The Costs and Benefits of Reinsurance
33 Pages Posted: 11 Jun 2008 Last revised: 11 Feb 2021
Date Written: February 10, 2021
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.
Keywords: Reinsurance, insolvency risk, risk management, financial intermediation, cost function, panel data.
JEL Classification: C34, C35, G21, G22
Suggested Citation: Suggested Citation