Value Creation in the Insurance Industry

Abstract

Using the insights of current research in corporate finance and financial institutions, the authors briefly present a consistent economic framework for looking at insurance. Shareholders of insurance companies provide risk capital that is invested in financial assets and therefore earns the market return of the assets it is invested in. However, due to the legal and fiscal environment insurance companies are in, they have a competitive disadvantage at investing, and this gives rise to frictional capital costs. The core competence of insurers is in managing the size of these frictional capital costs. Insurers must ensure that they can sell insurance for a price in excess of what they need to produce the cover they sell and compensate the incurred frictional costs on risk capital. It is through the ability to do so that insurers create shareholder value.

On the optimality of proportional reinsurance

“…So one may argue that less capital needs to be remunerated from the reinsurer's point of view. On the other hand, one may argue that the reinsurer's shareholders may require a higher cost of capital due to the agency costs (see Hancock et al (2001) for details) that apply when underwriting a business that is less well understood by the reinsurer than the primary insurer. This means that ceding companies should provide as much information as possible to reinsurers in order to reduce these agency costs.…”

EVA/RAROC vs. MCEV Earnings: A Unification Approach

“…Value creation thus is 8 See, for example, Hancock et al (2001);Walhin (2006). 9 See Liebwein (2006).…”

“…As a discount rate, a risk-free rate, derived from a 54 In an economic framework, such as embedded value, the equity capital is typically composed of the difference between the market value of assets and the market value of liabilities, that is, NAV (see, e.g. Hancock et al, 2001;Danhel and Sosik, 2004). For the purpose of our comparison between EVA/ RAROC and MCEV earnings we thus use NAV for equity capital.…”

“…35 See, for example, Cummins (2000); Koller et al (2005); Gru¨ndl and Schmeiser (2007). 36 See, for example, Hancock et al (2001); Danhel and Sosik (2004). 37 See, for example, Sheldon and Smith (2004); Exley and Smith (2006 Exley and Smith 7 show that the market value of equity, defined as the present value of all future dividends, is the sum of the book value of equity and MVA.…”

Insurance Market Development in the Former Yugoslav Republics, Non-EU Countries

“…The mutual insurance company is a company that has no basic assets and which is in a possession of the policy bearers. (Hancock, Huber & Koch, 2002) A committee of directors is being voted and they manage the company and run the business. All assets belong to the owners of the policies and they might be paid off to them in a form of dividends or reduced premiums.…”