Determinants of corporate demand for Islamic and conventional insurance in Malaysia

Abstract

Even though the modem financial theory of the Capital Asset Pricing Model (CAPM) developed by Sharpe (1964), Lintner (1965) and Mossin (1966) implies that variation in the pure risks that a firm assumes does not affect the firm`s value, some studies like Mayers and Smith (1990); Yamori (1999), Hoyt and Khang (2000); Zou et. al. (2003); Daniel and Paul (2003) and Zou and Adam (2006) suggest that insurance helps managers to alleviate business risks such as bankruptcy following a major accidental loss. The general takaful industry in Malaysia has recorded progressive growth, particularly over the last six years. Demand for general takaful products has continuously risen, as reflected in the improvement in contributions (premiums) of general takaful. Besides that, the conventional insurance industry also continued to register positive growth in 2005, buoyed by stronger growth in the general insurance sector. In addition, over 50 percent of total premiums were from the business corporation for takaful and conventional insurance in Malaysia. Hence, there appears to be a conflict in the implications of the CAPM and the actual behaviour of corporations in their takaful and conventional insurance demand in Malaysia. Moreover, although numerous theoretical and empirical articles investigate corporate demand for conventional insurance, empirical tests of the theories have never been conducted for Islamic insurance which is known as takaful. The main contribution of this study is that it is the first attempt to empirically investigate the determinants of corporate demand for takaful and also conventional insurance for property or assetbased risk exposures of non-financial corporations using data from the main board of public listed companies at Bursa Malaysia. Besides that, the unique data of this study i.e. pooled data of corporate demand for conventional insurance and takaful is performed to show the overall perspective of the corporate demand for insurance in Malaysia. Factors like underinvestment and leverage, growth opportunities, expected bankruptcy costs, tax considerations, managerial ownership, company size and regulatory environment have been examined in this study to identify the determinants of corporate demand for Islamic and conventional insurance in Malaysia. The data covers a five-year period from year 2002 - 2006. Three models of panel data estimation were employed, namely GLS with non-effects, GLS with fixed effects and GLS with random effects. The findings are robust to alternative specifications of the model i.e. GLS with the fixed effects model that help us to control for unobservable heterogeneity. The findings show that leverage, expected bankruptcy costs, tax considerations, company size, and managerial ownership play an important role in determining the corporate demand for conventional insurance and takaful in Malaysia. These findings are also parallel with the findings of the pooled data of the corporate demand for conventional insurance and takaful to represent the overall perspective of the corporate demand model for insurance in Malaysia. This study gives some important implications for various groups like the insurers and takaful operators, the shareholders and creditors as well as the regulators in reflecting with the financial exposition factors that determine the corporate demand for Islamic and conventional insurance in Malaysia.