We study multiline insurance companies with limited liability and limited capital, creating the possibility of insurer default. Insurance premiums are determined by no-arbitrage option pricing methods. The results are developed under the realistic assumption that the losses created by insurer default are allocated among policyholders following an ex post, pro rata, sharing rule. In general, the ratio of default costs to expected claims, and thus the ratios of premiums to expected claims vary across insurance lines. Moreover, capital and related costs are allocated across lines in proportion to each line’s share of a digital default option on the insurer. Our results differ from those derived elsewhere in the literature.

We study a competitive multiline insurance industry, in which insurance companies with limited liability choose which insurance lines to cover and the amount of capital to hold. The results are developed under the realistic assumptions that insurers face friction costs in holding capital and that the losses created by insurer default are shared among policyholders following an ex post, pro rata, sharing rule. We characterize the situations in which monoline and multiline insurance structures will be optimal. Markets characterized by a large number of essentially independent risks will be served by multiline firms. Markets for which the risks are asymmetric or correlated may best served by monoline insurers. The results are directly relevant to such catastrophe lines as bond and mortgage default insurance, and may be applicable more generally to industries in which risky activities can be carried out by either monoline or conglomerate entities. We illustrate the results with examples.