Abstract
Financial distress (FD) is a common occurrence in Kenyan commercial sector and is not lacking in non-life insurance companies in Kenya. Several insurance companies have been placed under statutory management for failure to pay genuine claims and other creditors. Insurance companies provide unique financial services, not only to individuals but also to the growth and development of the economy; giving employment to workers and dividends to investors. Financial distress places insurable properties and businesses at risk thus reducing the general public confidence in the insurance sector. For this paper, the goal was to investigate whether inadequate reserving of claims (IRC) causes financial distress in non-life insurance companies in Kenya. In accounting for insurance claims reserves, increases in reserves mean a reduction of profitability of an insurer, whereas a decrease in reserves increases the profitability resulting in higher taxation and payment of dividends, which drains the insurer’s cash flow, thus causing financial distress. Out of 37 non-life insurance companies, registered in 2018 in Kenya, four insurers were subjected to Pilot Testing and another four companies declined to participate in the survey. Secondary data from Insurance Regulatory Authority website was retrieved for calculations of Z-scores as per Altman (1993), amended formula. Primary data was also collected through a questionnaire. A partial least squares Structural Equation Modelling (PLS-SEM) was employed to assess the mediating effect of Insurance Regulatory Association (IRA) supervision on the association between inadequate reserving of claims and financial distress. Goodness-of-fit (GoF) indices were used to assess the model’s goodness of fit. By using the discriminative Z-score formula, 52% of the institutions considered in 2018 were financially distressed, compared to 48% in 2017. However, when considering the average of ten years (2009 to 2018), financially distressed Keywords: Non-life insurance companies, Policyholders, Insurance Regulatory Authority, Claims Reserving, Z-Scores, Structural Equation Modelling DOI: 10.7176/RJFA/12-12-06 Publication date: June 30 th 2021
Highlights
There have been waves of failures of insurance companies reported since the 1980s due to financial distress (Brennan & Kraft, 2013)
The structural path from inadequate reserving of claims (IRC) to financial distress (FD) was found to be significant at 5% level of significance
38%% of the non-life insurers in Kenya were financially distressed (Table 1). 4.4.2 Demographic Characteristics of respondents The demographic characteristics and behaviours of the respondents reveal that 65.8% of the respondents were males, while 34.2% were females. 46.8% of the respondents were from the management, while the rest (53.2%) belonged to other cadres. 60.7% of the respondents were graduates, 29.8% were post-graduates, while 7.1% were diploma holders. 65.7% had served in their current companies for a period of 0 to 5 years, 23.8% had served between 6 and years, 4.7% had served between and years, and only 5.8% had served in their current insurers for more than years
Summary
There have been waves of failures of insurance companies reported since the 1980s due to financial distress (Brennan & Kraft, 2013). The financial distress of an insurer usually plays out over a period of a long time. Financial distress is a common occurrence in Kenyan commercial sector and is not lacking in non-life insurance companies in Kenya (Kihooto et al, 2016; Kimathi & Mungai, 2018; Ntoiti et al, 2017; Ombaba & Kosgei, 2017). In accounting of claims reserves in insurance companies, increases in reserves translates into increases of expenses reducing profits whilst decrease of reserves gives higher profits to the company. The insurer estimates the cost of the claim in the books of accounts with an anticipation of getting more information to determine the cost. The estimates in the books may either be adequate or inadequate and this depends on the information available to the company
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