Opaque Liabilities, Learning, and the Cost of Equity Capital for Insurers

Abstract

Analyzing major U.S. property-liability insurers, we find that their cost of equity capital is negatively associated with their underwriting performance, but not with their investment performance. We provide cross-sectional evidence that the difference is attributable, at least in part, to investor learning about opaque insurer liabilities. We also find that capital market and product market imperfections are important determinants of insurers’ cost of equity capital. Overall, our evidence contributes to the important literature examining insurers’ cost of equity capital, and it suggests that opaque liabilities are a distinguishing feature of insurers in determining their cost of equity capital.

Keywords: insurer underwriting performance, cost of equity capital, asset pricing, opacity

JEL Classification: G22, G12, G31