I think you are confused by the difference between the market return and the
insurance company investment return. Please note that the CAPM formula has
two parts. The second part is the market return DESIRED by the investors for
investing their money in the insurance company, which is represented by
beta*[E(rM)-rF]. The first part reflects the insurance company investment
return that is used to offset the underwriting profit provision in the rates.
Therefore, when the overall market increase, the investors expect more from
their investment in the insurance company if other items stay the same.
Otherwise they would invest their money elsewhere. In this case the
insurance have to built more profit in their rates to meet the investors'
expectation. On the other hand, as you said, if the insurance company can
make more money from its investment, it can charge less in its rates and
still meet the investors' expectation. This is the first part of the CAPM
formula. The distinction here is the first part is related to the
individual company behavior and the second part is related to the market
behavior.
Hopefully this will dispel your confusion.
Joe Liang
----------
From: zhangg@towers.com
To: Liang,Xiaoying; studygroup6@casact.org
Subject: on CAPM model for insurance ratemaking
Date: Friday, March 06, 1998 10:12AM
I am confused by the CAPM model for insurance ratemaking in Chapter 8
of
"Foundations of C. A. S.". If other terms stay same, then the
underwriting profit
margin increases as the return from the market increases according to
this model.
It's my understanding that if an insurance company can make more money
from stock
and bonds, then they will be required to charge less in underwriting
portion. I think
that's also the point the author tries to say in this Chapter.
Can anyone help me on this? Thanks
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