building value together 13 November 2012 Governance Challenge in Takaful -Is there a solution to the Principal (participant) - Agent (Operator) Conundrum Zainal Abidin Mohd Kassim, FIA Istanbul 2012 www.actuarialpartners.com
The Conundrum (Isn t the Agent supposed to act in the best interests of its Principal) hires Asymmetric Information Self Interest Principal Agent Self interest performs 1
Examples of this relationship Agent Management Principal Shareholders Issues of Moral hazard and conflicts of interest as the agent usually has more information than the principal. Politicians Voters Agent Principal Brokers Purchasers Insurance Insurance Agent Policyholder Trader Rating Agency Investment Bank Company to be rated Takaful Takaful Operator /Shareholder Participants/ Policyholders 2
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! 3
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. 4
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 Operator to share in a certain percentage of losses. Establish a cap on the level of surplus the Operator can share in so as to discourage excessive risk taking. Establish tariffs for personal lines. Operators compete on level of surplus distributed. Potential implementation roadblocks Tantamount to risk transfer which the Sharia may not approve. Operator sharing in surplus is generally not acceptable to Sharia in many countries. Competition from conventional insurers may discourage policyholders towards takaful. 5
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. 6
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. 7
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