Institute of Lay Adventist of Kigali (Inilak)

INSTITUTE OF LAY ADVENTIST OF KIGALI (INILAK)

INTERNAL CONTROL AND FINANCIAL PERFORMANCE OF INSURANCE COMPANIES IN RWANDA: A case of SORAS Kigali

(2011 - 2013)

A thesis submitted to the coordination of MBA program in partial fulfillment of the requirements for the Degree of

Master of Business Administration, Option of Accounting

MUSHIMIYIMANA Genereuse

Reg. No MBAKG/00051

January 2015

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ACCEPTANCE SHEET

This thesis entitled « INTERNAL CONTROL AND FINANCIAL PERFORMANCE OF INSURANCE COMPANIES IN RWANDA ». A case study SORAS Rwanda written and submitted by MUSHIMIYIMANA Genereuse in partial fulfillment of requirements for the degree of Master of Business Administration (Accounting) is hereby accepted and approved.

Dr. MOSES MATUNDURA

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Date Signed

Dr. GERVAIS NDAYIZEYE Dr. FAUSTIN GASHEJA

Examiner Examiner

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Date Signed Date Signed

Professor Dr. BIDERI ISHUHERI NYAMULINDA

MBA Programme Coordinator

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Date Signed

Dr Augustine RUTAMU

Dean of Faculty of Economic Sciences and Management

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Date Signed

DECLARATION AND COPYRIGHT

I Genereuse MUSHIMIYIMANA, hereby declare that this thesis is my own original work. To the best of my knowledge it contains no materials previously published or written by another person, nor material which to a substantial extent has been accepted for the award of any other degree or diploma at the INILAK or any other institution, except where due acknowledgement is made in the thesis. Any contribution made to the research by others, with whom I have worked at INILAK or elsewhere is explicitly acknowledged in the thesis.

I also declare that the intellectual content of this thesis is the product of my own work, except to the extent that assistance from others in the thesis’s design and conceptions or in style, presentation and linguistic expression is acknowledged.

Signature: …………………………….

Date……………………………………

No part of this thesis may be reproduced, stored in any retrieval system, or transmitted in any form or by any means without prior written permission of the author or the Coordination/Faculty at INILAK.

DEDUCATION

This work is dedicated to my beloved husband, BIKORIMANA Bernard, my beloved daughters and my sons for their love, support, and encouragement.

ACKNOWLEDGEMENT

The completion of this work has been existed due to the effort of many people through the timely appearance, encouragement and support. First of all, I wish to thank Almighty God for giving me strength and wisdom to finish this work.

Special thanks go to my supervisor Dr. Moses MATUNDURA for his supervision and guidance which led to completing this study. Thank you very much for the great job done.

My heartfelt thanks go to my husband and children who supported my absence at home up to the completion of this work.

I am deeply indebted to the administration of INILAK and all my lecturers who, in spite of many responsibilities, made this programme successful. I acknowledge that without all kind of supports from my Employer, Rwanda Revenue Authority, this study could not meet the timing fixed. I am also grateful to my fellow classmates for their commitment during the whole periods of MBA studies.

I owe my deepest sense of gratitude to all research participants SORAS staff who regardless of their activities willingly took their valuable time to participate in interview, and shared with me their broad knowledge on internal control and its effect to enterprise performance, which assisted me to complete this study. It might not be easy to mention everyone with the endeavours they put toward achieving this work; therefore I would like to thank all people who had been involved in the completion of this piece of writing. Their support and encouragement made me today become what I am with lots of inspiration and recognition in life.

May God bless you all!

MUSHIMIYIMANA Genereuse

ABSTRACT

The present study was mainly aimed at finding out the impact of internal control on financial performance in SORAS. Specifically, it has the following objectives: to find out the control system used in insurance company; to find out the impact of internal control systems on financial performance and to find out challenges faced in internal controls. A questionnaire and interview were used to collect data. Both qualitative and quantitative approaches were used to analyse data. It used descriptive statistics to analyse quantitative data and thematic analysis for qualitative data. The population was SORAS staff involved in internal control. This study was guided by the following research questions: What are control systems used in insurance companies? What are challenges faced in internal control? How does internal control affect financial performance? It was only limited to SORAS located in Kigali city from 2011 to 2013.The main findings include that the control systems used in SORAS are preventive and detective control systems. It was stated that both control systems are found more important because they help the company to follow everyday transactions and take corrective actions if necessary as soon as possible. It was agreed that internal control has a positive effect on financial performance since it helps in follow up daily transactions and appropriate reporting. Although the internal control is conducted regularly in SORAS, it is still constrained by some challenges including poor information sharing and giving misleading information which may lead to poor reporting. The study recommends the company to improve the ways of sharing information.

TABLE OF CONTENTS

Contents

ACCEPTANCE SHEET i

DECLARATION AND COPYRIGHT ii

DEDUCATION iii

ACKNOWLEDGEMENT iv

ABSTRACT v

TABLE OF CONTENTS vi

LIST OF TABLES ix

LIST OF FIGURES x

LIST OF ABBREVIATIONS AND ACRONYMS xi

CHAPTER ONE 1

GENERAL INTRODUCTION 1

1.1. BACKGROUND TO THE STUDY 1

1.2. STATEMENT OF THE PROBLEM 3

1.3. RESEARCH OBJECTIVES 4

1.4. RESEARCH QUESTIONS 4

1.5. SCOPE OF THE STUDY 5

1.6. SIGNIFICANCE OF THE STUDY 5

1.7. CONCEPTUAL FRAMEWORK 5

1.8. ORGANIZATION OF THE STUDY 6

1.9. DEFINITIONS OF KEY TERMS 7

CHAPTER TWO 8

LITERATURE REVIEW 8

2.1. DEFINITIONS 8

2.2. PURPOSES OF INTERNAL CONTROL 10

2.3. INTERNAL CONTROL FUNCTIONS 11

2.4. BENEFITS OF INTERNAL CONTROL 12

2.5. TYPES OF INTERNAL CONTROL 13

2.6. THREATS TO INTERNAL CONTROL 16

2.7. LIMITATIONS OF INTERNAL CONTROL 17

2.8. ELEMENT OF A GOOD INTERNAL CONTROL SYSTEM 19

2.9. INTERNAL AUDIT VERSUS INTERNAL CONTROL 23

2.10. MANAGEMENT AND INTERNAL CONTROL SYSTEM 24

2.11. ORGANISATIONAL FINANCIAL PERFORMANCE 24

2.12. PERFORMANCE IN INSURANCE COMPANIES 25

2.12.1. RETURN ON INVESTMENT RATIO 26

2.12.2. INTEREST RATE RISK 26

2.13. MEASURES OF FINANCIAL PERFORMANCE 26

2.13.1. SURVIVAL 27

2.13.2. LIQUIDITY 28

2.13.3 ACCOUNTABILITY 28

2.13.4. REPORTING 28

2.14. INTERNAL CONTROL SYSTEMS AND FINANCIAL PERFORMANCE 29

CHAPTER THREE 33

RESEARCH METHODOLOGY 33

3.1. INTRODUCTION 33

3.2. RESEARCH DESIGN 33

3.3. DATA COLLECTION METHODS 33

3. 4. TARGET POPULATION 34

3. 5. SAMPLING TECHNIQUES 34

3.6. SAMPLE SIZE 34

3.7. SOURCES OF DATA 34

3.8. DATA ANALYSIS 35

3.9. VALIDITY AND RELIABILITY 35

CHAPTER FOUR 36

PRESENTATION OF FINDINGS, ANALYSIS AND INTERPRETATION 36

4.0. HISTORICAL BACKGROUND OF SORAS SA 36

4.1 .DATA ANALYSIS OF INTERNAL CONTROL SYSTEMS 37

4.2. FINANCIAL PERFORMANCE OF SORAS LIFE 43

4.3. RELATIONSHIP BETWEEN INTERNAL CONTROL AND FINANCIAL PERFORMANCE 49

CHAPTER FIVE 52

CONCLUSION AND RECOMMENDATIONS 52

5.1. CONCLUSION 52

5.2. RECOMMENDATIONS 54

5.3. SUGGESTIONS FOR FURTHER RESEARCH 55

5.4. LIMITATIONS TO THE STUDY 55

REFERENCE 56

LIST OF TABLES

Table 1 Respondents’ age…………………………………………………………………36

Table 2 Respondent’s gender …………………………………………………………….36

Table 3 Respondent’s level of education…………………………………………………37

Table 4 Conducting internal audit………………………………………………………...39

Table 5 Evaluation of internal control…………………………………………………….39

Table 6 Calculation of Current ratio………………………………………………………43

Table 7 Calculation of Quick ratio………………………………………………………..44

Table 8 Calculation of Solvency ratio…………………………………………………….45

Table 9 Calculation of Efficiency ratio………………………………………………...... 46

Table 10 Calculation of Return on Assets-ROA…………………………………………...47

Table 11 Calculation of Return on Equity…………………………………………………48

LIST OF FIGURES

Figure 1 The conceptual framework………………………………………………………6

Figure 2 Respondent’s occupation……………………………………………………….38

Figure 3 Years of experience…………………………………………………………...... 39

LIST OF ABBREVIATIONS AND ACRONYMS

ACCA Association of Chartered of Certified Accountants

AG Assurance General

CCM Customer Communications Management

COSO Committee of Sponsoring Organization of the Treadway Commission

ECM Enterprise Content Management

GENIMMO La Générale de l’Immobilier

ICT Information and Communication Technology

INILAK Institute of Lay Adventist of Kigali

MBA Master of Business Administration

MVA Market Value Added

ROA Return On Asset

ROE Return On Equity

ROI Return On Investment

ROS Return On Sale

SA Sociétés Anonymes

SOCAR Société Commerciale d'Assurances et de Réassurance

SORAS Société Rwandaise d’Assurance

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CHAPTER ONE

GENERAL INTRODUCTION

1.1. BACKGROUND TO THE STUDY

Insurance company is considered as one of the most dynamic and important institutions in many countries. These companies are very important in accordance with the features and benefits to society. Nowadays, insurance companies are working hard to advantageously manage the change that surrounds them, as the complexity and volume of the interactions around them continue to mount (CCM & ECM, 2010).

To stay profitable in the highly challenging and competitive global market economy, all factors of production should be wisely managed (Nosrati et al., 2013). It is in this respect that internal control has gained much attention in many organizations to ensure that both policies and strategies are well implemented in order to achieve the set objectives.

Internal control consists of all forms of control including internal audit exercised at the entity level, established by management in accordance with its objectives and legal regulations; it also includes organizational structures, methods and procedures in order to improve the financial performance of a company.

For any company to evaluate its performance, a financial analysis is important. Financial performance analysis is the process of determining the operating and financial characteristics of a firm from accounting and financial statements. The goal of such analysis is to determine the efficiency and performance of firm’s management, as reflected in the financial records and reports. The analyst attempts to measure the firm’s liquidity, profitability and other indicators that the business is conducted in a rational and normal way; ensuring enough returns to the shareholders to maintain at least its market value (Rajesh et al. 2011).

For any organization to succeed, it is imperative to maintain a good system of internal control which keeps on showing them how it is being run in comparison to objectives set; and whenever deviations are found they are automatically corrected. With internal control insurance companies are able to achieve employment activities in accordance with the procedures and instructions retained formally validated, redefining goals, appropriate allocation of resources and the establishment and development of organizational systems and adequate information.

Establishing and monitoring organizational procedures and policies is the responsibility of internal control system that retained a key manifestation of the concept of modern management theory and practice and responsibility. For the private sector, internal control activities cover all economic entity, each of them individually or collectively, may be the weak link in the chain that affect the performance of procedural goals in an efficient entity

(Boulescu,2004).

According to Holmes and Burns (1995), internal control aims at assisting all members of management to discharge effectively their responsibility by furnishing them with the analysis appraisals, recommendations and pertinent comments concerning the activities reviewed. Besides, internal control deals with the control of transactions, systems and operations, and with the improvement of accounting methods from the point of view of efficiency. This plays an important role in improving the financial performance of insurance company because controls of all operations, transactions are carried out. In this view, Okosie (1995) stated that internal control is like the “heart” which regulates the organisational blood. He also compares internal control as the “brake and steering in a vehicle”. In his point of view, no business can succeed without internal control.

Due to bankruptcy and failure of some organizations, Rwandan insurance companies put much effort in establishing strong internal control systems in order to avoid such scandals in their organizations. It is in this respect that the present study aims at finding out the impact of internal control in improving the organisational financial performance.

1.2. STATEMENT OF THE PROBLEM

COSO (1992) explained internal control as an integrated framework, with direct involvement of the board of director, management and other key personnel to provide assurance that would pursue the achievement of the company’s objective. By COSO’s definition, internal control is a process, effected by an organizational board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories: effectiveness and efficiency of operations; reliability of financial reporting and compliance with applicable laws and regulations.

It is now recognized that a sound internal control process is critical to an entity’s ability to meet its established goals and maintain its financial viability.

Insurance companies have also to be well positioned to respond to the dynamics taking place and the changes impacting each companies and industry. It is necessary to be able to take advantage opportunities. All these require an organization to be able to control its operations and transactions effectively.

As a result of the increase in accounting scandals in recent years worldwide, the internal control function has received impressive attention as an important contributor to effective corporate governance and financial reporting (Prawitt et al., 2008). An internal control system issue has been found so significant to organization especially in the aspect of assurance of the reliability and accuracy of financial reports, beside it is a subject that receives too little attention in the management literature (Changchit at al. 2001).

Little is known about effect of internal control on financial performance of insurance companies in Rwanda. Specifically, no work has been written about the impact of internal controls on financial performance of insurance at SORAS. This study tries to investigate the weaknesses of insurance companies such as a lack of effectiveness of internal control, failed reports due to poor control systems, misappropriate of accounting policies & accounting systems, preventive & detection of fraud and financial reports are not made timely. It is in this respect that the present study is carried out to find out the impact of internal control on financial performance at SORAS.