Estimating the Cost of Equity Capital for Property-Liability Insurers

Abstract

This article presents new evidence on the cost of equity capital by line of insurance for the property-liability insurance industry. To do so we obtain firm beta estimates and then use the full-information industry beta (FIB) methodology to decompose the cost of capital by line. We obtain full-information beta estimates using the standard one-factor capital asset pricing model and extend the FIB methodology to incorporate the Fama-French three-factor cost of capital model. The analysis suggests the cost of capital for insurers using the Fama-French model is significantly higher than the estimates based upon the CAPM. In addition, we find evidence of significant differences in the cost of equity capital across lines.