In a modern economy, the impor... free essay sample

In a modern economy, the importance of financial institutions such as Banks, Insurance, saving and credit unions, Cooperatives and the likes is certain. These institutions play a great role in facilitating and lubricating the economy of nations. According to Saunders and M.M Cornett (2004)the financial institutions perform essential function of channeling funds from those with surplus funds (supplier of funds) to those with shortage of funds (user of funds). Frederic Eakins (2009) also stated that the financial institutions not only affect our everyday life but also involve huge flows of funds, which in turn affect business profits, the production of goods and services, and even the economic well-being of countries.The financial institutions enable an economy to be more productive as it allows investors with few resources to use savings from those with few prospects of investing. Research had been conducted by Naved (2011); reveals that the efficiency of financial intermediation and transfer of risk can affect economic growth while at the same time institutional insolvencies can result in systemic crises which have unfavorable consequences for the economy as a whole. Among those financial institutions insurance companies are the one that play significant role in the service-based economy and its services are now being integrated into wider financial industry. Insurance companies (both private and public) consisting the organizations which provides life, fire, accident, causality and many other forms of insurance. The main objective of all insurance companies is maximizing their profit because one goal of financial management is to maximize the owner`s wealth and profitability is very important determinants of performance, in the work of (Ngoyen, 2006 as cited by Hailu,2007).Though it will be affected with firm-specific factors and external factors too play crucial role in influencing insurance companies` profitability.Insurance is a financial arrangement for redistributing the costs of unexpected losses where the insurer agrees to compensate the insured for its losses. The primary function of insurance is the payment by insurers of claims for losses incurred by those insured.The insurance sector in any country can have a great impact on economic growth and development (Brainard,2008; Ward Zurbruegg,2000). Previous studies on the determinants of profits were concentrated mainly in the banking sector (Bourke, 1989; Short, 1979; Molyneux and Thornton (1992),Demirguc-Kunt a nd Huizinga (2000), Goddard et al. (2004) as cited in Athanasoglou et al. ). Only a small number of previous studies are based on the determinants of profit in the insurance sector. These factors can be classified as internal factors of industry and of the macroeconomics (Ayele, 2012).The insurance sector plays an important role for the financial and economic development of both developed and developing countries. The increasing growth of insurance markets constituting a large part of overall financial sector might significantly affect stability of the financial system. Insurance companies provide financial services and together with pension funds belong to the major investors into financial markets and their influence is likely to increase because of the worldwide integration, ageing population and growing income imbalances. Market activity of insurance companies includes providing the risk transfer and financial intermediation (Peter Haiss and KjellSu ¨megi as cited by Lenka C (2015). Mirie M (2015) Insurance companies provide unique financial services to the growth and development of every economy. Such specialized financial services range from the underwriting of risks inherent in economic entities and the mobilization of large amount of funds through premiums for long term investments. The risk absorption role of insurers promotes financial stability in the financial markets and provides a sense of peace to economic entities. The insurance companies ability 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 development.Insurance is a form of risk management, used to hedge against the risk of a contingent loss. It involves the transfer of the risk of potential loss from one entity to another, in exchange for a risk premium. Insurance companies play a large role in the service-based economy. The financial guarantee services that insurance companies provide are now being integrated into the wider financial industry. Non-life insurance companies (both private and public) provide fire, marine, accident, causality and many other forms of insurance. wondewosen (2016). Performance is the ability of an organization to gain and manage its resources in several different ways to develop competitive advantage (Iswatia and Anshoria, 2007). High performance reflects management effectiveness and efficiency in making the use of a companys resources and this contributes to the economy at large (Batra, 1999). Generally, the performance of insurance companies can be estimated by measuring their profitability, which is a relative measure of success for a business and it acts as a proxy of financial performance. One of the objectives when managing insurance companies is to attain profit (Chen and Wong, 2004).The best performance of any industry in general and any firm in particular plays the role of increasing the market value of that specific firm coupled with the role of leading towards the growth of the whole industry which ultimately leads to the overall success of the economy. Measuring the performance of financial institutions has gained the relevance in the corporate finance literature because as intermediaries, these companies in the sector are not only providing the mechanism of saving money and transferring risk, but also helps to channel funds in an appropriate way from surplus economic units to deficit economic units so as to support the investment activities in the economy (Hifaz, M. 2011). Hamdan 2008) stated that return on assets (ROA), return on equity (ROE) and return on invested capital (ROIC) are used for the measurement of insurance companies profitabil ity. Accordingly, ROA is the measure of financial performance of the company using its total assets. This is an indication of how effective management is in using the total assets to generate earnings whereas ROE measures a companys profitability which tells how much a company generates earnings with the money shareholders have invested. ROIC is a measure used to measure a companys effectiveness in sharing the capital under its control in profitable business. This shows how well a company is in using its capital to generate returns. Comparing a companys ROIC with its weighted average cost of capital (WACC) indicates whether spent capital is used efficiently or not.William H. Greene and Dam Segal (2004) argued that the performance of insurance companies in financial terms is normally expressed in net premium earned, profitability from underwriting activities, annual turnover, return on investment, return on equity. These measures could be classified as profit performance measures and investment performance measures.According toHifza M. (2011) profitability is one of the most important objectives of financial management since one goal of financial management is to maximize the owners? wealth, and, profitability is very important determinant of performance. Therefore, insurance companies have importance both for businesses and individuals as they channel funds and indemnify the losses of other sectors in the economy and put them in the same positions as they were before the occurrence of the loss respectively. In addition, insurance companies provide economic and social benefits in the society by prevention of losses, reduction in anxious, fear and increasing employment. The term profit can take either its economic meaning or accounting concept which shows the excess of income over expenditure viewed during a specified period of time. On one hand, profit is one of the main reasons for the continued existence of every business organization. On the other hand, profit is expected so as to meet the required return by ow ners and other outsiders.In the other words the ability to earn profit that isprofitability; it is composed of two words profit and ability. The word profit represents the absolute figure of profit but an absolute figure alone does not give an exact ideas of the adequacy or otherwise of increase or change in performance as shown in the financial statement of the enterprise.The word ability reflects the power of an enterprise to earn profits, it is called earning performance (HaissandSumegi, 2008).There has been a growing number of studies recently that test for measures and determinants of firm profitability. Furthermore, some of these factors that affect insurance profitability could be below the control of the insurance management (internal factors) whereas others might be away of its control (external factors). Understanding the internal and external factors that can have an impact on the profitability of insurance is very essential not only for the insurance managers and supervisors but also for policy makers and regulators in financial institutions. Therefore, the purpose of this paper is to clearly identify the key determinants of profitability of insurance companies in the country.1. 2. Statement of the ProblemThe best performance of any industry in general and any firm in particular plays the role of increasing the market value of that specific firm coupled with the role of leading towards the growth of the whole industry which ultimately leads to the overall success of the economy. Measuring the performance of financial institutions has gained the relevance in the corporate finance literature because as intermediaries, these companies in the sector are not only providing the mechanism of saving money and transferring risk but also helps to channel funds in an appropriate way from surplus economic units to deficit economic units so as to support the investment activities in the economy (Hifaz,M2011). Profitability is one of the most important objectives of financial management because one goal of financial management is to maximize the owners wealth and profitability is a very important determinant of performance (HifzaM 2011). This is because the world is chara cterized by risks and uncertainties and insurance has evolved as a way of providing security against the risks and uncertainties.Emineoner(2015).Conducted a research on the effect of firms specific factors on profitability of non life insurance companies in Turkey. To carry out this study the data24 non life insurance companies from the period 2006-2013were taken and used in simple and multiple liner regression models.Muturi W(2011) factors affecting profitability of insurance firm in Kenya and also used in multiple regression model and censes sampling technique.DorinaK(2016) factors affecting profitability of insurance companies in Alabnia it uses both simple random sampling and purposive sampling technique used and data collected based on secondary sources of annual report from insurance companies2008-2013 using quantitative method.There were researches which have been done in Ethiopian related to factors affecting profitability of insurance companies. The study conducted by Abate G. (2012) the Factorsaffectingprofitabilityofinsurance companies in Ethiopia. In order to carry out this study secondary source of data were used in profitability of insurance companies in Ethiopia were taken from 2003-2011 G. C. The secondary data were collected from NBE and analysis by using E views 7Software and the variables are volume of capital,age, size, leverage, liquidity, tangibility of asset are included.MeazaM.(2014).Determinants of insurance companies in Ethiopia. Secondary data obtained from the financial statements (Balance sheet and Profit/Loss account) of insurance companies, and financial publications of MOFED are analyzed.,HailuZeleke (2007), in his investigation identified that determinant insurance companies profitability thatthe first significant event that the Ethiopian insurance market observation was the issuance of proclamation No. 281/1970 and this proclamation was issued to provide for the control regulation of insurance business in Ethiopia. Consequently, it created an insurance council and an insurance controllers office, its strange impact in the sector. The controller of insurance licensed 15 domestic insurance companies, 36 agents, 7 brokers, 3 actuaries ; 11 assessors in accordance with the provisions of the proclamation immediately in the year after the issuance of the law. Specifically, it investigates the internal or firm specific variables (size of insurance companies, leverage ratio, liquidity ratio, and loss ratio) and external or macro variables (market share and growth rate of GDP). The researchers most of them were conducted on the banking sectors in this regard that is determinants of profitability. However, few studies were conducted on the insurance sector in Ethiopia, as per the researchersknowledge; there were some studies which examined determinants of profitability of insurance compani esand, most of the studies focused only on firm specific factors that indicating factors affect the financial performance of insurance companies has not been adequately investigated. The main objective this studys was to identify and to what extent that the factors affecting profitability of insurance companies operating in Ethiopia. a comprehensive research on profitability determinants using both company specific factors and macroeconomic variables were not conducted in the Ethiopian insurance industry i.e. equity capital, cost to income ratioand also, insurance is a risky business and basic risk factors for insurance such as, technicalprovision, and solvency ratio have not used in previous studies but, these variables were the most important factors that affectthe profitability of the insurers. Therefore, this study seeks to fill the above explained gap by providing information about the internal and external factors that affects profitability by examining the untouched one, and replicating the existing in the Ethiopia by using all insurance company operating in the country that have 11 years data and also This study also differs regarding time coverage for data collection. To this end, the study provided insights into the profitability determinants of insurance companies in Ethiopian