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Risk-sharing benefits and the capital structure of insurance companies

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  • Degryse, Hans
  • Van Hulle, Cynthia
  • Smedts, Kristien

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.

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  • Degryse, Hans & Van Hulle, Cynthia & Smedts, Kristien, 2017. "Risk-sharing benefits and the capital structure of insurance companies," CEPR Discussion Papers 11838, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:11838
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    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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