This research investigates equilibrium risk pools in a market with risk-based solvency regulation and costly capital. It considers a market with two classes of risk, each having different aggregate volatility characteristics, such as personal auto and catastrophe exposed property. It identifies three possible equilibrium solutions: a single multiline pool, a multiline pool and a monoline pool, and two monoline pools. It determines conditions under which each of the three solutions occurs. The requirements are sensitive to the relative tail risk of the two classes and the capital standard. The model shows that the more volatile risk class bears a higher proportion of the capital cost. The results help explain various features seen in insurance markets, including the structure of the Florida homeowners market and the US medical malpractice market. It can be applied more broadly to any regulated risk market.
Presentation at the Robert A. Hedges Research Seminar Series, Temple University, 2020-10-27