Economies of scope, organizational form, and insolvency risk: Evidence from the takaful industry

Abstract

Abstract This study investigates scope economies, organizational form, and insolvency risk for a sample of takaful firms in 19 countries. Firm efficiency is estimated using data envelopment analysis, performance is also gauged using return on equity and return on assets, and insolvency risk is measured using distance to default. We test the strategic focus and conglomeration hypotheses for takaful operators. We also test for differences in performance between the two major takaful organizational forms – the mudharaba (profit-sharing) and the wakala (fee-based) models for compensating managers. The profit-sharing design is hypothesized to be more effective in aligning the incentives of managers and policyholders. The findings suggest that strategic focus is superior to conglomeration for takafuls in terms of performance, efficiency, and insolvency risk. The results also show that the profit-sharing model performs better than the fee-based model. This research is important because takafuls are growing rapidly in Muslim-dominated countries where insurance density and insurance penetration are low.