Analysis of Change in Profitability due to Reinsurance Utilization and Leverage Levels: Evidence from Non-Life Insurance Sector of Pakistan

Abstract

This paper examines the relationship between profitability, reinsurance and leverage level of private sector non-life stock insurers of Pakistan. The value and significance of reinsurance and leverage levels is analyzed by observing their nature and benefits to the insurer, insurance industry and for financial system as a whole. The study further assesses whether the profitability of the non-life insurance companies dependent on the reinsurance operations and leverage level or not. Secondary data is taken from the annual financial reports of insurance companies over the period of 10 years from 2002-2011. A panel data regression model, Random Effect Model is used which reveals that the profitability is positively related with reinsurance utilization. The leverage levels have a significant negative impact on the profitability. However, the increased dependence on reinsurer decreases the profitability and hence the risk of insolvency may increase. Majority of the insurance companies in order to increase their underwriting capacity and to stabilize their earnings depend a lot on reinsurance and leverage, and this extensive use exposes them to the potential risk of insolvency.