Fair Rate of Return in Property-Liability Insurance

In the spirit of the Hope Natural Gas decision, fair rate of return analysis in property-liability insurance has attempted to determine the rate of return "commensurate with the returns on investment in other enterprises having corresponding risks" (320 U.S. 591 (1944)). Two principal approaches have been taken: (1) book value methods and (2) market value methods. The initial fair rate of return studies in insurance adopted the book value approach. These studies looked at accounting returns in insurance (usually, rate of return on equity or on total assets) and compared them to returns in other industries. The variance of the book rate of return was adopted as the appropriate measure of risk. The other major method from determining fair rate of return is modern financial theory. This is the method reflected in the papers published in this book. Modern financial theory was first proposed for use in property-liability ratemaking by Cooper (1974) and Biger and Kahane (1978). Many of the influential papers were prepared in connection with automobile insurance rate hearings in Massachusetts, which has been the leading state in the use of modern financial theory in insurance rate regulation. Overall, the chapters in this book represent the state of the art of fair rate of return regulation in insurance. Along with a handful of recent journal articles they form the essential body of knowledge that will provide the underpinnings for all further work in this field.