Risk Management, Capital Budgeting and Capital Structure Policy for Insurers and Reinsurers

Kenneth Froot

No 10184, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper builds on Froot and Stein (1998) in developing a framework for analyzing the risk allocation, capital budgeting, and capital structure decisions facing insurers and reinsurers. The model incorporates three key features: i) value-maximizing insurers and reinsurers face product-market as well as capital market imperfections that give rise to well-founded concerns with risk management and capital allocation; ii) some, but not all, of the risks they face can be frictionlessly hedged in the capital market; iii) the distribution of their cashflows may be asymmetric, which alters the demand for underwriting and hedging. We show that these features result in a three-factor model that determines the pricing and allocation of risk and the optimal capital structure of the firm. This approach allows us to integrate these features into: i) the pricing of risky investment, underwriting, reinsurance, and hedging; and ii) the allocation of risk across all of these opportunities, and the optimal amount of surplus capital held by the firm.

JEL-codes: G20 G31 (search for similar items in EconPapers)
Date: 2003-12
Note: AP CF
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Published as Froot, Kenneth A. “Risk Management, Capital Budgeting and Capital Structure Policy for Insurers and Reinsurers.” Journal of Risk and Insurance 74, 2(June 2007): 273-299.

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Journal Article: Risk Management, Capital Budgeting, and Capital Structure Policy for Insurers and Reinsurers (2007)
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