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Revisiting optimal investment strategies of value-maximizing insurance firms

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  • Koch-Medina, Pablo
  • Moreno-Bromberg, Santiago
  • Ravanelli, Claudia
  • Šikić, Mario

Abstract

We study capital management and investment decisions of a value-maximizing insurance firm with a broad ownership base in a discrete-time setting. We highlight that the valuation measure used to determine the value of the cash flows to shareholders should reflect two economically sound requirements: market-consistency and indifference to idiosyncratic risk. We provide a rigorous construction of this economic valuation measure and use it to derive the optimal capital-management and investment strategies that realize the economic value of the firm. Our objective is to shed light on the controversial question of whether insurers should invest in liquidly-traded risky assets. Decomposing firm value into net tangible value, default option value, and franchise value, we find that whether to take investment risk is optimal or not essentially depends on the tradeoff between the impact of investment risk on the owner’s option to default and on the firm’s franchise value. A variety of numerical examples illustrate how changes in the regulatory and financial environment can result in materially different optimal investment strategies.

Suggested Citation

  • Koch-Medina, Pablo & Moreno-Bromberg, Santiago & Ravanelli, Claudia & Šikić, Mario, 2021. "Revisiting optimal investment strategies of value-maximizing insurance firms," Insurance: Mathematics and Economics, Elsevier, vol. 99(C), pages 131-151.
    • Handle: RePEc:eee:insuma:v:99:y:2021:i:c:p:131-151
    DOI: 10.1016/j.insmatheco.2021.03.013
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    More about this item

    Keywords

    Insurance firm; Default option; Franchise value; Dividend payments; Investment strategy; Market-consistent valuation;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy

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