Regulated Firms under Uncertain Price Change: The Case of Property and Liability Insurance Companies. Comment

Abstract

Even though the property-liability insurance industry is responsible for investing more than $160 billion in assets, the literature includes only a few studies in which finance theory has been applied to this industry. Professor Walter adds significantly to this literature by performing diverse analyses on the experience of a sample of 25 stock property-liability insurers during the period 1966 through 1976 [15]. Professor Walter's major findings are: 1. the ratio of the market price to the book value per share of the common stock of these sample insurers is positively correlated with the growth in book value per share and negatively correlated with systematic risk; 2. the two components of insurance profitability (underwriting profits and investment returns) exhibit a positive correlation and therefore are not independent as had been assumed in prior research [8 and 12]; 3. during the decade analyzed, the ratio of market price to book value per share tended to exceed one, but the median value for the sample fell to .90 at the end of the period. Professor Walter suggests that the ratio of market price to book value per share measures excess value attributable to regulation. Since this ratio generally exceeded one during the period, he concludes that insurance regulation fosters higher underwriting profit margins than would prevail under a competitive market. He supports this conclusion with the finding that the median stock price of the sample increased at a rate of 6.2 percent annually compared with only a 2 percent increase annually for the S&P 500. The development of the financial models and the empirical analysis are useful contributions to insurance literature. However, several problems in applying the models raise questions about the validity of the conclusions. First, the use of book value as a standard of measurement for an insurer is