Is Reinsurance a Substitute for or a Complement to Derivative Usage? Evidence from the U.K. Non-Life Insurance Industry

Executive compensation and corporate risk management

“…The first is the substitution hypothesis which argues that the goal of both insurance and derivatives is to reduce the variance of a firm's value and taxable income. Therefore, it is possible that insurance and derivatives may be used as substitutes to manage the overall risk exposure of the firm (Colquitt & Hoyt, 1997; Cummins et al, 2001; Shiu, 2016). On the other hand, the complementary hypothesis suggests that a firm's use of insurance might simply show the firm's predisposition to hedge its risk (Colquitt & Hoyt, 1997; Cummins et al, 2001; Shiu, 2016).…”

“…Both studies find that the proportion of premiums ceded to reinsurers has a positive relation to derivative usage, providing support for the complementary hypothesis. On the other hand, Cummins and Song (2008) and Shiu (2016) consider the effects of insurance on derivative volume under a simultaneous equation framework. Both studies find a negative relation between insurance and derivatives, providing support for the substitution hypothesis.…”

A note on risk and value from an underutilized dataset: Consolidated disclosures

“…For example, Hardwick and Adams (1999) as well as Shiu (2016), who analyze statutory data, find that the use of reinsurance and the use of derivatives are related. The data they use, however, does not allow them to identify why this relation exists.…”

On the Corporate Demand for Insurance: Evidence From the Global Reinsurance Market

“…This U.S./U.K. regulatory disclosure requirement has spawned several papers (Cummins et al., ; Drechsler and Cummins, ; Hardwick and Adams, ; Shiu, ), which document that reinsurance purchases are negatively correlated with derivatives usage by insurers; that is, the more insurers rely on reinsurance, the less they hedge using derivatives (and vice versa). This empirical result comports well with the notion that insurers coordinate the management of underwriting and investment risks within an integrated/enterprise risk management framework.…”