Effects of Risk Management Practices on the Performance of Insurance Companies in Nigeria

Effects of Risk Management Practices on the Performance of Insurance Companies in Nigeria

Chapter One of Effects of Risk Management Practices on the Performance of Insurance Companies in Nigeria

INTRODUCTION

Background to the Study

Insurance companies play an important role in the financial services sector of most countries by lowering total risk, contributing to economic growth and efficient resource allocation, reducing transaction costs, creating liquidity, facilitating economies of scale and spreading financial losses (Duompos, Gaganis, and Pasiouras, 2012). They do this through underwriting of risks inherent in most sectors of the economy and provide a sense of peace to most economic entities. Consequently, the financial performance of insurers is of major importance to various stakeholders such as shareholders, policyholders, agents and policymakers (Charumathi, 2012).

Due to globalization and intense competition, risks are increasing and risk management is becoming an integral part for the success of almost every organization, especially for the insurance sector because of their high-risk businesses, as the risks are associated with every client in the business and their own risk. Insurance companies are in the core business of managing risk (Gupta, 2011). The companies manage the risks of both their clients and their own risks. This requires an integration of risk management into the companies’ systems, processes and culture (Eric, 2005).

The risk management process consists of a series of steps, which are establishing the context, identifying, analyzing, assessing, treating, monitoring and communicating risks, which allow continuous improvement of decision making (Ross et al., 2009). By implementing risk management insurance organization can reduce unexpected and costly surprises and effective allocation of resources could be more effective. It improves communication and provides senior management a concise summary of threats, which can be faced by the organization, thus ultimately helping them in better decision making.

Financial performance is a measure of a firm’s overall financial health over a given period of time. It can be measured from various perspectives including: solvency, profitability, and liquidity. Solvency measures the amount of borrowed capital used by the business relative to the amount of owner’ equity capital invested in the business. For insurers, profitability is the excess of revenues from underwriting activities over the costs incurred in generating them (Almajali et al., 2012).

The financial performance of an insurance company depends on many other factors, some of which are difficult to quantify, including the quality of its management, organizational structure and systems and controls in place. An assessment of financial soundness thus needs to take into account both quantitative and qualitative indicators to achieve an acceptable degree of reliability (Udaibir et al., 2003).

According to Njogo (2012) risk management is the identification, assessment and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability or impact of unfortunate events. Risks can come from uncertainty in financial markets, project failures, legal liabilities, credit risk, accidents, natural causes and disasters as well as deliberate attacks from an adversary. Risk management ensures that an organization identifies and understands the risks to which it is exposed. Effective risk management seeks to maximize the benefits of a risk while minimizing the risk itself.

Various authors have asserted that risk management (RM) often leads to enhanced organisational performance. Proper and efficient RM by insurance firms is essential to the survival of most organizations and will generally influence their financial performance. A structured RM approach is therefore essential for achievement of better organizational results (Ashby et al, 2013; Banks, 2004). Thus, this study explores the impact of risk management on the performance of insurance companies in Nigeria.

Statement of the Problem

Whether in the insurance industry or any other sector of the financial system, a company’s risk management procedure is widely believed to be crucial to the success of the enterprise as it acts as a powerful brake on the possible deviations from the predetermined objectives and policies. This means that an insurance firm that lacks adequate risk management technique is prone to fraud, bankrupt, static, experience retardation of growth or even die a natural death a result of sub-optimal performance.

Insurance firms in Nigeria over time have shown an irregular trend in performance; ranging from some recording financial losses to some being pushed out of business. This may not be unconnected to inadequate liquidity management, underpricing, management issues and high tolerance to investment risks.

While much empirical works have given diverse reasons for the poor financial performance of insurance companies, research evidence on the effects of risk management on the corporate performance of insurance firms in the Nigerian context is scanty. Thus inadequate risk management could be negatively affecting the financial performance of insurance companies in Nigeria. Although prior research studies such as Hermanson and Rittenberg (2013); Kiragu (2014) suggest a link between risk management and organisational performance, majority of these studies have concentrated mostly in banks and other financial institutions and the available studies so far have dealt exclusively with large financial institutions in advanced countries. Little is known, at present, about the influences of risk management on the corporate performance of insurance companies in Nigeria. It is in an attempt to fill this gap that this study seeks to assess the effect of risk management on the performance of insurance companies in Nigeria.

OBJECTIVES OF THE STUDY

The primary purpose of this study is to examine the impact of risk management on the performance of insurance companies in Nigeria. Other specific objectives are:

(i)     To examine the impact of risk management on the performance of insurance companies in Nigeria.

(ii)   To find out the relationship between risk selection and financial performance of insurance companies in Nigeria.

(iii) To measure the impact of risk management on demand for insurance in Nigeria.

RESEARCH QUESTIONS

The study is being guided by the following research questions:

(i)     Will there be a relationship between risk transfer and performance of insurance companies in Nigeria?

(ii)   Will risk retention have a significant impact on financial performance of insurance companies in Nigeria?

(iii) Will there be a relationship between risk management and demand of insurance in Nigeria?

RESEARCH HYPOTHESES

1.      Ho:    There is no significant relationship between risk transfer                     and   performance of insurance companies in Nigeria.

Hi:     There is a significant relationship between relationship between risk transfer and performance of insurance companies in                           Nigeria.

2.      Ho:    Risk retention has no significant impact on financial                      performance of    insurance companies in Nigeria.

Hi:     Risk retention has a significant impact on financial        performance  of insurance companies in Nigeria