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Corporate hedging in the insurance industry: the use of financial derivatives by U.S. insurers

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  • J. David Cummins
  • Richard D. Phillips
  • Stephen D. Smith

Abstract

In this paper we investigate the extent to which insurance companies utilize financial derivatives contracts in the management of risks. The data set we employ allows us to observe the universe of individual insurer transactions for a class of contracts, namely, those normally through of as off-balance-sheet (OBS). We provide information on the number of insurers using various types of derivatives contracts and the volume of transactions in terms of notional amounts and the number of counterparties. Life insurers are most active in interest rate and foreign exchange derivatives, while property-casualty insurers tend to be active in trading equity option and foreign exchange contracts. Using a multivariate probit analysis, we explore the factors that potentially influence the existence of OBS activities. We also investigate questions relating to whether certain subsets of OBS transactions (e.g., exchange traded) are related to such things as interest rate risk measures, organizational form, and other characteristics that may discriminate between desired risk/return profiles across a cross-section of insurers. We find evidence consistent with the use of derivatives by insurers to hedge risks posed by guaranteed investment contracts (GICs), collateralized mortgage obligations (CMOs), and other sources of financial risk.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 96-19.

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Date of creation: 1996
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Handle: RePEc:fip:fedawp:96-19

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Keywords: Corporations - Finance ; Derivative securities ; Insurance industry;

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References

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  1. 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.
  2. J. David Cummins & Mary A. Weiss, 1991. "The structure, conduct, and regulation of the property-liability insurance industry," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 35, pages 117-164.
  3. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 391-405, December.
  4. Mayers, David & Smith, Clifford W, Jr, 1988. "Ownership Structure across Lines of Property-Casualty Insurance," Journal of Law and Economics, University of Chicago Press, vol. 31(2), pages 351-78, October.
  5. Mayers, David & Smith, Clifford W, Jr, 1990. "On the Corporate Demand for Insurance: Evidence from the Reinsurance Market," The Journal of Business, University of Chicago Press, vol. 63(1), pages 19-40, January.
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Cited by:
  1. Patricia Chelley-Steeley & Claire Lavers, 2005. "The propensity to hedge using futures contracts: the case of potato futures contracts," Applied Economics, Taylor & Francis Journals, vol. 37(18), pages 2143-2146.
  2. J. Cummins & Georges Dionne & Robert Gagné & A. Nouira, 2009. "Efficiency of insurance firms with endogenous risk management and financial intermediation activities," Journal of Productivity Analysis, Springer, vol. 32(2), pages 145-159, October.
  3. J. David Cummins & Richard D. Phillips & Stephen D. Smith, 1998. "Derivatives and Corporate Risk Management: Participation and Volume Decisions in the Insurance Industry," Center for Financial Institutions Working Papers 98-19, Wharton School Center for Financial Institutions, University of Pennsylvania.

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