Cash Flow Risk Management in the Ghanaian Insurance Industry (A Dynamic Factor Modelling Approach)

Abstract

This study investigated determinants of Cash Flow in the insurance industry, explained the time-varying patterns of Cash Flows and forecasted future Cash Flows for Cash Flow risk management. Sample financial data of 21 non-life insurance firms in Ghana from the year 2007 to 2015 was used for this Study. Statistical analyses were made using a combination of pooled ordinary least squares methods, principal component analysis and a novel Factor Augmented Autoregressive (FAAR) Model to incorporate capital management, risk management, financial (investment) management, firm characteristics, underwriting activities, and macroeconomic variables to forecast future Cash Flows. The study provided new evidence regarding the relationship of firms’ management activities with Cash Flow risk management. Findings indicate that Cash Flow in the Ghanaian insurance industry is significantly driven by capital ratio, short term and long term investment ratios and industry-specific variables such as reinsurance ratio and net premium received ratios. The results also validated the acute forecasting ability of FAAR (DFM) models in predicting future Cash Flows. In addition, the identification of possible variations in Cash Flows using the FAAR forecasting model can help firms to further apply different financial instruments to manage and control Cash Flow variations. i.e. Cash Flow Risks (Shortfalls). Findings imply that firms can generate favourable Cash Flows to meet future obligations such as dividend payments and unexpected insurance claims by controlling variables such as capital ratio, short term and long term ratios, reinsurance and net premium received to assets ratios.