Risk, Return, and the Capital Market: The Insurer Case

The analysis has shown that insurer investment performance parallels that of other investors; greater returns are associated with greater variability. However, with the acquisition of higher levels of investment risk insurers generally reduce the level of underwriting risk which is undertaken. Thus, insurer management apparently attempts to keep ruin probabilities within some undefinable but clearly present limits. In the process of trading off between investment and underwriting risk, a higher rate of return to net worth is sacrificed. The sacrifice of potentially higher rates of return to equity, however, does not place the insurer at a disadvantage relative to the capital market or make attractive the alternative of operating as an investment trust. Under reasonable conditions governing the risk and return associated with underwriting activities, the insurer return to net worth is in a more efficient position as the result of underwriting activities than that offered by the capital market alone. For a given risk position, the return to the insurer exceeds that available from the capital market alone. Thus, so long as marginal returns to underwriting are positive, the leveraging afforded by the expansion of premium volume produces a superior return over the traditional leveraging which might be employed by an investor in the capital market.