Risk-sharing benefits and the capital structure of insurance companies

We model that policy holders are paying a fee over the present value of indemnifications (i.e., technical provisions) to enjoy these risksharing benefits. This fee implies that a capital structure largely consisting of technical provisions is optimal for insurance firms, making the traditional Modigliani-Miller logic inappropriate for them. To support the issuance of technical provisions with socially desirable properties, insurance firms hold a surplus to absorb losses. We show that the Modigliani-Miller logic applies to the composition of this loss-absorption capacity. This explains why insurance companies may use, next to equity and technical provisions, financial debt in supporting their activities.