Effect of Financial Risk on Financial Performance of Insurance Companies in Kenya

Abstract

The study’s objective was to examine the effect of financial risk on financial performance of insurance companies in Kenya, utilizing a descriptive research design. The target population comprised 56 insurers and a census survey approach was employed to gather data. Secondary data sourced from annually published financial statements spanning the years 2018 to 2022 formed the basis of the analysis. The study employed descriptive and inferential statistical methods. Financial risk indicators namely liquidity risk, operational risk, counterparty default risk, and solvency risk, were considered in the analysis. To account for variations in the sizes of insurers, size of a firm was included as a control parameter. Correlation analysis revealed a weak negative correlation linking financial performance of insurers and liquidity risk. A moderate negative correlation was identified linking financial performance and operational risk. The correlation between financial performance and counterparty default risk was weak and negative, while financial performance and solvency risk exhibited a substantially weak negative correlation. Conversely, the correlation coefficient between financial performance and the size of the firm was positive and strong. Regression results indicated that the independent variables collectively explained 51.7% of changes in financial performance of insurers with the overall model achieving statistical significance (p<0.05). The study concluded that increased exposure to liquidity, operational, and solvency risks significantly reduced insurers financial performance. Regarding the effect of counterparty default risk, it was concluded that it insignificantly lowered financial performance. Lastly, the study found that the size of the firm had a significant positive effect on insurers financial performance. Recommendations arising from the study include urging regulatory bodies and policymakers to formulate policies incentivizing insurance firms to adopt effective risk management strategies for enhanced financial performance. Continuous monitoring of risk-taking by insurance companies is also recommended to ensure industry stability. The study underscores the necessity for insurers to institute robust risk management strategies as internal control measures to mitigate counterparty defaults, liquidity challenges, operational issues, and solvency risks thereby fortifying financial performance. Additionally, the study suggests continued investment by insurers to increase their size as this is expected to result in better financial performance. Future research could explore external risk analysis to assess the risks that insurers in Kenya are exposed to from external sources, such as economic, regulatory, or political factors.