IMPACT OF MACROECONOMIC VARIABLES ON FINANCIAL

PERFORMANCE OF INSURANCE COMPANIES IN KENYA

SUSAN LENEWA WANJIKU

A RESEARCH PROJECT SUBMITTED TO THE DEPARTMENT OF ECONOMICS,

ACCOUNTING AND FINANCE IN THE SCHOOL OF BUSINESS, JOMO KENYATTA
UNIVERSITY OF AGRICULTURE AND TECHNOLOGY IN PARTIAL
FULFILLMENT FOR THE DEGREE OF BACHELORS OF SCIENCE IN ECONOMICS

@2021
 CHAPTER ONE

INTRODUCTION

1.1 Background of the study

Macroeconomics is the branch of economics that investigates the behavior of the entire

economy. Macroeconomics is concerned with a large population, total output of the economy,

price levels, government budget and expenditure, inflation rate, employment/unemployment, and

exchange rates, among other things. It is one of the external settings over which businesses have

little control, thus they must adapt to fit in (Oxelhein, 2013).

Haiss and Sümegi (2013) noted that insurance companies play a significant role in a country's

economic growth. Individuals and businesses are offered financial protection against unexpected

events that could cause them to lose a lot of money. Insurance also protects people against risks

and uncertainty. According to Charumathi (2012), insurance companies aid in the growth and

development of a country's economy. It offers financial services such as risk underwriting and

the mobilization of large sums of money. The insurance industry is critical both in industrialized

and developing economies. It helps with economic growth, allocation of resources, transaction

costs, the spread of financial losses, and the creation of liquidity Kihara, 2012).

A company's financial performance is the degree to which it meets its financial objectives over a

given time period. Financial performance, according to Chen and Wong (2014), measures a

company's earnings, profits, and value appreciation. Net premiums earned, annual turnover,

return on investment, return on equity, and profits earned from underwriting activities are all

used to assess an insurance company's performance. Factors influencing an insurance company's

revenue and expenditure include industry characteristics, macroeconomic factors, and firm

characteristics.
The factors that influence Jordanian insurance companies' financial success Leverage, liquidity,

and size all have a beneficial impact on financial performance in Jordanian insurance companies,

according to his results (Almajali 2012). Financial success of Romanian insurance businesses is

influenced by a number of factors. According to their research, size has a positive link with

financial performance. This is due to the fact that large companies have more complicated

information systems, greater expense control, risk diversification, and more resources. It was

also shown that the rise of written premiums and an insurance company's financial performance

have a negative link (Burca & Batrinca 2014).

Wabita (2013) conducted a study on the drivers of insurance companies' financial success in

Kenya. According to his findings, financial performance has a positive impact on an insurance

company's growth, financial performance has a negative impact on leverage, and an insurance

company's tangible assets have a positive impact on financial performance. Mutungi (2012)

examined the elements that determine the financial performance of Kenyan life insurance

businesses. It was discovered that an insurance company's financial performance is determined

by capital structure, innovation, and ownership structure.

In their study of the consequences of financial performance in insurance companies in Nairobi,

Omondi and Muturi (2013) discovered that leverage (ratio of debt-to-equity) and ROA had a

negative impact on financial performance, whereas liquidity and company size have a good

impact. Interest rate variations, liquidity, and competition all affect the financial performance of

Kenyan insurance businesses, according to Mwangi (2013). According to Gitau (2013), the

adoption of insurance products and services is low globally. This is due to the fact that only a

small percentage of people attempt to use insurance services. The use of life insurance premiums

has decreased globally.

Macroeconomic Variables

Macroeconomics, according to Akers (2011), is a discipline of economics concerned with the

overall performance, structure, behavior, and decision-making of an economy rather than

individual markets. This encompasses economies at the national, regional, and global levels.

Macroeconomics investigates aggregate measures such as Gross Domestic Product (GDP),

unemployment rates, and occasionally indices in order to gain a better understanding of how the

entire economy works. They create models to describe the relationships between variables

including national income, output, consumption, unemployment, inflation, savings, investment,

international commerce, and international finance, among others.

GDP is the most common macroeconomic indicator used to assess an economy's degree of

economic performance. The favorable impact of GDP growth backs up the thesis that growth and

financial sector performance are linked (Kosmidou, 2016). The money supply is made up of total

currency outside of banks and commercial bank deposit liabilities (CBK, 2012). If merely a

change in money growth changes stock market participants' views about future monetary policy,

the money supply will have a considerable impact on stock market return. If there is knowledge

on an excess of money supply in the economy, the appropriate authorities will tighten monetary

policy in the future (Sellin 2014).

A lender charges the borrower an interest rate based on the amount of money or asset lent/loaned

or deposited (Crowley, 2017). It is the price that connects current and future resource claims.

Inflation is defined as a prolonged increase in the general price level of goods and services on the

market, with the result that the purchasing power of a country's currency is reduced. It is

generated using annual percentage increases in the consumer price index (CPI). In general, high

inflation rates imply high loan interest rates and high earnings. According to Bashir (2013),
predicted inflation has a beneficial influence on profitability, whereas unexpected inflation has a

negative impact.

Financial Performance

Performance is a term that refers to how well an organization achieves its goals and fulfills its

commitments over a period of time. A firm's goal might be financial or non-financial, and it can

also be measured in terms of performance. Financial performance can be assessed using financial

ratios after examining accounting data or information. Financial ratios generated utilizing

accounting data from the company's balance sheet and other financial documents can be used to

properly construct the company's financial status (Hassan & Bashir 2013).

Profitability, which is a crucial component of performance, is linked to financial performance.

Profitability, according to Helfert (2015), is the efficiency with which management has used a

company's total assets and net assets from its balance sheet. The ROA is calculated by dividing

net income by average total assets. As a result, the metric reveals how management allocates its

real investment resources to achieve profits. It's also a crucial metric for determining a

company's efficiency and operational effectiveness based on the returns generated by its assets.

Return on equity (ROE) is the second profitability metric, which illustrates how a company's

management can convert shareholders' equity into net profit. Great returns on investment (ROI)

and return on equity (ROE) indicate high managerial efficiency, and vice versa. The return on

investment (ROI) will be used to evaluate the performance of insurance businesses in this study.

1.2 Problem Statement

Financial performance aids in determining an insurance sector's efficiency. It aids in determining

the value contribution to shareholders. One of the issues facing Kenya's insurance market is low
insurance penetration. Financial performance is a measure of an organization's earnings, profits,

and value appreciation as indicated by the increase in the share price (Chen & Wong, 2014). Net

premiums earned, profitability from underwriting activities, annual turnover, returns on

investment, and return on equity are all common measures of performance in the insurance

industry. Profit performance measures and investment performance measures are two types of

measures.

The earnings evaluated in monetary terms are included in the profit performance. Simply said,

it's the gap between income and expenses. These two parameters, revenue and expenditure, are

influenced by firm-specific characteristics, industry features, and macroeconomic variables.

There are two types of investment performance. One is the return on assets other than cash used

in the firm, and the other is the return on investment operations of the excess cash gained on

operations at various levels (Samitas & Papadogonas, 2015).

According to the factors of financial success in Kenyan general insurance businesses, there is a

negative association between return on assets, size, and foreign ownership. It was suggested that

general insurance strengthen their competitive edge in order to perform better and boost their

performance, as well as increase their capital (Mirie 2015), Economic growth, interest rates, and

inflation are examples of indicators that can be used to determine MFI financial performance,

according to Njunguna (2013). He came to the conclusion that macroeconomic variables had an

impact on deposit-taking MFI financial performance.

As a result, there was a void in the literature in terms of research on the relationship between

macroeconomic variables and insurance company financial performance in Kenya. As a result,

the purpose of this study was to address this research gap by answering the following question:
What is the link between macroeconomic variables and insurance company financial

performance in Kenya?

1.3 Objectives

1.3.1 General Objective

The main purpose of this study was to establish effects of macroeconomic variables on financial
performance of insurance companies in Kenya.

1.3.2 Specific Objectives

To determine the effect of inflation on financial performance of insurance companies in Kenya

To establish the effect of interest rate on financial performance of insurance companies in Kenya

To establish the effect exchange rate on financial performance of insurance companies in Kenya.

To establish the effect money supply on financial performance of insurance companies in Kenya.

1.4 Significance of the Study

The findings of the study will be useful in understanding how macroeconomic conditions affect

insurance companies in Kenya. The findings of the study will be of interest to the Kenyan

government, shareholders, insurance companies in Kenya, the Association of Kenya Insurers

(AKI), and the Insurance Regulatory Authority (IRA), as well as academics and scholars.

Scholars and academicians who seek to do further research and add to the body of knowledge on

the impact of macroeconomic variables in Kenya can profit from the study. It will broaden

understanding of the link between macroeconomic variables and the financial performance of

Kenya's insurance market. It also identifies areas where there is a gap in the literature and where

additional research projects are needed so that experts in the fields of finance and economics can

investigate them further. Insurance businesses will have a better understanding of the

macroeconomic factors that affect their financial performance, allowing them to design risk-

mitigation strategies.
The Kenyan government will study the mechanisms that drive economic growth, particularly in

the insurance industry, in order to devise a policy mix that would address issues such as

unemployment, inflation, interest rates, and exchange rate volatility. The study will benefit the

Association of Kenya Insurers (AKI) and the Insurance Regulatory Authority (IRA) by providing

data and information on how macroeconomic variables affect the insurance industry, as well as

better strategies for dealing with macroeconomic variables, improving efficiency and growth in

the industry

1.5 Scope of the study

The study focused on the effect of macroeconomic variables on insurance companies in Kenya

between 2013 and 2020. The time period under examination was the most recent, and it

encompassed the most significant policy developments in Kenya that affected interest rates. This

study will rely only on primary and secondary sources of information.