap on the surplus/profit sharing quantum that the Operator share in.

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Solutions for this Agent-Principal Conundrum

Establish Takaful as Mutuals– No shareholders. However, who will provide capital for the set up?

Convert an existing Mutual/Cooperative into takaful– Existing members of the Mutual ‘owns’ the retained surplus within the

cooperative. Will they be willing to do this conversion?. What will be their rights in the takaful entity?

Revise the Operator’s compensation structure to be more aligned to participants

– Some possible variations to the takaful model and possible ‘road blocks’

Solution Potential implementation ‘roadblocks’

Operator to share in a certain percentage of losses.

Tantamount to risk transfer which the Sharia may not approve.

Establish a cap on the level of surplus the Operator can share in so as to discourage excessive risk taking.

Operator sharing in surplus is generally not acceptable to Sharia in many countries.

Establish tariffs for ‘personal’ lines. Operators compete on level of surplus distributed.

Competition from conventional insurers may discourage policyholders towards takaful.

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Search for the appropriate takaful model

There need to be strong regulations (and regulators) to manage the Agent-Principal conflicts which is present in many of the existing takaful models.

Are there alternatives to the wakala model?– Can existing contract ‘types’ which are inherited from Sharia

compliant trading models (i.e. used primarily to determine how trades are conducted) be adopted unchanged in takaful?

– The wakala model was in use even before the time of the Prophet (S.A.W). This can be taken to imply that new contract types which are Sharia compliant is possible.

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Search for the appropriate takaful model

Any new model needs to conform to the basic principles of Muamalat (Sharia business law).

AND

As much as possible aligns the interest of all stakeholders.

AND

Has the ability to work within the constrains imposed by modern insurance supervisory standards.

AND

Represents good value to the participants.

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