Market Endogenous Solvency and Dividend Policy

The value of insurance companies to the shareholders can be expressed in book values in the annual accounts, but it can also be assessed by evaluating the future expected cash flows to the owners of the firm. The paradoxical situation occurs that the shareholders' value approach guides many articles in modern insurance theory, but that dividend policy is not an issue which is addressed. This is probably due to the fact that Miller and Modigliani showed that in perfect capital markets dividend policy is irrelevant to the value of a company. Because insurance claims can be considered to be a peculiar form of corporate debt, the dividend irrelevance theorem of Miller and Modigliani might hold. We, however, assume in this article that the market for insurance coverage and the market for the concomitant insurance debt is far from perfect. Clients of insurance companies are not able to analyze the solvency of insurance companies perfectly, implying that the price of insurance will be determined by insurance market conditions and not as much by the solvency of the insurers that offer the insurance cover. The lack of responsiveness of clients implies that the amount of equity as well as dividend policy may affect the value of the insurance company to the shareholders. We therefore try to analyze the optimum level of equity for some given dividend distributions with a computerized search routine as well as the results of alternative dividend policies with simulation techniques.