Risk-Based Capital, Asset Allocation, Firm Size and Investment Returns of Insurance Companies in Kenya

Abstract

This paper’s main goal was to establish the joint effect of risk based capital, asset allocation and firm size on investment returns of insurance companies in Kenya. The population of the study comprised of 63 insurance companies licensed in Kenya that transact both life and general insurance. Secondary data was collected from the insurance companies’ annual returns submitted to the regulator for a five-year period (2014-2018). Risk-based capital was computed using the standard formulae as per the risk-based supervision model. Asset allocation was computed from investment vehicle and time horizon, firm size was measured using gross written premiums and total assets; and investment returns was calculated using the investment income ratio. Tests to ensure suitability for linear regression were undertaken. Linear regression was used to evaluate the relationship between the variables based on the hypothesis in the study and at a significance level of 5%. The study findings revealed that there is a positive significant relationship on the joint effect of risk based capital, asset allocation and firm size (total assets) on the investment returns of insurance companies in Kenya. It implies that all variables should be considered when looking at the risk based capital and investment returns of insurance companies. It has further revealed that the applicability of extreme value theory is not fully reliant on data obtained from extreme events, but rather insurance companies can use available data on capitalization and investments and still apply the concept to determine their survival in adverse operating environment or scenarios. The study also supports Markowitz portfolio selection theory in the sense that a Company is expected to allocate its assets in a manner that it receives maximum returns from the investment, but at the same time be cautious on the investment vehicles, since the capital charges imposed are pegged on how risky an investment vehicle is deemed. This will eventually influence the amount of risk based capital an insurer is expected to hold and determine its investment returns. It has further revealed that the association amongst risk based capital and investment returns is not purely direct, but it’s intervened by asset allocation