Is the Insurance Cost-of-Capital Fair?
21 Pages Posted: 10 Sep 2011 Last revised: 3 Apr 2012
Date Written: February 12, 2011
This paper aims to present the insurance cost-of-capital computation issue. It highlights two methodologies introduced by Chief Risk Officer Forum (2008) to perform the cost-of-capital rate and which more or less justify the risk premium adopted by supervisory authorities. These strategies are based either on market return of insurance companies or on the modelling of insurance business profit and loss. We estimate a cost-of-capital rate corresponding to these basic methodologies and point out the benefits and drawbacks of each method. We show that the risk premium adopted by the supervisory authorities is inside the interval confidence given either by market data or by the modelling: thus it would correspond to a fair cost-of-capital rate. In addition to that we discuss the fact that this rate is quite low and allows to adopt a relative conservative strategy.
Keywords: cost of capital, insurance, Solvency II, market value margin, frictional costs
JEL Classification: G22, G32, G38
Suggested Citation: Suggested Citation