Capacity as an Indicator of Insurer Insolvency

This paper examines factors explaining the underutilization of capacity observed in prior capacity studies. The paper expands previous works in capacity theory by including improved empirical measures for several variables and by explicitly considering reinsurance effects. Two separate estimates of 1986 capacity are developed and examined using regression analysis for 60 U.S. property-casualty insurers. The first measure uses a previously published formulation and excludes reinsurance while the second incorporates reinsurance. Results indicate that when capacity is defined without considering reinsurance, a large proportion of the variance in capacity utilization can be explained by company size, perceived financial strength, product mix, capitalization requirements, organizational form, and risk of investment operations. When capacity is defined to include reinsurance, variance in capacity utilization can be more fully explained with half the number of variables. A company’s perceived financial strength, capitalization requirements, and investment risk prove significant in explaining capacity underutilization.