Financial pricing of insurance in the multiple line insurance company

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This paper uses a contingent claims framework to develop a financial pricing model of insurance that overcomes one of the main shortcomings of previous models - the inability to price insurance by line in a multiple line insurer subject to default risk. The model predicts that prices will vary across firms depending upon firm default risk, but within a given insurer prices should not vary after controlling for line-specific liability growth rates. We also analyze an important qualification to this result for insurance groups, where several insurer subsidiaries are owned by a primary insurer or holding company. Because the owners of the group have the option to allow individual subsidiaries to fail, insurance groups with assets and liabilities widely dispersed among subsidiaries are predicted to command lower prices than otherwise identical insurers where assets and liabilities are concentrated in one or a few corporate entities. Empirical tests using data on publicly traded property-liability insurers support the hypotheses: prices vary across firms depending upon overall- firm default risk and the concentration of business among subsidiaries; but within a given firm, prices do not vary by line after adjusting for line-specific liability growth rates.