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Moral Hazard in Reinsurance Markets

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  • Neil Doherty
  • Kent Smetters

Abstract

This article attempts to identify moral hazard in the traditional reinsurance market. We build a multiperiod principal-agent model of the reinsurance transaction from which we derive predictions on premium design, monitoring, loss control, and insurer risk retention. We then use panel data on U.S. property liability reinsurance to test the model. The empirical results are consistent with the model's predictions. In particular, we find evidence for the use of loss-sensitive premiums when the insurer and reinsurer are not affiliates (i.e., not part of the same financial group), but little or no use of monitoring. In contrast, we find evidence for the extensive use of monitoring when the insurer and reinsurer are affiliates, where monitoring costs are lower. Copyright The Journal of Risk and Insurance.

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Bibliographic Info

Article provided by The American Risk and Insurance Association in its journal The Journal of Risk and Insurance.

Volume (Year): 72 (2005)
Issue (Month): 3 ()
Pages: 375-391

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Handle: RePEc:bla:jrinsu:v:72:y:2005:i:3:p:375-391

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  1. Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-90, September.
  2. Kenneth A. Froot & Paul G.J. O'Connell, . "On the Pricing of Intermediated Risks: Theory and Application to Catastrophe Reinsurance," Center for Financial Institutions Working Papers 97-24, Wharton School Center for Financial Institutions, University of Pennsylvania.
  3. Bengt Holmstrom, 1997. "Moral Hazard and Observability," Levine's Working Paper Archive 1205, David K. Levine.
  4. Franklin Allen & Douglas Gale, 1996. "Financial Markets, Intermediaries and Intertemporal Smoothing," Center for Financial Institutions Working Papers 96-33, Wharton School Center for Financial Institutions, University of Pennsylvania.
  5. Bond, E.W. & Crocker, K.J., 1993. "Hardball and the Soft Touch: The Economics of Optimal Insurance Contracts with Costly State Verification and Endogenous Monitoring Costs," Papers 10-93-1b, Pennsylvania State - Department of Economics.
  6. Bruce C. Greenwald & Joseph E. Stiglitz, 1990. "Asymmetric Information and the New Theory of the Firm: Financial Constraints and Risk Behavior," NBER Working Papers 3359, National Bureau of Economic Research, Inc.
  7. Randall Geehan, 1977. "Returns to Scale in the Life Insurance Industry," Bell Journal of Economics, The RAND Corporation, vol. 8(2), pages 497-514, Autumn.
  8. Kenneth A. Froot & David S. Scharfstein & Jeremy C. Stein, 1992. "Risk Management: Coordinating Corporate Investment and Financing Policies," NBER Working Papers 4084, National Bureau of Economic Research, Inc.
  9. Cremer, Jacques, 1995. "Arm's Length Relationships," The Quarterly Journal of Economics, MIT Press, vol. 110(2), pages 275-95, May.
  10. Keith J. Crocker & John Morgan, 1998. "Is Honesty the Best Policy? Curtailing Insurance Fraud through Optimal Incentive Contracts," Journal of Political Economy, University of Chicago Press, vol. 106(2), pages 355-375, April.
  11. Richard A. Lambert, 1983. "Long-Term Contracts and Moral Hazard," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 441-452, Autumn.
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Cited by:
  1. Guillaume Plantin, 2003. "Does reinsurance need reinsurers?," LSE Research Online Documents on Economics 24848, London School of Economics and Political Science, LSE Library.
  2. John Lewis, 2010. "Reinsurers as financial intermediaries in the market for catastrophic risk," DNB Occasional Studies 802, Netherlands Central Bank, Research Department.
  3. Bender, Klaus & Richter, Andreas, 2002. "Optimales Vertragsdesign bei moralischem Risiko in der Rückversicherung," Working Papers on Risk and Insurance 9, University of Hamburg, Institute for Risk and Insurance.
  4. repec:hal:wpaper:halshs-00800460 is not listed on IDEAS
  5. Franke, Günter & Krahnen, Jan Pieter, 2008. "The future of securitization," CFS Working Paper Series 2008/31, Center for Financial Studies (CFS).
  6. Benjamin Lorent, 2008. "Raisons Fondamentales d’une Régulation Prudentielle du Secteur des Assurances," Working Papers CEB 08-020.RS, ULB -- Universite Libre de Bruxelles.
  7. Lemoyne de Forges, Sabine & Bibas, Ruben & Hallegatte, Stephane, 2011. "A dynamic model of extreme risk coverage : resilience and efficiency in the global reinsurance market," Policy Research Working Paper Series 5807, The World Bank.
  8. Starbird, S. Andrew & Amanor-Boadu, Vincent & Roberts, Tanya, 2008. "Traceability, Moral Hazard, and Food Safety," 2008 International Congress, August 26-29, 2008, Ghent, Belgium 43840, European Association of Agricultural Economists.

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