Hello,
So I experiencing some confusion surrounding the use of the term cost of capital.
(1) In a financial sense, I understand cost of capital as being the required return of shareholders [Which is consequently is in calculations such as WACC to get the total cost of capital].
(2) However, we are now defining cost of capital as the cost of setting up reserves. That is, instead of using the capital provided by shareholders to write new business, it is being used to set up reserves of the existing policies. Since these reserves will be invested in assets possibly earning lower than their required return - this results in a cost.
So ultimately does that mean that there are different definitions to cost of capital?
Additionally, in a make belief world where insurers are not required to hold any reserves, if all the shareholder capital is used to finance new business (handle the new business strain) - does this then mean that there is no cost of capital since there are no reserves and shareholders will receive their required return from financing the new business? [Based on definition (2) of cost of capital]
Thanks in advance.
So I experiencing some confusion surrounding the use of the term cost of capital.
(1) In a financial sense, I understand cost of capital as being the required return of shareholders [Which is consequently is in calculations such as WACC to get the total cost of capital].
(2) However, we are now defining cost of capital as the cost of setting up reserves. That is, instead of using the capital provided by shareholders to write new business, it is being used to set up reserves of the existing policies. Since these reserves will be invested in assets possibly earning lower than their required return - this results in a cost.
So ultimately does that mean that there are different definitions to cost of capital?
Additionally, in a make belief world where insurers are not required to hold any reserves, if all the shareholder capital is used to finance new business (handle the new business strain) - does this then mean that there is no cost of capital since there are no reserves and shareholders will receive their required return from financing the new business? [Based on definition (2) of cost of capital]
Thanks in advance.