A Reexamination of the Corporate Demand for Reinsurance

Summary

---

This study examines the effect of the state of the international reinsurance market on the demand for reinsurance by U.S. insurers using data from the years 1993 through 2000. Both the overall demand for reinsurance and the utilization of foreign reinsurance by U.S. insurers are explored. In addition to supporting the findings of prior literature related to the traditional motives for the corporate demand for insurance, evidence indicates that the state of the U.S. reinsurance industry impacts the amount of reinsurance demanded by U.S. insurers. The study also investigates reasons why U.S. insurers utilize a reinsurance program composed of both U.S. and foreign reinsurers. The results indicate that the decision to utilize some percentage of foreign reinsurance is driven primarily by the financial and operational characteristics of the ceding company such as firm size, group affiliation, and organizational form. However, no support is found for the hypothesis that possible differences between the foreign and U.S. reinsurance markets impact the decision to utilize foreign reinsurance.

See the full content of this document

Extract

---

A Reexamination of the Corporate Demand for Reinsurance

INTRODUCTION

The reinsurance industry has undergone several major changes in recent years. For example, recent research indicates that there is increasing concern about adequate capacity as a result of several large wide-scale losses including Hurricane Andrew, the Northridge Earthquake, Typhoon Mireille, and most recently, the terrorist attack on the World Trade Center (e.g., Cummins and Weiss, 2000; Swiss Re, 2002; Standard and Poor's, 2002). In addition, there has been consolidation observed within the reinsurance industry. Finally, recent underwriting losses coupled with a decrease in investment returns also have impacted the reinsurance industry. These changes have resulted in reductions in both capacity and profitability within the global reinsurance market. With lower levels of capacity and potential increases in insolvency risk, the decision of how much reinsurance to purchase and how to construct an overall reinsurance program is of critical importance to insurers.

This study seeks to answer the question of whether the state of the reinsurance industry is related to the demand for reinsurance. Additionally, the article analyzes the way in which reinsurance programs are constructed by investigating the decision of U.S. insurers to utilize the foreign reinsurance market. By examining both the impact of the state of the reinsurance market on the demand for reinsurance and the utilization of foreign reinsurance by U.S. insurers, the study seeks to provide a more complete examination of the demand for reinsurance by U.S. insurers.

Reinsurance is an important transaction for primary insurers. Adiel (1996) finds that it can be used to increase insurer capital and earnings and to reduce regulatory costs. However, if a reinsurer becomes insolvent, due to some firm-specific cause or some external force, it can have severe adverse effects for a variety of stakeholders. For example, if a reinsurer is unable to pay for losses, the ceding company is then responsible for the losses. This can lead to one or more of the following: (1) decreased capacity and financial strength of the ceding company; (2) financial distress and/or increased costs of capital for insureds that may be without coverage; (3) a strain on remaining insurers if guaranty fund assessments are required to pay the claims of insolvent primary insurance companies; and/or (4) overall increased insurance costs and costs of capital related...

See the full content of this document

---