Patan Prospective Journal Volume: 3, Number: 2, Dec 2023 Narendra Sejuwal

Received Date: Sept. 2023 Revised: Nov. 2023 Accepted: Dec. 2023

Determinants of Profitability of Insurance

Companies in Nepal
Narendra Sejuwal1 Kamal Bahadur Koirala2
1
Assistant Professor, Head of Department of Finance, Faculty of Management
Patan Multiple Campus
Email: [email protected]
2
Assistant Professor, Head of Department of Accounts Faculty of Management
Patan Multiple Campus
Email: [email protected]
Doi: https://doi.org/10.3126/ppj.v3i2.66163
Abstract
The ability of a corporation to turn a profit from all of its business endeavors is expressed by its
profitability. It demonstrates how well management uses all available resources to generate profit.
This study attempts to investigate the determinants of profitability of insurance companies in Nepal.
This study is based on secondary data of 15 sample insurance companies using convenient sampling
and it covers the period 2016/17 to 2020/21 with 75 observations. The results of this study revealed
that expense ratio, financial leverage, claim ratio and size of company have impact on profitability
of the insurance companies in Nepal. Expense ratio and claim ratio have significant negative and
financial leverage and size of company have positive impact on profitability of the insurance
companies in Nepal. This study also revealed the insignificant effect of age on profitability of
insurance companies.
Key Words: Profitability, Net profit margin, Expense Ratio, Financial Leverage, Claim
Ratio, Size, Age.
Introduction
The firms that advocated risk management through agreements for insurance are the
insurance companies. The basic idea behind insurance is that one side, the insurer, will
always get payment in the event of an unforeseen future incident. Transferring risk to
insurance provider by paying a small premium will reduce the policyholder's financial loss.
The goal of insurance is to forecast the likelihood that a loss will occur in the future by
pooling a number of units that are influenced by comparable risks. This reduces the inherent
risk in the economy. Among all financial industries, insurance businesses are one of the
safest for investors. All commercial enterprises, including insurance firms, prioritize making
a profit. The insurance industry is a crucial area for the county's economic growth.
According to Haiss and Sumegi (2008), the insurance industry plays a significant role in the
financial services sector by fostering economic growth, effective resource allocation,
liquidity generation, the realization of economies of scale in investment, and the distribution
of financial losses. The financial dependability of an economy is greatly facilitated by the

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insurance sector. Recently, there has been an increase in the interaction between the many
players in the financial system, such as banks, other intermediaries, insurers, and financial
markets. Furthermore, according to the European Central Bank (2009), these companies not
only insure and guarantee the financial risk of residences and commercial buildings, but
they also make a major contribution to the financial markets. The ability to generate revenue
is a requirement for an insurance company to remain viable in the highly competitive,
globalized economy, provide clients with a variety of services, benefit the local community
economically and socially, or contribute to the GDP. Insurance companies are unable to
deliver services and rise outside funding to accomplish their goals due to a lack of profit
(Atsbeha and Kaur, 2015). Insurance industry has a vital role in the economy as a whole
since it offers services related to risk management, protection, and other financial services
(Ben Dhiab, 2021).
Reinsurance commissions, underwriting surplus, and gross investment income are all
sources of an insurer's profitability. The elements that affect an insurance company's profit
level are underwriting, investment income, claims expenses, gross premiums written,
operating expenses, commission expenses, and technical reserves. Profit measurement is
crucial for a company's success as well as for understanding of profit distribution and
investment strategy. As a result, information about profit is now transparent to all
stakeholders, including company owners, investor managers, creditors, governments,
employees, and the general public (Juwita & Rindiati, 2020). Insurance companies should
be profitable so that the entire system can experience the necessary growth, taking into
account the structure of our nation's financial system and the difficulties faced by insurance
companies in the process of developing and integrating non-bank finance. One of the main
objectives of financial management is profitability. This is because of the primary roles and
goals of financial management is to increase shareholder value. The key factors affecting
business performance is profitability (Malik, 2011). Any firm must be profitable in order to
remain competitive and enjoy long-run success. The efficacy of financial institutions is
regularly assessed using it globally.
Profitability is the major indicator of financial health of insurance companies of Nepal. The
profitability of the company is affected by so many factors. There might be internal as well
as external factors. The main objective of this study is to identify the variables influencing
the insurance company's profitability in Nepal.
Previous research demonstrates that empirical evidence on the factors influencing firm
profitability varies significantly amongst studies. Although the empirical evidence revealed
above exists in the context of other countries, some few studies exist in the context of Nepal.
Thus, the study's main objective is to investigate the variables influencing Nepalese life
insurance companies' profitability. It specifically examines at how Nepalese insurance
companies' profitability measures by net profit margin is impacted by expense ratio,
financial leverage, claim ratio, company size and age of company.

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Review of Literature
Mehari and Aemiro (2011) studied specific company factor that impact insurance
companies' profitability in Ethiopia, using return on assets (ROA) as a variable that is
dependent to represent the profitability of the insurance companies. The explanatory
variables included the company's age, size, leverage, loss ratio, tangibility of assets,
liquidity, and premium growth. The authors concluded that while age of the company,
liquidity, and premium growth had no impact on the profitability of insurance companies,
company size, leverage, loss ratio, and tangibility were statistically significant variables.
According to Charumathi (2012), the company's profitability was positively and
significantly impacted by its size and liquidity. Her empirical study on the Determinants of
Profitability of Indian Life Insurers showed no relationship between underwriting risk and
profitability. On the other hand, the profitability of Indian life insurance businesses was
significantly impacted negatively by leverage, premium growth, and the logarithm of equity
capital.
Yuvaraj and Abate (2013) stated that the size and amount of capital clearly had shown
negative effect on profitability of insurance companies, as well as liquidity ratio and
leverage ratio.
Burca and Batrinca (2014) conducted a study on the insurance market in Romania and found
that many factors, such as firm size, aggregate premium growth, underwriting risk ratio,
solvency margin, and financial leverage, affected the performance of the insurance industry.
Kaya (2015) focused the company specific variables that affect financial performance of
non life insurance companies in Turkey. Empirical results demonstrated that Turkish non-
life insurance enterprises' size, age, loss ratio, current ratio, and premium growth were the
distinctive company features which had an impact on their profitability.
Ortynski (2016) documented that firm size and the ratio of technical activity had a positive
influence on profitability, net claims ratio and net operational expenses had negative effect
on insurance companies’ performance.
Alomari (2017) investigated the influence of a firm-specific factor on how well Jordanian
insurance enterprises perform as measured by ROA, represented as an indicator of
profitability. As per results, underwriting risk, liquidity, and leverage all had a significant
negative effect on firm's performance. And market share and size had significant positive
effect on success of the Jordanian insurance industry. GDP per capita and inflation were not
causally related.
In addition to macroeconomic variables like GDP per capita, inflation, and the stock market
general index, Banerjee and Majumdar (2018) examined the factors that impact the
insurance market's financial performance in the United Arab Emirates using a variety of
variables, including size, growth in GWP, market share, leverage, solvency margin,
investment ratio, and loss ratio. It was discovered that the profitability of the firm was
significantly impacted by leverage, size, and growth in GWP; positively and significantly;

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the per capita GDP; significantly; the effect of inflation; and insignificantly; by risk
retention ratio and loss ratio.
Poudel (2019) investigated the relationship between ownership and a variety of firm-
specific elements that affect insurance companies' profitability and discovered a negative
correlation between ROA and tangibility and liquidity. Yet, there was a positive correlation
between the variables of business size, age, and leverage.
Bhattari (2020) examines the variables influencing the performance of Nepalese insurance
companies. Employee expenses ratio, financial leverage, and firm size were the study's
independent variables, and Return on Equity was used as a measure of profitability, as
dependent variable. The study came to the conclusion that the main determinants of
profitability in Nepalese insurance companies were financial leverage and company size,
with the costs ratio and other independent factors showing a positive link with profitability.
The factors affecting the profit growth of insurance companies listed on the Indonesia Stock
Exchange were examined by Ganefo and Anthoni (2021) and concluded that the
independent variables premium income, claim payments, and risk-based capital had an
impact on the dependent variable profit growth simultaneously and significantly, and that
premium income (PK) had a positive impact. While Risk Based Capital (RBC) had a
positive and considerable impact on profit growth, Claim Payment (PK) had no discernible
impact on profit growth.
Ahmeti and Iseni (2022) examined the effects of specific company factors on profitability.
The following factors were considered independent variables: liquidity, firm size, age,
physical assets, leverage, capital, and growth. The findings showed that the age, size, and
leverage of the business had a big impact on the NPM and ROA of insurance companies.
Research Methodology
This study uses a descriptive and casual comparative research design. The main objective of
the study is to investigate the factors influencing the profitability of Nepalese insurance
companies. Expense ratio (ER), Financial Leverage (FL), Claim Ratio (CR), Size of
company (LnSize) and Age of company (LnAGE) are the independent variables whereas
NPM is dependent variable. This study relies on secondary data obtained from annual
reports. An attempt has also been made to describe the character of performance of 15
sample insurance companies based on convenient sampling with a total of 75 observations
during fiscal year 2016/17 through 2020/21.The sample insurance companies are Asian Life
Co. Ltd, Life Insurance Co. (Nepal) Ltd., Prime life Co. Ltd, Surya life Co. Ltd, National
Life Insurance Co. Ltd, Nepal Life Insurance Co. Ltd., Nepal Insurance Co. Ltd.,
Sagarmatha Insurance Co. Ltd, Siddhartha Insurance Co. Ltd., Prudential Insurance Co.
Ltd., Niko Insurance Co. Ltd., United Insurance Co. Ltd., Nepal Reinsurance Co. Ltd.,
Lumbini Insurance Co. Ltd., NLG Insurance Co. Ltd.

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The Model
The econometric model is used to estimate the factors influencing the profitability of
insurance companies in Nepal. Regression analysis is taken as major tool. The model is
expressed as:

NPMit= α +β1 ERit+ β2 FLit + β3CRit + β4 LnSIZEit + β5LnAGEit + eit

Where,
NPMit = net profit marginfor insurance company during t period.
βit = coefficient parameters
ERit= expense ratio for insurance company during t period.
FLit= financial leverage for insurance company during t period.
CRit= claim ratio for insurance company during t period.
LnSIZEit= size of insurance company during t period.
LnAGEit= age of insurance company during t period.
Results and Discussion
Descriptive Statistics
Table 1 shows descriptive statistics of dependent and independent study variables during
2016/17 to 2020/21. It consists of mean, SD, minimum and maximum.
Table 1
Descriptive Statistics
Variables Mean Standard Deviation Minimum Maximum
NPM 0.264 0.273 0.01 1.11
ER 0.297 0.291 0.002 1.53
FL 0.675 0.187 0.17 0.95
CR 0.521 0.330 0.06 1.18
LnSIZE 22.665 1.162 20.98 25.35
Ln AGE 2.794 0.627 0.69 4.11
Source: Annual Reports
Table 1 reveals that net profit margin (NPM) of the selected insurance company in study
ranges from minimum 0.01 to maximum 1.11. The mean value and standard deviation of
0.264 and 0.273 respectively. In terms of expense ratio (ER), the value ranges from
minimum 0.002 to maximum 1.53 with average of 0.297 and the standard deviation of
0.291. Financial leverage (FL) ranges from minimum 0.17 to maximum 0.95 with a mean
value and standard deviation of 0.675and 0.187 respectively. Claim ratio (CR) falls within

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the range of minimum 0.06 to maximum 1.18 and the size of the company Ln SIZE from
20.98 to 25.35. Similarly, the age of the company falls within the range of minimum 0.69 to
maximum 4.11.
Correlation Analysis
The correlation analysis demonstrates an association between the dependent and
independent study variables. Bivariate Pearson correlation coefficients related to various
variable pairs are shown in Table 2.
Table 2
Correlation Coefficients of Variables

Variables NPM ER FL CR Ln SIZE Ln AGE

NPM 1
ER -.341** 1
FL -.047 -.195 1
CR -.302** .156 .228* 1
** ** **
Ln SIZE .361 -.318 .530 -.012 1
* *
Ln AGE -.017 .240 .258 .080 -.168 1
** Significant at the 0.01 level (2-tailed).
* Significant at the 0.05 level (2-tailed).
Source: Annual Reports
Table 2 demonstrates that although some of them are statistically significant, the
correlations between various pairs of explanatory variables are also generally lower. The net
profit margin (NPM) is significantly negatively related with expense ratio (ER) and claim
ratio (CR). Coefficients are -0.341 and -0.302 respectively and indicates decrease in expense
ratio and claim ratio, increases profitability (NPM) of insurance companies. Results are
consistent with the study of Ortynski (2016) and inconsistent with the study of Bhattarai
(2020). Similarly, it also shows the significant positive correlation between profitability
(NPM) and company size (LnSIZE) of correlation coefficient 0.316. The results show that
increasing the size of a corporation increases its net profit margin, and vice versa. This
finding is consistent with research by Charumathi (2012), Ortynski (2016), Alomari (2017),
Banerjee and Majumdar (2018), Bhattarai (2020) and Wolde et al. (2020). Similarly, net
profit margin (NPM) is negatively insignificant with financial leverage (FL) and age of the
company (Ln AGE). The findings imply that there is no association between financial
leverage and firm age in terms of insurance company’s profitability in Nepal.

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Regression Analysis
Regression analysis shows the effect of independent factors (expense ratio, financial
leverage, claim ratio, firm size, and company age) on the dependent variable (net profit
margin).
Table 3
Regression results of ER, FL, CR, Ln SIZE and Ln AGE on NPM
Collinearity
Variables Coefficient Std. Error T Sig. Statistics
Tolerance VIF
Constant 3.981 0.599 6.649 .000
ER -0.397 .090 -4.398 .000 .817 1.223
FL 0.484 .175 2.773 .007 .534 1.872
CR -0.258 .077 -3.364 .001 .888 1.126
Ln SIZE 0.162 .027 -6.087 .000 .592 1.690
Ln AGE -0.040 .044 -.916 .363 .754 1.327
2 2
R = 0.474Adj. R = 0.436F-stat.= 12.442 P-value = 0.00
Source: Annual Reports
Table 3 presents the outcome of the regression model to investigate how specific variables
affect the profitability of insurance companies in Nepal. R2 and its adjusted R2 values are
0.474 and 0.436, respectively. The regression model's total explanatory power is 47.4
percent. This indicates that variations in the explanatory variables—ER, FL, CR, Ln SIZE,
and Ln AGE could explain 47.4 percent of the variation in insurance companies'
profitability. F statistics, which p-value (0.000) is significant that represents the model is
fairly fitted statistically. The absence of multicollinearity is shown by VIF for each
independent variable that is less than 10. The claim ratio (CR), financial leverage (FL),
expense ratio (ER), and company size (Ln SIZE) all have a major impact on the insurance
companies' profitability (NPM). The profitability (NPM) of Nepalese insurance companies
is significantly impacted negatively by the expense ratio (ER) and claim ratio (CR). The
results indicate that one unit decrease in expense ratio and claim ratio result in an increase in
net profit margin and vice-versa of the insurance companies. These results are consistent
with Ortynski (2016) and inconsistent with Bhattarai (2020). Similarly, there is significant
positive effect of financial leverage (FL) and size of company (Ln SIZE) on profitability
(NPM) of insurance companies in Nepal. The results reveal that an increase of one unit in
financial leverage (FL) and size of company (Ln SIZE) results in an increase in profitability
(NPM) of insurance companies. The results are consistent with the study of Charumathi
(2012), Ortynski (2016), Alomari (2017), Banerjee and Majumdar (2018), Bhattarai (2020)

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and Wolde et al. (2020). The results also show that the profitability (NPM) of insurance
companies in Nepal is not significantly impacted by the age of the company (Ln AGE).

Conclusion
An organization's profitability reflects its capacity to turn a profit on all of its business
activities. Profitability of the company is major concern as well as major indicator of the
financial performance of any business organizations. It also determines the existence of the
company in the competitive market. There is a significant role of insurance companies in the
Nepalese economy. The goal of this study is to examine the factors that affect Nepalese
insurance firms' profitability. This study, which includes 75 observations encompassing the
years 2016/17 to 2020/21, is based on secondary data from 15 sample insurance companies.
The study findings indicate that the profitability of insurance companies in Nepal is
influenced by various factors, including the expense ratio, financial leverage, claim ratio,
and company size. The profitability of insurance firms in Nepal is positively impacted by
financial leverage and company size, whereas expense ratios and claim ratios have a
significant negative impact. The result also reveals that there is no effect of age of company
on profitability of the insurance companies.
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