Liquidity-Profitability Trade-off in the UK Insurance Industry: An Empirical Analysis

The study investigates the influence three liquidity metrics including current ratio, quick ratio and cash ratio have on two profitability indicators using ROA and ROE. The study employs panel data analysis of 10 UK insurance companies over a seven-year period (2017-2023). First the study used both random and fixed effect models before the Hausman test showed the fixed effect model should be used for analysis. Firm size and age are among the firm-specific characteristics that appear in the analysis through secondary data sources. Empirical data confirms the existence of connection points between liquidity performance indicators and profitability scores. The fixed effects model shows that current ratio has the most substantial positive influence on ROA (0.222911) and ROE (0.0292598). The association between quick ratio measurements and both profitability indicators (ROA: 0.0548891, p<0.002; ROE: 0.0218762, p<0.006) is identified as moderate and positive. "Research findings depict that cash ratio produces a direct positive connection to ROE (0.1590604, p<0.000) while creating an inverse relationship with ROA (-0.0913818, p<0.003). This contrasting effect can be explained through the trade-off theory perspective, where excess cash holdings benefit shareholders' returns by providing financial flexibility and reducing reliance on costly external financing during uncertain market conditions. However, the negative impact on ROA suggests that maintaining high cash reserves represents an opportunity cost, as these liquid assets generate lower returns compared to potential investments in productive operational assets specific to insurance underwriting. This divergence highlights the multifaceted nature of liquidity management decisions in insurance firms.