Risk-sharing benefits and the capital structure of insurance companies

Hans Degryse, Cynthia Van Hulle and Kristien Smedts

No 11838, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Providing risk-sharing benefits to risk-averse policy holders is a primary function of insurance companies. We model that policy holders are paying a fee over the present value of indemnifications (i.e., technical provisions) to enjoy these risk-sharing benefits. This fee implies that a capital structure largely consisting of technical provisions is optimal for insurance firms, making the traditional Modigliani-Miller logic inappropriate for them. To support the issuance of technical provisions with socially desirable properties, insurance firms choose a solvency risk target vis-Ã -vis policy holders and maintain a minimal surplus consistent with this risk choice to absorb losses. We show that the Modigliani-Miller logic applies to the composition of this loss-absorption capacity. This explains why insurance companies may use, next to equity and technical provisions, financial debt in supporting their activities.

JEL-codes: G22 G32 (search for similar items in EconPapers)
Date: 2017-02
New Economics Papers: this item is included in nep-cfn, nep-ias and nep-rmg
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