When Theories Fall Short: What Makes Insurance Profit Margins Fair?

Normally, the Capital Asset Pricing Model (CAPM), extended for insurance, would be a good starting point. But from what history tells us, competitive profit margins that are actually observed in the market are typically higher than the theory suggests. As a result, regulators and consumers have raised concerns about excessive premiums and a lack of transparency in how insurers justify their profit margins.

So how do we explain this gap? What’s driving profit margins to be higher than theory suggests? Is CAPM simply not adequately recognising the business and capital risks involved?

In Consumer utility and fair profit margins in insurance, a paper that was recently published in the British Actuarial Journal, Brett Ward addresses the persistent question of why profit margins in property and casualty insurance are often observed to be higher than CAPM would suggest. Brett aims to offer a more robust and transparent framework for defining what constitutes a “fair” profit margin in insurance.

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