An Underwriting Approach to Estimating the Cost of Property and Casualty Equity

Joseph Calandro


Accurately estimating the cost of equity is a critical corporate finance capability, which has been the subject of significant research, the results of which have uncovered a number of practical insights, such as the analytical value of multiple factors. This insight is often leveraged in practice; for example, consider the property and casualty (P&C) insurance industry where the Fama and French three-factor model is often employed. However, managerial use of this model has been hampered in certain cases by the fact that its size and book-to-market factors are disconnected from P&C considerations, and therefore the model’s output can be of limited use to some P&C executives, especially executive-level underwriters. Several researchers have taken a different approach, one that is based on a traditional market risk premium as well as a premium for illiquid risks that must be retained within a firm due to financing frictions. This approach has been applied to the banking industry, which we have built on to develop a practically-oriented cost of equity model for P&C insurance companies based on both equity market and P&C market systematic risk factors. We have applied our approach at a number of insurance companies and therefore include real life-based examples that demonstrate its practical utility.

Full Text:



Calandro, J., Gates, D., Madampath, A., and Ramette, F. (2015, March). “A Practical Approach to Business Unit Hurdle Rates, Portfolio Analysis and Strategic Planning.” ACRN Oxford Journal of Finance and Risk Perspectives. 4 (2). 75-90.

Calandro, J. (2006). “Accident Year Development, Bonus Banks and Insurance Incentive Compensation.” Risk Management and Insurance Review. 9 (2). 205-217.

Calandro, J., and Lane, S. (2002). “The Insurance Performance Measure: Bringing Value to the Insurance Industry.” Journal of Applied Corporate Finance. 14 (4). 94-99.

Copeland, T., Koller, T., and Murrin, J. (2000 [1990]). Valuation: Measuring and Managing the Value of Companies 3rd Ed. Hoboken, NJ: Wiley.

Cummins, J.D., and Phillips, R.D. (2003, June 23). “Estimating The Cost of Equity Capital For Property-Liability Insurers.” Working Paper [#03-31]. Wharton Financial Institutions Center.

Fama, E.R., and French, K.R. (1992, June). “Size and Book-to-Market Factors in Earnings and Returns.” Journal of Finance. 50 (1). 131-155.

Froot, K.A., and Stein, J.C. (1998, Summer). “A New Approach to Capital Budgeting.” Journal of Applied Corporate Finance. 11 (2). 59-69.

Fruhan, W.E. (1979). Financial Strategy. Homewood, IL: Irwin.

Graham, J.R., and Harvey, C.R. (2015). “The Equity Risk Premium in 2015.” Working Paper Duke University.

____ (2002, Spring). “How Do CFOs Make Capital Budgeting and Capital Structure Decisions?” Journal of Applied Corporate Finance. 1 (1). 8-22.

Kunreuther, H.C., Pauly, M.V., and McMorrow, S. (2013). Insurance and Behavioral Economics. NY: Cambridge.

Roll, R., and Ross, S.A. (1995, January-February). “The Arbitrage Pricing Theory Approach to Strategic Portfolio Planning.” Financial Analysts Journal. 122-131.

Stewart, G.B. (1999 [19991]). The Quest for Value. NY: HarperCollins.


  • There are currently no refbacks.

Copyright (c) 2016 Joseph Calandro

Creative Commons License
This work is licensed under a Creative Commons Attribution 4.0 International License.

Creative Commons License
This work is licensed under a Creative Commons Attribution 4.0 International License.