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Optimal incentives for takaful (Islamic insurance) operators

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  • Khan, Hayat

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.

Suggested Citation

  • Khan, Hayat, 2015. "Optimal incentives for takaful (Islamic insurance) operators," Journal of Economic Behavior & Organization, Elsevier, vol. 109(C), pages 135-144.
    • Handle: RePEc:eee:jeborg:v:109:y:2015:i:c:p:135-144
    DOI: 10.1016/j.jebo.2014.11.001
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    References listed on IDEAS

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    7. Basov Suren & Bhatti M. Ishaq, 2013. "Optimal Contracting Model in a Social Environment and Trust-Related Psychological Costs," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 13(1), pages 271-284, April.
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    Cited by:

    1. Jassem Alokla & Arief Daynes & Paraskevas Pagas & Panagiotis Tzouvanas, 2023. "Solvency determinants: evidence from the Takaful insurance industry," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 48(4), pages 847-871, October.
    2. Ghlamallah, Ezzedine & Alexakis, Christos & Dowling, Michael & Piepenbrink, Anke, 2021. "The topics of Islamic economics and finance research," International Review of Economics & Finance, Elsevier, vol. 75(C), pages 145-160.
    3. Khan, Ashraf & Hassan, M. Kabir & Paltrinieri, Andrea & Dreassi, Alberto & Bahoo, Salman, 2020. "A bibliometric review of takaful literature," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 389-405.
    4. Lukman Hanif Arbi, 2021. "A Contract Theory Approach to Islamic Financial Securities with an Application to Diminishing Mushārakah," JRFM, MDPI, vol. 14(1), pages 1-12, January.
    5. Dila Puspita & Adam Kolkiewicz & Ken Seng Tan, 2020. "Discrete Time Ruin Probability for Takaful (Islamic Insurance) with Investment and Qard-Hasan (Benevolent Loan) Activities," JRFM, MDPI, vol. 13(9), pages 1-24, September.
    6. Hayat Khan, 2019. "A Nontechnical Guide on Optimal Incentives for Islamic Insurance Operators," JRFM, MDPI, vol. 12(3), pages 1-14, July.

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    More about this item

    Keywords

    Takaful; Islamic insurance; Optimal incentives; Wakalah; Mudarabah; Agency theory;
    All these keywords.

    JEL classification:

    • D4 - Microeconomics - - Market Structure, Pricing, and Design
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs

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