Simulation of the Financial Planning Process of P-L Insurers

Abstract

This article reviews the investment-financing decision process of property and liability companies. It indicates the problems of measuring cost of capital and the need for an improved decision criterion for evaluating investment alternatives. A model is developed that simulates the long-run financing process of property and liability insurance companies. One of the key decision variables determined by the model is the rate of return required on new investments in order to produce management's desired earnings per share growth objective. Thus, the model links the investment and financing processes of property and liability insurance companies and provides decision makers probabilistic-oriented information for analyzing investment alternatives. One of the difficult problems in financial theory is the linking of the investment process and the long-run financing process. These two decision areas focus on longrun management decisions and are considered by some financial theorists to be the basis of the finance function.1 In recent years the analysis of the investmentfinancing decision process for property and liability insurance companies (PL Alexander A. Robichek and Stewart C. Myers, Optimal Financing Decisions (Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1965); James C. Van Horne, Financial Management and Policy (Englewood Cliffs, New Jersey: PrenticeHall, Inc., 1971). has been of interest to several authors.2 The objectives of this paper are to review the linkages of the investment-financing decision process for PL to develop a model that simulates the long-run financing process of property and liability insurance companies; and to offer a new measure for evaluating investment