The Effects of Probabilistic Insurance on the Capital Budgeting Decision in Respect of a Value Based Management

As empirical studies show, the policyholders' willingness to pay depends on the security level of the insurance cover. The choice of the security level determines the capital budgeting decisions and therefore the cost of capital, as well as th attainable insurance premiums. We call this cost of capital-effect and premium-effect. Hence, the choice of the security level seems to be an important aspect of value based management. In this context, the description of thepolicyholders' willingness to pay in dependence of the security level is of a special interest. In particular Wakker/Thaler/Tversky (1997) develop an explantion of the policyholders willingness to pay for probabilistic insurance based on Prospect Theory. In our paper we describe and compare the cost of capital-effect and the premium-effect for varying security levels, supported by an example. Under simplifying assumptions, our pragmatic model determine the value proposition of different security levels. Therefore, it generates important knowlefge for value based Management