Optimal incentives for takaful (Islamic insurance) operators

A Nontechnical Guide on Optimal Incentives for Islamic Insurance Operators

“…A mudarabah hybrid should be offered only when effort exerted by the operator in investing the premium is more rewarding than effort exerted by the operator in underwriting risks. Khan (2015b) empirical analysis provides support to the conclusion of Khan (2015a) and shows that offering a mudarabah hybrid is counter-productive.…”

“…There are only two papers which look at this relationship in the context of Islamic Insurance operations. A pioneering theoretical paper by Khan (2015a) studies the impact of competing incentives schemes on the performance of TOs and concludes that the TOs should be offered a share in the insurance surplus as well as some wakalah fee. A mudarabah hybrid should be offered only when effort exerted by the operator in investing the premium is more rewarding than effort exerted by the operator in underwriting risks.…”

“…According to the World Takaful Report (2016), the issue of the optimal structure of a takaful model is a challenge and unsettled so far. Khan (2015aKhan ( , 2015b analysis is too academic and technical in nature, which does not readily appeal to regulators. Moreover, the standard framework makes some simplifying assumptions for model tractability, which makes it difficult for regulators to appreciate its value.…”

“…Section 7 concludes the paper. 1 As discussed in Khan (2015a), the surplus-sharing contract is shariah complaint. However, the Islamic finance industry started justifying surplus sharing under the mudarabah arrangement where the operator, instead of receiving a share in profit generated by performance of the premium pool, receives a share in the insurance surplus, which is contentious.…”

“…They referred to this as a modified mudarabah model. See Khan (2015aKhan ( , 2015b for further discussion on these incentive schemes.…”