Optimal incentives for takaful (Islamic insurance) operators

Hayat Khan

Journal of Economic Behavior & Organization, 2015, vol. 109, issue C, 135-144

Abstract: 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.

Keywords: Takaful; Islamic insurance; Optimal incentives; Wakalah; Mudarabah; Agency theory (search for similar items in EconPapers)
JEL-codes: D4 D8 J3 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeborg:v:109:y:2015:i:c:p:135-144

DOI: 10.1016/j.jebo.2014.11.001

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