Optimal Weights for Accounting Earnings and Cash Flows for Explaining Stock Return of Insurance Companies

Joseph CHENG, Alfred LAM

Research output: Journal PublicationsJournal Article (refereed)Researchpeer-review

Abstract

The objective of this paper is to derive a composite index from earnings and cash flows that could be used to better evaluate insurance companies.
One significant difference between earnings and cash flows is depreciation, and in the case of insurance industry, the timing of recognition of premium income and expense paid out to claims can also cause significant difference between earnings and cash flows. Thus, there might be important components that are found in earnings of insurance companies but not in cash flows, or vice versa.We propose to create a composite index which is a weighted average of accounting earnings and cash flows that can explain stock return better than either earnings or cash flow alone. The advantage of this approach is that full information would be utilized for evaluating performance of insurance companies. Using this approach, we found that the optimal weight for earnings and cash flow for the insurance industry is found to be approximately 79% and 21%, respectively. Suchinformation may help managers of insurance firm to better manage the cash flow in order to maximize value of the firm for shareholders.
Original languageEnglish
Pages (from-to)33 - 43
Number of pages11
JournalJournal of Insurance and Financial Management
Volume3
Issue number4
Publication statusPublished - Sep 2017

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Stock returns
Cash flow
Insurance companies
Accounting earnings
Composite index
Insurance industry
Shareholders
Depreciation
Managers
Expenses
Insurance
Premium
Income

Keywords

  • Insurance Companies
  • Metrics
  • Value of Firms
  • Cash Flows
  • Accounting Income
  • Insurance Stocks
  • Stock Return

Cite this

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title = "Optimal Weights for Accounting Earnings and Cash Flows for Explaining Stock Return of Insurance Companies",
abstract = "The objective of this paper is to derive a composite index from earnings and cash flows that could be used to better evaluate insurance companies.One significant difference between earnings and cash flows is depreciation, and in the case of insurance industry, the timing of recognition of premium income and expense paid out to claims can also cause significant difference between earnings and cash flows. Thus, there might be important components that are found in earnings of insurance companies but not in cash flows, or vice versa.We propose to create a composite index which is a weighted average of accounting earnings and cash flows that can explain stock return better than either earnings or cash flow alone. The advantage of this approach is that full information would be utilized for evaluating performance of insurance companies. Using this approach, we found that the optimal weight for earnings and cash flow for the insurance industry is found to be approximately 79{\%} and 21{\%}, respectively. Suchinformation may help managers of insurance firm to better manage the cash flow in order to maximize value of the firm for shareholders.",
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Optimal Weights for Accounting Earnings and Cash Flows for Explaining Stock Return of Insurance Companies. / CHENG, Joseph; LAM, Alfred.

In: Journal of Insurance and Financial Management, Vol. 3, No. 4, 09.2017, p. 33 - 43.

Research output: Journal PublicationsJournal Article (refereed)Researchpeer-review

TY - JOUR

T1 - Optimal Weights for Accounting Earnings and Cash Flows for Explaining Stock Return of Insurance Companies

AU - CHENG, Joseph

AU - LAM, Alfred

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N2 - The objective of this paper is to derive a composite index from earnings and cash flows that could be used to better evaluate insurance companies.One significant difference between earnings and cash flows is depreciation, and in the case of insurance industry, the timing of recognition of premium income and expense paid out to claims can also cause significant difference between earnings and cash flows. Thus, there might be important components that are found in earnings of insurance companies but not in cash flows, or vice versa.We propose to create a composite index which is a weighted average of accounting earnings and cash flows that can explain stock return better than either earnings or cash flow alone. The advantage of this approach is that full information would be utilized for evaluating performance of insurance companies. Using this approach, we found that the optimal weight for earnings and cash flow for the insurance industry is found to be approximately 79% and 21%, respectively. Suchinformation may help managers of insurance firm to better manage the cash flow in order to maximize value of the firm for shareholders.

AB - The objective of this paper is to derive a composite index from earnings and cash flows that could be used to better evaluate insurance companies.One significant difference between earnings and cash flows is depreciation, and in the case of insurance industry, the timing of recognition of premium income and expense paid out to claims can also cause significant difference between earnings and cash flows. Thus, there might be important components that are found in earnings of insurance companies but not in cash flows, or vice versa.We propose to create a composite index which is a weighted average of accounting earnings and cash flows that can explain stock return better than either earnings or cash flow alone. The advantage of this approach is that full information would be utilized for evaluating performance of insurance companies. Using this approach, we found that the optimal weight for earnings and cash flow for the insurance industry is found to be approximately 79% and 21%, respectively. Suchinformation may help managers of insurance firm to better manage the cash flow in order to maximize value of the firm for shareholders.

KW - Insurance Companies

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KW - Value of Firms

KW - Cash Flows

KW - Accounting Income

KW - Insurance Stocks

KW - Stock Return

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