1. www.actuarialpartners.com building value together 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

2. 1 Actuarial Partners The Conundrum (Isn’t the Agent supposed to act in the best interests of its Principal) Principal Agent AsymmetricInformation Self interest hires performs Self Interest

3. 2 Actuarial Partners Examples of this relationship AgentPrincipal ManagementShareholders PoliticiansVoters BrokersPurchasers TraderInvestment Bank Rating AgencyCompany to be rated Issues of Moral hazard and conflicts of interest as the agent usually has more information than the principal. AgentPrincipal Insurance Insurance Agent Policyholder Takaful Takaful Operator /Shareholder Participants/ Policyholders

4. 3 Actuarial Partners 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!

5. 4 Actuarial Partners 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.

6. 5 Actuarial Partners 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’ SolutionPotential 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.

7. 6 Actuarial Partners 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.

8. 7 Actuarial Partners 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.

9. www.actuarialpartners.com Actuarial Partners Consulting Sdn Bhd Suite 17.02 Kenanga International Jalan Sultan Ismail 50250 Kuala Lumpur Tel +60 3 21610433 Fax +60 3 21613595 www.actuarialpartners.com zainal.kassim@actuarialpartners.com