Financial Pricing of Insurance in the Multiple-Line Insurance Company

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 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 of holding company. 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.