Investment Income and Profit Margins in Property-Liability Insurance: Theory and Empirical Results

In order to capital market equilibrium rates of return on equity for property-liability insurers and underwriting profit margins by line that are consistent with these, the capital asset pricing model and measurements of cash flows by line are used. The profit solutions depend on the yield of risk-free securities, cash flows, and the systematic risks of the lines, but they do not depend on company investment portfolios. Traditional target underwriting profit margins are not supported by any reasonable financial theory. Recent historical profit margins are proven to be much closer to the solutions derived than to the traditional profit margin factors routinely included in rate filings in almost every state. A reason that a bias between forecasted and realized profit figures could persist uncorrected for a long time is that the realized underwriting profit margin is highly variable.