Leverage, Exposure Ratios and the Optimal Rate of Return on Capital for the Insurer

The impact of insurance leverage on equity return for property and liability insurers is examined. Two financial models are developed to determine the exposure ratio and associated degree of insurance leverage to maximize the rate of return on insurance stockholder's equity. The optimal degree of insurance leverage is determined by the exposure ratio or quantity of sales which maximizes the rate of return on equity under the financial models specified herein. Accordingly, this study focuses on the use of reserves as a leverage source and attempts to establish a concept of optimal insurance leverage under certain specified conditions.