THE IMPACT OF RISK ON THE PERFORMANCE OF LISTED INSURANCE COMPANIES IN NIGERIA

CHAPTER ONE

INTRODUCTION

Background of the study: Risk management is an important discipline in business especially the insurance business. Recently, businesses put great emphasis on risk management as this determines their survival and business performance. Insurance companies are in the risk business and as such cover various types of risks for individuals, businesses and companies. It is therefore, necessary that insurance companies manage their risk exposure and conduct proper analysis to avoid losses due to the compensation claims made by the insured. However, Kadi (2003) observes that most insurance companies cover insurable risks without carrying out proper analysis of the expected claims from clients and without putting in place a mechanism of identifying appropriate risk reduction methods.

Poor management of risk, by insurance companies, leads to accumulation of claims from the clients hence leading to increased losses and hence poor financial performance (Magezi, 2003). Risk management activities are affected by the risk behaviour of managers. A robust risk management framework can help organizations to reduce their exposure to risks, and enhance their financial performance (Iqbal and Mirakhor, 2007) .Further; it is argued that the selection of particular risk tools tends to be associated with the firm’s calculative culture – the measurable attitudes that senior decision makers display towards the use of risk management models. While some risk functions focus on extensive risk measurement and risk based performance management, others focus instead on qualitative discourse and the mobilization of expert opinions about emerging risk issues (Mikes and Kaplan, 2014).

In recent years, insurance companies have increased their focus on risk management. Meredith (2014) suggests that there should be careful judgement, by management of insurance companies, of insurable risks in order to avoid excessive losses in settling claims. It follows that risk management is an important factor in improving financial performance (Okotha, 2003). According to Standard and Poor’s (2013), insurers, as risk-bearing institutions can, and do, fail if risks are not managed adequately.

The financial characteristics are variables which can be derived from the financial statement and profit and loss of insurance companies. These include firm size, premium growth, loss ratio or underwriting of risk, liquidity, tangibility, leverage and so on. On the other hand, non-financial characteristics are those variables which cannot be obtained from the financial statement and profit and loss of insurance companies. They comprise of age of the firm, management competencies, and scope of operation. Although management competencies lead to good financial performance, it is difficult if not impossible to assess management competencies directly because it is assumed that such competencies will be reflected in the operational performance of insurance firms. This study therefore combined five financial variables (firm size, premium growth, loss ratio, liquidity, and leverage) coupled with one non-financial variable which is age of the firm as proxies for firm specific characteristics against the financial performance of listed insurance firms in Nigeria. This study therefore embarks on empirical investigation to find out those firm specific attributes that affect the financial performance of listed insurance firms in Nigeria.

1.2 Statement of Problem

Financial performance can be measured through evaluating a firm’s profitability, solvency and liquidity. A firm’s profitability indicates the extent to which a firm generates profit from its factors of production. Financial performance can be measured by monitoring the firm’s profitability levels. Zenios et al. (1999) states that profitability analysis focuses on the relationship between revenues and expenses and on the level of profits relative to the size of investment in the business through the use of profitability ratios. The return on equity (ROE) and the return on assets (ROA) are the common measures of profitability. By monitoring a firm’s profitability levels, one can measure its financial performance.

Solvency measures give an indication of a firm’s ability to repay all its indebtedness by selling all of its assets. It also provides information about a firm’s ability to continue operating after undergoing a major financial crisis. Quach (2005) states that solvency measures the amount of borrowed capital used by the business relative to the amount of owners’ equity capital invested in the business as an indication of the safety of the creditors interests in the company.

The poor performance of insurance firms in Nigeria as noted by Agabi (2009) stemmed from several years of non-payment of claims by underwriting firms. This tradition of defaulting in claims by insurance firms in Nigeria resulted in reduction of their goodwill which translated to poor image of the sector and as a result, confidence in the sector seems to have eroded significantly. As such, Nigerians no longer consider insuring their valuables due to confidence crisis in the sector. In Nigeria today, there are evidence of performance of several industries such as banking and other financial institutions, however, the insurance sector is not responding appropriately to economic growth due to confidence crises in the sector. This implies that the overall financial performance of insurance firms in Nigeria is weak except for those who have diverse sources of investment.

Measuring the financial performance of insurance companies has therefore gained significant attention in the developed and some developing countries in the area of business and corporate finance literature.  As underwriters, these companies are not only providing good mechanism for transferring risk but also help to boost entrepreneurial confidence in appropriate way so as to support investment growth and general economic activities.

Profitability is a vital concern to all groups who have a direct or indirect interest in the firm. In spite of these vital roles that profit plays in the going concern of insurance firms, the profitability status of most insurance firms operating in Nigeria in relation to firm age, firm size, premium growth, loss ratio, liquidity and leverage of the firm have not attracted much attention of researchers in area of finance. This may be attributed to lack of thorough evaluation of factors that play critical role in profit realization of insurance firms in Nigeria. Therefore, it is of interest to know the extent to which firm specific characteristics (firm age, firm size, premium growth, loss ratio, liquidity and leverage) affect the financial performance of listed insurance firms in Nigeria. The firm specific characteristics of the insurance firms are to be assessed to provide valuable information in regards to their effects on performance.

This study therefore aims at examining the impact of risk on the performance of listed insurance companies in Nigeria.

1.3 Objectives of the study

The main objective of this study is to examine the impact of Risk on the performance of Listed Insurance Companies in Nigeria for a period of 2006 to 2013.

The specific objectives are to:

1. Examine the impact of age of the firm on the performance of listed insurance firms in Nigeria.

2. Evaluate the contribution of firm size to the performance of listed insurance firms in Nigeria.

3. Ascertain the impact of premium growth rate on the performance of listed insurance firms in Nigeria.

4. Analyze the impact of loss ratio on the performance of listed insurance firms in Nigeria.

5. Determine the impact of liquidity on the performance of listed insurance firms in Nigeria.

6. Examine the impact of leverage on the performance of listed insurance firms in Nigeria.

1.4 Research Questions

The study therefore addresses the following questions:

1. How does age of insurance firms affect the financial performance of listed insurance firms in Nigeria?

2. To what extent does firm size influence the financial performance of listed insurance firms in Nigeria?

3. What impact does premium growth rate has on the financial performance of listed insurance firms in Nigeria?

4. What is the contribution of loss ratio to financial performance of listed insurance firms in Nigeria?

5. How does liquidity influence the financial performance of listed insurance firms in Nigeria?

6. To what extent does leverage has on the financial performance of listed insurance firms in Nigeria?

1.5     Statement of Hypotheses

Following the above stated objectives, below are the hypotheses formulated in null form:

Ho1: Age of the firm has no significant impact on the financial performance of listed insurance firms in Nigeria.

Ho2: Firm size has no significant impact on the financial performance of listed insurance firms in Nigeria.

Ho3: Premium growth rate has no significant impact on the financial performance of listed insurance companies in Nigeria.

Ho4: Loss ratio has no significant impact on the financial performance of listed insurance firms in Nigeria.

Ho5: Liquidity has no significant impact on the financial performance of listed insurance firms in Nigeria.

Ho6: Leverage has no significant impact on the financial performance of Nigerian listed insurance firms.

1.6 Scope of the Study

The study investigates the impact of firm specific characteristics on the financial performance of listed insurance firms in Nigeria. In order to evaluate this impact, the study was conducted for the period of eight years that is from 2011 to 2018. The study period emerges from the fact that there were reforms aimed at increased productivity, performance and efficiency in the industry. The period is considered suitable owing to the fact that it marks the beginning of financial reforms where the insurance firms in Nigeria were required to increase their capital base. The study focused on internal factors because they can be easily measured by using data generated from financial statement of insurance firms in Nigeria and they are controllable factors that are within the control of management of listed insurance firms in Nigeria.

1.7     Significance of the Study

This study will be significant to insurance companies, general public, students and the insurance regulators as it will offer valuable contributions from both a theoretical and practical perspective. Theoretically, it will contribute to the general understanding of risk management practices and their effect on financial performance.  

The study will enable Insurance companies in Nigeria to improve their risk management process and to adopt efficient strategies to improve firm financial performance through the risk management processes. This will enable the insurance companies to perform better and to grow their businesses and maintain a competitive advantage.

Apart from benefiting the insurance companies, the general public will benefit from the study through improved insurance services and better management of risks. This will result to affordable rates of insurance premiums and reduction in levels of non-payment and fraud.

Lastly, the study will add to the existing body of knowledge on risk management to benefit academicians and aid further research on risk management in the insurance sector and the financial sector.

1.8 Organization of the Study

The study is divided into five chapters. Chapter one deals with the study’s introduction and gives a background to the study. Chapter two reviews related and relevant literature. The chapter three gives the research methodology while the chapter four gives the study’s analysis and interpretation of data. The study concludes with chapter five which deals on the summary, conclusion and recommendation.