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Equity Capital, Internal Capital Markets, and Optimal Capital Structure in the US Property-Casualty Insurance Industry

Equity Capital, Internal Capital Markets, and Optimal Capital Structure in the US... This article reviews the most pertinent literature on the sources and uses of equity capital in the US property-casualty (P-C) insurance industry. P-C insurers serve risk management and risk-bearing functions in the economy. Insurers create diversified risk pools consisting of large numbers of exposures. However, even in the most highly diversified risk pools, uncertainty is not reduced to zero, and insurers must hold equity capital to credibly promise that claims will be paid even if losses are higher than expected. We begin with a financial overview of the industry. Insurers are well capitalized and financially stable, withstanding large catastrophic events and economic crises. Analysis of capital regulation further shows that regulation is not binding for the vast majority of insurers. We then review the theoretical and empirical evidence on the most important economic phenomena impinging on capital in P-C insurance: underwriting cycles, internal capital markets (ICMs), and optimal capital structure. P-C insurers are heavy users of ICMs, and insurer ICM transactions are efficient. According to available evidence, P-C insurers have optimal capital structures and behave according to the trade-off theory of capital structure. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Annual Review of Financial Economics Annual Reviews

Equity Capital, Internal Capital Markets, and Optimal Capital Structure in the US Property-Casualty Insurance Industry

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Publisher
Annual Reviews
Copyright
Copyright © 2016 by Annual Reviews. All rights reserved JEL codes: G20, G22, G31
ISSN
1941-1367
eISSN
1941-1375
DOI
10.1146/annurev-financial-121415-032815
Publisher site
See Article on Publisher Site

Abstract

This article reviews the most pertinent literature on the sources and uses of equity capital in the US property-casualty (P-C) insurance industry. P-C insurers serve risk management and risk-bearing functions in the economy. Insurers create diversified risk pools consisting of large numbers of exposures. However, even in the most highly diversified risk pools, uncertainty is not reduced to zero, and insurers must hold equity capital to credibly promise that claims will be paid even if losses are higher than expected. We begin with a financial overview of the industry. Insurers are well capitalized and financially stable, withstanding large catastrophic events and economic crises. Analysis of capital regulation further shows that regulation is not binding for the vast majority of insurers. We then review the theoretical and empirical evidence on the most important economic phenomena impinging on capital in P-C insurance: underwriting cycles, internal capital markets (ICMs), and optimal capital structure. P-C insurers are heavy users of ICMs, and insurer ICM transactions are efficient. According to available evidence, P-C insurers have optimal capital structures and behave according to the trade-off theory of capital structure.

Journal

Annual Review of Financial Economics – Annual Reviews

Published: Oct 23, 2016

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