What is it about?
The relationship between policyholders and an Islamic insurance (takaful) operator is in essence a principal-agent relationship. This paper analyzes the power of incentives offered to takaful operators in mitigating problems associated with such a relationship. These incentives include wakalah, an upfront agency fee as a percentage of premiums; mudarabah, a share in investment income from technical reserves; and surplus-sharing (a share in the insurance surplus). The paper concludes that all incentives offered to takaful operators must include surplus-sharing and that offering mudarabah in the presence of surplus-sharing is optimal only when the risk-adjusted return on investing technical reserves outweighs a similar return on effort exerted in underwriting risks. A wakalah hybrid is also recommended as it induces the operator to increase the size of the pool that, in turn, reduces average risk to the benefit of policyholders.
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Why is it important?
A pioneering paper which derives optimal incentives for Islamic insurance operators
Perspectives
This was a very exciting project to work on. There are competing models of Islamic insurance in terms of the incentives offered to Islamic insurance operators with interest in regulations which could address the moral hazard issue. The technical analysis used in this paper seems to be a logical scientific approach.
Hayat Khan
Read the Original
This page is a summary of: Optimal incentives for takaful (Islamic insurance) operators, Journal of Economic Behavior & Organization, January 2015, Elsevier,
DOI: 10.1016/j.jebo.2014.11.001.
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