Reinsurance and Capital Structure: Evidence From the United Kingdom Non-Life Insurance Industry

Abstract

Using a data set consisting of statutory returns of U.K. non-life insurers from 1985 to 2002, I find that insurers with higher leverage tend to purchase more reinsurance, and insurers with higher reinsurance dependence tend to have a higher level of debt. My results are consistent with the expected bankruptcy costs argument, agency costs theory, risk-bearing hypothesis, and renting capital hypothesis. I also find that the impact of leverage on reinsurance will be weaker for insurers that use more derivatives than those that use less. Moreover, high levels of derivative use increase the leverage gains attributable to reinsurance.

The strategic role of reinsurance in the United Kingdom’s (UK) non-life insurance market

“…This observation accords with some prior studies (e.g., Shiu, 2011) and suggests that highly levered insurers tend to buy more reinsurance than lowly levered insurance firms. Table III further indicates negative and statistically significant correlations (at the 1% level, twotail) between firm size and the reinsurance ratio indicating that compared with small insurers, large insurers are likely to be relatively less reliant on reinsurance -for example, because they tend to be more naturally diversified.…”

“…In addition, 87 Lloyd's syndicates currently underwrite non-life premiums of roughly £24 billion (US$39 billion) mainly in marine, aviation and transport (MAT) lines of insurance (A.M. Best, 2012). By this standard, the UK is the largest insurance market in Europe and the third largest in the world after the US and Japan (Shiu, 2011).…”

“…The UK's non-life insurance and reinsurance markets are relatively unregulated with regard to the quantum of losses that can be covered, indemnity terms, type of contract permitted, and so on (Shiu, 2011). In 2 Additionally, 548 non-life insurers licensed by European Economic Area (EEA) member states are permitted to conduct business in the UK under the 1992 Third European Insurance Directive (Financial Services Authority, 2013).…”

Recent Research Developments Affecting Nonlife Insurance—The CAS Risk Premium Project 2011 Update

“…Härdle and Cabrera (2010) examine the calibration of a parametric catastrophe bond for earthquakes sponsored by the Mexican government. The two papers that consider the traditional reinsurance business analyze questions of capital structure (Shiu, 2011) and optimal layers for catastrophe reinsurance (Fu and Khury, 2010).…”

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

“…Previous empirical research on the demand for reinsurance typically relies on data from a single country (usually either the United States or the United Kingdom; Mayers and Smith, ; Shiu, ) and focuses attention on identifying firm‐level determinants of the demand for reinsurance. However, based on theory and evidence, we expect that reinsurance demand is affected not only by firm‐level factors but also by country‐level factors.…”