Opaque liabilities, learning, and the cost of equity capital for insurers

Abstract

Analyzing major US property-liability insurers, we find that their cost of equity capital is negatively associated with their underwriting performance, but not with their investment performance. We provide cross-sectional evidence that the difference is attributable, at least in part, to investor learning about opaque insurer liabilities. We also find that capital market and product market imperfections are important determinants of insurers' cost of equity capital. Overall, our evidence contributes to the important literature examining insurers' cost of equity capital, and it suggests that opaque liabilities are a distinguishing feature of insurers in determining their cost of equity capital.

Analyst coverage, executive compensation and corporate risk‐taking: Evidence from property–casualty insurance firms

“…Our next hypothesis exploits the richness of the insurance industry with respect to firm opaqueness. PC insurers are generally more opaque than other (nonfinancial) firms (Chiang et al, 2022; Epermanis & Harrington, 2006; Morgan, 2002). Insurers' opaqueness is largely a result of the complexity of insurance assets (e.g., holdings of bonds and stocks) and liabilities (e.g., the underwriting for homeowners, motor, liability insurance, among others).…”

“…Second, PC insurers are more opaque than other (nonfinancial) firms (Chiang et al, 2022; Epermanis & Harrington, 2006; Morgan, 2002). Insurers' opaqueness is largely a result of the complexity of insurance assets (e.g., holdings of bonds and stocks) and liabilities (e.g., the underwriting for homeowners, motor, and liability insurance, among others), and the risk associated with these assets and liabilities.…”

On the cost‐of‐capital rate under incomplete market valuation

“…On the other hand, their examples of incomplete market valuation methods are, fundamentally different from our change-of-measure approach, based on more classical actuarial premium principles. Even further away from our approach but still pursuing, directly or indirectly, refinements in the quantification of the cost-of-capital, recent contributions include Niehaus [31] who examines the impact from taxation on the cost-of-capital, Chiang et al [7] who study the impact from opaqueness of liabilities on the cost-of-capital, and Huggenberger and Albrecht [24] who investigate the impact of risk pooling on the capital requirements and, thereby, indirectly on the cost-of-capital.…”