An Exposition of the Implications of Limited Liability and Asymmetric Taxes for Property-Liability Insurance

This article elaborates upon the intuition underlying Doherty and Garven's (1986) option pricing model and extends its basic results to a further consideration of the implications of limited liability and asymmetric taxes for pricing and risk incentives in property-liability insurance. When compared with CAPM-based models of the insurer, a number of important insights emerge. First, the option pricing framework is shown to encompass the CAPM framework as a special case and may help to explain a number of empirical phenomena. Second, the option pricing framework is used to develop a "risk incentive" hypothesis which suggests that limited liability and asymmetric taxes provide mutuals with greater disincentives for riskbearing than stock companies, even in the absence of owner/manager conflicts.