Abstract:
Despite the importance of reinsurance in risk and capital management of insurance companies, its excessive use is harmful to the company, through reduced profitability and increased credit risk, and the economy as a whole through premium income flight outside the country. Insurers should therefore retain as much as possible and cede the residual risk. This study sought to analyze the effect of firm financial strength related factors on income retention of general insurance companies in East Africa. The study aimed specifically to determine the effect of capital adequacy, leverage, liquidity and earnings volatility as well as the moderating effect of the firm size on the relationship between these financial strength related factors and income retention of general insurance companies in East Africa.
Positivism research philosophy and explanatory sequential mixed research design were used. The study targeted all general insurance companies in existence throughout the period of study from 2015 to 2019 across five countries in East Africa comprising of Kenya, Uganda, Tanzania, Rwanda and Burundi. As at 31st December 2019, the total population of general insurance companies was 99, out of which 12 did not operate throughout the study period. Whereas all 87 companies operating throughout the study period were selected for secondary data collection, a stratified purposive sample of 25 senior executives was adopted for primary data collection. In accordance with the research design, in the quantitative phase secondary data were obtained from insurance regulatory reports, company annual reports and through data collection sheets where reports were not available. The information collected during the primary data phase through in-depth interviews was guided by the results obtained during the quantitative phase. Panel data regression was used to test the hypotheses of the study and make inferences at 95% confidence interval. The results were subsequently presented using tables and figures for ease of interpretation. The findings of the study were analysed in line with those of prior related studies and the theoretical foundation in order to draw conclusions, recommendations and suggestions on possible areas for further studies.
The study found that capital adequacy does not have a significant effect on income retention of general insurance companies in East Africa. Capital buffer ratio had a negative but insignificant effect on retention ratio. Likewise, solvency margin had a very low positive but insignificant effect on retention ratio. The study found a significant effect of leverage on income retention. Debt to equity ratio had a negative and significant effect on retention ratio of insurance firms in
East Africa while the relationship between debt to assets ratio and income retention was found positive but insignificant. The study results indicated an insignificant relationship between liquidity and income retention. Liquidity of assets had a positive but insignificant effect on retention ratio while current ratio has a positive but insignificant effect on retention ratio. The findings established a significant relationship between earnings volatility and income retention of general insurance companies in East Africa. Volatility of earnings had a negative and significant effect on retention ratio of insurance firms in East Africa. With regard to the moderation effect, firm size was found to moderate significantly the relationship between firm financial strength factors and income retention of general insurance firms in East Africa. More specifically, firm size was found to moderate significantly the relationship between earnings volatility and income retention. The moderation effect of firm size was found insignificant for capital adequacy, leverage and liquidity variables.
The study recommends that in addition to measures aimed at increasing the overall market retention, regulators in East Africa should come up with measures that address specifically the minimum retention per company to increase income retention. To increase income retention, insurance regulators in Tanzania, Rwanda and Burundi need to ensure that insurance firms keep adequate solvency margins so that reinsurance serves as a tool to mitigate residual risk. Building on the impact of recent regulations in respect cash collection of premium, insurance regulators in East Africa should come up with more enabling regulations allowing companies to have adequate liquid funds and retain more income. Managers of general insurance companies in East Africa need to weigh costs and benefits of mitigating volatility of their underwriting portfolios and apply all internal appropriate corrective measures to reduce the cost of risk transfer to retain more. Further studies are recommended on the relationship between income retention and other firm characteristics, both financial and non-financial, such as profitability, ownership structure, portfolio composition, as well as on the potential moderating effect of country specific factors such as market size, market concentration and insurance penetration.