WORLD ACADEMIC JOURNAL OF BUSINESS & APPLIED SCIENCES-MARCH-SEPTEMBER 2013 EDITION

Journal of Economics & Finance (JEF)

SEPTEMBER 2013 VOL.1, No.7

Effects of Weak Legislation on the Performance of Nonlife Insurance Companies in Kenya

Joseph Nyongesa Amambia (Corresponding author) & Joseph Githinji Kanai Jomo Kenyatta University of Agriculture and Technology P. O. Box 62000-00200, Nairobi, Kenya Accepted 29 September 2013 Abstract The paper asses how weak legislation in the insurance sector affects the performance of nonlife insurance companies in Kenya. The Insurance Regulatory Authority is a State Corporation established under the Insurance Act (Amendment) 2006, CAP 487 Laws of Kenya whose roles are to regulate, supervise and develop the insurance industry in Kenya with overall aim of ensuring financial stability of insurance firms. The study adopted descriptive research design covering a stratified sample of 108 respondents drawn from 27 Nonlife insurance companies in Kenya. Data was collected by use of questionnaires and was later analyzed using descriptive and inferential statistical analysis tools. According to the study findings there was a negative correlation between weak legislation in the insurance sector and insurance sector performance with correlation coefficient of -0.264 at 0.01 level of significance. The study recommended that insurance regulator needs to reduce the menace of under pricing by effectively administering the existing insurance legislation. Key words; Solvency Margin, Technical insolvency, Under pricing 1. Introduction The Insurance Regulatory Authority is a statutory government agency established under the Insurance Act (Amendment) 2006, CAP 487 of the Laws of Kenya to regulate, supervise and develop the insurance industry. It is governed by a Board of Directors which is vested with the fiduciary responsibility overseeing operations of the Authority and ensuring that they are consistent with provisions of the Insurance Act. The Authority deploys significant resources in monitoring market behaviors, compliance and solvency issues (IRA 2012). According to the National Insurance commission of Ghana insurance premium is the actual amount of money charged by insurance companies for the indemnifying a risk. An insurance premium for the same service can vary widely among insurance providers, which is why experts strongly recommend getting several quotes before committing to an insurance policy. Insurance agents or brokers will normally take the basic information and calculate an estimated insurance premium based on needs and other risk factors. The lowest quoted price on an insurance premium may be the better bargain, but the level of coverage may also be lower. According to PWC (2013), on key issues facing the insurance sector in Kenya, There are several legislative and taxation changes made in recent years that have had an impact on the Kenyan insurance industry. These include increase in the minimum capital requirements for insurers, increase in the solvency margin for
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long term insurers, introduction of cash and carry rules which will require that insurers shall assume risk upon receipt of the premium, relaxation of investment limits for general insurers, introduction of penalties on late settled claims, change in the rules on taxation of long term insurance business and taxation of dividend income earned by a financial institution Wahome (2013), argues that cut-throat competition in the motor insurance business is resulting in under-pricing tactics, thereby affecting performance of the firms as they have to squeeze thin the margins from their deals.This is happening even as the regulator, the Insurance Regulatory Authority (IRA), says supervision of the industry will get tighter through a shift from compliance-based to risk-based supervision, starting this year.Competition in the insurance industry has gone to pricing and the issues of undercutting are coming up. When the undercutting gets severe, it can go down with many, said Mr Robert Kuloba, the policy, research and development manager at IRA. Melbourne (2013), argues that poor pricing strategies can lead to short-term business expansion at the expense of sustainable financial positions. Under pricing, for one, leads to negative business margins. The problem is compounded if poor pricing also leads to poor estimations of reserving needs, or if it compromises an insurer's capacity to reserve adequately for future claims. Poor policy design and pricing is the root of the issue, which are often by-products of insufficient experience in a particular business line and exacerbated by competitive pressures. Year 2010 Insurance Regulatory Authority (IRA) issued motor insurance rates guidelines in an attempt to stem out stiff competition in the insurance sector . The recommended rate for private motor insurance was set at 7.5% of the sum insured. The rate was to be charged in the first year of insurance contract to the insured and an yearly discount of 10% was to be awarded every year if the client had no claim record in the previous year. This noble idea was to reduce the challenge of undercutting that had been practiced in the past years and reduce stiff competition resulting into a profitable motor insurance business (Wahome,2013).This noble idea was not sustainable due to interplay between competition law and regulation in the insurance sector in Kenya as the players engage in to massive insurance rates undercutting in order to attract more business. There is interplay between competition, law and regulation of the insurance sector in Kenya. The regulation of the insurance industry in Kenya is inherently weak thus failing to stimulate competition in the industry (Kerubo, 2011). Most nonlife insurance companies are technically insolvent since IRA does not recognize debtors as assets when assessing the solvency margin of an insurer. Compromising cash and carry rules has led to insurers accumulating non performing debts thus rendering the companies technically insolvent (Mukiri, 2011). Relaxation of investment limits for general insurers which require insurer to invest their idle cash in liquid assets than illiquid ones as it will be easier for the insurer to liquidate the investments and settle claims as they arise (Namaemba,2010). By not collecting premium on time leads to poor performance by insurers due to reduced investment income. Kenyan insurance companies generally report high loss ratios. Between 2004 and 2007, the loss ratios for the industry as a whole ranged between 56% and 60%. Insurers have traditionally relied on investment income to act as a cushion for their underwriting results (AKI 2007) The main aim of this study was to understand how weak insurance legislation affects the performance of nonlife insurance companies in Kenya. As a result, the following specific objective was pursued: To establish how under pricing by insurers impact on overall organization performance. 2. Literature review According to consumer Federation of America (2005) One of the reasons for regulation is to prevent competition that routinely causes insurers to go out of business, leaving consumers unable to collect on claims. Insolvency regulation has historically been a primary focus of insurance regulation. After several insolvencies in
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the 1980s, state regulators and the National Association of Insurance Commissioners (NAIC) enacted risk-based capital standards and implemented an accreditation program to help identify and prevent future insolvencies. As far fewer insolvencies occurred in the 1990s. There are various characteristics of insurance business which single it out from other industries for special treatment such as; insurance contacts are promissory in nature in that at the time of the sale, the insurer undertake to make a payment to, or on behalf of the policy holder upon the occurrence of a specified future event or at a future date (Mungara, 2009). There is interplay between competition law and regulation of the insurance sector in Kenya. The regulation of the insurance industry in Kenya is inherently weak thus failing to stimulate competition in the industry. There is need to establish a regulatory framework in the insurance industry that is efficient and able to stimulate competition in the industry in a manner that will stir growth (Matara, 2011). Insurers have blamed their losses on consumer apathy and rampant price under-cutting arising from unhealthy competition in the industry. This is as a combination of fraudulent claims and low penetration of products took a toll on their earnings. (Okoth, 2013). Munaita,( 2006) urges that Insurance premiums for public service and commercial vehicles have fallen by a tenth following the success of reforms in the road transport sector initiated two years ago. But the premiums could slide further because of fierce competition in the industry that has seen some players charge up to 40 per cent less than the monthly installments that have been filed with the Commissioner of Insurance. 3. Methodology The study adopted the descriptive survey design. Kombo and Tromp (2006) state that the major purpose of descriptive research is description of state of affairs as it exists. The design was chosen because the researcher was fairly knowledgeable about the aspects of the phenomenon, but little knowledge was available regarding their characteristic, nature or details. , Quantitative data was analyzed using descriptive and inferential statistical analysis tools; percentages and Pearson correlation to determine the relationship between variables under study while analysis of qualitative data involved organization of data into themes, as guided by the study objectives. 4. Results and Analysis The study targeted a total population of 108 respondents, however due to study limitations; the study gathered a total of 104 responses which represents 96.3% response rate of which 69.3% were male and 30.7% were female. The study also targeted main decision makers in respective insurance companies 25 % of the respondents were finance managers, 25% risk and compliance managers, 25% underwriting managers and 25% were claims manager Table 4.1: Summary of Insurance legislation in Kenya Interaction Quality IRA closely monitors motor insurance premium rates charged by insurers IRA conducts regular audits in your organization to ensure insurance legislation are followed. IRA imposes stiff penalties to insurers for deviating the regulators guidelines. Key: SD-Strongly Disagree; D- Disagree; N-Neutral; A- Agree; SA- Strongly agree According to the research findings as shown in table 4.1 above, 87% of the respondents disagreed that IRA monitors rates charged by insurers while 13% of the respondents agreed with this statement. On the issue of
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SD(%) 82.3 79.2

D(%) 4.7 14.2

A(%) 9.1 5.2

SA(%) 3.9 1.4

65.2

17.3

9.8

7.7

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conducting regular audits to ensure the issued underwriting guidelines are followed 93.4 % of the respondents disagreed while 6.6% agreed. On the aspect of IRA penalizing insurance companies that deviate from regulators guidelines 82.5% of the respondents disagreed while 17.5% of the respondents disagreed. Table 4.2: Summary of Insurance companies performance Interaction Quality Adequate legislation leads to profitable insurance firms Adherence to insurance legislation improves service quality Effective legislation improves insurers liquidity SD(%) 3.5 2.9 2.8 D(%) 2.5 9.1 4.3 A(%) 7.6 12.2 10.5 SA(%) 86.4 75.8 82.4

Key: SD-Strongly Disagree; D- Disagree; N-Neutral; A- Agree; SA- Strongly agree As shown in Table 4.2 above 94% of the respondents agreed that adequate legislation in the insurance sector leads to profitable insurance firms while 6% disagreed. On the aspect of adherence to insurance legislation improving service quality 88% of the respondents agreed while 12% disagreed. Regarding the issue of effective legislation improving insurers liquidity 92.9% of the respondents agreed while 7.1% disagreed on this issue. Table 4. 2: Correlation IL Correlation Coefficient IL Sig. (2-tailed) N Pearson correlation Correlation Coefficient IP Sig. (2-tailed) N **. Correlation is significant at the 0.01 level (2-tailed). IL: Insurance Legislation IP: Insurers` Performance Further, there is a negative relationship between Weak legislation in the insurance sector and Insurance performance as indicated in Table 4.3 above with a correlation coefficient of -0.0264 at 0.01 significance level. This means that the two variables move in opposite direction and this implies that the weaker the legislation in the sector, the higher the chances that an insurer will perform poorly. These results are consistent with other studies that have shown a significant and negative correlation between Weak legislation in the insurance sector and optimal insurers performance (Thirima, 2010) 5. Conclusions and recommendations Nonlife insurance companies in Kenya engage in massive under pricing due to laxity of the insurance regulator as indicated that 87% of the respondents disagreed that IRA monitors rates charged by insurers while 13% of the respondents agreed with this statement. On the issue of conducting regular audits to ensure the issued underwriting guidelines are followed 93.4 % of the respondents disagreed with this statement while 6.6% agreed.
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IP . -.264** .007 104 1 . 104

1 . 104 . -.264** .007 104

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On the aspect of IRA penalizing insurance companies that deviate from regulators guidelines 82.5% of the respondents disagreed while 17.5% of the respondents disagreed. Effective and adequate legislation is also important for the insurers to boast their financial performance. Insurer`s performance and weak legislation also indicated a negative correlation with Pearson Correlation coefficient of -0.264 at 0.01 level of significance implying that weak legislation affects insurers performance negatively. To ensure that insurance legislation in Kenya is effectively administered IRA need to come up with drastic measures to cap the menace of under pricing. This include regular auditing of nonlife insurance companies to ensure adherence to the regulators guidelines in underwriting , imposing stiff penalties to companies that deviate from the guidelines and educating the insurers on the repercussions of charging unsustainable insurance premium on regular basis. Reference AKI(2007), Insurance Industry Annual Report , Nairobi Consumer Federation Of America November, 2005; Florida Statement Why is Regulation of Insurance Necessary.pdf; Task force on long term solutions for Frolida`s hurricane Insurance Market http://www.myfloridacfo.com/hurricaneinsurancetaskforce/TaskforceRS2/Appendix5/9 Insurance Regulatory Authority Kenya; Insurance industry report January December 2012 Page 1 Jackson Okoth 2013 . http://www.standardmedia.co.ke/?articleID=2000091975&story_title=nine-insurance-firms-swim-in-losses-on-b ack-of-under-cutting. Kerubo, ( 2011) Competition aspects in regulation of the insurance industry in Kenya, Published MBA Thesis, University of Nairobi . Kombo, D.K. & Tromp, D.L. (2006). Proposal writing and thesis proposal: An introduction. Paulines Publications, Africa: Nairobi Kumbai Pauline Mukiri (2011) ,X-efficiency of insurance companies in Kenya, Published MBA Thesis University of Nairobi . Maryanne, W Mung`ara, (2009) An Exploratory Study of capital Requirement for Kenyan Life insurance Companies, Published MBA Dissertation. Strathmore Business School Michael J Vine, Melbourne ; ( 2013); What May Cause Insurance Companies To Fail.pdf pg 8 .And How This Influences Our Criteria http://www.standardandpoors.com/spf/upload/Ratings_EMEA/2013-06-13 Mwaniki Wahome (2013) Under Pricing Main Threat to Insures Daily Nation Tuesday 20 August 2013page 8 smart company. http://property.n-soko.com/mortgage-insurance/insurers-turn-to-under-pricing-for-survival/ Namaemba,(2010).Underwriting challenges facing public service vehicles insurance in Kenya, University of Nairobi, Kenya. National insurance Commission of Ghana http://www.ibrokerghana.com/news-and-market-information/5-local/451-insurance-industry-under-threat-from-p remium-undercutting updated on 5th January 2012. Peter Munaita, the Eastafrican, 31 January 2006; http://allafrica.com/stories/200601310801.html PWC 2013Key issues facing the insurance sector in Kenya http://www.pwc.com/ke/en/industries/insurance-issues.jhtml Thirima, (2010) Strategic responses to challenges of insurance regulation in Kenya by the Insurance Regulatory Authority, A published MBA Thesis University of Nairobi.

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