Influence of capital structure and operational risk on profitability of life insurance industry in Taiwan

Purpose - The solvency of insurance companies is closely related to the policyholders, and consequently regulators in Taiwan pay considerable attention to this area. Several studies have demonstrated a close correlation among capital structure, operational risk and profitability. This study seeks to provide evidence regarding the influence of capital structure and operational risk on profitability of the life insurance industry in Taiwan. Design/methodology/approach - Structural equation modeling, which involves factor-analysis and path-analysis, is used to justify the relationship among capital structure, operational risk and profitability. Adding the macroeconomic latent variable to the model as a control variable demonstrates that the macroeconomic latent variable positively influences capital structure, operational risk and profitability. Findings - The study leads to four key findings. First, according to the empirical result, the research model has excellent goodness-of-fit. That is to say, using multiple financial indices suitably measures the specific financial factors. Second, the capital structure exerts a negative and significant effect on operational risk. Third, there is no reciprocal relationship but a one-way effect between capital structure and operational risk. Fourth, the operational risk exerts a negative and significant effect on profitability. Practical implications - The empirical result shows the profitability decreased with the higher equity ratio. Hence, the regulatory organizations must urge insurance companies to effectively diversify their investments and employ risk avoidance strategies. Effective use of hedging and diversifying will help to divide risk and create financial revenue. Originality/value - The study proposes that the government should loosen investment restrictions and develop other instruments to assist risk-based capital in checking the financial condition of insurance companies.