External Financing and Insurance Cycles

In this paper we explore the conjecture that the periodic episodes of high prices and constrained supply in the property- casualty industry are the result of temporary capital shortages. We do this by looking for increases in activities aimed at increasing capital at these times: dividend cuts, repurchase cuts, equity issues, and debt issues. We also look for evidence that the costs of raising external capital are unusually high relative to other industries by examining the market price response to security issues. We find that there is some evidence of payout policy changes in the expected direction, and also of an increased volume of debt and equity issues following low capacity periods. However, the total amount of capital obtained by security issues or reduced payouts appears to be small relative to the observed drops in net worth, suggesting that insurers rely primarily on future retained earnings to rebuild their capital position. When property-casualty insurers do go to the capital markets, we find no evidence that they receive an unusually poor reception. In fact, the market price reaction to equity issues appears to be considerably less negative than for industrial issuers but similar to that for banks and utilities.