Mathematics Colloquium, Spring 2008
SPECIAL LECTURE

Linkage of Risk Management, Capital Management, and Financial Management of the Property/Liability Insurance Industry: An Application of Structural Equation Modeling

This study uses the property/liability insurance industry as a research sample to examine how risk management, financial management, and capital management are related to each another, thereby reflecting such interactions in the managerial decisions on the choice of derivative and reinsurance use, the allocation of asset risks, the determination of underwriting activities as well as liability risks, and the adequacy of capital levels. This paper contributes to the existing literature by adopting structural equation modeling (SEM) to capture not only the direct effects from regulations on capital management, financial management, and risk management, but also the interacted effects of the three managerial decisions.

This paper augments the models and findings of Stein and Froot (1998) and Cebenoyan and Strhan (2004) by incorporating the dynamic interactions among the three managerial decisions under the SEM framework. Results provide empirical evidence which shows that the more emphasis on capital management can lead to the lesser degree of risk management implementation in terms of using less reinsurance and financial derivatives to manage underwriting risks and investment risks, respectively.