1.
Introduction1.1 Background of the StudyRisk is inherent in every business, but organizations that embed the right risk management strategies into business planning and performance management are more likely to achieve their strategic and operational objectives. The insurance sector is not excluded from this phase. Whether in Mauritius or international platform, insurance companies are immersed in a permanent updating cycle, which requires constant strategic changes to adapt to the unstable economic environment to the growing level of safety and transparency which are required by financial markets and potential clients.
In Mauritius, we have the Financial Services Commission (FSC) which act like a regulatory body and monitors the financial activities of insurance companies. The FSC is a state created agency to keep track on these institutions and to make sure they are all operating which the appropriate licenses and that we are not moving towards a ‘Ponzi Scheme’. Each year, the FSC publishes a communiqué to enhance the observance of the International Association of Insurance Supervisors, an extract of the most recent communiqué is found below:The Rules aim to enhance the observance of the International Association of Insurance Supervisors’ (‘IAIS’) core principle 16 (‘ICP 16’): ‘Enterprise Risk Management for Solvency Purposes’. In addition to observing compliance with ICP 16, the objectives of the Rules are to: (a) deliver a better managed insurance sector with a focus on risk by encouraging sounder risk management and risk assessment in the insurance sector.
As a consequence, insurers would be able to seek more economically aligned strategies and pricing on both their liability and asset sides of their balance sheets, making the insurance sector more efficient, and at the same time, more viable and financially sound; (b) empower the FSC to be better placed to oversee the risk assessment and supervision of the sector and have improved scope for intervention in a measured and credible way; (c) enhance the reputation and potential for Mauritius to develop its financial services sector in line with the Commission’s vision and the government’s objectives. Insurers are required to have in place a Risk Management Function (‘RMF’), pursuant to Rule 12 of the Rules, as from 01 January 2017. The RMF includes the appointment of a risk officer who shall be a person of sufficiently senior status, suitably qualified and experienced.During the past years we have witness a lot of insurance companies closing down, with some having their license cancelled due to ‘Ponzi-like Schemes’. The most common example is the British American Insurance group crash; which left thousand of policy holders in uncertainties about their investments. It is essential to prevent future case like these as they have a significant impact on the economic stability of the country, not only for the policy holders but also the people employed there.
The insurance companies’ ability to continue to cover risk in the economy hinges on their capacity to create profit or value for their shareholders. A well-developed and evolved insurance industry is a boon for economic development as it provides long- term funds for infrastructure development of every economy (Charumathi, 2012).There are numerous techniques to manage financial risks of insurance companies and in this paper we will have a look at some major ones.1.1.1 Relationship between Financial Risk Management and Financial PerformanceThe management of insurance companies should take sound risk management techniques when planning for the future so as not to deplete the assets of the company (Gold, 1999). He further argued that insurance companies could not survive with increased loss and expense ratios. Preventing losses by taking precautionary measures is a key driver of profitability and a key element in reducing risks (Jolly, 1997).
He further stated that insurance companies have a direct financial interest in reducing losses though preventing accidents and ensuring that if one occurs, its effects on human life and environment are minimized. Johnson (2001) asserts that when insurance companies accept a large risk that 7 would financially affect them, they also insure against a possibility of such large losses so as to spread the risk of loss and improve on their financial status. 1.1.2 Research ProblemAfter the recent 2007/2009 financial crisis, risk management has gained an important role for almost every financial institution.
Risk management is one of the most important practices to be used especially in insurance companies in order to get higher returns, (Gabriel, 2008). In today’s ever-changing financial environment, every single decision taken has its share of risk being involved. Managing financial risk involves setting appropriate risk environment, identifying and measuring the insurances risk exposure, mitigating risk exposure, monitoring risk and constructing controls for protecting the insurance companies from financial risk (Tcankova, 2002). During the past ten years, the local insurance industry has been hit with a number of crisis and ponzi schemes which made investors reluctant. The technological revolution resulted in changes in the operation of markets, increased access to information, changes in the types of services available to investors, and major changes in the production and distribution of financial services (Crouhy et al.
, 2001). Therefore financial regulators play an important role to maintain the image of the insurance industries and it is also believed that insurance industry act as a mirror for the financial stability of a country.Nowadays, people holds more than one type of policy and the annual revenues of insurance companies are large and also difficult to get the exact numbers from them. They are very reluctant to provide the final data which made the study a bit complex and only figures and facts available to the public were used for this study.
1.1.3 Problem StatementThis topic was chosen in order to investigate about the current financial health of our insurance companies and also to verify how much they take risk management into consideration. It is believed that the majority of insurance companies concentrate more on profitability and lesser on risk management. However, the government must make sure that the insurance companies are operating within the required norm. The question now rises whether regulations concerning risk management are enough to prevent problems from occurring as we saw in the last crisis.
1.1.4 Objective of the Study: • What is risk?• How can risk be managed?• The benefits of an adequate risk management.• What is financial performance?• How risk management can improve financial performance. Chapter twoLiterature Review2.1 Introduction This chapter reviews the literature of the relationship between financial risk management and financial performance of insurance companies in Mauritius. The literature review has been divided into two parts; first one gives focus on the theoretical framework of financial risk management and the determinants of financial performance of insurance companies. The second part, stress on empirical studies on the relationship between financial risk management and financial performance of insurance companies in Mauritius.
Finally, the summary of the whole chapter. What is Financial Risk Management?Financial risk management is the quality control of finance. It is a broad term used for different senses for different businesses or things but basically it involves identification, analyzing, and taking measures to reduce or eliminate the exposures to loss by an organization or individual. Various authors including Stulz (1984), Smith et al (1990) and Froot et al (1993) have offered reasons why managers should concern themselves with the active management of risks in their organizations. To put the financial risk in simpler terms, it can be defined as an umbrella term for multiple categories of risk associated with financial transactions. It can further be explained as the possibility where the investors lose money if they are investing in the company whose cash flows are inadequate to meet the matured obligations. The aim of financial risk management in insurance companies is to maximize expected profits by taking into account their available resources.
Besides the 2007/2009 financial crisis, insurance companies have to take into account the growing number of competitors in the local market. Along with that, a study concluded that potential clients are now reluctant to invest after the BAI episode. So now managers must also seek to provide a clean image of the company. However, besides Financial Risk, we have different types of risk in the insurance sector; they are Operational risk and Business Risk. Operational risk summarizes the risks a company undertakes when it attempts to operate within a given field or industry. Operational risk is the risk not inherent in financial, systematic or market-wide risk. It is the risk remaining after determining financing and systematic risk, and includes risks resulting from breakdowns in internal procedures, people and systems. Then Business Risk impairs a company’s ability to provide its investors and stakeholders with adequate returns.
The company is also exposed to financial risk, liquidity risk, systematic risk, exchange-rate risk and country-specific risk. This makes it increasingly important to minimize business risk. To calculate the risk, analysts use four simple ratios: contribution margin, operation leverage effect, financial leverage effect and total leverage effect.What is Financial Performance?Measuring the performance of insurance companies has gained the momentum from the last couple of years, because insurance sector is not only an avenue for money saving, but also serves as a vehicle to channel funds in an appropriate way from surplus economic sectors to deficit sectors so as to support the investment activities in the economy.
Technically, financial performance is defined as a subjective measure which determines how well the organizations use their available resources to generate more revenues. The financial performance measures the financial stability of the organization in monetary terms and thus, can be used to compare the performance of different corporations within any particular industry or between the industries. It is of great importance to note that no single measure of financial performance should be considered on its own. Rather, a thorough evaluation of a company’s performance should be taken into account many different measures of its performance. Companies must evaluate and monitor their profitability levels periodically so as to measure their financial performance through use of the profitability measures computed from the measures explained above.
The two most popular measures of profitability are Returns on Equity and Returns on Assets. ROE measures accounting earnings for a period per dollar of shareholders’ equity while ROA measures return of each dollar invested in assets.2.2 Theoretical reviewThe theoretical review is guided by the following theories; Stakeholders Theory, Contingency Theory, and Institutional Theory. These theories will help to elaborate on the relationship between financial risk management and financial performance on insurance companies in Mauritius.
2.2.1 Stakeholder TheoryIn this study, the concept of stakeholder theory has been acknowledged after the publishing of the book titled ‘Strategic Management: A Stakeholder Approach’ by Freeman (1984) although the first emergence of the term dates back to a study conducted by Stanford Research Institutes in 1963.
Edward Freeman is considered to be the founder of the stakeholder theory and he describes the term stakeholder as any group or individual who can affect or is affected by the achievements of the organization’s objectives.Stakeholder theory highlights the necessity to serve all the stakeholders regardless of the amount of their legal interests in an organization and deals with the relationships with the stakeholders both in terms of the process and the outcome (Gilbert and Rasche, 2008). This theory also suggests that the relationships with stakeholders can be managed effectively and claims that successful business management is based on the relationships and collaboration practices with stakeholders (Sarikaya, 2009). Stakeholder theory aims at increasing the efficiency of organizations by bringing new definitions to organizational responsibilities. In this respect, the theory suggests that the needs of shareholders cannot be met before the needs of stakeholders are met. Similarly, it claims that developing strategies by considering a broader stakeholder network and interaction will produce more successful results than focusing merely on direct profit maximization attempts (Jamali, 2008). Carroll and Buchholtz (2000) point out that the concept stakeholder has a basic role in understanding enterprise-society relationship. Moreover, this theory involves certain elements such as interests, demands and rights by giving a new dimension to the share concept.
Stakeholders might have legal rights on the enterprise as well as the rights in terms of ethic (Carroll and Buchholtz, 2000). To deal with the concept of sharing in such a wide perspective enables enterprises to understand the expectations of society and to meet these expectations more effectivelyStakeholder theory is an organizational management and ethic theory, which highlights values and morality as the basic characteristics of organizational management (Phillips et al., 2003). In other words, it is possible to consider stakeholders theory as a strategic management method based on ethical principles.
The attempts made by enterprises to meet the demands of their stakeholders are not only to avoid the possible pressures from the stakeholders but also to create a better society. The fact that enterprise-stakeholder relationships as well the relationships among stakeholders are getting more and more complex leads to the acknowledgement of stakeholder theory as a management model to a great extent (Russo and Perini, 2010).2.2.2 Contingency TheoryA contingency theory is an organizational theory that claims that there is no best way to organize a corporation, to lead a company, or to make decisions. Instead, the optimal course of action is contingent (dependent) upon the internal and external situation.
Contingency theory has sought to formulate extensive generalizations about the formal structures that are typically associated with or best fit the use of different technologies. The perception originated with the work of Joan Woodward (1958), who argued that technologies directly determine differences in such organizational attributes as span of control, centralization of authority, and the formalization of rules and procedures.It is fair to say that every big organization is equipped with the latest technologies, whether manufacturing or non-manufacturing. How best to organize the IT function is a long-standing question for researchers and practitioners alike (von Simson, 1990). For ERM projects, and for post-implementation support, this issue is critically important, especially with regard to the use of subject matter experts (Worrell et al., 2006). However, until recently (Zhu et al., 2010), research has primarily focused on implementation efforts rather than post-implementation.
Subject matter experts are invaluable contributors to the success of ERM installations, whose knowledge of business practices and system processes are critical to configuring enterprise systems (Volkoff et al., 2004). As a result, project managers often plan carefully and petition strongly to secure the best and the brightest employees from each of the functional business units that will be impacted by an implementation project (Gallagher and Gallagher, 2006). 2.2.3 Institutional TheoryInstitutional theory is a theory on the deeper and more flexible aspects of social structure. It considers the processes by which structures, including schemes; rules, norms, and routines, become conventional as authoritative strategy for social behavior.Burns and Scapens (2000) have observed that the social sciences have taken an escalating interest in institutional theory, and that the accounting literature reflects this interest in at least two ways: new institutional sociology; and old institutional economics.
According to Burns (2000), analytical studies of changes in management-accounting routines are founded on Old Institutional Economics – which is a heterogeneous body of theory.Fonseca and Machado da Silva (2002) have observed that, according to the institutional approach, individual behavior is modeled by principles that are originally created and shared in interactions, but which later become incorporated in the form of objective standards and rules about the most efficient way of functioning. From the perspective of Old Institutional Economics, the institution becomes the main object of analysis. According to this view, coherent and optimizing behavior no longer proceeds from individual decision-makers (as posited by neoclassical theory). Scapens (1994) emphasized the institutional approach and rejected the postulates of neoclassical theory as being appropriate to perceptive management-accounting practices.
It is therefore important to conceptualize the institution; however, no simple and widely accepted definition of an “institution” exists. Burns and Scapens (2000, p. 8) defined an institution on the basis of Barley and Tolbert’s (1997) work “presuppositions that are shared and taken for granted, which identify categories of individual agents and their appropriate activities and relations”. Scapens (1994) noted that, in the context of the Old Institutional Economics, the first definition of institution was established by Veblen in 1919 “a habit of thought common to the generality of men”. According to Burns (2000), the idea of an institution that has been most frequently applied in Old Institutional Economic was derived from Hamilton (1932), who considered an institution to be a way of thinking or acting by something that prevails and continues, which is inserted into the habits of a group or the customs of a people. This definition emphasizes the social and cultural character of an institution, and the importance of habitual behavior. Rowsell and Berry (1993) utilized certain concepts of Selznick (1957), who defined an institution as a natural product of social needs and pressures. The institution is a social structure that gives significance to the integrated aspirations of a group of people.
Selznick (1957) contrasted an institution with an administrative organization – describing the latter as a coherent instrument defined to carry out a task.The concept of “habits” and “institutions” are connected through the notion of “routine”. A “habit” is a predisposition or tendency to become implicated in previously adopted or acquired forms of action. However, the existence of habits does not exclude the possibility of intentional individual behavior; indeed, habits can be customized. In contrast to such habits, which are located in the personal sphere, “routines” involve a group of people (Oliver, 1997). Routines are formalized and institutionalized behaviors that are guided by rules. Such routines are reinforced by the process of repeating actions to comply with rules. Routines correspond to forms of thinking and acting that a group of individuals takes for granted.
Rules and routines provide an “organizational memory” and constitute the basis for the evolution of organizational behavior. According to Scapens (1994), they are the organizational equivalents of genes in the biological process and, in this sense; evolution is not the creation of optimal behavior, but simply the reproduction and potential adaptation of behaviors over time. Oliver (1997) has emphasized that, from the institutional perspective, companies administer within a social structure of standards, philosophy, and presuppositions about appropriate or adequate behavior. The institutional perspective thus suggests that motives for human behavior go further than economic optimization to involve justification and social obligation.In the present study, the concept of institutionalization is clearly important.
Oliver (1997) has noted that institutional activities tend to be long-lasting, socially acknowledged, resistant to change, and not directly reliant on rewards or monitoring of their permanence. In the framework of management accounting, Scapens (1994) has observed that, over time, management accounting can constitute a structure that reflects a particular organization’s way of thinking and acting – which is taken for established and detached from its specific historical circumstances. It consequently becomes an unquestioned approach of doing things.2.
3 Determinant of Financial PerformanceThe financial performance f insurance companies may be determined by various factors. These factors, as explained above could be further classified as internal, industry, and macroeconomic factors. However, as will be discussed in the coming consecutive sections of the review, in most literatures, profitability with regard to insurance companies usually expressed in as a function of internal determinants, (Hifza, 2011).
Wright (1992) conducted their study on determinants of life and health insurance companies. Hence, most of the researchers focused on internal factors affecting profitability and most of the factors considered are going to look at the firm age and corporate reputation, firm size, government policies, capital, liquidity, tangibility of assets and political stability. 2.31 Firm Age and Market Reputation It is logical that newly opened insurance companies are not going to have instant success.
Nowadays, people are more and more conscious while investing in insurance companies and the majority of them are most likely to invest their capital in established firms. Newly established insurance companies are not particularly profitable in their first years of operation, as they place greater emphasis on increasing their market share, rather than on improving profitability Athanasoglou et al., (2005). Similarly, Yuqi (2007) indicate that older banks expected to be more profitable due to their longer tradition and the fact that they could build up a good reputation. The corporate reputation also plays a fundamental role in the turnover of insurance companies. Corporate reputation can be viewed as a critical intangible resource, important to a firm’s performance and therefore long-term survival.
Given the intuitively appealing proposition that a good or superior corporate reputation has a positive influence on a firm’s financial performance, there has been much interest from researchers. During the data collection, we found that there is significantly positive association between age and corporate reputation of the company and profitability. The older the firm the more may be the profitability of the firm. This could be justified as experience and efficiency in the operation process may decrease cost of production and even that age is the strongest determinant of profitability. 2.3.
2 Firm SizeNumerous studies have been conducted to study the effect of size on firm profitability. However, the empirical evidences of the linkage between profitability and firm size are somewhat inconsistent. For example, evidence collected by Philip Hardwick and Mike Adams (1999) from UK companies suggests that there is an inverse relation between profitability and firm size. Jay (2007) found that there is a positive and significant relationship between the age of a company and its profitability as measured by Return on Assets. Similarly, the research conducted on the relationship among firm characteristics including size, age, location, business group, profitability and growth by Swiss Re (2008) indicated that larger firms are found to grow faster than smaller and younger firms found to grow faster than older firms.2.3.
3 Government PoliciesWe have various government policies that affects which affects the financial performance of Insurance companies directly or indirectly. But let’s focus on the major policies that impact the financial performance. Among the various government policies, the ones which affect the financial performance of insurance companies are the Taxation Policy and legislations to regulate their activities.
Taxation policy can affect businesses. High tax rate would discourage investors to invest more and to expand their trade. For example, a rise in corporation tax (on business profits) will definitely affect the net profit of the organization. Life insurance which has been favored by generous tax incentives and has also benefitted from the growth of pension business and housing finance represents around 61 percent of total premiums.
The rest is non life insurance which includes industrial and commercial risk being insured and motor insurance. They have all benefitted from the taxation policies and the constant expansion of insurance industries reflects this statement. On the other hand, the insurance sector is highly concentrated, with the three largest groups having 76 percent of total assets. Despite the high level of concentration, the insurance sector appears to be competitive, operating with high efficiency and reasonable profits. But the issue arises with state created insurance companies which usually takes form of public corporation.
In Mauritius we have the State Insurance Company of Mauritius (SICOM) and National Insurance Company (NIC); the latter was incorporated after the ‘crash’ of British American Insurance (BAI) so as to save the clients and also employment of the people. The best will be privatization in which industries are sold off to private shareholders to create a more competitive business environment. In order to make the insurance sector robust, we have the Financial Services Commission (FSC), which is responsible to regulate and supervise their activities. This was a must after recent saga of White Dot and Bramer Bank/BAI.
The current framework has many strong elements, including reliance on solvency monitoring, prudent asset diversification, international accounting standards, and actuarial methods. But there are some important gaps in corporate governance, internal controls and risk management. The state has tried to close these gaps by introducing the Insurance Act 2005 and amending it in 2015 by giving the government to hire a special administrator to investigate and regulate fishy activities. Section 110A. reflects on the Appointment of special administrator; subsection 1 is as follows; Notwithstanding section 48 of the Financial Services Act, where the Minister is satisfied, on the basis of a report submitted by the Commission, that the liabilities of an insurer and any of its related companies exceed its assets by at least one billion rupees and that such excess is likely to be a threat to the stability and soundness of the financial system of Mauritius, he may request the Commission to appoint a special administrator to the whole or part of the business activities of the insurer and any of its related companies. Moving towards subsection (2), on receipt of a request under subsection (1), the Commission shall appoint a person who possesses the qualifications of an Insolvency Practitioner under the Insolvency Act as a special administrator in relation to the whole or part of the business activities of the insurer and any of its related companies. Subsection (3) stresses that the appointment of any – (a) administrator, other than by Court, under section 215 of the Insolvency Act; (b) administrator under section 48 of the Financial Services Act; or (c) conservator under section 106, to the insurer and any of its related companies shall end on the appointment of a special administrator under subsection (2) to that insurer and any of its related companies. Then as per subsection (4), in the discharge of his functions under this Act, a special administrator appointed under subsection (2) shall have all the powers, duties and functions of an administrator under the Financial Services Act and Insolvency Act and of a conservator under this Act.
Finally subsection (5) talks on the appointment of a special administrator under subsection (2), any person whose appointment has ended under subsection (3) shall, not later than 3 days from the appointment of the special administrator, transfer to him all property, books, records, documents and effects of the insurer and any of its related companies. The subsection (6) makes sure that the person who contravenes subsection (5) shall commit an offence and shall, on conviction, be liable to a fine not exceeding 50,000 rupees and to imprisonment for a term not exceeding 12 months. With all these regulators, it is sure that our insurance sector is moving towards the right direction, when it comes to risk management to improve financial performance. Despite this, the Act has attracted certain criticism because the Special Administrator is most of the time a political nominee. The main question that people are asking is ‘will the special administrator work with total independence and good faith?’. This is the major area where we need to correct. 2.
3.4 Volume of CapitalIn most of the studies concerning insurance companies ‘volume of capital measures as the difference between total assets and total liabilities and in some cases it is measured by the ratio of equity capital to total asset’. Insurance companies’ equity capital can be seen in two ways. Narrowly, as stated by Uhomoibhi T. Aburime (2008), it can be seen as the amount contributed by the owners of an insurance (paid-up share capital) that gives them the right to enjoy all the future earnings. More comprehensively, it can be seen as the amount of owners’ funds available to support a business. The later definition includes reserves, and is also termed as total shareholders? funds.
No matter the definition adopted, volume of capital is widely used as one of the determinants of insurance companies? profitability since it indicates the financial strength of the firm. As it has been expected positive relationship between profitability and capital has been demonstrated by Athanasoglou et al. (2005). Evidence found in earlier studies show that insurance companies have suffered in different extends during the recent crisis. Some insurance companies had some setbacks and decreasing capital, while other companies had to be bailed out by the government to prevent default (example: American Insurance Group (Eling & Schmeiser, 2010); Laeven & Perotti, 2010)).Studies conducted in different countries found that for non-life insurance companies, size of capital is one of the important factors that affect Return on Assets; Malik (2011) examined the relationship between volume capital and return on asset for Pakistan insurance industry and found positive and statistically significant relationship between insurance capital and profitability. Similarly Al-Shami (2008), found in his investigation that there exists a positive and significant relationship between volume of capital and profitability of the UAE insurance companies.2.
3.5 LiquidityLiquidity from the context of insurance companies is the probability of an insurer to pay liabilities which include operating expenses and payments for losses/benefits under insurance policies, when due then shows us that more current assets are held and idle if the ratio becomes more which could be invested in profitable investments. For an insurer, cash flow (mainly premium and investment income) and liquidation of assets are the main sources of liquidity Renbao and Kie (2004). Several studies also have been conducted to measure the performance of the insurance companies. In contrast, Chen and Wong (2004) examined that, liquidity is the important determinants of financial health of insurance companies with a negative relationship. Similarly, Hakim and Neaime (2005) observed that liquidity, current capital and investment are the important determinants of banks profitability, which also applies to insurance. Flamini, McDonald, and Schumacher (2009) in their investigation regarding Sub-Saharan countries found significant and negative relationship between bank profitability and liquidity.
2.3.6 Tangibility of AssetsTangibility of assets in insurance companies in most studies is measured by the ratio of fixed assets to total assets. A recent study by Ahmed, (2011) investigates the impact of firm level characteristics on performance of the life insurance sector of Pakistan over the period of seven years. For this purpose, size, profitability, age, risk, growth and tangibility are selected as explanatory variables while Return on Assets is taken as dependent variable. The results of ordinary east squares regression analysis revealed that leverage, size and risk are most important determinant of performance of life insurance sector whereas Return on Assets has statistically more of insignificant relationship with, tangibility of assets. However, Malik (2011) found that there exists a positive and significant relationship between tangibility of assets and profitability of insurance companies and argued that the highest the level of fixed assets formation, the older and larger the insurance company is.
In contrast to this, Li (2007) in UK found no significant relationship between tangibility of assets and profitability of insurance companies.2.3.7 Political StabilityThe external environment is dynamic and ever changing. Organizations respond to the external environment and develop strategies that enable them to survive the ever changing environment that they operate in (Beck et al., 2010). One of the environmental factors that most enterprises have to deal with is the political environment. Companies have to respond to the environment strategically in order to be sustainable and avoid losses (Johnson et al.
, 2008; 2005). There is often a high degree of uncertainty when conducting business in a foreign country, and this risk is often referred to as political risk or sovereign risk. The political processes within a country generate laws and regulatory requirements. Companies doing business within that country must follow the laws and comply with the regulations or face legal penalties. Theoretically, the laws and regulations reflect the social values and governmental objectives of the host country. Unsurprisingly, these will vary widely among countries.A complex and dynamic modern environment is inevitably difficult to forecast and the inherent uncertainties can make it highly unpredictable and potentially chaotic (Porter, 1980). It is important for organizations to anticipate where the greatest threats and opportunities lie at any time in order to focus their attention and resources and initialize strategies to deal with them.
This will help us to prevent another Bramer Bank/BAI episode, these two institutions were operating simultaneously. A lot of things about this issue have been kept secret to the public. The whole population knows that the owner of Bramer Bank/BAI was close with the previous Prime Minister and after the latter’s mandate was over, the new government cancelled his banking license.
This created havoc among the population and many questioned the government lack of action to redress the situation. Bramer was still a profitable bank though not very profitable. It has however for some time been facing a liquidity deficit and also had non-performing loan issues.
It must be pointed out that a liquidity deficit situation is something quite normal at the level of individual banks and that can happen to any sound bank on any day. The cash deficit bank can then obtain overnight funds from the interbank market or from the central bank as a lender of last resort. BAI is a more complex case.
In so far as the insurance products are concerned, these have existed for quite some time and it is probably true that some agents might have tried to encourage people to rollover at time of maturity. But that does not constitute enough evidence to allow us conclude that there is existence of a Ponzi scheme. However, the possibility is there because sometimes we do have the combination of legitimate financial activities with Ponzi schemes. In such cases, the initiators would invest the money collected from savers and lend these or acquire financial instruments. However, right from inception they know that the return from the “underlying business” in which they are investing the money cannot be high enough to allow them meet their obligations. Is that the case with BAI? Not sure. So far we only know that BAI was operating with “a substantial proportion of its assets invested in its related companies” and that was in contravention with regulations made by FSC about exposure limits of 10% of the assets in any related company. That over exposure with related companies put BAI in a risky posture and the management was just happy with that until being pressed to improve.
But to make this issue more controversial, the report of the Commission Enquiry conducted by Singaporean consultants did not mention any Ponzi scheme, but ‘Ponzi like Scheme’. This has raised a lot of questions among the opposition members and also the public. In addition, it has affected our finance sector and made people more reluctant to invest in insurance schemes. 2.4 Empirical ReviewThe issue of risk and management accounting was also examined in manufacturing and not for profit organizations (Collier and Berry, 2002).
They conducted an exploratory case study to understand the relationship between risk and budgeting. The budgeting process is a formal method by which plans are established for future time periods, thereby implying a consideration of risk. However, there was a separation between budgeting and risk management. Despite managerial perceptions of risk, in which each organization faced several type of risk, there was no explicit regard to risk in the budgeting process or the content of the budget document. Budgeting did not appear to be a tool used in managing risk (Collier and Berry, 2002).Soin (2005) investigated the contribution of management accounting and control information on the practice of risk management in the UK financial services sector. Consistent with Williamson (2004), she argued that management accounting has a potential role in supporting risk management.
Soin (2005) examined whether current MASs support the changing patterns of demand for information about risk by corporate stakeholders. However, the study suggested that risk management systems in the financial services sector were not utilizing management accounting techniques and that there was no clear role for management accountants in risk management. The lack of stress on management accounting control systems in the financial services sector was cited as the reason for the findings. There was some emphasis on budgeting, cost control, and performance measurement, but not in relation to risks.Ali (2006), did a study on credit risk management: a survey of practices. The study sought to investigate the current practices of credit risk management by the largest US-based financial institutions. Owing to the increasing variety in the types of counterparties and the ever-expanding variety in the forms of obligations, credit risk management has jumped to the forefront of risk management activities carried out by firms in the financial services industry.
This study is designed to shed light on the current practices of these firms. A short questionnaire, containing seven questions, was mailed to each of the top 100 banking firms headquartered in the USA. It was found that identifying counterparty default risk is the single most-important purpose served by the credit risk models utilized. Close to half of the responding institutions utilize models that are also capable of dealing with counterparty migration risk. Surprisingly, only a minority of insurance companies currently utilize either a proprietary or a vendor-marketed model for the management of their credit risk. Interestingly, those that utilize their own in-house model also utilize a vendor-marketed model. Not surprisingly, such models are more widely used for the management of non-traded credit loan portfolios than they are for the management of traded bondsMikes (2006), on the other hand, examined both risk management and management accounting control as multiple control systems in an organization.
She conducted a case study to explore the changing context and internal dynamics of a multiple control system acting as the divisional control in a financial services organization. Based on a political and institutional perspective, the study showed how two control systems, namely, firm-wide risk management system and accounting controls, complemented each other (as the contingency theory suggests), as well as competed with each other for relevance and attention from top management. Accounting control has been found to possess institutional appropriateness compared to risk control (ERM) and was extensively used in decision making (Mikes, 2006). Collier et al. (2007) investigated the roles of management accountants in managing risk.
Similar to Williamson (2004) and Soin (2005), they viewed that management accountants – who have skills in analysis of information, systems, performance, and strategic management – should play a significant role in developing and implementing risk management. The survey results show that there was little integration between management accounting and risk management and that the involvement of management accountants in risk management was only marginal. However, results from post-survey interviews indicated that management accountants did actually play an important role in risk management, especially in analyzing the impact of risks to support risk managers. The finance director was identified as having a pivotal role in risk management (Collier et al., 2007), and, in most organizations, management accounting functions are normally under the responsibility of the finance director.
Woods (2009) conducted a case study on the risk management control system in a public sector organization. Contingent variables that affected the risk management system at the operational level were central government policies, information and communication technology, and organizational size. The most important contingent variable was central government policies as many of the strategic objectives were driven by government policy and resources were also determined by the central government (Woods, 2009). This is similar to financial institutions where government regulation drives the risk management system.2.5 Summary of Literature ReviewThis chapter has reviewed the existing literature on the relationship between financial risk management and financial performance. In addition, most of the literature review in this study has been conducted in the developed countries; Collier et al.
(2004) found that there was very little integration between risk management and management accounting. The study found that the systems and controls that were in place in the UK financial services sector were very closely matched to the requirements set out by the regulator (Soin, 2005). This study sought to bridge the existing research gap between the developed countries and developing countries like Mauritius.Chapter 3Insurance sector in Mauritius.Since gaining our independence back in 1968, our economy has mainly depended on the tourism, textile and agricultural sector. However, due to the increasing number of competitors worldwide, it became more difficult to depend on those three only. Then we had the rise of the insurance sector and more recently the offshore sector. The GDP of the insurance sector has been on constant rise since 1990 till 2010.
The table below shows an extract of the contribution of insurance companies. Our insurance sector is a direct source of employment for a majority of people and it is imperative that more studies are done so as to improve the financial performance of the insurance sectorChapter FourResearch Methodology4.1 IntroductionIn this chapter, we shall focus on the collection of data, the research design that was adopted, the study population, the sampling, and the methods of collecting data, the research procedures, and method of analyzing and presenting data.4.2 Research DesignBurns and Grove (2003) define a research design as a blueprint for conducting a study with maximum control over factors that may interfere with the validity of the findings.
Dooley (2007) notes that a research design is the structure of the research, it is the ”glue” that holds all the elements in a research project together. The explanatory research design was employed in this study in order to identify the extent and nature of cause-and-effect relationships. Explanatory research suggests causal linkages between variables by observing existing phenomena and then searching back through available data in order to try to identify plausible causal relationships.
This study is concerned with determining the cause and effect relationship and to understand which variable is dependant and which one is independent. Thus after some reflection; this research design was most suitable to explain if two variables are related or if they differ. This was reflected by the use of enough information and data for testing the cause and relationship. The aim of this research was to help in showing the relationship between financial risk management and financial performance of insurance companies in Mauritius.
4.3 Target PopulationThe target population for this study was top five insurance companies in Mauritius. The companies are as follow: LAMCO, State Insurance Company of Mauritius, Sun Insurance, SWAN Insurance and Mauritius Union. Different levels of the organization were questioned and their views were taken into consideration for the analysis and recommendations. 4.
4 Data CollectionPrimary data will be collected during this study. Barker (2013) states that primary data is important for all areas of research because it is unvarnished information about the results of an experiment or observation. It is like the eyewitness testimony at a trial.
No one has tarnished it or spun it by adding their own opinion or bias so it can form the basis of objective conclusions. Questionnaire is the most evident method of data collection, which is comprised of a set of questions related to the research problem which was on financial performance. This method is very convenient in case the data are to be collected from the diverse population. In this study, one hundred questionnaires were distributed; with 20 at each of the five listed companies above. 4.5 Data AnalysisThe collected secondary data was analyzed using Statistical Package for Social Science (SPSS) version 20. A Chi Square Test, regression analysis, correlation analysis and frequencies were used to analyze the data. The findings from the analysis were organized, summarized and presented using tables, and used to answer the study question.
.Chapter fiveData Analysis, Results and Discussion.5.1 IntroductionThis chapter presents the data obtained from the research in chapter four. These data will be used to show the relationship between financial risk management and financial performance.
The chapter is divided into three parts. In the first one we shall look at the descriptive statistical result, the second one was a Chi square test. 5.2 Descriptive Statistical AnalysisTable A. Methods to manage risk. Frequency Percent Valid Percent Cumulative Percent Valid A 43 43.0 43.0 43.
0 B 20 20.0 20.0 64.
0 C 12 12.0 12.0 76.0 D 14 14.0 14.0 90.0 E 10 10.
0 10.0 100.0 Total 100 100.0 100.0 Key: A – Avoid, B – Accept, C – Exploit, D – Mitigate, E – Transfer.Table A, shows the result obtained when asked about which method to prefer while managing risk. The majority of them chose option A which was to avoid the risk. This is a good strategy for when a risk has a potentially large impact on your project.
The sales and administrative department were among the majority who chose this option. While questioning them further, they suggested that January is when the company Finance team is busy doing the corporate accounts, putting them all through a training course in January to learn a new process isn’t going to be a great idea. There’s a risk that the accounts wouldn’t get done.
It’s more likely, though, that there’s a big risk to their ability to use the new process, since they will all be too busy in January to attend the training or to take it in even if they do go along to the workshops. Instead, it would be better to avoid January for training completely. Change the project plan and schedule the training for February when the bulk of the accounting work is over.To transfer the risk is not the best strategy and the response reflects this suggestion. Concerning accepting the risk, most of the believed that it can only be considered for small projects where a failure will not have a huge impact on the organization.
Then we had to exploit the risk whereby some believed it should be used more often and lastly to mitigate it which means is that you limit the impact of a risk, so that if it does occur, the problem it creates is smaller and easier to fix. People working in the management and risk department said that they would rather go by mitigating the risk.Table B. Level of risk in the organization.
Frequency Percent Valid Percent Cumulative Percent LOW 28 28.0 28.0 28.0 HIGH 38 38.0 38.
0 66.0 VERY HIGH 34 34.0 34.0 100.0 Total 100 100.0 100.0 Moving forward, the employees were asked to rate to rate the level of risk in their respective organization.
The surprising part was that 38% rated it as high and 34% as very high. When asked about this answer they suggested that our current legislation is not enough to prevent r manage risk. Though compared with our off shore sector, the insurance sector seems to be less affected by the legislation. Table C below shows the result. Table C: Current legislation enough to prevent risk? Frequency Percent Valid Percent Cumulative PercentValid 1 36 36.
0 36.0 36.0 2 36 36.0 36.
0 72.0 3 19 19.0 19.0 91.
0 4 9 9.0 9.0 100.0 Total 100 100.0 100.0 Table D: In accordance to FSC regulations. Frequency Percent Valid Percent Cumulative PercentValid AGREE 24 24.
0 24.0 24.0 STRONGLY AGREE 12 12.0 12.0 36.0 NEUTRAL 24 24.
0 24.0 60.0 DISAGREE 26 26.0 26.0 86.0 STRONGLY DISAGREE 14 14.
0 14.0 100.0 Total 100 100.0 100.0 The employees were also questioned if whether their respective companies are operating in accordance to the FSC regulations. Here the results obtained were quite balanced with 24% agreeing to this and 12% were strongly in favor to a yes. However 24% were neutral in this case and 26% disagreed, with 14 percent strongly against this statement. Table D shows the obtained frequency and percentage.
Table E: Independence To Financial Institutions Frequency Percent Valid Percent Cumulative PercentValid AGREE 16 16.0 16.0 16.0 STRONGLY AGREE 11 11.0 11.0 27.0 NEUTRAL 20 20.0 20.
0 47.0 DISAGREE 35 35.0 35.0 82.0 STRONGLY DISAGREE 18 18.0 18.0 100.
0 Total 100 100.0 100.0 But then they believed that the government is tampering to much with the job of our financial institutions. 35% disagreed and 18% strongly disagreed that the financial institutions are operating with total independence. They also expressed their views further about this issue as most of the do not believe that the BAI/Bramer case was a Ponzi scheme. 38% disagree and 19% strongly disagreed that it was a Ponzi scheme. Their opinion was that it was an investigation carried out by ministers rather than our financial institutions. Refer to Table F below to find the detailed result.
With this, they suggested that the government is not helping enough to prevent risk by tampering with the task of our financial institutions. Table F: Do you think BAI/BRAMER case was a PONZI scheme? Frequency Percent Valid Percent Cumulative PercentValid AGREE 14 14.0 14.0 14.0 STRONGLY AGREE 10 10.0 10.
0 24.0 NEUTRAL 19 19.0 19.
0 43.0 DISAGREE 38 38.0 38.
0 81.0 STRONGLY DISAGREE 19 19.0 19.0 100.0 Total 100 100.0 100.0 In the chapter 2, we discussed about the importance of firm age and size.
During the research, this part was also investigated and the result obtained reflects the statement. An astonishing of 77% believed that potential clients do take firm age and size into consideration before investing their money. 42 % strongly agreed and 35% agreed to it. The rest of 8% who disagreed and 3% who strongly disagreed, believed that if the organization comes up with a proper business plan, the factor of age and size shall not influence the potential clients.
Table G and Figure 5 shows the data obtained. Table G: Firm age before investing. Frequency Percent Valid Percent Cumulative PercentValid 1.AGREE 35 35.0 35.
0 35.0 2.STRONGLY AGREE 42 42.0 42.0 77.0 3.NEUTRAL 12 12.
0 12.0 89.0 4.DISAGREE 8 8.0 8.0 97.0 5.STRONGLY DISAGREE 3 3.
0 3.0 100.0 Total 100 100.0 100.0 Figure 5.5.
4 Chi Square TestCase Processing Summary Cases Valid Missing Total N Percent N Percent N PercentPosition * Do you have knowledge of risk management? 100 100.0% 0 0.0% 100 100.0%Chapter SixSUMMARY, CONCLUSION AND RECOMMENDATIONS.6.
1 IntroductionFrom the analysis and data collected, the following discussions, conclusion and recommendations were made. The responses were based on the objectives of the study. The main focus was to establish the relationship between financial risk management and financial performance of insurance companies in Mauritius. 6.
2 SummaryThe objective of the study was to establish the relationship between financial risk management and financial performance of insurance companies in Mauritius. Primary Data was collected from five insurance companies’ descriptive statistical test and Chi square test were carried out. From the findings, it was concluded that firm size and age have a direct impact on the financial performance of insurance companies. 77% of the respondents claimed that most of the clients take firm age and size into consideration before investing. When asked about their preferred method to manage risk, 43% suggested that avoidance is the best solution. But they also believed that the level of risk in the organization is quite high with 38% rated it as high and 34% as very high.
Furthermore they stated that they stated that the current legislation in place is not enough to protect them from risk and also the financial institutions are not operating with total independence. To prove this point, they went to on to suggest that the BAI/Bramer case was not a Ponzi scheme and that the crash of the company was inevitable after the government started to initiate actions in the place of our financial institutions. From the Chi Square Test, it was found that most of the employees working in administrative, debt collection and sales department did not have the knowledge of financial risk management. This is quite alarming and 51% of the respondents were unaware of the FSC communiqué that is released which talks about insurance companies and risk management. 6.3 ConclusionThe study concludes that firm size and age has a positive influence on the financial performance of insurance companies in Mauritius. From the finding of the study, we found that only people working in the management and risk department have the knowledge of risk management.
Furthermore, the majority of the employees believes that there too much of government interference in the investigation process of our financial investigations and our current legislation is not enough to prevent financial risk.The study also found that the level of risk in the organizations is quite high, thus concludes that government policies have a direct impact on the financial performance of insurance companies. 6.4 Policy RecommendationsFrom the finding the study recommends that there is need for insurance companies in Mauritius to manage the financial risk as it was found that financial risk negatively affects their financial performance.The study also recommends that there is need for insurance companies in Mauritius to increase their size through increase in their assets base as it was found that an increase in size would lead to increase in their financial performance.There is also the need to have an independent financial institution and amended legislations in order to improve the financial performance of insurance companies. Every insurance company must have a Risk Committee whereby they will investigate the risk level and look for solutions to improve the financial performance.
The Risk Committee can be set up by the FSC, where their qualified officers visit the insurance companies and investigate on the level of risk and provide their valuable feedback. But moving forward, the financial institutions need to work independently and to make this possible, it will be better that the FSC reports to the DPP instead of the Minister of Good Governance. Another recommendation is to provide courses to all level of employees on risk management. The government can provide his help here by organizing events to talk about risk management. Or else the insurance companies can invest further in their employees by providing their most qualified employees scholarship to study risk management. In this way, the employees will be more motivated and consequently the financial performance of the company will improve. 6.
5 Limitations of the StudyThe study was limited to precision of data as primary data was collected and the majority of the employees did not have the knowledge of risk management. So their views might be biased. The insurance companies were not willing to provide the secondary data which are the company’s financial reports. The time lapse of the study was for 6 months which is quite limited. A period of five years would have been more appropriate. 6.6 Areas for Further ResearchThe study sought to establish the relationship between financial risk and financial performance of insurance companies in Mauritius, the study also recommends a further study to be done on the relationship between financial risk management and financial performance of insurance companies in Mauritius. This can be done by the government and by the setting up of a Fact Finding Committee to do further research. The study should be done on the determinants of financial performance of insurance companies in Mauritius. Table H: Position * Do you have knowledge of risk management? Cross tabulation Do you have knowledge of risk management? Total Yes No Position Management Count 11 0 11 Expected Count 5.4 5.6 11.0 Risk and Audit Count 25 0 25 Expected Count 12.3 12.8 25.0 Administrative Count 8 25 33 Expected Count 16.2 16.8 33.0 Debt collection Count 3 11 14 Expected Count 6.9 7.1 14.0 Sales Count 2 15 17 Expected Count 8.3 8.7 17.0Total Count 49 51 100 Expected Count 49.0 51.0 100.0Chi-Square Tests Value df Asymp. Sig. (2-sided)Pearson Chi-Square 59.254a 4 .000Likelihood Ratio 75.171 4 .000Linear-by-Linear Association 43.015 1 .000N of Valid Cases 100 a. 0 cells (0.0%) have expected count less than 5. The minimum expected count is 5.39.A Pearson Chi Square test was carried out to find out the relationship between the position and knowledge of financial risk management. Ultimately it was found that most of the people working in the administrative, debt collection and sales department did not have the knowledge of risk management. The frequencies that do not have knowledge of financial risk management are as follow; in the administrative level it was 75.6%, in debt collection 78.5% and in sales department it was the highest with 88.2%. These three departments did not even come close to the expected count. Table I: Do you have knowledge of FSC communiqué? Frequency Percent Valid Percent Cumulative PercentValid Yes 49 49.0 49.0 49.0 No 51 51.0 51.0 100.0 Total 100 100.0 100.0 A further study conducted on whether they are aware about the communiqué of FSC on insurance companies; 51% are not aware of this. Chapter SixSUMMARY, CONCLUSION AND RECOMMENDATIONS.6.1 IntroductionFrom the analysis and data collected, the following discussions, conclusion and recommendations were made. The responses were based on the objectives of the study. The main focus was to establish the relationship between financial risk management and financial performance of insurance companies in Mauritius. 6.2 SummaryThe objective of the study was to establish the relationship between financial risk management and financial performance of insurance companies in Mauritius. Primary Data was collected from five insurance companies’ descriptive statistical test and Chi square test were carried out. From the findings, it was concluded that firm size and age have a direct impact on the financial performance of insurance companies. 77% of the respondents claimed that most of the clients take firm age and size into consideration before investing. When asked about their preferred method to manage risk, 43% suggested that avoidance is the best solution. But they also believed that the level of risk in the organization is quite high with 38% rated it as high and 34% as very high. Furthermore they stated that they stated that the current legislation in place is not enough to protect them from risk and also the financial institutions are not operating with total independence. To prove this point, they went to on to suggest that the BAI/Bramer case was not a Ponzi scheme and that the crash of the company was inevitable after the government started to initiate actions in the place of our financial institutions. From the Chi Square Test, it was found that most of the employees working in administrative, debt collection and sales department did not have the knowledge of financial risk management. This is quite alarming and 51% of the respondents were unaware of the FSC communiqué that is released which talks about insurance companies and risk management. 6.3 ConclusionThe study concludes that firm size and age has a positive influence on the financial performance of insurance companies in Mauritius. From the finding of the study, we found that only people working in the management and risk department have the knowledge of risk management. Furthermore, the majority of the employees believes that there too much of government interference in the investigation process of our financial investigations and our current legislation is not enough to prevent financial risk.The study also found that the level of risk in the organizations is quite high, thus concludes that government policies have a direct impact on the financial performance of insurance companies. 6.4 Policy RecommendationsFrom the finding the study recommends that there is need for insurance companies in Mauritius to manage the financial risk as it was found that financial risk negatively affects their financial performance.The study also recommends that there is need for insurance companies in Mauritius to increase their size through increase in their assets base as it was found that an increase in size would lead to increase in their financial performance.There is also the need to have an independent financial institution and amended legislations in order to improve the financial performance of insurance companies. Every insurance company must have a Risk Committee whereby they will investigate the risk level and look for solutions to improve the financial performance. The Risk Committee can be set up by the FSC, where their qualified officers visit the insurance companies and investigate on the level of risk and provide their valuable feedback. But moving forward, the financial institutions need to work independently and to make this possible, it will be better that the FSC reports to the DPP instead of the Minister of Good Governance. Another recommendation is to provide courses to all level of employees on risk management. The government can provide his help here by organizing events to talk about risk management. Or else the insurance companies can invest further in their employees by providing their most qualified employees scholarship to study risk management. In this way, the employees will be more motivated and consequently the financial performance of the company will improve. 6.5 Limitations of the StudyThe study was limited to precision of data as primary data was collected and the majority of the employees did not have the knowledge of risk management. So their views might be biased. The insurance companies were not willing to provide the secondary data which are the company’s financial reports. The time lapse of the study was for 6 months which is quite limited. A period of five years would have been more appropriate. 6.6 Areas for Further ResearchThe study sought to establish the relationship between financial risk and financial performance of insurance companies in Mauritius, the study also recommends a further study to be done on the relationship between financial risk management and financial performance of insurance companies in Mauritius. This can be done by the government and by the setting up of a Fact Finding Committee to do further research. The study should be done on the determinants of financial performance of insurance companies in Mauritius.
