Capital and risk in property-liability insurance markets

TLDR

The paper investigates how property‑liability insurers decide on capital and portfolio risk. A theoretical option‑pricing model predicts a positive link between insurer capital and risk, and the authors test this with simultaneous‑equations estimation. Empirical results confirm the model, show managerial incentives influence capital and risk choices, and suggest important implications for solvency regulation.

Abstract

This paper investigates the capital and portfolio risk decisions of property-liability insurance firms. A theoretical model based on option pricing theory is developed which predicts a positive relationship between insurer capital and risk, as firms balance these two factors to achieve their desired overall insolvency risk. The implications of the model are then tested empirically using a simultaneous equations methodology. The results support the predictions of the model. They also provide evidence that managerial incentives play a role in determining capital and risk in insurance markets. The findings have significant implications for insurance solvency regulation.