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A Comparison of Property-Liability Insurance Financial Pricing Models. Stephen P. D’Arcy, FCAS, MAAA, Ph.D. Richard W. Gorvett, FCAS, MAAA, Ph.D. Department of Finance University of Illinois at Urbana-Champaign Presented to the Casualty Actuarial Society Spring Meeting May, 1998.
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Stephen P. D’Arcy, FCAS, MAAA, Ph.D.
Richard W. Gorvett, FCAS, MAAA, Ph.D.
Department of Finance
University of Illinois at Urbana-Champaign
Presented to the
Casualty Actuarial Society Spring Meeting
Target Total Rate of Return
Private Passenger Auto
(These assumptions avoid the need
to allocate surplus)
Model Indicated UPM
Target UPM 5.0%
Internal Rate of Return 1.7
Option Pricing 0.2
Discounted Cash Flow 0.1
Arbitrage Pricing - 2.9
Target Total Rate of Return - 3.6
Insurance CAPM - 4.9
Model Target: 13%
State Farm Target: 15%
(Per 1994 KY Auto Filing)
Model UPM Indication: -3.6%
State Farm Indication: 0%
(1) Capital Attraction/Retention Standard
(2) Amount of Equity Capital Generating
Investment Income for Tax Calculation
“No distinction is introduced here between the market value of equity, VE, and the various accounting or book values of equity. The two may of course diverge over time, but in competitive markets the expected book and market values of new equity capital put into the insurance business should be the same. Since the Hope standard is a capital-attraction standard, it is appropriate in the analysis of returns and of target returns to treat VE as if it were new equity.”Fairley, 1979, “Investment Income and Profit Margins in Property-Liability Insurance: Theory and Empirical Results,” Bell Journal of Economics
Target Total Rate of Return 1
Insurance CAPM 1 and 2
Discounted Cash Flow 2
Internal Rate of Return 1 and 2
Option Pricing 1 and 2
Arbitrage Pricing Model 1 and 2
Statutory Surplus 150,958
Equity in the UEP Reserve 20,412
Nominal - Discounted Loss Reserves 8,289
Market - Book Value of Bonds 13,928
Non Admitted Assets 946
Tax Liability on Unrealized Capital Gains (5,173)
Adjusted Statutory Surplus 189,360
Market Value of Company 220,399
Models Are Generally More Sensitive To:
Models Are Generally Less Sensitive To: