Tesfaye Madda

FACTORS THAT AFFECT FINANCIAL
PERFORMANCE OF INSURANCE
COMPANIES IN ETHIOPIA: A STUDY
CONDUCTED AT WOLAITA SODO TOWN,
ETHIOPIA
BY: TESFAYE MADDA
JULY, 2017
Wolaita Sodo University

i
List of Abbreviations
CBE: College of Business and Economics
EIC: Ethiopian Insurance Corporation
NICE: National Insurance Company of Ethiopia
FP: Financial Performance
WSU: Wolaita Sodo University

ii
Table of Contents
Contents
Dedication..............................................................................................Error! Bookmark not defined.
STATEMENT OF THE AUTHOR..........................................................Error! Bookmark not defined.
ACKNOWLEDGEMENTS.....................................................................Error! Bookmark not defined.
List of Abbreviations .......................................................................................................................... i
Table of Contents .............................................................................................................................. ii
List of Tables ....................................................................................................................................iv
List of Figures...................................................................................................................................vi
Abstract...........................................................................................................................................vii
CHAPTER ONE................................................................................................................................1
1. Introduction............................................................................................................................1
1.1. Background of the Study...................................................................................................1
1.2. Statement of the Problem..................................................................................................2
1.3. Research Questions ..........................................................................................................4
1.4. Hypothesis .......................................................................................................................4
1.5. Objective of the Study ......................................................................................................5
1.7. Scope of the Study............................................................................................................6
1.8. Limitations of the Study....................................................................................................6
1.9. Organization of Thesis......................................................................................................6
CHAPTER TWO................................................................................................................................8
2. Review of literature.................................................................................................................8
2.1.4.1. Underwriting risk........................................................................................................15
2.2. Empirical Review...........................................................................................................20
2.3. Variable Identification ....................................................................................................24
2.4. Conceptual Framework...................................................................................................24
2.5. Mathematical Model.......................................................................................................24
CHAPTER THREE..........................................................................................................................27
3. Research Methodology..........................................................................................................27
3.1. Target Population...........................................................................................................27

iii
3.2. Research Design.............................................................................................................27
3.3. Data Source and Type.....................................................................................................27
3.4. Data Collection Method..................................................................................................27
3.5. Instrument and Scale ......................................................................................................28
3.6. Sampling Design ............................................................................................................28
3.7. Sampling Frame .............................................................................................................28
3.8. Sample Size ...................................................................................................................28
3.9. Data Processing and Analysis..........................................................................................29
3.10. Pilot Study .................................................................................................................29
3.11. Ethical Considerations ................................................................................................31
CHAPTER FOUR............................................................................................................................32
4. Data Analysis and Interpretation ............................................................................................32
4.1. Data Analysis Method.............................................................................................................32
4.2. Descriptive Statistics...............................................................................................................32
4.2.1. Demographic Variables of the Respondents..........................................................................32
4.4. Inferential Statistics ...........................................................................................................42
4.5. Secondary Data Analysis ................................................................................................44
CHAPTER FIVE..............................................................................................................................57
5. Summary, Conclusions and Recommendation.........................................................................57
5.1. Summary .......................................................................................................................57
5.2. Conclusions ...................................................................................................................58
5.4. Recommendations for Future Research...............................................................................61
REFERENCES.................................................................................................................................62
Appendix I: Questionnaires ...............................................................................................................67
Appendix II: Secondary Data.............................................................................................................72
Appendix III: Name of Insurance Company Used for This Study Purposes...........................................74

iv
List of Tables
Table Page
1. Insurance Companies in Ethiopia with their Type 39
2.
Summary of Reliability Test (Cronbach’s Alpha)
40
3. Sex of the Respondents 42
4. Age of the Respondents 43
5. Educational Level of the Respondents 43
6. Marital Status of the Respondents 44
7. Service Year of the Respondents 45
8. Descriptive Statistics of Independent and Dependent Variables 46
9. Descriptive Statistics of Under Writing 47
10. Descriptive Statistics of Reinsurance Dependence 47
11. Descriptive Statistics of Solvency Ratio 48
12. Descriptive Statistics of Premium Growth 49
13. Descriptive Statistics of Company Size 49
14. Descriptive Statistics of Growth Rate of GDP 50
15. Descriptive Statistics of Inflation Rate 51
16. Descriptive Statistics of Interest Rate 51
17. Descriptive Statistics of Financial Performance 56
18. Normality Testing by Skewness and Kurtosis 57
19.
Pearson Correlation
58
20. Regression Analysis 59
21. Predicting Financial Performance by Regression Model 60
22. ANOVA (Analysis of Variance) 61
23. Hypothesis Testing of the Independent Variables 63

v
List of Tables Continued
24. ANOVA of financial performance by Sex 63
25. ANOVA of FINANCIAL PERFORMANCE by Age 64
26. ANOVA of FINANCIAL PERFORMANCE by Educational Level 64
27. ANOVA of financial performance by Marital Status 65
28.
ANOVA of financial performance Service Year of respondents
65
29. Descriptive Statistics of the Variables 66

vi
List of Figures
Figure Page
1. Factors that Affect Financial Performance of Insurance Company 23
2. Histogram for Normality Test 42
3. P-P Plot of the Normality Test 43

vii
Abstract
The main objective of this study was to assess the factors that affect financial performance of the
insurance companies in Ethiopia. For this study purposes, causal research design was used.
Stratified sampling technique was used to determine the number of the respondents from each
insurance company from Ethiopia, Wolaita Sodo Town. The primary and secondary sources of
data and also qualitative and quantitative types of data were also used in this study. In this
study, a total of 90 questionnaires were prepared and distributed to the employees whose work is
related to the finance in each insurance company. Both descriptive statistical analysis method
(frequency, percentile, mean and standard deviation) and inferential statistics (Pearson
correlation, linear regression and ANOVA one-way) were used through Statistical Package for
Social Science (SPSS) version 20.0.
The findings of this study indicated that reinsurance dependence, solvency ratio, premium
growth, company size, growth rate of GDP of this study are positively correlated with financial
performance of insurance company in Ethiopia, Wolaita Sodo Town but under writing risk,
inflation rate and interest rate are negatively correlated with financial performance of insurance
company in Ethiopia, Wolaita Sodo Town. Based on the findings of this study, the premium
growth and gross domestic product have highest impact on the financial performance of the
insurance company in Ethiopia. Out of the independent variables, solvency ratio and company
size have the lowest impact on the financial performance of the insurance company in Ethiopia.
The finding of this study shows that reinsurance dependence, company size and interest rate
have no significant effect on financial performance of the insurance company of Ethiopia,
Wolaita Sodo Town. But under writing, premium growth, solvency ratio, growth rate of GDP,
inflation rate, and interest rate have significant effect on financial performance of the insurance
company of Ethiopia, Wolaita Sodo Town.
Key Words: Financial Performance, Insurance

1
CHAPTER ONE
1. Introduction
1.1. Backgroundof the Study
The Ethiopian insurance industry does not have a long history of development despite the
country’s long history of civilization. Modern forms of insurance service, which were introduced
in Ethiopia by Europeans, trace their origin as far back as 1905 when the bank of Abyssinia
began to transact fire and marine insurance as an agent of a foreign insurance company. The
number of insurance companies increased significantly and reached 33 in 1960. At that time,
insurance business like any business undertaking was classified as trade and was administered by
the provisions of the commercial code. This was the only legislation in force in respect of
insurance except the maritime code of Ethiopia that was issued to govern the operations of
maritime business and the related marine insurance. The law required an insurer to be a domestic
company whose share capital (fully subscribed) to be not less than Birr 400,000 for a general
insurance business and Birr 600,000 in the case of long-term insurance business and Birr one
million to do both long-term & general insurance business.
Non-Ethiopian nationals were not barred from participating in insurance business. However, the
proclamation defined domestic company as a share company having its head office in Ethiopia
and in the case of a company transacting a general insurance business at least 51% and in the
case of a company transacting life insurance business, at least 30% of the paid-up capital must be
held by Ethiopian national companies. Four years after the enactment of the proclamation, the
military government that came to power in 1974 put an end to all private entrepreneurship. Then
all insurance companies operating were nationalized and from January 1, 1975, onwards the
government took over the ownership and control of these companies & merged them into a
single unit called Ethiopian Insurance Corporation. The insurance sector during the command
economic system was characterized by monopoly of the sector by the government, lack of
dynamism and innovation, volatile premium growth rates and reliance on a couple of classes of
insurance business (motor and marine) for much of gross premium income.

2
The nationalization of private insurance companies, the restrictions imposed on private business
ventures, and management of the insurance sector had significant adverse impact on the
development and growth of Ethiopian insurance industry (Hailu, 2007).
However, following the change in the political environment in 1991, the proclamation for the
licensing and supervision of insurance business No. 86/1994 heralded the beginning of a new
era. Immediately after the enactment of the proclamation, private insurance companies began to
flourish. According to the directive of ISB/34/2014, any insurance company required to be a
domestic company whose share capital (fully subscribed) to be not less than Ethiopian Birr 60m
for a general insurance business and Ethiopian Birr 15min the case of long term (life) insurance
business and Ethiopian Birr 75m to do both long-term & general insurance business.
Today, the total number of insurance companies, branches and their capital increased
significantly. At 2014, there are seventeen insurance companies in operation.
1.2. Statement of the Problem
Insurance plays a significant role in a country's economic growth and offers financial protection
to an individual or firm against monetary losses suffered from unforeseen circumstances (Kihara,
2012).This is because the world is characterized by risks and uncertainties and insurance has
evolved as a way of providing security against the risks and uncertainties. In this context, it is
crucial to know what drives insurers’ financial performance. Financial performance is propulsive
element of any investments in different projects and relative measure of success for a business; it
is the efficiency of a company or industry to generate earnings
Due to the unique accounting system used by insurance companies, financial performance of the
industry has always been difficult to measure as compared with other financial institutions or
corporations. Different scholars using empirical investigation on the determinants of insurers’
financial performance are resulted in different conclusions. For insurers’, financial performance
is affected by a host of factors including actual mortality experience, investment earning, capital
gains or losses, the scale of policyholder dividends, and federal and state taxes (Wright 1992).

3
According to Swiss (2008), insurers’ financial performance is determined first by underwriting
performance (losses and expenses, which are affected by product pricing, risk selection, claims
management, and marketing and administrative expenses); and second, by investment
performance, which is a function of asset allocation and asset management as well as asset
leverage. Khan (2013) revealed that leverage, size, earnings volatility and age of the firm are
significant determinants of financial performance while growth opportunities and liquidity are
not significant determinants of financial performance. A study of Ahmed (2008) examined the
determinants of insurers’ financial performance indicated that size, volume of capital, leverage &
loss ratio are significant determinants of financial performance. Other studies conducted in the
area of insurers’ financial performance (Curak, 2012; Shiu, 2014; Maria and Ghiorghe, 2014)
verified that there is a direct association between financial performance of insurance companies
and it’s both internal and external determinants. Even though, all these and other researchers
conducted study on this area, the determinants of financial performance have been debated for
many years and still unsolved issues in the corporate finance literature.
Coming back to the case of the Ethiopian insurance sector, while a large body of research on
financial institutions financial performance has been undertaken in the banking industry in
Wolaita, to the researcher's best knowledge, the studies will be conducted in the areas of
insurance are few in number and did not give such an emphasis on the factors considered to be
determinants of financial performance of insurance industry in Ethiopia. For instance,(Abate,
2012) studied factors affecting insurance companies’ financial performance in Ethiopia. He
focused only on internal factors and have not considered external factors like macroeconomic
(gross domestic products, Inflation) and basic internal factors like underwriting risk, operational,
technical reserve, reinsurance risks and solvency ratio that are potentially accountable for
determinant of insurers’ financial performance (Lee 2014) &(Shiu 2014).
Therefore, the factors, which affect the financial performance of insurance companies, have not
been adequately investigated. Thus, current paper extended prior research and contributes to the
literature on the determinants of financial performance in a number of ways. First, a
comprehensive research on financial performance determinants using both company specific
factors and macroeconomic variables was not conducted in the Ethiopian insurance industry.
Second, insurance is a risky business and basic risk factors for insurance such as underwriting

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risk, operational, technical reserve, reinsurance risks and solvency ratio have not used in
previous studies but, these variables are the most important factors to determine the financial
performance of the insurers. Third, prior studies mostly adopted a quantitative and qualitative
approach only without considering many limitations of it, which resulted, fail to perform their
conclusions.
Therefore, this study seeks to fill the above-explained gap by providing information about the
internal and external factors that affects financial performance by examining the untouched one,
and replicating the existing in Wolaita by using all insurance company operating in Wolaita the
country that have 4 years data. To this end, the study provided insights into the financial
performance determinants of insurance companies in Wolaita. There was no too much earlier
study related to the topic in Ethiopia in general and Wolaita Zone in particular.
1.3. ResearchQuestions
The following were the major research questions of this study. These are:
1. What are the internal factors that determine the insurance company’s financial
performance in Ethiopia, Wolaita Sodo Town?
2. What are the external factors that determine the insurance company’s financial
performance in Ethiopia, Wolaita Sodo Town?
3. What is the rank the determinants according to their degree of influence on insurance
companies’ financial performance Ethiopia, Wolaita Sodo Town?
1.4. Hypothesis
Based on the above internal and external factors and empirical review, the researcher tested the
hypothesis of this study as follows:
H1: Underwriting risk has significant impact on financial performance of insurance companies in
Ethiopia.
H2: Reinsurance dependence has significant impact on financial performance of insurance
companies in Ethiopia.

5
H3: Solvency ratio has significant impact on financial performance of insurance companies in
Ethiopia.
H4: There is significant effect between growths of gross written premium on financial
performance in insurance companies’ in Ethiopia.
H5: Company size has significant impact on financial performance of insurance companies in
Ethiopia.
Ho6: Gross domestic product has significant impact on financial performance of insurance
H7: Inflation has significant impact on financial performance of insurance companies in Ethiopia.
H8: Interest rates have significant impact on financial performance of insurance companies in
Ethiopia.
1.5. Objective of the Study
1.5.1. GeneralObjective
The main objective to conduct this study was to investigate factors that affect performance of
insurance around Ethiopia, Wolaita Sodo Town.
1.5.2. Specific Objectives
The following are the specific objectives of this study. These were:
 To identify the internal factors that determines the insurance company’s performance in
Ethiopia, Wolaita Sodo Town.
 To identify the external factors that determines the insurance company’s performance in
 To identify the macroeconomic factors on insurance companies financial performance in
 To identify the micro economic factors on insurance companies’ financial performance.
 To rank the determinants according to their degree of influence on insurance companies’
financial performance Ethiopia, Wolaita Sodo Town.
1.6. The significance ofthe study

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The study was conducted on the factors affecting financial performance of insurance companies
in Ethiopia, Ethiopia, Wolaita Sodo Town.
- It will help the management of the insurance companies in Ethiopia in general and
Ethiopia, Wolaita Sodo Town in particular to take corrective measures to in the
recommended areas.
- It will help in filling the existing gaps in knowledge regarding factors affecting financial
performance of insurance companies in Ethiopia in general and Ethiopia, Wolaita Sodo
Town in particular.
- Finally, it will serve as a secondary material for further researchers for those who have an
interest in relation to this area and
- It also helps the researcher to acquire knowledge and skills.
1.7. Scope of the Study
The study was limited to examination of the internal and external factors affecting financial
performance of all insurance companies registered around Ethiopia, Wolaita Sodo Town ten
year’s data i.e. 2006-2016.
Geographically, this study focused on Ethiopia, Southern, Nations, Nationalities and Peoples’
Regional State, Ethiopia, Wolaita Sodo Town.
1.8. Limitations of the Study
For this study purposes, the following are major limitations. These are:
- This thesis was limited to only financial performance of insurance companies in Ethiopia
in Ethiopia, Wolaita Sodo Town.
- Lack of awareness among respondents to fill out the questionnaire with due care and not
returning the filled questionnaire on time may affect the study.
- Insufficiency of the secondary data about insurance companies may affect the study.
1.9. Organizationof Thesis

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This thesis was organized into five chapters. The details are as follows.
- The first chapter is about introduction which includes background of the study, statement
of problem, research questions, and objectives of the study, significance of the study,
limitations of the study and organization of the thesis.
- The second chapter deals with literature review which includes theoretical literature
review and empirical literature review.
- The third chapter is about proposed methodology of the study which includes target
population, research design, data source and type, data collection method, instrument and
scale, sampling design, sampling frame, sample size, data processing and analysis, and
pilot study ethical considerations.
- The fourth chapter deals with analysis and presentation of the results analysis of
questionnaire and interview.
- The five chapter deals with summary, discussion, conclusion and recommendation of the
study.

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CHAPTER TWO
2. Review of literature
Several factors influence insurance financial performance, recognizing and understanding the
underlying concepts and definitions of the insurance sector is essential in order to vouch results
and analyses. Hence, chapter two serves as background for this study by describing concepts of
financial intermediation and factors that could influence insurance financial performance.
2.1. Theoreticalreview
This section reviews the basic theoretical issues related to insurance and insurer’s financial
performance and its determinants. Hence, section 2.1.1 presents the role of insurance in the
economy. Then, section 2.1.2 presents concepts of insurers’ financial performance. Finally,
section 2.1.3 presents the theories related to insurer’s financial performance.
2.1.1. Definition and Role of Insurance
Insurance is a contract in which the insured transfers risk of potential loss to the insurer who
promises to compensate the former upon suffering loss. The insured then pays an agreed fee
called a premium in consideration for this promise. The promise is called the insurer and the
promise is called the insured (Lowe, 1999). Insurance premium is the monetary consideration
paid by the insured to the insurer for the cover granted by the insurance policy. The Insurer takes
on a number of clients (Insured) who pay small premiums that form an aggregate fund called the
premium fund (Norman, 2000). The likelihood of an event or loss may be mathematically
calculated or it may be based on the statistical results of past experience in order to determine the
amount of premiums that would be required to accumulate a common fund or pool, to meet the
losses upon their arising (Grose, 1992).
The term insurance defined by referring two important schools of thoughts: i) transfer school and
ii) pooling school. According to transfer school, “insurance is a device for the reduction of
uncertainty of one party, called the insured, through the transfer of particular risks to another
party ; called the insured, who offers a restoration, at least in part of economic losses suffered by
the insured” (Irving, 1956). On the other hand, according to pooling school “the essence of
insurance lies in the elimination of uncertainty or risk of loss for the individual through the
combination of large number of similarly exposed individuals” (Alfred, 1935), cited in (Tanveer

9
2010). Insurance operates on the principle of pooling risks where the people contribute to a
common fund in form of premiums andwhere the lucky ones who do not suffer loss help the
unlucky ones who suffer loss during a defined insurance period (Irukwu 1994).
It seems Insurance not only facilitates economic transactions through risk transfer and
indemnification but it also promotes financial intermediation (Ward and Zurbruegg, 2000). More
specifically, insurance can have effects such as promote financial stability, mobilize savings,
facilitate trade and commerce, enable risk to be managed more efficiently, encourage loss
mitigation, foster efficient capital allocation and also can be a substitute for and complement
government security programs (Skipper, 2001). Insurance provides economic protection from
identified risks occurring or discovered within a specified period. Insurance is a unique product
in that the ultimate cost is often unknown until long after the coverage period, while the revenue
premium payments by policyholders are received before or during the coverage period.
Insurance is an important growing part of the financial sector in virtually all the developed and
developing countries (Das et al., 2003). A resilient and well regulated insurance industry can
significantly contribute to economic growth and efficient resource allocation through transfer of
risk and mobilization of savings. In addition, it can enhance financial system efficiency by
reducing transaction costs, creating liquidity and facilitating economies of scale in investment
(Bodla et al., 2003).
Insurance business is usually divided into two main classes namely: a) General insurance
business - This is a contract between an insurer and the insured where by the insurer undertakes
to indemnify the assured against losses, which may result from the occurrence of specified
events within specified periods. General insurance business can be subdivided into: motor, fire,
accident, oil and gas, contractors’ all risks and engineering risks; marine and credit insurance,
bond and surety ship etc. This is a contract between the assurer and the assured whereby the
assurer undertakes to pay benefits to the policyholder on the attainment of a specified event. b)
Life assurance business: comprises individual life business, group life insurance and pension
business, health insurance business and annuities.

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2.1.2. The Conceptof Insurance Financialperformance
Financial performance refers to the act of performing financial activity. In broader sense,
financial performance refers to the degree to which financial objectives being or has been
accomplished. It is the process of measuring the results of a firm's policies and operations in
monetary terms. It is used to measure firm's overall financial health over a given period of time
and can also be used to compare similar firms across the same industry or to compare industries
or sectors in aggregation.
According to Hifza Malik (2011) insurance plays a crucial role in fostering commercial and
infrastructural businesses. From the latter perspective, it promotes financial, social stability,
mobilizes, and channels savings, supports trade, commerce and entrepreneurial activity and
improves the quality of the lives of individuals and the overall wellbeing in a country. Renbao
Chen et.al (2004) stated in his investigation that “higher profits provide both the means (greater
availability of finance from retained profits or from the capital market) and the incentive (a high
rate of return) for new investment”. Therefore, we can understand from the above explanation
that insurance companies have double responsibility: in one way they are required to be
profitable so as to have high rate of return for new investment. On the other hand, insurance
companies need to be profitable in order to be solvent enough so as to make other industries in
the economy as they were before even after risk occurred.
Financial performance is a measure of evaluating the overall efficiency of the business. The best
possible course for evaluation of business efficiency may be input-output analysis. Financial
performance can be measured by relating output as a proportion of input or matching it with the
results of other firms of the same industry or results attained in the different periods of
operations. Financial performance of a firm can be evaluated by comparing the amount of capital
employed i.e. the input with income earned i.e. the output. This is popularly known as return on
investment or return on capital employed. Profitable means that insurance companies are earning
more revenues than being disbursed as expenses.
Financial performance is a measure of an organization’s earnings, profits, appreciations in value
as evidenced by the rise in the entity’s share price. In insurance, performance is normally
expressed in net premiums earned, financial performance from underwriting activities, annual

11
turnover, returns on investment and return on equity. These measures can be classified as profit
performance measures and investment performance measures. Profit performance includes the
profits measured in monetary terms. Simply, it is the difference between the revenues and
expenses. These two factors, revenue and expenditure are in turn influenced by firm-specific
characteristics, industry features and macroeconomic variables. Investment performance can take
two different forms. One the return on assets employed in the business other than cash, and two,
the return on the investment operations of the surplus of cash at various levels earned on
operations (Chen and Wong, 2004; and Asimakopoulos, Samitas, and Papadogonas, 2009).
Another factor that impacts the financial performance of an insurance company is the ownership.
There are two main dimensions of the ownership structure: Ownership concentration that is, the
distribution of shares owned by majority shareholders and identity of owners especially, foreign
investors and institutional investors. Ownership structure influences the management of the
company to either pay dividends or interest, or decide whether to retain much of its profits for
further use in the company (Agiobenebo and Ezirim, 2002).
2.1.3. Theories ofinsurer’s financial performance
There is no general theory that provides a unifying framework for the study determinant
of the insurer’s financial performance. Because of this, this study tries to view some theories,
which are nearer to the concept of insurance financial performance and its determinants.
2.1.3.1. Modern Portfolio Theory
Modern portfolio theory was developed by Harry Markowitz in 1952. The theory suggests that
investors can improve the performance of their portfolios by allocating their investments into
different classes of financial securities and industrial sectors that are not expected to react
similarly if new information emerges. It assists in selecting the most efficient investments by
analyzing various possible portfolios of the given securities. By choosing securities that do not
move exactly together, MPT model shows investors how to reduce their risk. It is based on
expected returns (mean) and the standard deviation (variance) of the various portfolios. MPT
attempts to maximize expected portfolio returns for a given amount of portfolio risk, or
equivalently minimize risk for a given level of return by carefully choosing the proportions of

12
various assets. It models a portfolio as a weighted combination of assets, so that the return of a
portfolio is the weighted combination of the assets return.
Since insurance firms are investments by themselves, its standard practice for them to invest in a
diversified portfolio to minimize risk and harness the returns of the various investment options
on offer. When choosing a portfolio investors should maximize the discounted (or capitalized)
value of future returns. Since the future is not known with certainty, it must be expected or
anticipated returns, which are discounted. Through combining different assets whose returns are
not perfectly positively correlated, MPT seeks to reduce the total variance of the portfolio return.
MPT also assumes that investors are rational and the markets are efficient.
MPT emphasizes maximizing returns while minimizing risks, while giving recognition to the
existence of systematic and non-systematic risks. These concepts are usually referred to when
discussing financial investments. Insurance being influenced by risks and returns as well, also
finds meaning through MPT. Diversification is the solution against being a victim of
concentration risk. Over-reliance on similar assets’ financial performance and hopes that
contingent liabilities do not become actual obligations are risks that can wipe-out risk portfolios
in an instant. Non-systematic risks and alphas are the main items that give underwriting skills
meaning. Non-systematic risks can be eliminated by widening the coverage of insurance over
more assureds. In doing so, diversification is achieved.
Alphas, on the other hand, represent the surprise return or inherent financial performance of an
asset and in converting this concept onto the insurance industry, this is perhaps the inherent
characteristics of an insured property and how the hazards and other circumstances are
minimized, wherein it is more probable that the premiums paid by the assured will eventually be
kept at the end of the insurance policy coverage period. While financial assets are capable of
delivering abnormal returns, insurable risks are also able to remain abnormally intact and avoid
transforming into real obligations for the insurance company. The fewer obligations an insurance
company has, the more the profit they have.

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2.1.3.2. Arbitrage Pricing Theory
Arbitrage Pricing Theory (APT) was proposed by Stephen Ross in 1976. APT agrees that though
many different specific forces can influence the return of any individual firm, these particular
effects tend to cancel out in large and well-diversified portfolio. This is the principle of
diversification and it has an influence in the field of insurance. An insurance company has no
way of knowing whether any particular individual will become sick or will be involved in an
accident, but the company is able to accurately predict its losses on a large pool of such risk.
However, an insurance company is not entirely free of risk simply because it insures a large
number of individuals. Natural disaster or changes in health care can have major influences on
insurance losses by simultaneously affecting many claimants.
Cummins (1994) states that insurance companies are corporations and insurance policies can be
interpreted as specific types of financial instrument or contingent claim thus it is natural to apply
financial models to insurance pricing. The models are designed to estimate the insurance prices
that would pertain in a competitive market. Charging a price at least as high as the competitive
price (reservation price) increases the market value of the company. Charging a lower price
would reduce the company’s market value. Thus, financial models and financial prices are
among the key items of information that insurers should have at their disposal when making
financial decisions about tariff schedules, reinsurance contract terms, etc.
2.1.3.3. Black SwanTheory
The concept of black swan events was popularized by Nassim Nicholas Taleb in 2008. It states
that the world is severely affected by events that are rare and difficult to predict, events of low
probability but high impact. Silberzath (2013), states that a black swan does not create a new
category of events, but is simply the occurrence of a known category, the probability of which
was under estimated. They occur not because their probability is inherently incalculable, but
because the model used to calculate them is wrong, or because though the model was, correct,
the possibility of occurrence was dismissed in practice. Their implications for markets and
investment are compelling and need to be taken seriously. The Black Swan is an essential
concept for understanding how we make mistakes in estimating the probabilities of different

14
events belonging to a known universe. Davidson (2010) states that since probabilistic risks can
be quantified by human computing power, the future is insurable against risky probabilistic
occurrences. The cost of such insurance, or self-insurance, will take into account all
entrepreneurial marginal cost calculations (or by contingency contracts in a complete general
equilibrium system).
This insurance process permits entrepreneurs to make profit maximizing rational production and
investment choices even in the short run when dealing with risky known processes. It is just that
the short run does not provide a sufficiently large sample, for enough black swans to appear to
calculate the probabilistic risk of encountering a black swan. In the long run, those entrepreneurs
who in their price marginal cost calculations include these insurance costs as if they knew the
objective probabilities implicit in Knight’s unchanging reality will make the efficient decision
and will, in Knight's system, earn profit. The greatest risks are never the ones you can see and
measure, but the ones you can’t see and therefore can never measure. The ones that seem so far
outside the boundary of normal probability that you cannot imagine they could happen in your
lifetime even though, of course, they do happen, more often than you care to realize. What may
bea black swan to society may have limited insurance impact; likewise, some events that cause
catastrophic losses may not seem extreme from other perspectives.
Nobody wants to de-risk, in the sense that they want to actually take some money off the table. It
is all about pricing and quantifying risk, and of course hedging against it. Demand for protection
against so-called tail risks is increasing as investors react to black swan events. An investor or a
firm does not have to try to be too smart in trying to forecast what is going to happen and which
hedge is going to perform better what they need to do is accumulate cheap protection. Insurance
firms offer this cheap protection where by large losses can be hedged against by paying small
amounts known as Premiums. By having such products, insurance firms accumulate premiums in
a pool, since the occurrence of these events is minimal, they may end up paying none thus better
financial performance.

15
2.1.4. Internal Factors ThatAffect Financial Performance ofInsurance
Companies
The internal determinants of insurance company’s financial performance are those management
controllable factors, which account for the inter-firm differences in financial performance, given
the external environment.
2.1.4.1. Underwriting risk
Underwriting risk is the risk that the premiums collected will not be sufficient to cover the cost
of coverage. Insurance prices are established based on estimates of expected claim costs and the
costs to issue and administer the policy. The estimates and assumptions used to develop policy
pricing may prove to ultimately be inaccurate. This may be due to poor assumptions, changing
legal environments, increased longevity, higher than expected weather catastrophes (Ernst &
Young, 2010). Huge fluctuations in net premiums written indicate a lack of stability in
underwriting operation of an insurance company. An unusual increase in net premiums written
might indicate that the company is engaging in the so-called “cash-flow underwriting” to attempt
to survive its financial difficulty. However, this is not necessarily the case. An unusual increase
in net premiums written could indicate favorable business expansion if it is accompanied by
adequate reserving, profitable operations, and stable products mix (National Association of
Insurance Commissioner, 2001).
Organizations that engage in risky activities are likely to have more volatile cash flows than
entities whose management is more averse to risk-taking (Fama and Jensen, 1983). As a
consequence, insurers that underwrite risky business (e.g., catastrophe coverage) will need to
ensure that good standards of management are applied to mitigate their exposure to underwriting
losses ex-ante and maximize returns on invested assets ex-post.
This could improve annual operational performance by encouraging managers to increase cash
flows through risk taking. On the other hand, excessive risk-taking could adversely affect the
financial performance of reinsurance companies. Furthermore, higher annual insurance losses
will tend to increase the level of corporate management expenses ex-post (e.g., claims
investigation and loss adjustment costs) that could further exacerbate a decline in reported

16
operational performance. In contrast, insurers companies with lower than expected annual losses
are likely to have better operational performance because, for example, they do not incur such
high monitoring and claims handling costs.
2.1.4.2. Reinsurance Dependence
Insurance companies usually take out reinsurance cover to stabilize earnings, increase
underwriting capacity and provide protection against catastrophic losses. Nevertheless, there is a
cost for reinsurance. As a result, determining an appropriate ceding level is important for
insurance companies, and they have to try to strike a balance between decreasing insolvency risk
and reducing potential financial performance. Although it increases operational stability,
increasing reinsurance dependence, i.e. lowering the retention level, reduces the potential
financial performance. Purchasing reinsurance reduces insurers’ insolvency risk by stabilizing
loss experience, increasing capacity, limiting liability on specific risks, and/or protecting against
catastrophes. However, transferring risk to reinsurers is expensive. The cost of reinsurance for an
insurer can be much larger than the actuarial price of the risk transferred. Cummins, Dionne,
Gagne, and Nouira (2008), analyzed empirically that the costs and the benefits of reinsurance for
a sample of US property-liability insurers.
The results show that reinsurance purchase increases significantly the insurer’s costs but reduces
significantly the volatility of the loss ratio. With purchasing reinsurance, insurers accept to pay
higher costs of insurance production to reduce their underwriting risk. Insurers with higher
reinsurance dependence tend to have a lower level of firm financial performance.
2.1.4.3. SolvencyRatio (Capital adequacy)
Available solvency ratio means the excess value of assets over the value of insurance liabilities
and other liabilities of policyholders and shareholders’ funds (Charumathi 2013). Solvency ratio
is an important indicator of the financial health of an insurance firm and denotes its ability to
survive in the long run.
Insurance companies with higher solvency margin are considered to be sounder financially.
Financially sound insurance companies are better to attract prospective policyholders and are

17
better to adhere to the specified underwriting guidelines. Insurance companies with higher
solvency margin outperform those with lower solvency margin (Shiu, 2004).
On the other hand, assuming that the company is in its first stage, the manager will choose to
invest using the retained earnings in order to increase financial performance. This means that the
internal financing will continue until the retained earnings reach the amount of zero.
Furthermore, Durinck et al. (1997) found that the faster the growth, the more external financing
firms will use. However, this increase in external financing is mainly through an increase in the
liabilities, as the increase in external equity financing was not found significant. As a company
grows, the solvency ratio will thus become smaller.
2.1.4.4. Premium growth
Premium revenue is the primary source of revenue for most insurers, and it is generally more
persistent than other revenue sources. Therefore, premium growth should help predict future
revenue and earnings growth. For insurance company, especially those writing long-tail policies,
income in periods of premium growth is understated due to the overstatement of losses and loss
expenses, which are measured undiscounted. If premium revenue is relatively stable over time,
this bias is offset by the omission of interest expense on the loss reserve. However, when
premium revenue increases (declines) over time, the omitted interest expense is smaller (larger)
than the overstatement of the losses and loss expenses, and so income is understated (overstated)
Charumathi (2013). Premium growth measures the rate of market penetration.
Premium growth is driven by exposure growth (an increase in the number of policyholders) and
rate-level growth (an increase in the average price per exposure). These two sources of growth
have different persistence and risk implications. Exposure growth is valuable if the products are
properly priced, but in a competitive market, significant exposure growth may be an indication of
under pricing. This is the primary motivation for using premium growth as a potential early
warning signal of financial impairment. In contrast, premium growth attributable to rate
increases may reduce risk if the same customers are paying more for the same risk exposure.
However, if the rate increases alter or reflect a change in the mix of customers, the new book of
business can generate unexpected losses if it is mispriced. Maria (2014) argue that an excessive
growth of underwritings generates a higher underwriting risk and the necessity to increase the

18
volume of technical reserves and excessively increase the volume of the gross written premiums
may lead to self-destruction, as other important objectives, such as selecting profitable
investment portfolios could be neglected. Thus, the expected sign of the premium growth is
unpredictable based on prior research.
2.1.4.5. Company Size
It has been suggested that company size is positively related to financial performance (Shiu,
2004). The main reasons behind this can be summarized as follows. First, large insurance
companies normally have greater capacity for dealing with adverse market fluctuations than
small insurance companies. Second, large insurance companies usually can relatively easily
recruit able employees with professional knowledge compared with small insurance companies.
Third, large insurance companies have economies of scale in terms of the labor cost, which is the
most significant production factor for delivering insurance services (Shiu, 2004). Company size
is computed as decimal logarithm of total assets of the insurance company.
2.1.5. External Factors ThatAffect Financial Performance ofInsurance
Companies
2.1.5.1. Growth rate of GDP
Growth rate of GDP reflects economic activity as well as level of economic development and as
such affect the various factors related to the supply and demand for insurance products and
services. GDP is the most informative single indicator of progress in economic development.
Poor economic conditions can worsen the quality of the finance portfolio, thereby reducing
financial performance. If GDP grows, the likelihood of selling insurance policies also grows and
insurers are likely to benefit from that in form of higher profits.
2.1.5.2. Inflation Rate
For instance, unexpected inflation makes real returns on fixed-rate bonds lower than expected.
As a consequence, profit margins of insurance companies are compressed and financial
performance is accordingly impaired (Browne, Carson & Hoyt, 1999).

19
The inflation could affect insurance companies’ financial performance influencing both their
liabilities and assets. In expectation of inflation claim payments increases as well as reserves that
are required in anticipation of the higher claims, consequently reducing technical result and
financial performance. Taking into consideration that inflation affects assets side of the balance
sheet, as the bond markets adjust to the higher level of inflation, interest rates begin to rise. This
result in bond prices fall, negatively affecting value of investment portfolio. Given the negative
relationship between inflation and returns on both fixed-income securities and equities, it is
expected that the relationship between financial performance and inflation will be negative.
2.1.5.3. Interest Rate
Antolin P. Schich S. &Yermo J. (2011) low interest rates are one whereby interest rates stay at
(relatively) low levels for prolonged periods of time. At the outset, it should be noted that it is
hard, if not impossible, to generalize about the insurance sector as a whole, as individual
companies have different mixes of assets and liabilities, and operate in different environments,
so that the implications of protracted low interest rates would differ from company to company.
That said, a distinction can be made between the life and non-life insurance sectors, with adverse
effects more likely to arise for life as compared to non-life insurance companies. The need to
distinguish between life and non-life insurance companies arises because the structure of assets
and liabilities of these two sectors typically differs. Many non-life insurance contracts are rather
short-term, extending over one year (although they are typically tacitly renewed), with payouts
for short-tailed risks expected to be paid in the short to medium term.
Antolin P. Schich S. & Yermo J. (2011) concludes that, lower interest rates will impact pension
funds and insurance companies on both the asset and the liability side of their balance sheets.
While lower interest rates increase the value of fixed-income securities, they increase the
liabilities of pension funds and insurance companies, with the extent of the impact depending on:
(1) whether future cash flows are fixed; and (2) to what extent benefits to be paid in the future
are being adjusted to reflect the new economic environment. Protracted low interest rates
reflective of a lower-growth economic environment will reduce the returns on portfolio
investments.

20
2.2. Empirical Review
Inequality of profit among insurance companies over the years in a given country would result to
suggest that internal factors or firm specific factors and macroeconomic factors play a crucial
role in influencing their factors that affect financial performance. It is therefore imperative to
identify what are these factors as it can help insurance companies to take action on what will
increase their factors that affect financial performance and investors to forecast the factors that
affect financial performance of insurance companies in Ethiopia. To do so, it is better to see what
factors were considered in previous times by different individuals in different countries.
Rudolf (2001), in his paper, examined the key factors and latest trends factors that affect
financial performance in the major non-life insurance markets. The study focused on the non-life
insurance markets of the group of seven countries for the period of 1996 to 2000. To analyze the
factors that affect financial performance, investment results and underwriting results were
compared between countries and across lines of business and to analyze the drivers of factors
that affect financial performance, return on equity were decomposed into its main components
namely underwriting results and investment income. The results indicated that only Germany
and Japan did not have negative underwriting results and return on equity was high in UK,
moderate in Canada and US, and low in France and Germany. The study found that underwriting
result and investment yield are negatively correlated. The research suggested that due to
uncertain prospects for investment results, the insurers must focus on underwriting results to
achieve greater factors that affect financial performance. Shiu (2004) analyzed the determinants
of the performance of the UK general insurance companies, over the period 1986–1999, by using
three key indicators: investment yield, percentage change in shareholders’ data set, the author
empirically tested 12 explanatory variables and showed that the performance of insurers have a
positive correlation with the interest rate, return on equity, solvency margin and liquidity, and a
negative correlation with inflation and reinsurance dependence.
Greene (2004) argued that the factors that affect financial performance of insurance is normally
expressed in net premium earned, factors that affect financial performance from underwriting
activities, annual turnover, return on investment, and return on equity. These measures could be
classified as profit performance measures and investment performance measures.
Hoyt and Powell (2006), in their research paper, analyzed the financial performance of medical

21
liability insurer by using two appropriate measures, namely, the economic combined ratio and
the return on equity. The period for the study was from 1996 to 2004. Based on ECR, medical
liability insurers, as a group reported modest factors that affect financial performance in only
three years (1996, 1997 and 2004). In contrast, these insurers sustained losses in six consecutive
years from 1998 to 2003. The average profit ratio (return on net premiums earned) during the
period 1996 to 2004 was negative thirteen per cent. The study found that there was no evidence
that medical liability insurers had been earning excessive returns or that they were over-
capitalized. The research concluded that there was no evidence that medical malpractice
insurance was overpriced.
Holzheu (2006), in his research paper, measured the underwriting factors that affect financial
performance of insurance markets. The study used economic combined ratio as alternative key
performance indicator instead of conventionally published combined ratio. It reflects
underwriting factors that affect financial performance more accurately. The study focused on the
underwriting factors that affect financial performance of six major non-life markets, the US, the
UK, Germany, Japan, France and Canada from 1994 to 2004. The results indicated the picture
for the business year results for Japan, Canada, France, Germany and the UK were broadly
consistent with the US results. The results for the years 1994 to 1997 and 2002 to 2004 were
profitable, though often only moderately. The period from 1998 to 2001 exhibited dismal
underwriting results. Substantial improvements in underwriting results from 2001 to 2003
restored factors that affect financial performance to the level of the 1994 to 1997 period. The
study further pointed out that the ten year average underwriting margins before taxes were
positive in all countries implying a positive contribution to profits from the insurance activities.
However, the contribution was only about one- two per cent in the US and Japan, two-three per
cent in France, five per cent in Canada and the UK, and six per cent in Germany. The study
found that these positive results were necessary but not a sufficient condition for creating
shareholder value. Profits must also cover tax and the insurers' capital cost. During the period
1994 to 2004, it was difficult for the industry to earn its underwriting cost of capital.
The study used secondary data for the period of 2004-2007. The study revealed that there is no
relationship between factors that affect financial performance and age of the company and there
is significantly positive relationship between factors that affect financial performance and size &
volume of capital. Result also shows that Leverage ratio & loss ratio significantly and opposite

22
related to factors that affect financial performance.
According to Swiss (2008) profits are determined first by underwriting performance (losses and
expenses, which are affected by product pricing, risk selection, claims management, and
marketing and administrative expenses); and second, by investment performance, which is a
function of asset allocation and asset management as well as asset leverage. The first division of
the decomposition shows that an insurer‟s ROE each unit of net premiums (or profit margin) and
by the amount of capital funds used to finance and secure the risk exposure of each premium unit
(solvency).
Malik (2011) examined in his paper, the de factors that affect financial performance proxied by
ROA. The study used secondary data for the period of 2005-2009 and the sample was 34
insurance companies of Pakistan. The variables tested in the study are age, size, voc, leverage
and loss ratio. Descriptive statistics and multiple regression analysis were performed to describe
the factors that affect financial performance among Pakistani insurance companies. Result
showed that there is no relationship between factors that affect financial performance and age of
the company and there is significantly positive relationship between factors that affect financial
performance and size. Result also shows that volume of capital was significantly and positively
related to factors that affect financial performance. On the other hand the analysis suggests that a
reverse and significant relationship between leverage ratio and loss ratio as independent variables
and factors that affect financial performance.
Kozak (2011) examined determinants of factors that affect financial performance of non-life
insurance companies in Poland during integration with the European financial system for the
period of 2002–2009. The results indicated that the reduction in the share of motor insurance in
the portfolio, with simultaneous increase of other types of insurance has a positive impact on
factors that affect financial performance and cost-efficiency of insurance companies. However,
offering too broad spectrum of classes of insurance negatively impacts its factors that affect
financial performance and cost efficiency. Companies improve factors that affect financial
performance and cost efficiency with an increase of their gross premiums and decrease of total
operating expenses. Additionally increases of the GDP growth and the market share of foreign
owned companies positively impact factors that affect financial performance of non-life
insurance companies during the integration period.

23
Curak et al. (2012) examined the determinants of the factors that affect financial
performance of the Croatian composite insurers‟ between 2004 and 2009. explanatory
variables include both internal factors specific to insurance companies and external factors
specific to the economic environment. By applying panel data technique, the authors show
that company size, underwriting risk, inflation and return on equity have a significant
influence on insurers‟ factors that affect financial performance. The fin has a low level of
development, but it is very dynamic.
Daniel and Tilahun (2013) in their paper e performance in Ethiopia over the period of 2005 to
2010. The results revealed that firm size, leverage, loss ratio and tangibility of assets were
statistically significant to explain performance of insurance companies in Ethiopia. The resu
leverage and tangibility of assets were positively related to insurance performance, while loss
ratio was negatively related to performance (ROA). Firm age, liquidity and growth in written
premium have no a statistical significant relationship with performance of insurers.
Anna-Maria and Ghiorghe (2014) in their paper evaluated the determinants of financial
performance in the Romanian insurance market, between 2008 and 2012. The authors analyzed
the financial performance of insurance companies at micro and macroeconomic level, being
determined both by internal factors represented by specific characteristics of the company, and
external factors regarding connected institutions and macroeconomic environment by applying
specific panel data techniques. The results achieved the determinants of the financial
performance in the Romanian insurance market are the financial leverage, company size, growth
of gross written premiums, underwriting risk, risk retention ratio and solvency margin.
Lee (2014) investigated in his study the relationship between firm specific factors and
macroeconomics on factors that affect financial performance in Taiwanese property-liability
insurance industry using the panel data over the1999 through 2009 time period. Using operating
ratio and return on assets (ROA) for the two kinds of factors that affect financial performance
indi show that underwriting risk, reinsurance usage, input cost, return on investment and
financial holding group have significant influence on factors that affect financial performance in
both operating ratio and ROA models. The insurance subsidiaries of financial holding group
compared with other insurance companies, showing lower factors that affect financial
performance. In addition, economic growth rate has significant influence on factors that affect

24
financial performance in operating ratio model but insignificant influence on factors that affect
financial performance in ROA.
2.3. Variable Identification
After reviewing the above empirical studies, insurers’ company financial performance is
subjective to both internal and external factors. The internal factors focused on firm specific
characteristic and the external factors concerned on the country macroeconomic variables.
2.4. ConceptualFramework
Different empirical evidences suggested that financial performance of financial institutions
affected by internal and external factors. This study used both internal and external determinants
of insurance’s financial performance includes underwriting risk, reinsurance dependence,
solvency ratio, liquidity, premium growth, technical provisions, company size, growth rate of
GDP and inflation. The study will identify how these variables determine the financial
performance of insurance company in Ethiopia.
Figure 1: Factors that Affect Financial Performance of Insurance Company
Source: Prepared by the Researcher (2017)
2.5. MathematicalModel
Underwriting risk
Reinsurance
dependence
Solvency ratio
Liquidity
Premium growth
Company size
Technical
provisions
Growth
rate of
GDP
Inflation
Interest
Rate
Internalfactors External factors
FP

25
In order to developing an empirical model and will minimize specification errors in addition to
the review of foregoing related study the model selection criteria will considers the following
aspects;
 The data will be admissible; that is, predictions made from the model will be logically
possible.
 The model consistent with theory; that is, it must make good economic sense.
 Have weakly exogenous regresses; that is, the explanatory variables, or regresses, will
be uncorrelated with the error term.
 Exhibit parameter constancy; that is, the values of the parameters will expect stable.
Otherwise, forecasting will be difficulty.
 Exhibit data coherency; that is, the residuals estimated from the model will be purely
random (technically, white noise). In other words, if the regression model is adequate,
the residuals from this model will be white noise.
Therefore, In general, the best approach will be include only explanatory variables that, on
theoretical grounds, directly influence the dependent variable and that will not accounted for by
other included variables. The functional form of the model will be;
FP= α+ β1(UR) + β2(RD) + β3(SR) + β4(PG) + β5(CS) + β6(GDP) + β7(I)i+ β8(IR) + Є
Where:
FP = Dependent variable which financial performance
Internal Factors
UR = Underwriting Risk
RD = Reinsurance Dependence;
SR = Solvency Ratio; Total Liabilities/ Total Assets
PG = Premium Growth
CS=Size of companies; Natural log of Total Assets
External Factors
GDP = growth rate of GDP
I = Inflation
IR= Interest Rate
Є = is the error component for company i at time t assumed to have mean zero E [Є it] = 0

26
α= Constant or interpretation of the parameters
β= 1, 2, 3…8 are the slop of the coefficient or parameters that will be estimated

27
CHAPTER THREE
3. ResearchMethodology
3.1. TargetPopulation
There are 6 general insurance companies in Wolaita Zone. The insurance companies in Wolaita
Zone are Berhan Insurance S.C, Niyala Insurance S.C , NICE Insurance S.C, Nile Insurance S.C
Branch, Ethiopian Insurance Corporation (EIC), and Africa Insurance S.C. The target
populations of this study were all the branches and all the employees of general insurance
companies in Ethiopia, Wolaita Sodo Town.
3.2. ResearchDesign
This study is basically a causal study because it shows the cause and effect relationships of the
two variables called independent and dependent variables. For this reason, the researcher
employed causal research design.
3.3. Data Source and Type
The primary and secondary sources of data were used for this study purposes.
The primary sources of data were from interview from branch managers of each insurance
company in Ethiopia, Wolaita Sodo Town and questionnaire from employees of each branch.
The secondary source of data were from all relevant documents such as books, journal articles,
published and unpublished research papers, insurance manuals, reports, financial statement,
performance measures of insurance company through the report of National Bank of Ethiopia,
and other related documents.
For this study purpose, both the qualitative and quantitative types of the data were used. The
qualitative types of the data were interview from branch managers. The quantitative type of the
data was from close-ended questionnaire from employees of each branch whose work is related
with finance and from financial statement reports.
3.4. Data CollectionMethod

28
The primary sources of data were collected through interview from branch managers and open
and close-ended questionnaire from employees of each branch whose work is related with
finance.
The secondary sources of data were collected from all relevant documents such as books, journal
articles; published and unpublished research papers, financial reports, financial statement and
other related documents were reviewed and analyzed.
3.5. Instrument and Scale
The researcher used Likert scale questionnaire for this study purposes. When responding to a
Likert questionnaire item, respondents specify their level of agreement or disagreement on a
symmetric agree-disagree scale for a series of statements. Thus, the scale captures the intensity
of their feelings. A five point Likert scale that range from 1 (strongly disagree) to 5 (strongly
agree) were used to gather respondents opinion.
3.6. Sampling Design
For this study purposes, stratified sampling technique were used to determine the number of the
respondents from each campus or stratum. The researcher believed that the selected respondents
represent a balanced mix of various demographic factors. Accordingly, a total of 90 respondents
were selected as census to fill the questionnaire from six insurance companies in Ethiopia,
Wolaita Sodo Town.
3.7. Sampling Frame
The sampling frame of this study mainly included all branch managers and all the employees of
general insurance companies in Ethiopia, Wolaita Sodo Town.
3.8. Sample Size
There are about 90 employees in all the insurance companies in Ethiopia, Wolaita Sodo Town
whose work is more related with financial activities in the company. Since the numbers of the
employees whose work is related with finance are small, the researcher used all the respondents
to fill the questionnaire. In this case, the researcher used census.

29
3.9. Data Processing and Analysis
3.9.1. Data Processing
Inconsistency and completeness of questionnaire was checked by manually. Editing and sorting
of the questionnaires were done to determine the completeness of the questionnaires manually.
The responses in the completed questionnaire were coded and entered into a data entry template.
All the data processing was done manually and electronically.
3.9.2. Data Analysis
Descriptive and inferential statistical techniques were used to analyze the quantitative data.
Descriptive statistical techniques such as mean and standard deviation and skweness and kurtosis
were used. Inferential statistical techniques like Pearson Correlation, linear regression analysis
were used. Statistical Package for Social Sciences (SPSS) version 20.0 was employed to analyze
the quantitative data.
Tables were used for data presentation. Correlation analysis was used to test the strength of the
relationship between the two variables, independent variables and dependent variable. Finally,
linear-regression analysis was employed to test the proposed hypotheses of this study.
3.10. Pilot Study
To safeguard the quality of this study, the quality control procedures were employed. For
this study, the researcher used reliability test by using Cronbach’s Alpha and validity test by
using advisor’s comment and lecturers’ comment from Department of Management, Wolaita
Sodo University.
3.10.1. Reliability Test
To test the reliability of the questionnaires, Cronbach’s Alpha was employed. To proceed
to the next step, the value of Cronbach’s Alpha (α) must be at least 0.7. George and Mallery
(2003) provided more detailed categories of reliability values as i.e., (α>0.9 “Excellent”, α>0.8

30
“Good”, α>0.7 “Acceptable”, α>0.6 “Questionable”, α>0.5 “Poor”, while α<0.5
“Unacceptable”).
To test the reliability of the instruments, 25 questionnaires were distributed to some staff
members of Insurance Companies of Ethiopia, Wolaita Sodo Town which will not be part of the
sample in the final study. After running the data using SPSS version 20.0, it was found that all
the measures possess more than acceptable reliability standard ranging from 0.713 up to 0.807.
Consequently, given the established benchmark of 0.70, all the constructs are reliable and
therefore, there was no need to delete any item from any variable.
The reliability tests of the items were summarized in the below table and the detailed reliability
test statistics annexed in Appendix-B.
Table 1: Summary of Reliability Test(Cronbach’s Alpha)
S.No. Variables Value of Cronbach’s Alpha
1. UNDER WRITING 0.779
2. REINSURANCE DEPENDENCE 0.805
3. SOLVENDY RATIO 0.775
4. PREMIUM GROWTH 0.762
5. COMPANY SIZE 0.713
6. Growth rate of GDP 0.760
7. INFLATION 0.807

31
8. Interest Rate 0.722
9. Financial Performance 0.806
Source: Own Survey Result, 2017
3.10.2. Validity Test
The purpose this is to make sure that the instrument is measuring what it is supposed to assess
(Hebert and Miller, 2013). Content validity is the extent to which the elements within a
measurement procedure are relevant and representative of the construct that will be used to
measure validity (Haynes, Richard & Kubany, 1995). It is measured by relying on the knowledge
of subject-matter experts.
The content validity of the questionnaires was ascertained by the advisor and three lecturers from
Department of Management, Wolaita Sodo University. The construct validity of the instrument
was confirmed since there is high reliability of the instrument of this study. Based on the
reliability test of the items within each variable, there is positive correlation among items.
Therefore, there is convergent validity among items within their respective variables.
3.11. Ethical Considerations
To ensure that ethical principles in this study, the researcher upheld the highest ethical standards
with regard to issues such as informed consent, confidentiality, privacy and secrecy.
All the primary and secondary data obtained from different sources were used only for this
research purposes. Confidentiality was assured by indicating that respondents are not required to
write their name on the questionnaire and by assuring that their responses will not in any way be
linked to them and will not be used for other purposes except for this research purposes. The
researcher also acknowledged all authors’ and previous researchers’ work in this research.

32
CHAPTER FOUR
4. Data Analysis and Interpretation
This chapter discusses about data analysis and interpretation of this study. This chapter in
general presents two main analysis, personal information analysis and analysis of the questions
related to factors that affect performance of insurance around Ethiopia, Wolaita Sodo Town.
4.1. Data Analysis Method
For this study purposes, the data collected through questionnaires were analyzed using SPSS
version 20.0. To analyze the data through SPSS, the researcher used both descriptive and
inferential statistic analysis methods.
To analyze demographic variables under the descriptive statistics, frequency and percentages
were used. For the main questions or questions in Likert Scale, the researcher used mean and
standard deviation under the descriptive statistics, and Pearson correlation, ANOVA, and linear
regression analysis were used under the inferential statistics analysis methods.
4.2. Descriptive Statistics
4.2.1. Demographic Variables of the Respondents
The demographic variables of the participants include sex, age, educational level, marital status,
monthly salary, and service year of the respondents in insurance company of Ethiopia, Wolaita
Sodo Town. The analysis of the demographic variables from the questionnaires is presented
below.
Table 1: Sexof the Respondents
Sex Frequency Percent
Male 61 67.8
Female 29 32.2
Total 90 100.0
Source: Own Survey, 2017

33
From the table 1, out of the total 90 respondents, 61(67.8%) are males and 29(32.2%) are
females. This implies that majority of the employees in insurance company are male.
Table 2: Age of the Respondents
Age Frequency Percent
18-25 14 15.6
26-33 31 34.4
34-41 25 27.8
42-49 13 14.4
50-60 7 7.8
Total 90 100.0
From table 2, out of the total respondents, 14(15.6%) are under the age category of 18-25,
31(34.4%) are under the age category of 26-33, 25(27.8%) are under the age category of the 34-
41, 13(14.4%) are under the age category of 42-49, and only 7(7.8%) are under the age category
of 50-60. From this, it can be inferred that majority of the employees of the insurance company
in Ethiopia, Wolaita Sodo Town are under the productive age group.
Table 3: EducationalLevel of the Respondents
Educational Level Frequency Percent
Diploma 17 18.9
Bachelor Degree 69 76.7
Masters Degree 4 4.4
Total 90 100.0
From the table 3, out of the 90 respondents, 17(18.9%) are diploma holders, 69(76.7%)
are bachelor holders, and 4(4.4%) are masters degree holders. From this, it can be concluded that
majority of the employees of insurance company in Wolaita Sodo are bachelor degree holder.
Masters degree holders are rare in the case study area.
Table 4: MaritalStatus of the Respondents
Marital Status Frequency Percent
Single 46 51.1

34
Married 36 40.0
Divorced 6 6.7
Widowed 2 2.2
Total 90 100.0
Table 4 shows that out of the total respondents, 46(51.1%) are single or not married, 36(40.0%)
are married, only 6(6.7%) are divorced and only 2(2.2%) are widowed. From this, it can be
concluded that majority of the employees in insurance company are single or not married.
Table 6: Service Yearof the Respondents
Service Year Frequency Percent
Below 1 year 12 13.3
1-3 years 33 36.7
4-10 years 28 31.1
7-9 years 8 8.9
Above 10 years 9 10.0
Total 90 100.0
Table 6 shows that out of the 90 respondents, 12(13.3%) have below one year service, 33(36.7%)
have 1-3 service years, 28(31.1%) have 4-6 service years, 8(8.9%) have 7-9 service years and
9(10.0%) have above 10 service years in insurance company. From this, it can be generalized
that majority of the staffs have 1-6 service years in insurance company.
4.3. Descriptive Statistics ofVariables
Table 7: Descriptive Statistics ofUnder Writing
S.No Under Writing Mean Std. Deviation
1. Registration system of claim of the insurance company
affects the financial performance of the insurance
company.
4.11 0.710
2. Employees’ performance affects the performance of the
insurance company.
4.31 0.788

35
3. Brokers and agents affect the operation of insurance
companies.
3.23 0.750
Operational system of the insurance company is fair. 3.27 0.747
From the above table, out of the total respondents, Item (1) shows the mean score and standard
deviation of the statement ‘registration system of claim of the insurance company affects the
financial performance of the insurance company’ is 4.11 and 0.710 respectively. The responses
of the respondents are towards the lower side of agree. This implies that the registration system
of claim of the insurance company affects the financial performance of the insurance company in
Item (2) of the above table shows that mean score and standard deviation of the statement
‘employees’ performance affects the performance of the insurance company’ is 4.31 and 0.788
respectively. The responses of the respondents are towards the lower side of agree. This implies
that the ‘employees’ performance affects the performance of the insurance company in Ethiopia,
Wolaita Sodo Town.
‘brokers and agents affect the operation of insurance companies’ is 3.23 and 0.750 respectively.
The responses of the respondents are towards the lower side of average/neutral. This implies that
the ‘brokers and agents affect the operation of insurance companies in Ethiopia, Wolaita Sodo
Town.
‘operational system of the insurance company is fair’ is 3.27 and 0.747 respectively. The
responses of the respondents are towards the lower side of average/neutral. This implies that the
operational system of the insurance company is fair for insurance companies in Ethiopia, Wolaita
Sodo Town.
Table 8: Descriptive Statistics of Reinsurance Dependence
S.No Reinsurance Dependence Mean Std. Deviation

36
1. Risk transferring system of the insurance company
affects the financial performance of the insurance
company.
2.46 0.889
2. There risk transferring system of the insurance
company is good.
2.74 1.214
3. The risk transferring system of the company helped to
manage cost of the company.
2.79 0.930
Item (1) shows the mean score and standard deviation of the statement ‘risk transferring system
of the insurance company affects the financial performance of the insurance company’ is 2.46
and 0.89 respectively.
Item (2) shows the mean score and standard deviation of the statement ‘there risk transferring
system of the insurance company is good’ is 2.74 and 1.214 respectively.
Item (3) shows the mean score and standard deviation of the statement ‘the risk transferring
system of the company helped to manage cost of the company’ is 2.79 and 0.930 respectively.
Table 9: Descriptive Statistics of SolvencyRatio
S.No Solvency Ration Mean Std. Deviation
1. The insurance company has cost management system to
reduce cost of the operation.
2.57 1.082
2. The availability of the current assets helped the
company to grow easily.
2.89 1.240
3. The insurance company has effective assets that can be
easily converted into cash within short period of time.
2.64 1.063
Item (1) shows the mean score and standard deviation of the statement ‘the insurance company
has cost management system to reduce cost of the operation’ is 2.57 and 1.082 respectively.
Item (2) shows the mean score and standard deviation of the statement ‘the availability of the
current assets helped the company to grow easily’ is 2.89 and 1.240 respectively.

37
has effective assets that can be easily converted into cash within short period of time’ is 2.64 and
1.063 respectively.
Table 10: Descriptive Statistics of Premium Growth
S.No Premium Growth Mean Std. Deviation
1. The insurance company has effective assets that can
easily be converted into cash within short period of
time.
1.83 0.890
2. The insurance company has effective growth
opportunity.
2.43 0.900
3. The management of the insurance company is
committed to growth of the insurance.
2.37 0.756
has effective assets that can easily be converted into cash within short period of time is 1.83 and
0.890 respectively.
has effective growth opportunity’ is 2.43 and 0.900 respectively.
Item (3) shows the mean score and standard deviation of the statement ‘the management of the
insurance company is committed to growth of the insurance’ is 2.37 and 0.756 respectively.
Table 11: Descriptive Statistics of Company Size
S.No Company Size Mean Std. Deviation
1. The number of the shareholders is good enough to raise
the required amount of the finance for the operation.
2.83 1.202
2. The number of the branches of the insurance company
is good enough to increase the number of the customers.
3.20 1.041
3. The activity of the management is good to grasp new
customers.
2.71 1.274

38
4. The instruments that the insurance company is using are
excellent to give services to the customers.
2.84 1.226
deviation of the statement ‘the number of the shareholders is good enough to raise the required
amount of the finance for the operation’ is 2.83 and 1.202 respectively.
Item (2) of the above table shows that mean score and standard deviation of the statement ‘the
number of the branches of the insurance company is good enough to increase the number of the
customers’ is 3.20 and 1.041 respectively.
activity of the management is good to grasp new customers’ is 2.71 and 1.274 respectively.
instruments that the insurance company is using are excellent to give services to the customers’
is 2.84 and 1.226 respectively.
Table 12: Descriptive Statistics of Growth Rate of GDP
S.No Growth Rate of GDP Mean Std. Deviation
1. From time to time, the increase in the growth of the country can
affect the financial performance of the insurance companies in
Ethiopia.
2.71 1.274
2. The growth of the country’s economy affects financial
performance of insurance company.
2.84 1.226
3. The insurance company has good opportunity to invest in the
areas.
2.73 1.026
deviation of the statement ‘from time to time, the insurance company shows improvement in the
financial performance’ is 2.71 and 1.274 respectively.

39
growth of the country’s economy affects financial performance of insurance company’ is 2.84
and 1.226 respectively.
insurance company has good opportunity to invest in the areas’ is 2.73 and 1.026 respectively.
Table 13: Descriptive Statistics of Inflation Rate
S.No Inflation Rate Mean Std. Deviation
1. Taxation system of the government towards insurance
company is fair.
3.27 1.068
2. From time to time, the amount of the payment by the customer
is based on the rules and regulations.
3.28 0.900
3. Inflation in the market affects the financial performance of the
company.
3.24 0.903
From the above table, out of the total respondents, item (1) shows the mean score and standard
deviation of the statement ‘the taxation system of the government towards insurance company is
fair’ is 3.27 and 1.068 respectively. This implies that the taxation system of the insurance
companies is not fair. From this it can be concluded that if the taxation system towards the
insurance companies in Ethiopia is not fair, it can affect the financial performance of the
insurance companies adversely. The payment by the customer is based on the fair rules and
regulation.
Item (2) of the above table shows that mean score and standard deviation of the statement ‘from
time to time, the amount of the payment by the customer is fair’ is 3.28 and 0.900 respectively.
This implies that the payment by the customer is based on the fair rules and regulation.
‘Inflation in the market affects the financial performance of the company’ is 3.24 and 0.903
respectively. This implies that increase in the price of the goods and service can affect the
financial performance of the insurance companies in Ethiopia.

40
Table 14: Descriptive Statistics of Interest Rate
S.No Interest Rate Mean Std. Deviation
1. From time to time, the amount of the payment for the
customer is fair.
3.24 0.903
2. Interest rate of the insurance company is good. 3.36 0.916
From the above table, out of the total respondents, item (1) shows the mean score and standard
deviation of the statement ‘from time to time, the amount of the payment for the customer is fair’
is 3.24 and 0.903 respectively. This implies that the amount of the payment paid to the customers
is fair enough but some of the customers are still now complaining regarding the payment.
‘Interest rate of the insurance company is good’ is 3.36 and 0.916 respectively. This implies that
the insurance companies interest rate good to attract the customers.
Table 15: Descriptive Statistics of Financial Performance
S.No Financial Performance Mean Std.
Deviation
1. Technology that the company applies help to facilitate operation
and the process of providing insurance service to insured.
2.83 1.202
2. The level of the customer satisfaction affects financial
performance of the insurance company.
3.20 1.041
3. Financial performance of the insurance company is affected by
the amount and quality of the assets the company holds.
2.71 1.274
4. The quality of the services given the company affects the
financial performance.
2.84 1.226
5. Financial performance of the insurance company is affected by
the quality of the equipments the company holds.
3.33 1.446
6. Customer handling system of the insurance company affects the
financial performance of the insurance company.
2.73 1.026

41
deviation of the statement ‘the technology that the company applies help to facilitate operation
and the process of providing insurance service to insured’ is 2.83 and 1.202 respectively. This
implies that the quality of the services given by the insurance companies in selected insurance
level of the customer satisfaction affects financial performance of the insurance company’ is 3.20
and 1.041 respectively. This implies that the satisfied customers are believed that they can bring
other customers and they are loyal to the insurance company. If the numbers of the loyal
customers increase, the financial performance of the insurance companies can also increase.
financial performance of the insurance company is affected by the amount and quality of the
assets the company holds’ is 2.71 and 1.274 respectively. This implies that the amount and
quality of the assets the company holds can affect the financial performance of the insurance
company adversely.
quality of the services given the company affects the financial performance’ is 2.84 and 1.226
respectively. This implies that the amount and quality of the service that the insurance companies
give to their respective customers can affect the financial performance of the insurance company
adversely.
financial performance of the insurance company is affected by the quality of the equipments the
company holds’ is 3.33 and 1.446 respectively. This implies that the quality of the equipments
the company holds can affect the financial performance of the insurance company adversely.
customer handling system of the insurance company affects the financial performance of the
insurance company’ is 2.73 and 1.026 respectively. This implies that the customer handling
system of the insurance company affects the financial performance of the insurance companies in

42
Ethiopia. From this it can be concluded that the way the customers are handled by their
respective customers the way how customers are handled by their respective customers can
affect the loyal customers. If the loyal customers are affected by the way they are handled can
affect the financial performance.
4.4. Inferential Statistics
Before starting inferential statistical analysis, normality test was used. Pearson correlation
analysis, regression analysis, and ANOVA analysis were used under inferential statistical
analysis. To test hypotheses, to conclude and to make recommendations, these tests were
employed.
4.4.1. Normality Test
According to Gujarati (1995) before running regression analysis, it should be noted that there are
four classic assumptions in undertaking the regression analysis and one of them is normality of
data. Therefore, normality test becomes relevant. The normality assumption is about the mean of
the residuals is zero. Therefore, we used graphical methods of testing the normality of data.
According to Krithikadatta (2014), a normal distribution looks like a symmetric bell-shaped
curve, and the mean, median, and mode are equal or close to each other.
Figure 2Histogram for Normality Test
Source: SPSS Output of the Own Survey, 2017

43
Therefore, the data were normally distributed because the histogram is almost bell-shaped.
Figure 3: P-P Plot of the Normality Test
P-P plot of the normally distributed data shows that the dots must touch the straight diagonal line
which starts from the origin. In this study, the p-p plot shows the residuals are normally
distributed.
Table 16: Normality Testing by Skewnessand Kurtosis
Variables N Skewness Kurtosis
Statistic Statistic Std. Error Statistic Std. Error
UNDERWRITING 90 0.446 0.254 -0.611 0.503
REINSURANCEDEPENDENCE 90 0.245 0.254 -0.223 0.503
SOLVENDYRATIO 90 0.301 0.254 -0.246 0.503
PREMIUMGROWTH 90 0.478 0.254 0.993 0.503
COMPANYSIZE 90 0.201 0.254 -0.701 0.503
DGPSS 90 0.191 0.254 -0.898 0.503
INFLATION 90 -0.749 0.254 -0.063 0.503
INTERSTRATE 90 -0.607 0.254 -0.183 0.503
FINANCIALPERFORMANCE 90 0.227 0.254 -0.842 0.503
The descriptive statistics like Skewness and Kurtosis of this study fall within a range of ±2.0. A
distribution is normal, if Skewness and Kurtosis fall within a range of ±2.0 (Cameron 2004).

44
From the table 17, for both Skewness and Kurtosis value, statistics divided by standard error lay
between ±2. Therefore, the data of this study are normally distributed because both Skewness
and Kurtosis lay within±2 range..
4.5. SecondaryData Analysis
4.5.1. Descriptive statistics
Table 28 presents a summary of the descriptive statistics of the dependent and independent
variables for six insurance companies for a period of ten years from 2001-2016. Key figures,
including mean, maximum, minimum and standard deviation value were reported.
Table 17: Descriptive Statistics ofthe Variables
Variables Minimum Maximum Mean Std.
Deviation
Return on Asset 2.00 3.80 2.5745 0.53054
Under Writing 1.27 3.65 2.1565 0.56471
Company Size 5.04 9.71 7.4700 1.11666
Premium Growth 1.02 3.18 1.7739 0.58202
Reinsurance Dependence 1.10 3.12 1.6104 0.53634
Solvency Ratio 1.11 3.29 2.0372 0.59842
Gross Domestic Product 1.10 3.12 1.7771 0.70351
Inflation Rate 1.03 3.16 1.7549 0.53921
Interest Rate 1.10 3.80 2.4567 0.57353
Source: SPSS Output of Financial statements of sampled six insurance companies
Return on Assets (ROA) was used to measure the financial performance of the insurance
companies. As indicated in the above table, the financial performance measures (ROA) shows
that Ethiopian insurance company achieved on average a positive before tax profit over the last
10 years. For the total sample, the overall mean of ROA was 2.57% with a maximum of 3.8 %
and a minimum of 2%. That means the most profitable insurance company among the sampled
earned 3.8 cents of profit before tax for a single birr invested in the assets of the firm. Regarding
the standard deviation, it’s mean to both sides by 53.4 percent which indicate there was high
variation from the mean. This implies that private insurance companies need to optimize the use
of their assets to increase the return on their assets.
Underwriting risk variable, as proxies by losses incurred divided by annual premium earned; the

45
overall mean of incurred claims to earned premium ratio was 21.56 percent. This implies that on
average, most insurance companies from the sample paid 21.56 percent loss incurred out of the
total premium earned per year. The minimum and maximum values of the under writing are 1.27
and 3.68 respectively. The mean value of underwriting risk overall deviate from its mean to both
sides by 0.5647 percent. This indicates that there is high variation in underwriting performance in
private insurance company in Ethiopia during the study period.
Logarithm of total asset is used as proxy to the size of the insurance company and its mean of the
logarithm of total assets over the period 2006 to 2016 was 7..47. Size of insurance companies
was highly dispersed from its mean value with the standard deviation of 1.116. The maximum
and minimum values of the size of the company were 9.71.29 and 5.04 respectively.
The average value of the growth variable as proxies by change in gross written premium was
1.77 percent. This implies that on average, the insurance companies‟ gross pre increased by 1.77
percent over the study period. While the maximum & minimum values of premium growth were
3.18 & 1.02 percent respectively. This high increase in premium growth for a company in a
particular year indicates that unstable premium underwritings.
The outputs of the descriptive statistics of the data indicate that the mean of reinsurance
dependence of the total asset was 1.61%. This means that on average 1.61% of gross premium
collected as percentage of total asset was ceded to reinsurance which is below the standard of
around 53.63%. The maximum value of premium ceded ratio was 3.12 percent and a minimum
value of 1.10 percent respectively.
The average value for solvency ratio as measured by net asset to net written premium was 2.03
percent. The standard deviation is 59.84 percent, and maximum of 3.29 and the minimum of 1.11
percent respectively.
Regarding GDP, the mean value of real GDP growth rate was 1.777% indicating the average real
growth rate of the country’s eco of the economy was recorded. The standard deviation is 70.35
percent, and maximum of 3.12 and the minimum of 1.10 percent respectively.
Regarding the inflation rate, the mean score was 1.7549%. This implies that the increase in
inflation rate of the insurance company can decrease the financial performance of the Ethiopian

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