The Economics of Reinsurance

TLDR

Reinsurance use is influenced by insurer market power, with monopolistic managers opting for reinsurance and overall market power limiting its adoption. The study examines how insurance market features influence reinsurance utilization. Reinsurance activity arises in imperfectly competitive direct markets, with monopsonistic insurer managers opting for reinsurance when their risk aversion exceeds that of clients, aligning with owner interests. Reinsurance use falls as the policy‑holder to manager risk‑aversion ratio rises, and costs borne by insurers or reinsurers in the reinsurance market diminish its use, whereas insurer‑side transaction costs do not affect self‑coverage.

Abstract

Features of insurance markets that affect the use of reinsurance are examined. An active reinsurance market exists when the direct market is imperfectly competitive. The manager of an insurer with monopoly power takes reinsurance. Market power in the reinsurance market restricts its use. The manager of a monopsonistic insurer takes reinsurance when his or her risk aversion is greater than that of clients; this behavior is consistent with the interests of owners. The use of reinsurance is then decreasing with the ratio of policy-holder to manager risk aversion coefficients. Costs incurred by either insurers or reinsurers in the reinsurance market reduce the use of reinsurance, while costs incurred by insurers in the original transaction leave coverage provided by insurers themselves unchanged.