The Effects of Insurance Pool Size Among Small Property & Casualty Firms and Recommendations for Insurance Regulators.

Small insurance firms with the limited number of policyholders have larger standard deviations of expected losses. The Risk-Based Capital (RBC) standards use the Value at Risk (VaR) methodology to determine the required capital and penalize small firms to allocate relatively large amounts. This study investigates the lowest insurance pool size and premium level that satisfy the RBC standards for a small hypothetical firm without raising additional capital. The insurance regulators have a chance to mitigate the adverse effects of RBC standards and enhance market efficiency if they: (a) determine how many of the small firms in the insurance market are distressed under the RBC standards, (b) create a residual reinsurance market that provides reinsurance coverage for small insurance firms, (c) provide easy access to financial markets for small insurance firms to raise additional capital, especially through common stock issuance, and (d) establish a two-tier RBC standards while expanding the coverage limits of the existing guarantee funds to protect policyholders from small insurance firm bankruptcies. [ABSTRACT FROM AUTHOR]