Financial Pricing of Insurance in Multiple Line Insurance Companies
96-09
Posted: 25 Jun 1998
Date Written: March 1996
Abstract
This paper develops a financial pricing model to determine prices by line of business in a multiple line insurer subject to default risk. The model implies that it is not appropriate to allocate equity capital by line; rather, the price in a given line depends upon the overall default risk of the firm. Thus, prices should not vary by line within a given insurer after controlling for line-specific liability growth rates. This result is modified somewhat for groups of insurers under common ownership. Corporation law gives the owners of the group the option to allow individual subsidiaries to fail, and claimants against the subsidiary cannot reach the assets of other group members unless they succeed in "piercing the corporate veil." Thus, insurers that concentrate their business in one or a few corporate entities are predicted to command higher prices than otherwise similar insurers where business is widely dispersed among group members. Empirical tests based on publicly traded property-liability insurers support the hypotheses: prices vary across firms depending upon overall-firm default risk and the concentration of business among subsidiaries; but within a given firm, prices do not vary by line after adjusting for line-specific liability growth rates.
JEL Classification: G22, G32
Suggested Citation: Suggested Citation