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Enterprise Risk Management, Insurer Value Maximisation, and Market Frictions*

  • Shaun Yow (a1) and Michael Sherris (a2)
Abstract

Enterprise risk management has become a major focus for insurers and reinsurers. Capitalization and pricing decisions are recognized as critical to firm value maximization. Market imperfections including frictional costs of capital such as taxes, agency costs, and financial distress costs are an important motivation for enterprise risk management. Risk management reduces the volatility of financial performance and can have a significant impact on firm value maximization by reducing the impact of frictional costs. Insurers operate in imperfect markets where demand elasticity of policyholders and preferences for financial quality of insurers are important determinants of capitalization and pricing strategies. In this paper, we analyze the optimization of enterprise or firm value in a model with market imperfections. A realistic model of an insurer is developed and calibrated.

Frictional costs, imperfectly competitive demand elasticity, and preferences for financial quality are explicitly modelled and implications for enterprise risk management are quantified.

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Acknowledgement: The authors acknowledge financial support from Australian Research Council Discovery Grants DP0663090 and DP0556775 and support from the UNSW Actuarial Foundation of the Institute of Actuaries of Australia. Support from Georgia State University 2007 Bowles Symposium and the ERM Symposium is gratefully acknowledged. Yow acknowledges the financial support of Ernst and Young and the award of the Faculty of Business Honours Year Scholarship.

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References
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ASTIN Bulletin: The Journal of the IAA
  • ISSN: 0515-0361
  • EISSN: 1783-1350
  • URL: /core/journals/astin-bulletin-journal-of-the-iaa
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