Multiple Linear Regression Approach to Modeling Determinants of Profitability of Life Insurance Companies in Kenya

Abstract

Life insurance today plays an important role in the society and the global economy; it accounts for 59.7% of the market value. Global life premiums rose by 5% in real terms over the last three decades, reaching USD 2.4 trillion in 2010, or over 3.8% of global gross domestic product (GDP). Life insurance companies are important institutional investors, managing investments of about USD 21.5 trillion in 2010, or approximately 10% of total global investments. In the Kenya Vision 2030 blue print, insurance falls under the economic pillar. Insurance will be a useful component only if the insurance companies are profitable. Just like any business venture, the longevity and usefulness of life insurance business can only be realized if this segment of insurance business is profitable. However, the ultimate profitability of life insurance policies sold in a given year is subject to a number of variables that take many years to surface. Currently accounting methods are used to determine profitability; however, these methods cannot be used to predict profitability of insurance companies. Although several studies have been conducted in other countries to develop models on determinants of profitability of insurance companies, there are not such models developed for the Kenyan case. This therefore has created the need to develop a model using the Kenyan data to establish relationships of the various company level factors to profitability to enable predictability. It is on this basis that this study was carried out. For the purposes of this study, the following company level characteristics; liquidity, volume of capital, company size and underwriting risk were regressed on Return on Assets (ROA) using financial data for the year 2010. ROA was used as a proxy for profitability. The study sample was 20 life insurance companies in Kenya. This study found that the most important determinant of ROA of life insurance companies is company size. Key words: Multiple Linear Regression, Life Insurance companies, Return on Assets, Liquidity, Company size, Volume of Capital, Underwriting Risk