The Demand for Reinsurance: Theory and Empirical Tests

Abstract

This paper investigates the valuation effects of reinsurance purchases in a contingent claims framework. The comparative statics of the model suggest that, other things held constant, the demand for reinsurance will be greater, 1) the higher the firm's leverage, 2) the lower the correlation between the firm's investment returns and claims costs, 3) for firms which write "longer-tail" lines of insurance, and 4) the more the firm concentrates its investments in tax-favored assets. These predictions are tested in an empirical analysis of the reinsurance behavior of U.S. property-liability insurance firms during the 1980's.