I think the difference is semantics. The CAPM has been used as a
pricing model for insurers. This presumes that the policyholders are
paid the risk-free rate of return on the funds they provide to the
insurer (premiums) until the funds are returned in the form of expenses
or losses. Thus, I would term it a pricing model since it is not used
to determine the cost of capital - that is set, based on an assumption
(or regulatory decree) at the risk-free rate.
In the utility industry, the CAPM has been used directly as a cost of
capital model. The capital structure of the company, its debt-equity
ratio, is determined. The cost of debt is determined based on bond
interest rates. The cost of its equity is determined based on the CAPM
(risk-free rate plus beta times the market risk premium). The weighted
average cost of capital is determined for the company using these two
values and then that value is used as the cost of capital for the
company in setting rates.
Thus, the difference in terminology depends on whether you are using the
CAPM in its traditional approach, in which it would be a cost of capital
model, or the modified approach in which it has been applied to the
property-liability insurance industry as a pricing model.
Does this clarify anything?
Steve
> -----Original Message-----
> From: Snaps99999 [SMTP:Snaps99999@aol.com]
> Sent: Saturday, May 16, 1998 4:05 PM
> To: casnet@lists.casact.org
> Subject: Question to Steve D'Arcy (apologies to other CASNET
> members)
>
> Steve,
>
> I have another question regarding CAPM. In one of your responses to
> my
> earlier messages, you stated that CAPM is not a cost of capital model.
> In
> checking the Actuarial Standard of Practice on the profit provision in
> ratemaking for another purpose, I found that CAPM is described as a
> cost of
> capital model. What can you tell me about this distinction?
>
> Frank Schnapp
>
>
>
> Visit the CAS Web Site at http://www.casact.org
> ===============================================
> To subscribe or unsubscribe from CASNET:
> Send an e-mail to caslists@lists.casact.org
> Type in the body join casnet to subscribe
> or leave casnet to unsubscribe.
Visit the CAS Web Site at http://www.casact.org
===============================================
To subscribe or unsubscribe from CASNET:
Send an e-mail to caslists@lists.casact.org
Type in the body join casnet to subscribe
or leave casnet to unsubscribe.