Final answer:
Cash flow underwriting refers to reducing underwriting standards to increase cash flow for investing, with the hope that investment income will make up for the underpriced policy risks. It's a practice that's contrasted with other methods of obtaining financial capital, such as loans or issuing stocks, each with unique pros and cons.
Step-by-step explanation:
The correct answer to the question, "Which of the following statements best describes cash flow underwriting?" is B) A tactic involving the reduction of underwriting standards to generate additional cash for investment purposes. Cash flow underwriting is a controversial practice in which an insurer intentionally prices its insurance policies at a rate lower than what is needed to cover expected losses and expenses. They do this to increase business volume and cash flow with the expectation that the investment income generated from this increased cash flow will offset the underwritten losses. This approach can be risky because it relies on the performance of the underlying investments to ensure profitability, instead of solely relying on accurate pricing of insurance risk.
Firms seeking financial capital can operate through borrowing from banks, issuing bonds, or issuing stocks—each with their advantages and disadvantages. Borrowing allows firms to maintain control over operations without shareholder influence but comes with the obligation of making scheduled interest payments. Issuing stock, on the other hand, dilutes ownership but does not require regular interest payments and can offer relief if the company does not generate enough income to cover debt obligations. The choice between these options should be balanced with the firm's financial strategies and the current economic climate.