The Capital Structure of Insurers :

This paper develops and tests a theory of insurers' choice of the mix of equity and liabilities. The role of equity in insurance markets (and in our model) is to back insurers' promises to pay claims when there is aggregate uncertainty, or dependence among risks. Depending on the nature of this aggregate uncertainty, the equity held by rms in a competitive insurance market may increase with rising uncertainty, or it may initially increase then decrease. The ratio of equity to revenue unambiguously increases with uncertainty. We test the model, as well as implications of recent models of insurance market dynamics, on a cross-section of U.S. property-liability insurers.