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

J. David Cummins () and Mary A. Weiss ()
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J. David Cummins: Department of Risk, Insurance, and Healthcare Management, Temple University, Philadelphia, Pennsylvania 19122
Mary A. Weiss: Department of Risk, Insurance, and Healthcare Management, Temple University, Philadelphia, Pennsylvania 19122

Annual Review of Financial Economics, 2016, vol. 8, issue 1, 121-153

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.

Keywords: property-casualty insurance; optimal capital structure; internal capital markets; underwriting cycles; reinsurance (search for similar items in EconPapers)
JEL-codes: G20 G22 G31 (search for similar items in EconPapers)
Date: 2016
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