Liquidity Management And Financial Performance Of Listed Insurance Companies In Nigeria

Project and Seminar Material for Accountancy / Accounting

Abstract

This study was carried out to examine liquidity management and financial performance of listed insurance companies in Nigeria. The core purpose of this research study was to establish the influence of liquidity management on insurance companies’ financial performance in Nigeria. 14 licensed insurance firms made up the research population. Only secondary data was gathered for the research. The data included annual liquidity ratio for insurance companies and the annual ROA. The study covered a 5-year period from 2015-2019. SPSS V 25.0 was employed in generating quantitative data. Tables, frequencies and percentages were used in exhibiting the research results. Statistical assumptions tests were done. The study recorded that liquidity jointly impacted insurance corporations’ financial performance in Nigeria. The outcomes indicated that when predictor variables are constantly held, financial metric indicator is 0.831, the research showed that increasing asset quality results in a rise of profitability by 0.636, furthermore, it was recorded that a rise in management of liquidity increased financial performance by 0.721, an expansion of capital adequacy grows financial performance by 0.701 and an increase in the size of firms increases financial performance by 0.523. The study made the recommendation that insurance companies should take the responsibility of ensuring constant liquidity irrespective of different products available to the customer. Liquidity management is constructed around a reasonable working capital system of any firm. By so doing, a well-structured plan will moderate how inflow and outflow occur depending on the risk and return measure that is dependent on the agreement made to customers and to potential customers.

Table of Content

Chapter One:

Introduction

1.1 Background of the Study
1.2 Statement of the Problem
1.3 Objective of the Study
1.4 Research Questions
1.5 Research Hypothesis
1.6 Significance of the Study
1.7 Scope of the Study
1.8 Limitation of the Study
1.9 Definition of Terms
1.10 Organization of the Study

Chapter Two:

Review of Literature

2.1 Conceptual Framework
2.2 Theoretical Framework
2.3 Empirical Review

Chapter Three:

Research Methodology

3.1 Introduction
3.2 Research design
3.3. Population of the Study
3.4 Data Collection
3.5 Data Analysis
3.5.1 Test of Significance
3.5.2 Diagnostic Test

Chapter Four

Data Analysis, Results and Interpretation

4.1 Introduction
4.2 Descriptive Statistics
4.3 Diagnostic Tests
4.3.1 Tests of Normality
4.3.2 Test for Multicolinearity
4.3.3 Serial Correlation
4.3.4 Heteroscedasticity
4.4 Regression Analysis
4.5 Interpretation of the Study Findings

Chapter Five:

Summary, Conclusion and Recommendation

5.1 Summary
5.2 Conclusion
5.3 Recommendation
References

Chapter One

Introduction

1.1 Background to the Study

Liquidity is a financial institution’s capacity to meet it cash and collateral responsibilities without incurring unacceptable losses. Adequate liquidity is reliant upon the institution’s capacity to efficiently meet both expected and unexpected cash flows and collateral needs without negatively affecting either day to day operations or the financial state of the institution. So, liquidity management entails the supply/withdrawal from the market the amount of liquidity consistent with the desired level of short-term interest rates or reserve money. It is the capacity of an organization to meet demands for funds thereby ensuring that such organization maintain adequate cash and liquid assets to satisfy the demand of client for loans and savings withdrawals and then meet its expected expenses, (Owolabi, & Obida, 2012).

According to Panigrahi (2013), it is frequently observed that on every occasion a financial analysis of firms is done; more emphasis is given on the financial performance (profitability) of the business rather than on its liquidity. This is quite evident, as the most important financial aim of any business entity is to earn profit. Therefore, the managers lay more emphasis towards financial performance of the business. However, another significant variable is liquidity which means the ability of an organization to honor its short term financial obligations. If the organization isn’t able to honor its short-term financial obligations, it moves a step forward towards its bankruptcy. Liquidity management, therefore, entails the amount of investments in liquid assets to meet the short-term maturing obligation of creditors and others.

Basically, the liquidity management role is to prospectively evaluate the needs for funds to meet obligation and ensure the availability of cash or collateral to fulfill those need at the right time by coordinating the different sources of funds accessible to the organization under normal and stressed conditions. It depends on the day to day assessment of the liquidity conditions in the insurance companies, so as to measure its liquidity needs and thus the volume of liquidity to allot or withdraw from the market. Management of liquidity involves a day to day evaluation and detailed estimation of the size and timing of cash inflows and outflows over the coming days and weeks to lessen the risk that savers will be unable to access their deposits in the moment they demand them. Thus, liquidity is lifeblood of a business organization. Ebhodaghe (2002), Biety (2003), and Anyanwu (1993), assert that the objective of liquidity management is to gear organizations towards a financial position that enables them meet their financial obligations as they occur.

Shortage of adequate liquidity in a business organization is often characterized by the inability to meet day to day financial obligations. At times it may have the risk of losing clients which erodes its supply of cash and thus forces the institution into disposal of its more liquid assets. As opined by (Pandy, 2005), managing monies of a business organization in order to maximized cash availability and interest income on any idle cash is a function of liquidity management.

Current assets are liquid so holding more current assets refers to high liquidity however on the other hand; current assets include such items which reduce firm’s financial performance. It must be remembered that different items of current assets have different degree of liquidity. Cash is the most liquid asset. For another types of current assets, liquidity concept has two dimensions of time and risk. The speed with which current assets other than cash can be converted into cash is regarded as time dimension of liquidity consideration, (Falope & Ajilore, 2009). More quickly and rapidly current assets are converted into cash, more liquid those current assets shall be. The greater the relative proportion of liquid assets, the lesser the risk of running out of cash, all other things being equal. All individual components of working capital including cash, marketable securities, account receivables and inventory management play a significant role in the financial performance of any organization.

For owners of business, one of the most vital tasks is to estimate and assess cash flows of the business, to well identify the long-run and short-run cash inflows and outflows to timely sort out the cash shortages and excess to formulate financing and investing strategies respectively. It also helps in planning the payments to creditors on time to avoid losing reputation and trust of the customers and to avoid potential bankruptcy, (Bardia, 2004).
If all the current responsibilities are met without any delay as and when these become due, creditors or clients and all others will have a feeling of confidence in the financial strength of the organization and this will sustain the credit standing of the organization, (Chen & Wong, 2004). However, failure to meet such responsibilities on regular basis would cause a negative effect on the credit standing and market reputation resulting in more difficult to finance the level of current assets from the short-term sources. Keeping liquidity is usually costly, although helps avert negative effects of unexpected cash-flow shocks.

According to Bhunia (2010), liquidity plays a crucial role in the successful functioning of an organization. A company should ensure that it doesn’t suffer from lack-of or excess liquidity to meet its short-term obligations. A study of liquidity is of major significance to both the internal and the external analysts simply because of its close relationship with daily operations of a business. Liquidity requirement of an organization relies on the peculiar nature of the organization and there is no particular rule on measuring the optimal level of liquidity that an organization can maintain so as to ensure positive impact on its profitability.

However, one should try neither to maximize nor minimize the liquidity ratios; one should try to optimize them in relation to the objective, which in case of a commercial company is probably the maximization of profit on capital employed. The lower the liquidity ratios are, the more vulnerable the company is to pressure from creditors or clients which it unable to meet and vice versa. So, one should seek to have as little working capital as is consistent with not being unduly vulnerable to pressure from creditors.

According to Brealey (2012), liquidity is expressed in terms of liquidity ratios such as current ratio, quick (acid test) ratio and cash ratio. Current ratio is the ratio of the current assets to the current liabilities and it measures the margin of liquidity. Rapid fall in the current ratio sometimes signify trouble. But, they can also be misleading. For instance, suppose that a firm borrows a huge sum from the bank and invests it in short-term securities. If nothing else happens, net working capital is unaffected, but the current ratio changes. For this reason, it might be preferable to net off the short-term investments and the short-term debt when calculating the current ratio.

According to Brealey (2012), quick (acid test) is a sign of firm’s short term liquidity and is calculated as current assets net of inventories divided by current liabilities. It measures a firm’s ability to meet its short-term obligations with its most liquid assets thereby excluding inventories. The quick ratio measures the naira amount of liquid assets available for each naira of current liabilities. Thus, a quick ratio of 1.5 implies that a company has N1.50 of liquid assets available to cover each N1 of current liabilities. The higher the quick ratio the better the firm’s liquidity position and vice versa.

According to Brealey (2012), cash ratio is the ratio of a firm’s total cash and cash equivalents to its current liabilities. The cash ratio is most generally used as a measure of firm liquidity. A firm’s most liquid assets are its holdings of cash and marketable securities and that is why analysts also look at the cash ratio. It can therefore determine if, and how quickly, the company can repay its short-term debt. A strong cash ratio is useful to creditors when deciding how much debt, if any, they would be willing to extend to the asking party.

One of the most severe liquidity stress scenarios faced by an insurer is a mass surrender of policies owing to a loss of confidence in its financial strength. This happened to Equitable Life following the House of Lords ruling on its guaranteed annuity liabilities in 2000. Risk is a natural element of business and community life. It is a condition that raises the chance of losses/gains and the uncertain potential events which could manipulate the success of financial institutions (Crowe, 2009). As a result, well establish risk management practices (RMPs) can assist insurance to reduce their exposure to risks. Effective risk management is accepted as a major cornerstone of insurance firm’s management by academics, practitioners and regulators and acknowledging this reality and the need for a comprehensive approach to deal with insurance risk management (Sensarma & Jayadev, 2009).

Moreover, liquidity management is found to be one of the determinants of returns of insurance s’ stocks. Indeed, as Holland (2010) observed, liquidity management failure is considered one of the main causes of the crisis. The inability of insurance firms to raise liquidity can be attributed to a funding liquidity risk that is caused either by the maturity mismatch between inflows and outflows and/or the sudden and unexpected liquidity needs arising from contingency conditions (Duttweiler, 2009). Insurers will typically hold cash in the form of bank deposits, Treasury Bills, commercial paper, and other money market instruments to meet outflows. Liquidity losses on realizing listed securities depend not only on the amount sold, but also on quoted maximum deal sizes and spreads, which are in turn affected by market conditions (Kumar, 2015).

Liquidity Risk is a risk of insufficient liquid assets to meet payouts from policies (surrender, expenses, maturities, etc.), forcing the sale of assets at lower prices, leading to losses, despite company being solvent. Loss from meeting liquidity comes either from fire sale or by paying interest on borrowing to meet payouts. Liquidity risk arises due to two reasons, one on the liability side and other on the asset side (Sonjai, 2008). Hence, insurance companies in Nigeria are statutorily required to increase their Statutory Deposit with the Central Bank of Nigeria to an amount equal to 10% of the New Minimum Capital Requirement for their respective classes of insurance operations.

1.2 Statement of the Problem

The problem of insufficient studies of the assessment of the relationship between liquidity management and the performance of Insurance companies in Nigeria calls for more work under the subject matter. The assessment of liquidity management in relation to performance becomes imperative as a result of Insurance Market Review in 2009. The National Insurance Commission (NAICOM) makes it important to examine the management of liquidity in Insurance companies in Nigeria. Theoretical studies and empirical evidence have shown that countries with better developed financial system enjoy faster and more stable long-run growth of which insurance companies contribute to. Well-developed financial markets have a significant positive impact on total factor productivity, which translates into higher long-run development. Based on Solow’s (1956) work, Merton (2004) noted that due to the absence of a financial system that can provide the means of transforming technical innovation into broad implementation, technological progress will not have significant and substantial impact on the economic development and growth.

Liquidity risk in an insurance company is considered as less threatening than in bank because of higher frequency of money exchange takes place in banking industry compared to insurance industry. However, liquidity risk management is equally important in insurance as in banking sector because of interconnection of financial system leading to cash crisis and secondly liquidity risk may prove very expensive to insurer due to meeting the cost of liquidity and also impacting the Assets and Liability mismatch.

There is a trade-off between liquidity and financial performance; gaining more of one ordinarily means giving up some of the other, (Eljelly, 2004). For instance, if a company’s balance sheet is listed in order of liquidity with five items namely cash, marketable securities, accounts receivables, inventory and fixed assets it can be observed that moving from cash to fixed assets decreases liquidity. However, as you move from fixed assets to cash financial performance increase. In other words, profitable investment for a company is normally its fixed assets and the least profitable investment is cash, (Boadi, Antwi, & Lartey, 2013).

Mathuva (2009) found a highly significant positive relationship between the time it takes the firm to pay its creditors (average payment period) and financial performance. Maina (2011) found the relationship between liquidity and financial performance was weak and also that all the independent variables had a significant relationship with Return on assets except the quick ratio and cash conversion cycle. The results further revealed that, there was a strong negative relationship between a firm’s leverage and quick ratio with its Return on assets. Owolabi & Obida (2012) found causative relationships between financial performance expressed in terms return on assets (ROA), return on equity (ROE) and return on investment (ROI) and liquidity management of companies was measured in terms of its Debtors Collection Period (DCP), Creditors Payment Period (CPP) and Cash Conversion Cycle (CCC).

Wambu (2013) found out that there was a positive relationship between profitability and liquidity however, the coefficients from the study were not significant. Lartey, Antwi & Boadi (2013) found that there was a very weak positive relationship between the liquidity and the financial performance of the listed banks in Ghana.

Based on earlier researches, the studies did not center on the liquidity management especially in the insurance industry, also the empirical evidence revealed mixed results with some showing negative relationship and others showing positive or no relationship, finally, from the above reviews, it was found that out that, most of the studies were not conducted in Nigeria. Therefore, there was a yawning gap in existence since there was no comprehensive study on the effect of liquidity management on financial performance of insurance companies listed at the Nigeria Securities Exchange. Earlier studies broadly concentrated on effect of liquidity and relationship of liquidity and profitability of commercial banks. This study therefore concentrated on what effect liquidity management has on financial performance of insurance companies in Nigeria.

1.3 Objectives of the Study

The main objective of the study is to examine liquidity management and financial performance of listed insurance companies in Nigeria with a view to providing solutions to the problem. The study specifically tends to ascertain whether liquidity management have a significant effect on the financial performance of listed insurance companies in Nigeria.

1.4 Research Question

Does liquidity management have a significant effect on the financial performance of listed insurance companies in Nigeria?

1.5 Research Hypothesis

H0: There is no relationship between liquidity and insurance companies’ financial performance.

Ha: There is a significant relationship between liquidity and insurance companies’ financial performance.

1.7 Significance of the Study

The study would contribute immensely to knowledge and total understanding of liquidity management in insurance companies especially in Nigeria where insurance is not considered as Important to success of businesses as it is in Europe and USA This study will also provide future insurance seekers the information needed to make a good decision about what insurance company to use.

The results of this study could also help in insurance managers know the adequate liquidity needed to more effectively run an insurance company and keep its long term stability.

Regulators in Nigeria would also benefit from findings of this study by recognizing important liquidity management measures that promote financial stability.

Students, researchers and other scholars who wish to undertake further research on liquidity management and financial performance would find the literature arising from this study to be of great value, as it would be added to existing literature and also widen the scope.

1.8 Scope of the Study

The study examined the extent to which liquidity management has impacted on the financial performance of listed insurance companies. This study is however, delimited to selected insurance companies that are listed on the Nigerian stock exchange. The study will cover the period of 5years, from 2015-2019.

1.8 Limitations of the Study

The researcher came across some difficulties while undertaking the study, the financial statements of some of the insurance firms were not availed to the researcher in time for their inclusion in the research, thus the reduction in the sample population from which data was gathered. The research targeted insurance companies in Nigeria, hence the irrelevance of the findings in other nations where the insurance industry operates in different environments.

The research concentrated on a time period of only 5 years; this is not enough time for proper conclusions to be made.

Secondary data from financial statements was gathered from selected insurance firms, and NSEM bulletin.

1.9 Definition of Terms

Liquidity Management:

This is a concept broadly describing a company’s ability to meet financial obligations through cash flow, funding activities and capital management.

Financial Performance:

This is subjective measure of how well a firm can use assets from its primary mode of business and generate revenue

Listed Insurance Company:

Thus is a business that provides coverage, in the form of compensation resulting from loss damage, injury treatment or hardship in exchange for premium and also listed on the Nigeria stock Exchange.

1.10 Organization of the Study

This research work is organized in five chapters, for easy understanding, as follows

Chapter one is concern with the introduction, which consist of the (overview, of the study), statement of problem, objectives of the study, research question, significance or the study, definition of terms etc.
Chapter two highlight the theoretical framework on which the study is based, thus the review of related literature.
Chapter three deals on the research design and methodology adopted in the study.
Chapter four concentrate on the data collection and analysis and presentation of finding.
Chapter five gives summary, conclusion, and recommendations made of the study.

Chapter Five

Summary, Conclusions and Recommendations

5.1 Introduction

A high level summary of the results, conclusions and policy recommendations as well as highlights of the study limitations with respect to the goals of the research are the focus of this chapter.

5.1 Summary

The research objective was to determine the effect of liquidity management on the financial performance of Insurance Corporations in Nigeria. The research used secondary data from annual financial statements of 14 insurance companies and other industry publications covering the period from 2015-20189. The data collected was based on 5 research variables; financial performance as the dependent variable was measured by annual ROA while liquidity management as measured by a ratio of premiums to total assets, was the independent variable under study. There were three control variables; Asset quality, capital adequacy and firm size.

Multiple regression analysis was used to analyze the relationship between the variables under study. Test of statistical assumptions was carried out on the individual variables under study and on the statistical model itself confirm that it’s adequacy in predicting the relationship between the variables involved. The results of all statistical tests of regression analysis revealed that no assumptions were violated hence the conclusions drawn were not biased.
Statistical package developed by IBM Corporation, SPSS v25.0 was used to generate quantitative output of statistical results.

Descriptive statistics applied to analyze the data collected include the statistical measures of mean, standard deviation and range (the difference between maximum and minimum values).

The results show that Liquidity jointly influenced financial performance of insurance corporations in Nigeria represented by r=0.891. The R squared value of 0.794 revealed that the independent variables contributed to 79.4% of the financial performance variance of insurance corporations in Nigeria. At a 5% confidence level, the F statistic was significant, implying that the predictor variables show financial performance variation and the model was significant.

The outcomes indicated that when predictor variables are constantly held, financial performance is 0.831, the research showed that increasing asset quality results in a rise of profitability by 0.636, more it was recorded that a rise in management of liquidity increased financial performance by 0.721, an increase in capital adequacy increases financial performance by 0.701 and an increase in the size of firms increases financial performance by 0.523.

5.3 Conclusion

The analysis on the previous chapter shows that liquidity is a financial performance important determinant. The correlation between ROA and deposit to asset and liquidity ratio is positive, meaning that a rise in liquidity results in an improvement in insurance firms’ financial performance in Nigeria. The research draws the conclusion that liquidity jointly influences insurance firm’s financial performance as revealed by the r value 0.891. The R squared value of 0.794 revealed that the independent variables contributed to 79.4% of the financial performance variance of insurance corporations in Nigeria. At a 5% confidence level, the F statistic was significant, implying that the predictor variables show financial performance variation and the model was significant.

5.4 Recommendation

The following recommendations were proffered with respect to the findings of the study;

Insurance companies should take the responsibility of ensuring constant liquidity irrespective of different products available to the customer. Liquidity management is constructed around a reasonable working capital system of any firm. By so doing, a well-structured plan will moderate how inflow and outflow occur depending on the risk and return measure that is dependent on the agreement made to customers and to potential customers.
Insurance companies with a higher proportion of property and casualty division vis a vis life and health experience a high level of uncertainty in their claims operations and therefore require a high level of liquidity. Such companies should invest heavily in highly liquid securities.
Insurance companies ought not to only pay attention to financial performance but to also guarantee efficient management of liquidity. This promotes their growth. Moreover, these firms ought not to possess a high level of liquidity but devise ways of ensuring the sustainability of liquidity. The liquidity that is in excess ought to be used for short term investments for ROI increase.

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