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.