Featured, Takaful Corner

Corporate Governance

Dr Omar Clark Fisher explores the alignment of corporate governance and company performance in relation to takaful companies, while calling for a far more active role for policyholders in the decision-making process.

Corporate governance and company performance

From board rooms to regulators’ offices and to stock exchange trading floors, the global debate marches on: does good corporate governance enhance stock prices and/or shareholder value? While research studies are by no means conclusive, evidence is mounting up that better corporate governance leads to better future financial and stock performance. According to the Policy Brief published by the Hawkamah Institute for Corporate Governance, “In its September 2005 report, ‘The Irresistible Case for Corporate Governance,’ the International Finance Corporation (IFC) asserts that sound corporate governance increases company valuations by 20-30 per cent in developing markets and leads to higher credit ratings and a corresponding improvement in access to finance.”

A Wilshire Report in July 2009 documented statistically the positive impact of good corporate governance on share prices of 139 public companies that the California Public Employees’ Retirement System (CalPERS) invested in beginning in 1987 and thereafter insisted they adopt corporate governance policies and best practices. Compared to a benchmark return on cumulative basis, average companies invested into by CalPERS yielded three per cent per annum higher, or a five-year excess return of 15.3 per cent. Significantly, Wilshire found that institutional investment by CalPERS and the upgrading of corporate governance led within one year to “targeted poorly performing companies to underperform by only 1.5 per cent vs. a massive 23.6 per cent underperformance just one year prior.”

Another finding of the Hawkamah Institute is that: “Shari’a-compliant insurance companies need to explain clearly the relationship between the policyholders’ fund and the operating company. In particular, shareholders need to know what their obligations will be to support the policyholders’ fund in the event that the fund faces financial difficulties. Disclosure should focus on the legal relationship between the two entities, and also disclose any regulations to which the takaful firm is subject, which may affect the flow of funds between the two entities.”

Dr John Lee, executive director at KPMG, commented in June 2009 on Exposure Draft No 8 from the International Financial Services Board (IFSB) of Malaysia regarding corporate governance for takaful companies: “Because of structure of Islamic finance, the need for transparency is even greater than perhaps in conventional. The fact that participants have a direct stake in some of these transactions, I think that’s why there’s so much emphasis on the need for transparency. So who’s looking after the interests of policyholders? Some would argue that perhaps it’s the shari’a board…but a lot of the role of the shari’a board has been confined to product development areas as opposed to looking at broader issues such as fairness to policyholders.”

Although worldwide there are four variations of the basic system of takaful, the Islamic alternative to conventional insurance, common elements are apparent. Succinctly put, these are:

. Insureds make contributions (often called “tabar’ru or donations) rather then
pay premiums
. Core essence is mutual assistance to needy members of the group (or ta’awun)
. Risk-sharing among members (form of joint indemnification) rather than risk transfer
. Avoidance of prohibited elements such as al maisir (form of gambling), al gharar (uncertainty and deception) and al riba (interest or forbidden types of commercial gain)
. Separation of ownership interests of policyholders (members) from shareholders
. Use of Shari’a compliant agreements in all activities – including investment of contributions and share capital
. Excess funds resulting from annual operations – called surplus not profits – legally belongs solely to policyholders (who after all contributed the risk capital) and not to shareholders, as is featured by stock insurance companies.

Based on points listed above, five observations arise.

Misalignment of shareholders’ and policyholders’ interest
With the exception of several cooperative risk pools in Sudan, the takaful models employ an organisational structure whereby shareholders assert themselves as “agents” for the policyholders through Mudareb or Wakala arrangements.

This arrangement is typically legitimised by the voluntary purchase by the policyholder/member of a takaful operator’s policy. However, many takaful policies are frankly oblique in terms and conditions, and may not fully disclose rights, responsibilities and fees attendant to this arrangement. Hence, the first important observation is the rights, responsibilities and role of policyholders are not always clearly set forth and readily disclosed in ads, brochures, websites, let alone in actual policy wordings.

Common practice under good corporate governance requires that customers (read policyholders/members) be provided clear, unambiguous and easily accessible descriptions of rights, responsibilities and other consumer protection disclosures, today circumscribed by normal business practices – especially in financial services. No doubt in reaction to the recent global financial crisis, regulators and insurance practitioners alike are giving more attention to transparency and disclosures.

Secondly, nearly all takaful operators establish themselves as managers of the risk pool with no consultation with policyholders – the main beneficiaries of that risk pool. Of the various policies the author has read, not one specifies how policyholders can appoint management or even remove management. It seems their sole recourse is to lapse their policy, or to terminate the policy early if aggrieved or somehow poorly represented by their “agent”, the takaful operator. Again, good corporate governance practices among stock companies generally (including insurance) sets forth the manner in which customers (read policyholders) can complain, influence business management or in extreme cases, mount an appeal to the board via a proxy campaign or via legal recourse called “class action suit” to impress upon management its grievances.

Thirdly, on a slightly more technical point, the calculation of surplus at year-end is conducted by shareholders only through management with no consultation (again) with policy holders. The decision about retaining surplus, adding to reserves or size and timing of distribution of funds is totally determined by the takaful operator. Some industry experts take comfort in the Sharia Supervisory Board’s oversight of takaful business operations, which does include this issue of surplus calculation. Nonetheless, surplus is the right of policyholders who have contributed that risk capital to the takaful pool. Good corporate governance should dictate that policyholders be actively involved in such calculation and decision-making, rather than resort to a “watch-dog” status for scholars or discovery through a shari’a audit, which is still not a regular and respected fixture of takaful operations globally.

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