Methodological aspects of the income approach to insurance companies’ valuation

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Methodological aspects of the income approach to insurance companies’ valuation

Journal Title: Регіональна Економіка - Year 2017, Vol 84, Issue 2

Abstract

In recent years, the Ukrainian insurance market has been growing in need to assess the value of insurance companies, which is due not only to a change in the management paradigm of the company, but also to objective market processes occurring in the state. The purpose of the study is to substantiate methodological approaches to determining the market value of an insurance company when using a revenue approach with the forecasting of cash flows of the insurer under different options for the development of insurance activities. The income approach determines the value of the company (business) based on the estimation of discounted cash flows generated by it. It is based on the principle of expectation that any asset acquired for the purpose of generating income is worth as much as it will bring in the future in the light of the time factor. In modern economists’ works a large number of methods and models of discounting are presented within the income approach, the article analyzes the problems of their application for the assessment of Ukrainian insurance companies. The author suggests an algorithm for calculating the cost of an insurance company by discounting cash flows taking into account the specifics of the insurance business, with an approach to determining the cost of capital of the insurer, estimating the amount of free cash flow (FCF) of the company. The algorithm is approved in assessing the value of one of the Ukrainian insurance companies. The discount rate is calculated on the basis of the weighted average cost of capital model, using data on the company’s capital structure and the value of its individual components. To predict future cash flows, the following steps have been taken: the choice of the initial data for forecasting, the construction of the regression equation, the forecasting of model parameters, the interval forecast of free cash flows. The lower limit of the forecast interval in each period is taken by the pessimistic value of the cash flow, the upper limit is optimistic, and the point value is moderate. For each of the variants of development, the company’s residual value is also calculated, added to the amount of current cash flow values and the value of the insurer’s liabilities at the valuation date is taken. Thus, an estimate of the insurer’s value is given with an optimistic, pessimistic and moderate forecast of the activity of the insurance company. The income approach allows carrying out variant calculations with regard to development and innovation in companies, using the methodology proposed in this research.

Authors and Affiliations

Oleksandra O. Shevchuk

Keywords

EP ID EP435491
DOI -
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