Lessons from the Financial Crisis on Risk and Capital Management: The Case of Insurance Companies

9 Pages Posted: 16 Dec 2009

See all articles by Neil A. Doherty

Neil A. Doherty

University of Pennsylvania - Insurance & Risk Management Department; University of Pennsylvania - Business & Public Policy Department

Joan Lamm-Tennant

affiliation not provided to SSRN

Abstract

Finally, the authors argue that risk management can raise the confidence of investors in their estimates of future growth by removing the “noise” in earnings that comes from bearing non-core risks, thereby making current earnings a more reliable guide to future earnings. In support of this possibility, the authors provide evidence showing that, for a given level of reported return on equity (ROE), (re)insurers with more stable ROEs have higher price-to-book ratios, suggesting investors' willingness to pay a premium for the stability provided by risk management. Second, risk management can create value by securing sources of capital that, like contingent capital, can be used to fund profitable growth opportunities that tend to arise in periods following large losses. Insurers can manage solvency risk by using Enterprise Risk Management (ERM) models to limit the probability of financial distress to levels consistent with the firm's specified risk tolerance. While ERM models are effective in managing “known” risks, we discuss three practices widely used in the insurance industry to manage “unknown” and “unknowable” risks using the logic of real options - slack, mutualization, and incomplete contracts. This article proposes that risk management be viewed as an integral part of the corporate value-creation process - one in which the concept of economic capital can provide companies with the financial cushion and confidence to carry out their strategic plans.

Suggested Citation

Doherty, Neil A. and Lamm-Tennant, Joan, Lessons from the Financial Crisis on Risk and Capital Management: The Case of Insurance Companies. Journal of Applied Corporate Finance, Vol. 21, Issue 4, pp. 52-59, Fall 2009. Available at SSRN: https://ssrn.com/abstract=1523984 or http://dx.doi.org/10.1111/j.1745-6622.2009.00249.x

Neil A. Doherty (Contact Author)

University of Pennsylvania - Insurance & Risk Management Department ( email )

Philadelphia, PA 19104-6365
United States
215-898-7652 (Phone)
215-898-0310 (Fax)

University of Pennsylvania - Business & Public Policy Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6372
United States

Joan Lamm-Tennant

affiliation not provided to SSRN ( email )

Register to save articles to
your library

Register

Paper statistics

Downloads
7
Abstract Views
730
PlumX Metrics