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Insurance Company Finance and Investments.

Insurance Company Finance and Investments (American Institute For Property and Liability Underwriters), 1990. Reviewer: David C. Shimko, Assistant Professor of Finance, University of Southern California

As the forward states, "The Second Edition of Insurance Company Finance and Investments (ICFI) was written specifically to prepare students to meet the current educational objectives of the AIAF [Associate in Insurance Accounting and Finance] 113 course." The program assumes students have working knowledge of insurance principles and exposure to general accounting practices. It is recommended for technical accounting, statistical, financial and systems personnel of insurance companies.

The text was written in close concert with examination authorities. As such, it provides an excellent source for material related to the AIAF 113 exam. Students using the text to prepare for the exam will be satisfied that coverage is generally concise, exhaustive and accurate. To pass the exam, students need to study this book carefully.

Academics, practitioners and other students of finance interested in application of financial techniques to insurance problems may also be interested in this book. For these readers, I urge some caution.

Academics, practitioners and other students of finance interested in application of financial techniques to insurance problems may also be interested in this book. For these readers, I urge some caution.

Chapter 1 (The Financial System) describes the structure of the financial system in the U.S. Unlike many financial texts, ICFI interweaves details of the insurance provision system into the overall financial system. The result is a bird's-eye view of financial intermediation with a focus on the insurance industry. The presentation is up-to-date, mostly factual, and would be considered complete for a student at the undergraduate level. The authors occasionally intersperse subjective material; this is of great value to beginning students in the area. The chapter also discusses the regulatory system in appropriate detail.

Chapter 2 (Financial Management) begins the process of integrating finance theory into insurance practice. It provides a quick view of financial management concepts, including time value, risk and return, portfolio theory, and leverage. The application to insurance companies at the end of the chapter is thoughtful and comprehensive; for example, economic cash flows and leverage are shown to take on subtly different meanings in insurance applications. However, the finance theory in the beginning of the chapter is limited. The presentation of finance theory is innocent of modern developments in the finance field. The level of analysis is consistent with value maximization, institutional constraints and transaction costs, but it overlooks agency, signalling, and strategic considerations in the determination of optimal financial policies.

Chapter 3 (Cash Management) presents basic working capital management principles on the level of an undergraduate finance text. The presentation is factual if desultory, and reasonably comprehensive. However, the link to insurance practices is weak. For example, we learn about trade credit scoring systems, but never find out why they are important for insurers. Calculations of float costs would be desirable, as well as a link to shareholder wealth maximization, a principle stressed in Chapter 2.

Chapter 4 (Capital Structure) makes a clear distinction between insurance approaches and non-insurance approaches to the determination of optimal capital structure. Unfortunately, the presentation of the financial theory of capital structure overlooks modern developments in the field. The EPS/EBIT approach lacks risk considerations, and the value of tax deductibility is never calculated. However, insurance companies rarely use debt, according to the authors. It would be interesting to know what features of insurance companies make debt undesirable.

Chapter 5 (Insurance Company Income and Dividend Policy) provides an excellent (but not information-theoretic) description of income measurement and dividend payout policies. The empirical facts are interesting, and the discussion of the real effects of apparently nominal accounting changes is compelling.

Chapter 6 (Financial Planning) provides a typical discussion of asset-side decision rules, capital budgeting and capital rationing. It leads the reader to incorporate beta estimates of underwriting portfolios into premium valuation, but the linkage is never forged. The discussion of the ISO State X method at the end of the chapter is interesting and thorough.

Chapter 7 (Investment Strategy) presents the Markowitz model of portfolio selection. The financial theorist may find the inclusion of the coefficient of variation as a measure of portfolio performance puzzling in this context. The expected introduction of a risk-free security never materializes. The authors seem to have assumed that insurance companies should diversify their holdings, without providing any explanation why. The chapter continues to describe interest rate risk, duration, and immunization. Once again, the technical aspects of the exposition are accurate, but the reader never knows why insurance companies should hedge interest rate risk.

The remaining chapters (8: The Economic Environment, 9: Financial Markets, 10: Money Markets and Related Instruments, and 11: Capital Markets) attempt to cover a great deal of material. Given the space limitations, the coverage is excellent. Occasionally, one will find the theory outdated; the monetarist/Keynesian dichotomy is dated, and discussions of the term structure do not mention modern theories. However, the student with limited time and the pressure to pass the AIAF 113 examination will find these chapters particularly valuable.

Overall, the text meets its objectives well. The examination-bound student will find the complete text indispensable. The competent and curious finance student (defined broadly) with interest in insurance company management should concentrate on Chapters 1, 5, 6 and the last part of Chapter 2. However, insurance practitioners seeking decision-making guidance from modern finance theory may wish to consult other sources.
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Author:Shimko, David C.
Publication:Journal of Risk and Insurance
Article Type:Book Review
Date:Jun 1, 1991
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