Risk-Return Tradeoff and Capital Asset Pricing for Life Insurers: An Empirical Study

This paper investigated relationship between risk and return of life insurers. The results indicate that systematic risk is not the only factor in determining the risk-return relationship in life insurance companies. Rather, empirical finding of this study reveals that nonsystematic risk is more important than systematic risk for life insurers. If historical relationship between both total risk and beta and various fundamental characteristics of insurers can be verified, it may be easier to forecast future risk. Since a life insurer's risk is conceptually the function of firm's underwriting and investment, insurers' managers may be able to control some of the specific variables in order to explain a very small amount of the variation in beta. Only a growth was found to be significant in explaining beta. Also, growth and dividend yield were to be significant in explaining total risk but overall explanatory power was weak. The empirical finding suggests that insurance industry should be careful in using beta as a proxy for the future estimate of return. Thus, the use of Insurance Capital Asset Pricing Model(ICAPM) in regulating insurance pricing(premium rate making) should be applied very cautiously.