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Corporate Reinsurance Utilisation and Capital Structure: Evidence from Pakistan Insurance Industry

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Abstract

The core objective of this work was to define significant determinants of corporate reinsurance utilisation in the life and non-life insurance industries in Pakistan based on the corporate demand for insurance theory, the bankruptcy cost argument, the agency cost theory, the risk-bearing hypothesis and the renting capital hypothesis. It also assessed which of these two insurance sectors has greater demand for reinsurance. Covering 33 insurance companies (6 life and 27 non-life insurance companies) over the period 2002–2012, the study outcomes show that some factors have a more significant impact on reinsurance purchases by insurance companies than others. Solvency risk, underwriting risk, firm performance, rate of interest and business mix are shown to be significant factors in defining the demand for reinsurance, but they influence reinsurance utilisation differently in the life and non-life branches. Only the variables firm size and inflation rate show similar results in both insurance branches in Pakistan, in contrast to the mixed outcomes generated by other variables of interest. The study further concluded that life insurance firms with high leverage levels lean more towards reinsurance purchases and solvency risk than non-life stock insurance firms operating in Pakistan.

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Notes

  1. Shiu (2016).

  2. Wehrhahn (2009).

  3. Swiss Re (1999).

  4. This study focuses on external reinsurance, in contrast to internal or coinsurance activity in Pakistan, due to the difficulty in unravelling external reinsurance from coinsurance activates. Insurance accounting laws in Pakistan do not require separate disclosure of such information in financial statements, and much of the reinsurance business in Pakistan is being underwritten by foreign reinsurers. For this reason, reinsurance data are considered as external reinsurance figures.

  5. Ho (2016).

  6. e.g. Borch (1968).

  7. Mayers and Smith (1990).

  8. Garven and Lamm-Tennant (2003).

  9. Shiu (2011).

  10. Modigliani and Miller (1958).

  11. Titman and Wessels (1988).

  12. Carson and Hoyt (1995).

  13. Altuntas et al. (2015).

  14. http://www.sbp.org.pk/FSR/2013/FirstHalf/pdf/Chapter-7.pdf.

  15. http://store.bmiresearch.com/pakistan-insurance-report.html.

  16. Bartram et al. (2009).

  17. Graham and Rogers (2002).

  18. Aunon-Nerin and Ehling (2008).

  19. Dionne and Triki (2004).

  20. Adams et al. (2008).

  21. Cole and McCullough (2006).

  22. MacMinn (1987).

  23. Plantin (2006).

  24. Zou and Adams (2008).

  25. Cummins et al. (2002); Cummins and Doherty (2002).

  26. Cummins et al. (2008).

  27. Krvavych and Sherris (2004).

  28. Froot (2007).

  29. Lee and Lee (2012).

  30. Culp and O'Donnell (2009).

  31. Liu et al. (2016).

  32. Hoerger et al. (1990).

  33. Shortridge and Avila (2004).

  34. Powell and Sommer (2007).

  35. Kader et al. (2010).

  36. Chang and Tsai (2014).

  37. Re (2002).

  38. Baur et al. (2004).

  39. Pitselis (2008).

  40. Adams (1996).

  41. Chen et al. (2001).

  42. Malik (2011).

  43. Al-Shami (2008).

  44. Adiel (1996).

  45. Cummins et al. (2012).

  46. Lee and Lee (2011).

  47. Kader et al. (2010); Lee and Lee (2011).

  48. Mayers and Smith (1990); Chen et al. (2001); Garven and Lamm-Tennant (2003); Cole and McCullough (2006); Lee and Lee (2011).

  49. Frank and Goyal (2009).

  50. Kozak (2011).

  51. Grace and Hotchkiss (1995).

  52. Browne and Hoyt (1995).

  53. Wooldridge (2006).

  54. Greene (2008).

  55. A test for endogeneity suggested by Hausman (1978) was conducted to remove endogeneity in the models. The Durbin chi-square statistics and the p-value showed that the problem of endogeneity prevails because the p-values were statistically significant at the 5 per cent level in both the non-life and life insurance sector models, stating that the variable LEV in Equation (i) and (iii) and REINS in Equation (ii) and (iv) are endogenous variables.

  56. Lags were utilised for controlled variables to address the problem of endogeneity per Cole and McCullough (2006) and Shiu (2011).

  57. Control variables are taken from the previous studies on reinsurance and leverage by Hoerger et al. (1990), Titman and Wessels (1988), Chen et al. (2001), Garven and Lamm-Tennant (2003), Cole and McCullough (2006) and Shiu (2011).

  58. Tests were done to check the validity of the instruments utilising STATA, where they were reported to be valid instruments in both models.

  59. A 12-month KIBOR (Karachi Interbank Offered Rate) obtained from the State Bank of Pakistan (www.sbp.org.pk) was used for the rate of inflation. Because of the unavailability of the yearly KIBOR rates for the years 2002 and 2003, six-month average KIBOR rates were included in the study. Moreover, the consumer price index was used as a proxy for the inflation rates obtained from the data sources of the World Bank (www.worldbank.org).

  60. The Breusch–Pagan test results generated from STATA of all four equations are provided in Appendices A and B.

  61. The Hausman test results generated from STATA of all four equations are provided in Appendix A.

  62. The GMM approach was first examined for the models, which generated insignificant results with downward-biased standard errors because of the unsuitability of the approach for small samples, as evidenced by Arellano and Bond (1991).

  63. The endogeneity test results generated from STATA are provided in Appendix A.

  64. Tests determining whether the instruments used were strong or weak are provided in Appendix A.

  65. Mayers and Smith (1990); Chen et al. (2001); Garven and Lamm-Tennant (2003).

  66. The results pertaining to the quadratic specifications are listed in Appendix B.

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Author information

Authors and Affiliations

  1. PhD Scholar, National College of Business Administration & Economics, Lahore, Pakistan

    Sana Sheikh

  2. Assistant Professor, College of Business Administration, Imam Abdulrahman Bin Faisal University, Dammam, Saudi Arabia

    Ali Murad Syed

  3. PhD Scholar, University of Management & Technology, Lahore, Pakistan

    Syed Sikander Ali Shah

Authors
  1. Sana Sheikh
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  2. Ali Murad Syed
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  3. Syed Sikander Ali Shah
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Corresponding authors

Correspondence to Sana Sheikh, Ali Murad Syed or Syed Sikander Ali Shah.

Appendices

Appendix A

Serial no.

List of non-life insurance companies

Name of insurance companies

Listed at Pakistan stock exchange

 

Public sector

1

National Insurance Company Limited

Listed

2

Pakistan Reinsurance (Pakistan Insurance Corporation Limited)

Listed

 

Private sector

3

Adamjee Insurance Company Limited (General Insurance)

Listed

4

Alpha Insurance Company Limited

 

5

Asia Insurance Company Limited

Listed

6

Askari General Insurance Company Limited

Listed

7

Atlas Insurance Limited (formerly Muslim Insurance Company Limited)

Listed

8

Capital Insurance Company Limited

 

9

Central Insurance Company Limited (Cyan Limited)

 

10

Century Insurance Company Limited

Listed

11

East West Insurance Company Limited

Listed

12

EFU General Insurance Limited

Listed

13

Habib Insurance Company Limited

Listed

14

International General Insurance Company Limited

Listed

15

New Jubilee Insurance Company Limited

Listed

16

PICIC Insurance Limited

Listed

17

Premier Insurance Company of Pakistan Limited

Listed

18

Reliance Insurance Company Limited

Listed

19

Saudi Pak Insurance Company Limited

 

20

Security General Insurance

 

21

Shaheen Insurance Company Limited

Listed

22

Silver Star Insurance Company Limited

Listed

23

The Cooperative Insurance Society of Pakistan Limited

 

24

The Crescent Star Insurance Company Limited

Listed

25

The Pakistan General Insurance Company Limited

Listed

26

The United Insurance Company of Pakistan Limited

Listed

27

The Universal Insurance Company Limited

Listed

Serial no.

List of life insurance companies

Name of insurance companies

Listed at Pakistan stock exchange

 

Public sector

1

State Life Insurance Corporation of Pakistan

Listed

 

Private sector

2

Adamjee Insurance Company Limited (Life Insurance)

Listed

3

American Life Insurance Company

 

4

East West Life Assurance Company

Listed

5

EFU Life Assurance Limited

Listed

6

New Jubilee Life Insurance Company Limited

Listed

For the non-life insurance sector

figure a

For the life insurance sector

figure b

Appendix B: Robustness and sensitivity test

Results for Equation (i)

Effects of leverage on reinsurance in the non-life insurance sector

Dependent variable = REINS

Two-stage least-squares regression coefficients

Independent variables

Expected sign

LEVSq

+

−0.001***

  

(0.000)

URW

+

0.530***

  

(0.182)

LnSIZE

−

−0.260

  

(1.899)

GROW

+

23.092

  

(32.214)

EXP

+

−1.648***

  

(0.191)

INT

−

−3.341

  

(2.644)

INF

+

4.138**

  

(1.921)

BMIXI

+

0.836

  

(0.676)

BMIXII

+

0.470

  

(0.713)

BMIXIII

+

1.033*

  

(.073)

BMIXIV

+

0.394

  

(0.719)

L2.LEVSq

 

−0.000

  

(0.000)

Constant

 

59.302

R 2

 

0.302

  1. Corporate reinsurance utilisation (REINS), financial leverage (LEV), firm underwriting risk (URW), firm size (LnSIZE), firm growth opportunities (GROW), firm profitability (ROE), firm performance (EXP), interest rate (INT) (INT), inflation rate (INF), proportion of fire & property damage (BMIXI), proportion of motor (BMIXII), proportion of marine aviation & transport (BMIXIII), proportion of miscellaneous (BMIXIV).
  2. ***Significance at 1 per cent.
  3. **Significance at 5 per cent.
  4. *Significance at 10 per cent.

Results for Equation (ii)

Effects of reinsurance on leverage in non-life insurance sector

Dependent variable = LEV

Two-stage least-squares regression coefficients

Independent variables

Expected sign

REINSSq

+

−0.000***

  

(0.000)

URW

+

0.211*

  

(0.142)

LnSIZE

−

−0.606

  

(1.258)

GROW

+

2.518

  

(23.967)

ROE

−

−0.178

  

(0.202)

INT

−

−4.804***

  

(1.924)

INF

+

0.6544

  

(1.442)

BMIXI

+

0.177

  

(0.433)

BMIXII

+

0.543

  

(0.456)

BMIXIII

+

2.190***

  

(0.410)

BMIXIV

+

1.535***

  

(0.439)

L1.REINSSq

 

−0.000

  

(0.000)

Constant

 

4.441

R 2

 

0.318

  1. Corporate reinsurance utilisation (REINS), financial leverage (LEV), firm underwriting risk (URW), firm size (LnSIZE), firm growth opportunities (GROW), firm profitability (ROE), firm performance (EXP), interest rate (INT) (INT), inflation rate (INF), proportion of fire & property damage (BMIXI), proportion of motor (BMIXII), proportion of marine aviation & transport (BMIXIII), proportion of miscellaneous (BMIXIV).
  2. ***Significance at 1 per cent.
  3. **Significance at 5 per cent.
  4. *Significance at 10 per cent.

Results for Equation (iii)

Effects of leverage on reinsurance in life insurance sectors

Dependent variable = REINS

Two-stage least-squares regression coefficients

Independent variables

Expected sign

LEVSq

+

0.000*

  

(0.000)

URW

+

−9.071***

  

(0.191)

LnSIZE

−

−0.511

  

(2.940)

GROW

+

−170.478

  

(456.323)

EXP

+

−0.043

  

(0.090)

INT

−

1.483

  

(1.383)

INF

+

0.583

  

(1.062)

L2.LEVSq

 

0.000

  

(0.000)

Constant

 

15.312

R 2

 

0.366

  1. Corporate reinsurance utilisation (REINS), financial leverage (LEV), firm underwriting risk (URW), firm size (LnSIZE), firm growth opportunities (GROW), firm profitability (ROE), firm performance (EXP), interest rate (INT) (INT), inflation rate (INF).
  2. ***Significance at 1 per cent.
  3. **Significance at 5 per cent.
  4. *Significance at 10 per cent.

Results for Equation (iv)

Effects of reinsurance on leverage in life insurance sector

Dependent variable = LEV

Two-stage least-squares regression coefficients

Independent variables

Expected sign

 

REINSSq

+

−0.098*

  

(0.112)

URW

+

20.822*

  

(14.457)

LnSIZE

−

467.737***

  

(234.200)

GROW

+

4471.767

  

(41573.100)

ROE

−

−0.219

  

(10.186)

INT

−

−104.272

  

(99.395)

INF

+

10.998

  

(77.216)

L1.REINSSq

 

−0.165

  

(0.113)

Constant

 

−9640.230

Adjusted R 2

0.029

  1. Corporate reinsurance utilisation (REINS), financial leverage (LEV), firm underwriting risk (URW), firm size (LnSIZE), firm growth opportunities (GROW), firm profitability (ROE), firm performance (EXP), interest rate (INT) (INT), inflation rate (INF).
  2. ***Significance at 1 per cent.
  3. **Significance at 5 per cent.
  4. *Significance at 10 per cent.

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Sheikh, S., Syed, A.M. & Ali Shah, S.S. Corporate Reinsurance Utilisation and Capital Structure: Evidence from Pakistan Insurance Industry. Geneva Pap Risk Insur Issues Pract 43, 300–334 (2018). https://doi.org/10.1057/s41288-017-0063-2

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