The Effect of Asset- Liability Management on the profitability of long-term insurance businesses in Kenya

Abstract

Asset-Liability Management (ALM) is critical for the financial sustainability of long-term insurance companies, where the balance between profitability and fulfilling policyholder obligations must be meticulously managed. Despite the significance of the insurance sector to Kenya's economy, contributing approximately 2% to the GDP, the relationship between ALM and the profitability remains insufficiently studied compared to the banking sector. This study aims to fill this gap by investigating the impact of ALM on the profitability of 25 long-term insurance companies in Kenya over the period from 2013 to 2022. The research adopts a positivist approach, leveraging secondary panel data and employing a Three-Stage Least Squares (3SLS) regression model, complemented by Random Effects (RE) and Fixed Effects (FE) models for robustness checks. The findings of the study indicate that effective asset management, characterized by the efficient utilization of resources, significantly enhances profitability. This suggests that insurers who adeptly manage their assets can achieve superior financial outcomes. Furthermore, larger firms with greater market share are better positioned to capitalize on asset management efficiencies, due to economies of scale and more diversified investment portfolios, which enhance their profitability. Conversely, the study found that maintaining excessively high levels of solvency—while crucial for risk management—can negatively impact profitability. This implies that an overly conservative approach to solvency, which prioritizes high capital buffers, may inadvertently constrain profitability. Interestingly, the analysis showed that claims management did not have a significant direct impact on profitability, indicating that the mere handling of claims does not necessarily drive financial success. Additionally, the study identified that macroeconomic factors, specifically inflation and interest rates, also play a significant role in influencing profitability. Higher inflation rates were found to potentially boost nominal returns on investments, while higher interest rates contributed to increased returns on fixed-income investments. These factors can partially offset the negative effects of high solvency levels, highlighting the complex interplay between external economic conditions and internal financial management strategies. Given these findings, the study recommends that insurers focus on optimizing asset management strategies, such as diversifying investment portfolios and adopting innovative asset management technologies, to improve profitability. Additionally, larger firms should leverage their size to further enhance financial outcomes through better risk management practices. Regulators should consider setting optimal solvency benchmarks that balance the need for financial stability with the goal of maintaining healthy profitability, avoiding excessively stringent solvency requirements. Since claims management alone was not a significant determinant of profitability, insurers are encouraged to integrate comprehensive risk assessment frameworks to identify and address other factors that may influence profitability. Finally, the study suggests that insurers should monitor and respond to macroeconomic conditions, such as inflation and interest rates, to better align their investment strategies with prevailing economic trends.

Keywords: Asset-Liability Management, Asset Turnover Ratio, Loss Ratio, Solvency Ratio