We provide estimates of the equity capital needed and the resulting tax costs incurred when supplying catastrophe insurance/reinsurance using a partial equilibrium model that incorporates a specific loss distribution for US catastrophe losses. After consideration of insurer investment in tax-exempt securities, tax loss carry-back/forward provisions, and personal taxes, our results imply that the tax costs of equity finance alone have a substantial effect on the cost of supplying catastrophe reinsurance. These results help explain a variety of industry developments that reduce tax costs. Also, when coupled with non-tax costs of capital, these results help explain the limited scope of catastrophe insurance/reinsurance.

We demonstrate analytically that cross-sectional variation in the effects of events, i.e., in true abnormal returns, necessarily produces event-induced variance increases, biasing popular tests for mean abnormal returns in short-horizon event studies. We show that unexplained cross-sectional variation in true abnormal returns plausibly produces nonproportional heteroskedasticity in cross-sectional regressions, biasing coefficient standard errors for both ordinary and weighted least squares. Simulations highlight the resulting biases, the necessity of using tests robust to cross-sectional variation, and the power of robust tests, including regression-based tests for nonzero mean abnormal returns, which may increase power by conditioning on relevant explanatory variables.

This paper analyzes the accuracy of the risk-based capital formula for property-liability insurers that was adopted in 1993 by the National Association of Insurance Commissioners (NAIC). A logit analysis is conducted on a large sample of solvent and insolvent insurers spanning the period 1989–1993. Predictive accuracy is very low when the ratio of NAIC risk-based capital to actual capital is the sole indendent variable in the logit analysis, but accuracy improves significantly when the components of the formula and variables for firm size and organizational form are used as regressors. Improvements in the formula are needed to facilitate prompt corrective action and reduce insolvency costs.

Prior work suggests that heterogeneous information or weak incentives for solvency could have caused some general liability insurers to charge low ex ante prices during the early 1980s and mid-to-late 1990s, putting downward pressure on other firms’ prices and plausibly aggravating subsequent periods of rapid premium growth. We analyse whether the 1994–1999 “soft” market in medical malpractice insurance led some firms to underprice, grow rapidly, and subsequently experience upward revisions in loss forecasts (“loss development”), which could have aggravated subsequent market “crises”. Consistent with the underpricing hypothesis, the results indicate a positive relation between loss development and premium growth among growing firms. Underpricing was likely more prevalent among non-specialist malpractice insurers.