The Pure-Play Cost of Equity for Insurance Divisions
研究了用纯玩法估计保险部门权益资本成本的可行性，提出了针对保险承保杠杆调整的新模型，并用多家保险公司数据验证了准确性。
The pure-play method allows estimation of the cost of equity for corporate divisions not having publicly traded equity via the use of market data for competitors. In this study, two pure-play models previously proposed in the financial literature are tested for accuracy using a sample of multiple division insurers. A new model, adjusted for the unique characteristic of insurance underwriting leverage, is developed and tested. The results provide initial evidence about the feasibility of using the pure-play method within the data limitations applicable to the insurance industry. The pure-play technique is an analogical approach to the estimation of the cost of equity capital for corporate divisions not having publicly traded common shares. The method uses the Capital Asset Pricing Model (CAPM) to estimate the division's cost of equity based upon ex post stock market data for a relatively competitor. The cost of equity often is called the stockholders' required rate of return. Corporate management is interested in the cost of equity for capital budgeting purposes because projects must generate sufficient income to pay the common shareholders' required rate of return, as well as payments on contractual indebtedness, if the total value of the firm is to be maintained. In regulated industries, regulators are interested in the corporation's cost of equity because regulated rates should result in a rate of return on equity approximately equal to the cost of equity. For corporations operating in a single line of business, market-derived estimation of the firm's cost of equity is a fairly simple process using the CAPM if the firm has issued actively-traded common shares. Ex post stock price data can be used to estimate the systematic risk parameter, or beta, of Larry A. Cox is Assistant Professor at the University of Georgia. Gary L. Griepentrog is Associate Professor at the University of Wisconsin-Oshkosh. When the initial draft was submitted, Professor Griepentrog was a faculty member at the University of South Carolina. Both authors wish to thank the faculty at the University of South Carolina for their help and support in this research effort. This content downloaded from 157.55.39.45 on Thu, 01 Sep 2016 05:59:31 UTC All use subject to http://about.jstor.org/terms The Pure-Play Cost of Equity for Insurance Divisions 443 the firm. This estimated beta, possibly adjusted for the financial leverage of the firm, then can be used within the CAPM formula to estimate the cost of common equity for the firm. When a corporation has no publicly-traded equity or consists of multiple divisions with diverse lines of business, estimation of a market-derived cost of equity becomes more difficult. Direct estimation using the CAPM either is impossible or, in the case of the multi-division firm, provides information that is not specific to the individual division. The pure-play approach has been proposed and tested as an indirect method for using market data and the CAPM to overcome these problems. With the pure-play technique, a corporate division is matched with a competitor that predominantly operates in the same business as the corporate division and has issued actively-traded common shares. The competitor is known as the play. Objective criteria such as industry classification, firm size, and financial leverage can be used to match the corporate division with the pure play, but the subjective observations of management also may be applicable if the primary analytical purpose is capital budgeting. Ex post market data for the pure-play firm are used to estimate systematic risk for the corporate division and the CAPM implemented to generate an estimate of the divisional cost of equity. As shown later in this study, adjustments for differences in debt leverage can be made. To the insurance industry, the pure-play approach represents a potentially promising method for estimating investor-required rates of return useful in both the capital budgeting and regulatory processes. Direct estimation of the cost of equity for most large life and property-liability insurers is not possible because they are mutual firms or divisions of diversified multiple-line insurers or conglomerates. The pure-play technique represents a theoretically valid way to estimate systematic risk and the required rate of return for those insurers without publicly-traded equity. Estimation of a division's systematic beta also allows further extraction of market-derived rates of return on individual underwriting lines via the processes introduced by Fairley [3] and Hill and Modigliani [7]. The purpose of this study is to test the pure-play approach for a sample of multiple line (ML) insurers. If pure-play estimates of the beta risk parameter are good proxies for observed ML betas, support is generated for using the method to estimate the cost of equity for insurance divisions, subsidiaries, and mutuals. The Pure-Play Models Fuller and Kerr (FK) [4] provide the normative base for application of the mean-variance (E V) CAPM using the pure-play approach. Based upon the standard assumptions underlying the CAPM and the assumed absence of synergism, FK show that the value additivity principle applies such that: This content downloaded from 157.55.39.45 on Thu, 01 Sep 2016 05:59:31 UTC All use subject to http://about.jstor.org/terms 444 The Journal of Risk and Insurance