The Effect of Interest Rate on Financial Performance of Insurance Companies in Kenya

Abstract

Interest rates are one of the economy single strongest influences and have a profound effect on everything from individual investment decisions to job creation, monetary policy and corporate profits. Economic environments have an intense consequence on the growth of the insurance companies. A strong insurance industry promotes a developed contractual saving sector which contributes to a more resilient economy that would be less vulnerable to interest rates and demand shocks while creating a more stable business environment, including macroeconomic stability. The main objective of the study was to establish the effect of general interest rates the financial performance of licensed insurance companies in Kenya. Further, the researcher went ahead to ascertain the influence of other firm specific (micro) and macro-economic factors that affect the financial performance of insurance companies, specifically; GDP, liquidity risk, age, size and inflation. The research study used secondary data sources which was analyzed and presented inform of tables and figures to provide a clear picture of how interest rates are related to performance. Descriptive research design was adopted on a population of 49 licensed insurance companies and covered a six year period from 2008-2013. The findings showed R2 of 100% implying that interest rates, GDP, age, size, liquidity risk and inflation are major determinant of the return on asset which was a measure of financial performance for the insurance companies in Kenya. Using regression outputs of the insurance companies; the study established that interest rates negatively affect the return on assets of the insurance companies in Kenya. GDP, inflation, liquidity risk were found to have negative coefficient with the return on assets illustrating that an increase in one of these variables will leave a negative effect on the financial performance of the insurance companies. However, the study established that age of the companies has a positive impact on the financial performance of the insurance companies in Kenya. The study concluded that that there is a negative and statistically significant relationship between interest rates and financial performance of insurance companies in Kenya. The researcher therefore, recommended that insurers especially life insurance companies should have either well-matched asset and liability cash flows or have established additional reserves that are available to cover any interest rate or reinvestment rate risk since low interest environment creates spread compression on earnings.