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Dr. Fisher has extensive industry experience spanning over 15 years, which
include leading the investment banking team that launched t'azur company;
Managing Director, Takaful Business Development at Unicorn Investment Bank; as
well Deputy Head Takaful Division at Bank Al-Jazira. He is a frequent presenter
at internationally-recognized trade and insurance industry conferences and is
the author of numerous articles on Islamic finance, leasing and Takaful
(including three books). Omar holds a PhD Management Philosophy-Takaful, a joint
degree conferred by International Islamic University of Malaysia and Camden
University.
Corporate Governance and Company Performance
From Board rooms, to regulators' offices, 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"1. According to the Policy Brief published by the Hawkamah
Institute, "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% in developing
markets and leads to higher credit ratings and a corresponding improvement in
access to finance."2
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 3% per annum higher, or a 5 year
excess return of 15.3%3. Significantly, Wilshire found that institutional
investment by CalPERS and the updgrading of corporate governance led within one
year to "targeted poorly performing companies to underperform by only 1.5% vs. a
massive 23.6% underperformance just one year prior." 4
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, KPMG commented in June 2009 on Exposure Draft
No. 8 from 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 upon the above, lets examine five (5) observations that
arise.
Misalignment of Shareholders' and Policyholders' Interest
With one exception5, the Takaful models employ an organizational structure
whereby shareholders assert themselves as "agents" for the policyholders
through Mudareb or Wakala arrangements. This arrangement is typically
legitimized 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, web sites, 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 (2007-2009), 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 amongst 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 policyholders. 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 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.
Fourthly, a survey of Takaful companies around the globe will demonstrate that
so far the Board of Directors represents solely the shareholder's interests.
Many boards do not yet have even independent board members (ISAS recommends
1-3), nor any representatives from policyholders6. Fifth and finally, despite
the importance of policyholder capital (in the forms of annual contributions
as well as accumulated reserves) in addition to shareholder capital (albeit
not at direct risk to claims payments), Takaful companies typically are not
involving policyholders in either investment decision-making neither in major
decisions such as mergers, acquisitions or divestment of large assets. Again,
these decisions significantly influence the financial strength of the Takaful
yet occur at the Board level with no consultation or inputs from the Takaful's
constituency-the policyholders. By contrast as shown in the descriptive table
below, mutual insurers dare not resolve such decisions at the Board level
alone, and usually consult policyholders via a referendum, survey or even
proxy voting.
Comparative Roles of Policyholders
Intuitively, people feel safer in a group. Most people will opt for the
security, relative safety and economic benefits to themselves at mutual
risk-sharing. Indeed, mutual risk sharing in the modern day bears a striking
resemblance to the ancient Arab tribal practices. However, upon closer
examination there are important differences, as are shown in the table below:
Guidance from IAIS and IFBS on Corporate Governance
IAIS guidelines and IFBS recommendations on good corporate governance for
Islamic insurance companies may be summarized:
1. Clear roles and responsibilities for
- Board
- Board Committees - remuneration, investment, risk management, audit
and perhaps Corp Governance Implementation
- Senior management- job descriptions; Lines of authority; authority
matrix
- Shari'a Supervisory Board - how appointed; how removed
- Auditors - both internal and external audit; who conducts a Shari'ah
audit
- Policyholders - what are PH rights; obligations; how to terminate a
policy; how to lodge a complaint; or appeal a complaints resolution
- 2. Clear pathway to resolve conflicts and disputes - explain the treatment
of complaints
3. Verification of compliance - adhere to U/W guidelines; financial reporting;
regulatory; Shari'a; investments compliance
4. Adopt Code of Ethics for business and conduct of personnel - both
operations and sales staff; how does the Code extend to 3rd parties like
banks, brokers, other intermediaries; how to enforce compliance
Essential Elements in Takaful Corporate Governance
We may conclude, therefore, that essential elements of good corporate governance
for a Takaful operations would incorporate the following items:
- Be consistent with Takaful risk sharing model (congruent with
Takaful business principles)
- Existence of Ethics Code for business operations and binding on
personnel
- A fair balance of Shareholder (SH) interests and Policyholder (PH)
interests
- Encourage policyholder representation and, where possible,
participation in management decision-making in matters of direct impact to
policyholders
- Market discipline imposed through disclosures and financial
reporting
- A goal to manage the business to be self-sustaining, fulfilling
solvency requirements (in compliance with insurance regulations of that
jurisdiction) rather than maximizing profits for only the Shareholders
Pursue sound investment strategies (matching assets/liabilities, sound
liquidity, safety and diversification) in accordance with Shari'a compliant
rules
Given the above discussion, the author humbly suggests that an additional core
principle be included into the definition of what makes a Takaful:
- Tabar'ru - contributions from members or policyholders are donation
- Ta'awun - mutual assistance extended from the group risk pool
- Prohibition of riba and other impermissible commercial elements- in
both Shareholder capital and Policyholder common funds
- Surplus excess funds at year end legally belongs solely to
Policyholders
- (added) "Voice" and participation by Policyholders in Takaful
operations
Moving Forward - The Major Challenges
As Takaful companies enter only their 4th decade of existence, as contrasted
with conventional insurers whose longevity exceeds 400 years, one may assert
that formidable challenges lie ahead in execution of good corporate governance;
namely:
1. Balancing the conflicting responsibilities and interests of
Shareholders/Policyholders within the hybrid Takaful model as to:
- Capital adequacy
- Risk management
- Transparency
- Market discipline/disclosures
- Financial returns (dividends vs. surplus refunds)
This is because financial objectives are generally not aligned, consequently
Surplus enhancing activities quite often reduce the final profits to
Shareholders and potential for dividend payouts.
2. When Takafuls conduct cross-border transactions or open branches or joint
ventures to expand horizons, there looms large the challenge of balancing
various Shari'a issues of differing Takaful models, variations in product
implementation, styles of risk management, lack of range of investment vehicles
and even identifying and appointing local, qualified Shari'a scholars to advise
the company. In addition, often poor/no audits occur on actual compliance within
the Takaful to Shari'a principles espoused during business operations.
3. What "voice" - if any - to provide Policyholders in operations. To date, the
author is unaware of any Takaful operator that gives an active role to
Policyholders. Among the potential roles-representation on the Board of
Directors (non-voting), representation on the Executive Operations Committee
(observer status), representation on Committees of the Board or Executive
Management, are some examples.
Other open areas for research are:
- What is proper mechanism to appoint a Takaful Operator (TO), or to dismiss
a TO by Policyholders?
- Information asymmetry - ie TO has all data, and develops all
financial statements whereas the Policyholder has no access to data and no
role in financial decision-making
- Misalignment of incentives - Shareholders through the CEO they
appoint set the rates, dividends and surplus policies without inputs from
Policyholders. Note that some TOs charge their expenses and fees to the
Policyholders' risk pool and also demand an Incentive bonus. (ie what's left
for PHs?)
- Inherent Conflicts of Interest - in those circumstances where
Shareholders make all business decisions, which gives rise to potential for a
Conflicts of Duties - Shareholders serving own aims over those of PHs
Data compiled by global Takaful reports make clear that the nascent industry
is growing rapidly - more than 25% per annum in some countries - and
outstripping the growth of conventional insurance. Although, global Takaful
contributions amount to less than 1 percent of insurance industry annual
premiums of $4 Trillion dollars (2009), both the impressive rates of adoption of
Takaful coverages and the proliferation of new Takaful entities assure that this
segment of the industry will swell in breadth and importance. Eventually by
capturing just 1% of global risk coverages, the Takaful volumes of contributions
can reach $40 Billion annually worldwide, which would position Takaful alongside
cooperative and mutual insurance as a truly global player and risk protection
mechanism of choice for millions of policyholders. Thus, implementation by
Takafuls of good corporate governance equally fair to shareholders and
policyholders most assuredly will propel enduring growth for this sector.
References:
1 Stanford Professors working paper (2008) as reported by Eric Jackson, "Does
Corporate Governance Impact Performance", July 2009.
2 Hawkamah Institute for Corporate Governance, Policy Brief, March 2009
3 Wilshire Report, "The CalPERS Effect- on Targeted Company Share Prices", July
31, 2009.
4 IBID, p. 4.
5 In Sudan, the original home to rediscovered Takaful (1979), several of the
cooperative risk pools do not have shareholder capital and hence like mutuals
appoint management from amongst members.
6 Excluding those standing Board members who coincidentally may also own a
Takaful policy issued by their company.
Your feedback and comments are very important to us, please feel free to contact
the author via email.
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