Graphic By TMR 

This paper examines regulatory and market practices issues relating to consumer protection in the takaful sector.

Based on review of technical literature and a survey conducted across regulatory and supervisory authorities and takaful operators, it explores how an effective and comprehensive consumer protection regime can be applied throughout the different stages of the customer’s engagement with takaful operators and intermediaries.

A large proportion of takaful sales in the consumer sector are distributed through traditional distribution channels.

The analysis and survey results suggest that market practices can deviate significantly from supervisory expectations, particularly with regards to the scope for takaful operators and intermediaries to seek to maximise their own benefit rather than pursue the consumer’s best interest.

The conflict of interest often present, and the ability of market players to exploit this, suggest a potential for reputational damage to occur, threatening consumer confidence in the sector which is an essential attribute.

The paper recommends emphasis on fair treatment of consumers, to cover the whole product lifecycle from product development, through distribution to claim settlement, to reduce the potential for mis-selling and other forms of consumer detriment. It recognises that different jurisdictions take different approaches to addressing these issues.

The working paper also identifies evolving business models and the use of emerging technologies to re-engineer consumers’ experience from the purchase of takaful products to filing of the claim, with benefits and threats that these changes bring.

The paper identifies regulatory and supervisory approaches to product oversight, disclosure, intermediation, privacy and data protection, complaints handling and claim settlement, including in matters specific to takaful, that could form a basis for a common framework in addition to the existing Islamic Financial Services Board (IFSB) standards and guiding principles. Besides, consideration should be given to consumer education on takaful and the ways in which it could be delivered.

Information Asymmetry
Information asymmetry is a recognised issue in the field of insurance. The product typically has many conditions and features, setting out for example the levels of cover, exclusions, optional extras and the duties of the policyholder.

In the case of takaful, the contract has further complexities compared to conventional insurance products, for example in the remuneration structure for the operator.

Consumers typically lack the ability to assess a financial services contract, or to negotiate its terms to their advantage. This inequality between the provider and consumer serves as a significant justification for regulation.

In addition to access to information and ability to interpret it, providers may also, in the absence of regulation, be able to control how information is framed and presented to the consumers by varying the explanation or the relative prominence of product features, and so influence consumer decisions contrary to the consumer’s own interest. Mere disclosure may not be adequate to mitigate these risks.

Concerns over fair treatment of consumers in this respect are the strongest in the case of longterm savings and protection products where decisions on purchasing or modification are made only infrequently.

Pricing regulation poses practical difficulties where contracts vary in form, as regulated pricing cannot easily reflect nuances in cover and conditions of contracts, or changes in exogenous factors for example, longevity or weather that may affect contracts differently.

Where this is evident, comparison of products along price and quality dimensions presented by takaful operators or intermediaries may yield little result even where premium varies with risk characteristics of individual consumers.

Intermediaries
Much consumer takaful is sold through intermediaries rather than directly. The activities of intermediaries can range from promoting takaful awareness to identifying the suitability of products for consumers’ needs, and delivering takaful products. Consumer protection concerns may arise from distribution practices that promote adverse consumer outcomes, perhaps due to conflicting incentives or failure to exercise due skill.

The traditional basis of remunerating intermediaries on a commission basis may work against fairness to consumers, particularly where the seller has a significant advisory role to play in the consumer’s choice of product.

Regulation can set minimum standards for objectivity and quality of advice, or prohibit particular incentive structures.

Promotional activities conducted by providers or intermediaries may affect consumers’ perceptions of products and influence their behaviour. Misleading advertising or product brochures can impair the consumer’s ability to make an informed decision. Advertising and other promotional materials should therefore be fair, clear and not misleading.

In takaful, further issues may arise. For example, using surplus distribution as a selling point in general takaful raises the risk of creating unrealistic expectations as to future financial performance.

Evolving business models and the use in takaful of emerging technologies can create additional opportunities for consumer detriment to occur, and require regulatory consideration.

Growth in digital services is changing customer expectations, preferences, and the nature of takaful operators and intermediary interactions with customers. These developments can challenge the adequacy and effectiveness of traditional regulatory and supervisory frameworks in respect of conduct of business.

Conclusion
The conduct of insurance business in consumer lines is vulnerable to the risk of inappropriate consumer outcomes. Key drivers include the providers’ control over information on products and prices and how that information is presented to consumers, the possibility of conflicts of interest influencing provider behaviour, and the limited ability of consumers to evaluate information presented — emerging technologies also present additional challenges.

The potential for consumer detriment is particularly high for certain long-term products.

Specificities of takaful, though giving effect to the requirements of Shariah, can provide scope for further manifestation of these risks. Attention is drawn to conflicts of interest in takaful models and issues arising from surplus distribution.

Regulatory frameworks for takaful in different jurisdictions use a combination of approaches to mitigate risks of adverse consumer outcomes, addressing among other things takaful operators and intermediaries’ product oversight, disclosure, intermediation, privacy and data protection, complaints handling and claim settlement, including in matters specific to takaful. Any standard framework for general adoption would need to provide flexibility for regulatory and supervisory authorities to adopt it within the context of their own institutional and market structure, as well as recognising the different risk attaching to different consumer products.

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Extracted from a working paper prepared for IFSB. Dr Dauda Adeyinka Asafa is from IFSB’s technical and research department.