Paying for Expertise: The Effect of Experience on Insurance Demand

Abstract

This paper investigates whether corporations purchase insurance for the real services that insurers provide. We examine the real-service efficiency hypothesis in the insurance industry by exploiting within firm-year variation in reinsurance usage and experience at the line of business level. Our results show that insurers purchase reinsurance to access reinsurers' expertise and specialized knowledge. We find that, within the same year, the average multi-line insurer purchases 2.4 to 3.3 percentage points more reinsurance for new lines relative to existing lines. The demand for reinsurance declines by 0.55 to 0.80 percentage points with each additional year of experience. The size of these effects differs by the line of business, indicating that the development of internal expertise and specialized knowledge varies by line.

Keywords: Risk Management, Expertise, Risk Management, Expertise, Reinsurance

JEL Classification: G22, G32, D21, D83