Financial Risk and Cost Efficiency of General Insurance Companies in Kenya
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Date
2022-07
Authors
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Journal ISSN
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Publisher
Kenyatta University
Abstract
Insurance companies play a key role in protecting customers from the risks that they are insured against them occurs. In order for insurance firms to meet this objective they incur
costs that are related o this and so the firms should be financially sound and meet every
need as it arises. Cost efficiency is the manner in which the processes and products are transformed to minimize costs in order (0 add value to the firm. Cost efliciency is enhanced through different strategies to make directions, drive innovation, and reduce operational costs as well as to minimize financial risk. There has been increasing inputs in the insurance industry in terms of wages for highly qualified stafY, costly digital software and competition from both insurance and banking sector which may reduce the profitability. General insurance companies in Kenya have been underperforming in recent years leading to massive losses as a result of increased costs and reduced revenues leading to reduced efficiency. The study sought to ascertain the effect of financial risk on the cost cfficiency of general insurance in Kenya. Specifically: credit risk, liquidity risk, interest rate risk, and foreign exchange rate risk on cost efficiency and finally to evaluate the moderating effect of capital adequacy on the relationship between financial risk and cost efficiency. This study used the Neoclassical Theory of the Firm, the Arbitrage Pricing Theory, Theory of
Optimal Capital Structure and the X-efficiency Theory. Explanatory research design, and
Data Envelopment Analysis model was employed to analyze general insurance companies
from 2015 to 2019.DEA and panel data logit model was also adopted. The study targeted
38 general insurance companies in Kenya and formed a sample size of 38 using the census
method because of the small number. The study conducted descriptive and inferential
analysis. Correlation and logit regression analysis to establish the onship between the
variables. The study found that credit risk and cost efficiency were negatively and
significantly related (B=-5.6018, P=0.0123). This mecans that cost efficiency would .
increase with a decrease in credit risk. The study also showed that liquidity risk has a
negative and significant effect on cost efficiency (=-15.1983, P=0.001). This implies that
when liquidity gap increases then the cost efficiency of a firm decreases significantly.
Moreover, interest rate risk was positively and significantly related to cost efficiency ratio (B=9.277, P=0.004). This implies that when liquidity gap increases then the cost efficiency
of a firm decreases significantly. The study also revealed that foreign exchange risk
negatively affects cost efficiency (B=-0.1093, P=0.027). This implies that the bigger the
position an insurance firm holds in foreign markets relative to local markets, the more
exposed they are to fluctuations in exchange rates. The study therefore concluded that
credit risk, liquidity risk and foreign exchange risk had a negative influence on cost
cfficiency while interest rate risk had a positive influence on cost efficiency of general
insurance companies in Kenya. Finally, it can be concluded that capital adequacy
moderates the relationship between financial risk and cost efficiency among insurance
firms in Kenya. The study recommends that general insurance companies should have
sufficient capital reserves in order to be able to handle financial risks they are exposed to
should they occur and that the IRA should set up policies that guide the industry and enable
insurance companies to improve their cost efficiency and reduce their exposure to different
forms of financial risk. The study also reccommended that further research be conducted
on other factors that may affect cost efficicncy apart from those discussed in the study.
Description
A Research Project Submitted to the School of Business in Partial Fulfillment of the Requirements for the Award of the Degree of Master of Business Administration (Finance) of Kenyatta University
Supervisor
1. Mungami, Eddie Simiyu