Economic Valuation and Financial Management of an Insurance Firm
46 Pages Posted: 4 Aug 2018 Last revised: 29 Apr 2019
Date Written: April 26, 2019
We use a dynamic framework to address the questions: i) when should an insurance firm pay out dividends and raise (costly) capital and ii) when should an insurance firm take (liquid) investment risk. Financial decisions are made by a manager who strives to maximize firm value and operates in the presence of financial frictions and regulatory capital constraints. We show there is a unique pricing measure that is consistent with market prices and a broad ownership base and use it to compute the risk-adjusted net present value of cash flows to shareholders. We describe the capital and dividend strategies of the firm and show that, from a shareholder perspective, investment in risky assets can be value adding. Risky investments may add value by boosting the value of the option to default or, sometimes, by increasing the firm's franchise value.
Keywords: Insurance Firm, Default Option, Franchise Value, Dividend Payments, Investment Strategy, Market-Consistent Valuation
JEL Classification: G21, G28, G32, G35
Suggested Citation: Suggested Citation