UNDERWRITING PROFITS IN PROPERTY AND CASUALTY INSURANCE: EQUILIBRIUM VERSUS ACTUAL

Han B. Kang
Illinois State University

ABSTRACT

Theoretical underwriting profits and losses can be determined by the Capital Asset Pricing Model. The model developed by Biger and Kahane (1978) indicates that property and casualty insurers are subject to underwriting losses, assuming the underwriting beta is zero. In other words, P&C insurers have sufficient amount of investment earnings that are more than enough to offset underwriting losses. The fact is that individuals pay premiums in advance and losses occur throughout the year, so insurers can invest their earned premiums and loss reserves in securities. How much they can earn in investments depends upon the claim settlement period/fund-generating coefficients and bond yields since bonds are their primary investment holdings. This study uses the model and computes theoretical/equilibrium underwriting returns and compare those to actual/historical underwriting profits/losses. The excess/abnormal return for each year is the difference between actual and theoretical underwriting gain or loss. The study examined the excess/abnormal returns for 19 years from 1996 to 2014 and found that property and casualty insurers were able to have excess returns for 11 years, amounting 55.47% whereas the excess losses for 8 years were 31.75%. The whole industry was able to have the net excess return of 23.72% over the entire 19-year period. It implies that insurers paid too much premiums if the theory is right with zero underwriting beta.

Keywords: Underwriting results, investment earnings, excess underwriting gains/losse.