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The costs and benefits of reinsurance
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The costs and benefits of reinsurance

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  • Cummins, J. David

    (Temple University)

  • Dionne, Georges

    (HEC Montreal, Canada Research Chair in Risk Management)

  • Gagné, Robert

    (HEC Montreal, Department of Applied Economics)

  • Nouira, Abdelhakim

    (HEC Montreal, Canada Research Chair in Risk Management)

Abstract

Purchasing reinsurance reduces insurers’ insolvency risk by stabilizing loss experience, increasing capacity, limiting liability on specific risks, and/or protecting against catastrophes. Consequently, reinsurance purchase should reduce capital costs. However, transferring risk to reinsurers is expensive. The cost of reinsurance for an insurer can be much larger than the actuarial price of the risk transferred. In this article, we analyze empirically the costs and the benefits of reinsurance for a sample of U.S. property-liability insurers. The results show that reinsurance purchase increases significantly the insurers’ costs but reduces significantly the volatility of the loss ratio. With purchasing reinsurance, insurers accept to pay higher costs of insurance production to reduce their underwriting risk.

Suggested Citation

  • Cummins, J. David & Dionne, Georges & Gagné, Robert & Nouira, Abdelhakim, 2021. "The costs and benefits of reinsurance," Working Papers 08-1, HEC Montreal, Canada Research Chair in Risk Management.
    • Handle: RePEc:ris:crcrmw:2008_001
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    Cited by:

    1. Georges Dionne & Denise Desjardins, 2022. "A re‐examination of the US insurance market's capacity to pay catastrophe losses," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 25(4), pages 515-549, December.
    2. J. David Cummins & Mary A. Weiss, 2009. "Convergence of Insurance and Financial Markets: Hybrid and Securitized Risk‐Transfer Solutions," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 76(3), pages 493-545, September.
    3. Chia-Ling Ho & Gene Lai & Sangyong Han & Licheng Jin, 2022. "Organisational structure, corporate governance and reinsurance decisions in the U.S. property-liability insurance industry," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 47(4), pages 737-784, October.
    4. Ilyes Abidi & Mariem Nsaibi & Boutheina Regaieg, 2020. "Challenges of Islamic Insurance," International Journal of Economics and Financial Issues, Econjournals, vol. 10(4), pages 69-79.
    5. J. Cummins & Georges Dionne & Robert Gagné & A. Nouira, 2009. "Efficiency of insurance firms with endogenous risk management and financial intermediation activities," Journal of Productivity Analysis, Springer, vol. 32(2), pages 145-159, October.
    6. Lucia Spotorno & Ornella Moro, 2020. "Do bank-affiliated P&C insurers perform better? An empirical investigation," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 45(2), pages 225-255, April.
    7. Veprauskaite, Elena & Sherris, Michael, 2014. "Reinsurance decisions in life insurance: An empirical test of the risk–return criterion," International Review of Financial Analysis, Elsevier, vol. 35(C), pages 128-139.
    8. Elena Veprauskaite & Michael Sherris, 2012. "An Analysis of Reinsurance Optimisation in Life," Working Papers 201204, ARC Centre of Excellence in Population Ageing Research (CEPAR), Australian School of Business, University of New South Wales.
    9. Aduloju Sunday Adekunle & Ajemunigbohun Sunday Stephen, 2017. "Reinsurance and Performance of the Ceding Companies: The Nigerian Insurance Industry Experience," Economics and Business, Sciendo, vol. 31(1), pages 19-29, August.
    10. Dionne, Georges & Desjardins, Denise, 2017. "Reinsurance Demand and Liquidity Creation," Working Papers 17-3, HEC Montreal, Canada Research Chair in Risk Management.
    11. Desjardins, Denise & Dionne, Georges & Koné, N’Golo, 2022. "Reinsurance demand and liquidity creation: A search for bicausality," Journal of Empirical Finance, Elsevier, vol. 66(C), pages 137-154.
    12. Silvia Bressan, 2023. "Reinsurance and Sustainability: Evidence from International Insurers," Journal of Applied Finance & Banking, SCIENPRESS Ltd, vol. 13(6), pages 1-8.
    13. Yan, Tingjin & Park, Kyunghyun & Wong, Hoi Ying, 2022. "Irreversible reinsurance: A singular control approach," Insurance: Mathematics and Economics, Elsevier, vol. 107(C), pages 326-348.
    14. Sana Sheikh & Ali Murad Syed & Syed Sikander Ali Shah, 2018. "Corporate Reinsurance Utilisation and Capital Structure: Evidence from Pakistan Insurance Industry," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 43(2), pages 300-334, April.
    15. Pavić Kramarić Tomislava & Miletić Marko & Kožul Blaževski Renata, 2019. "Financial Stability of Insurance Companies in Selected CEE Countries," Business Systems Research, Sciendo, vol. 10(2), pages 163-178, September.
    16. Kramarić Tomislava Pavić & Miletić Marko, 2019. "The Boone Indicator as Determinant of Croatian Insurance Market Soundness," South East European Journal of Economics and Business, Sciendo, vol. 14(2), pages 1-12, December.
    17. Nicoleta RADU, 2022. "Reinsurance – an efficient solution of catastrophe risk transfer for the housing stock of Romania," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania / Editura Economica, vol. 0(2(631), S), pages 139-150, Summer.

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    More about this item

    Keywords

    Reinsurance; insolvency risk; risk management; financial intermediation; cost function; panel data;
    All these keywords.

    JEL classification:

    • C34 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Truncated and Censored Models; Switching Regression Models
    • C35 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Discrete Regression and Qualitative Choice Models; Discrete Regressors; Proportions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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