Property-Liability Insurance Pricing Models: An Empirical Evaluation

Authors: Stephen P. D’Arcy (sdarcy@fullerton.edu) and James R. Garven (James_Garven@baylor.edu)

Journal of Risk and Insurance, Vol. 57, No. 3, September 1990, pp. 391-430 (reprinted in Volume 1 of the 1990 Discussion Paper Program of the Casualty Actuarial Society and as Chapter 8 in Managing the Insolvency Risk of Insurance Companies, Richard Derrig and J. D. Cummins, editors (Norwell, MA: Kluwer Academic Publishers, 1991), pp. 209-247).

Keywords: ratemaking, Black-Scholes, option pricing, financial pricing models.

ABSTRACT.  Over the past two decades, several pricing models that integrate underwriting and investment performance have been proposed or used to determine property-liability insurance rates. In general, these models have been tested separately and only over a relatively limited time horizon. In this article, the major property-liability insurance pricing models (based upon option theory, CAPM, Adjusted Net Present Value, Internal Rate of Return, Total Rate of Return) are evaluated over the 60-year period from 1926 through 1985 and the results of the various models are compared in terms of the ability to predict actual underwriting profit margins. Differences between model predictions and realized underwriting profit margin series are examined over the entire period as well as various subperiods in order to demonstrate how individual models perform under different conditions. The goal of this research is to assist actuaries and researchers in the application of pricing models and interpretation of results.

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