Dynamic Capital Adequacy Theory for Insurance Companies in Developing Economies: Evidence from Nigeria

This study develops a dynamic capital adequacy theory for insurance companies operating in developing economy institutional environments and tests its predictions using panel data from Nigerian insurance companies. Conventional insurance capital adequacy theory, embedded in frameworks such as Solvency II, assumes well-functioning capital markets, stable regulatory enforcement, and reliable financial data, assumptions that are systematically violated in developing economies including Nigeria. This study proposes a Dynamic Developing Economy Solvency Model that incorporates three dimensions absent from standard theory: regulatory enforcement imperfection as a stochastic process affecting the probability that capital shortfalls are detected and corrected, market imperfection frictions in capital raising that make external capital costly and uncertain, and institutional quality drift driven by political economy and governance dynamics. The model is estimated using a 15-year panel of Nigerian insurance company financial data combined with regulatory enforcement action records and institutional quality indices. Dynamic panel GMM and structural estimation methods are employed. Predictions of the model regarding capital buffer holdings, dividend behaviour, and insolvency probability under different institutional quality scenarios are tested against the data. Findings support the model's prediction that Nigerian insurers maintain capital buffers significantly above regulatory minimums as a precaution against enforcement imperfection, and that institutional quality improvements are associated with more efficient capital management. The study contributes an original developing economy solvency theory and recommends a risk-sensitive regulatory capital framework calibrated to Nigeria's institutional environment.

Keywords: capital adequacy, insurance theory, developing economies, solvency, institutional quality.