By Olufemi A. ABASS (PhD., AIIN., ACIB)
Introduction
Industries and firms can be distinguished from one another on the basis of financial and non-financial characteristics including size, value, profitability, structure, leverage, liquidity, sales growth, age, customers’ base, liquidity, reserve and so on.
These characteristics are unique and are directly traceable to the operations of an identified industry.
While some characteristics cut across various sectors, there are some characteristics that are peculiar to certain industries.
In the same vein, the nature of insurance operation which is hinged on risk transfer, homogeneous exposure, charging of equitable premium among others depend highly on specific technical characteristics that distinguish the industry from others.
The fragmented state of Nigerian insurance market may not be unconnected to little attention given to core technical characteristics of insurance operations.
Apart from a few larger and stronger insurance companies, the market is characterized with a large tail-end of insurers with small balance sheets and often weak business fundamentals.
What are the characteristics of Insurance operations? Firm characteristics according to Bannier and Hänsel (2008) are the managerial and demographic fickle which are embedded in the internal attributes in a company.
The internal attributes can further be sub divided into financial and non-financial variables. While financial variables as the determining factors that are directly driven from items in a balance sheet and profit and loss accounts, the non-financial variables are those factors that cannot be driven from the items in the balance sheet and profit and loss accounts.
In lieu of this, technical characteristics of insurance business must be based on its core technical operations. Therefore, these technical characteristics may include; age, size, premium growth, loss ratio, liquidity, investment, capital adequacy, solvency margin, reserves, shareholders’ fund, reinsurance dependence, underwriting capacity and leverage.
Insurance company’s size refers to how large or small firm is, it measures a firm’s market value in relation to its competitors.
“Big” insurance companies can effectively diversify their assumed risk, possess a greater capacity to deal with adverse market fluctuations and respond quickly to changes in market conditions compared to small insurers.
The size of an insurance company may be measured by log of total assets.Premium is the insurance rate and the number of unit power exposure.
Premium growth measures the rate of sales growth, market penetration, profitability in the succeeding year, and contribution of insurance to Gross Domestic Product (GDP).
Premium growth of an insurance company may be measured by percentage change in net premium. Loss ratio is measured by the ratio of incurred claims to premium earned.
It demonstrates the effectiveness of the underwriting activities of insurance companies. Loss ratio reflects the adequacy of insurers underwriting performance and emphasizes the efficiency of the insurer’s underwriting activity.
It may be measured by net claim divided by net premium income.Liquidity on the other hand characterizes the ability of an organisation to meet its payment obligations in a short term by using liquid funds at its disposal.
It indicates insurance companies’ ability to finance all its contractual obligations like claims payment, underwriting expenses, claims expenses, reinsurance expenses, investment and maturity of liabilities.
Liquidity may be measured by cash and equivalent of an insurance company.Investment practice of insurance companies involves the dispensation that allowed assets into various investments to earn additional revenues.
This may be measured by financial assets including short term and long-term investment.Capital adequacy is the level of capital required by insurance companies to enable them withstand operational risks that they are exposed to.
It is instrumental to the survival of an insurance company because it generates a good level of profitability.
Capital adequacy of an insurance company is measured by shareholders’ fund divided by net premium earned.
Reserve is an amount representing actual or potential liabilities kept by an insurer to cover debts to policyholders.
Insurance reserve is formed by an insurance company to ensure future payments insured sums and insurance compensation.
The need for reserving may include; delayed and uncertain costs, claims reserving, under requirements and quantum of reserves.
Shareholders’ fund is made up of called up capital which gives an insurance company continuity of ownership and reserves that do not include loan capital.
It represents a protection net of cushion that allows an insurance company to remain solvent and continue operation despite unexpected disturbance.
Underwriting capacity is the maximum amount of liability that an insurance company agrees to assume from its underwriting activities.
It represents an insurer’s ability to retain risk and assume larger unexpected risk.
How relevant are these characteristics to insurance operations in Nigeria?
A study carried by Abass, Oyetayo and Dansu (2023) investigated the impact of these technical characteristics on the performance of non-life insurance companies in Nigeria.
The study used forty-one (41) licensed non-life insurance companies operating in Nigeria as at 31st January 2020.
The study employed secondary data that covered a fourteen (14) year period from 2006-2019.
The study affirmed the importance of these characteristics to insurance operations.
The findings revealed a joint significant effect of these technical characteristics on the financial performance of non-life insurance companies in Nigeria.
However, a closer look at the individual characteristics suggested that share capital, shareholders’ fund, firm size, capital adequacy, and premium growth significantly influenced financial performance of non-life insurance companies in Nigeria.
While loss ratio, and investment showed a weak influence on the financial performance variables.
Conclusion
Major operational characteristics of non-life insurance companies operating in Nigeria are share capital, shareholders’ fund, size of an insurance company, capital adequacy, premium growth, ability to monitor loss ratio and investment proceeds. Hence, insurance companies must concentrate on building share capital or reserve, surpass the regulated shareholders’ fund in order to assume more risk and by extension generate increase in premium growth.
Moreover, they must continually increase their asset base through diversification either in related or non-related businesses.
Attention may also be given to investment income that may help shore up the profitability level.
Lastly, net claim must be monitored vis-à-vis net premium income.
Olufemi Abass is an Associate Professor and Former Head, Department of Insurance, LASU.
