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Corporate Hedging in the Insurance Industry: The Use of Financial Derivatives by U.S. Insurers

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Author Info
J. David Cummins
Richard Phillips
Stephen D. Smith

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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 thought 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 which 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.

This paper was presented at the Financial Institutions Center's May 1996 conference on "

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Paper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 96-26.

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Date of creation: Sep 1996
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Handle: RePEc:wop:pennin:96-26

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. " Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, vol. 48(5), pages 1629-58, December. [Downloadable!] (restricted)
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  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, pages 117-164. [Downloadable!]
  3. Smith, Clifford W. & Stulz, Ren? M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 391-405, December. [Downloadable!]
  4. Mayers, David & Smith, Clifford W, Jr, 1990. "On the Corporate Demand for Insurance: Evidence from the Reinsurance Market," Journal of Business, University of Chicago Press, vol. 63(1), pages 19-40, January. [Downloadable!] (restricted)
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  1. Patricia Chelley-Steeley* & Claire Lavers, 2005. "The propensity to hedge using futures contracts: the case of potato futures contracts," Applied Economics, Taylor and Francis Journals, vol. 37(18), pages 2143-2146, October. [Downloadable!] (restricted)
  2. J. David Cummins & Georges Dionne & Robert Gagné & Abdelhakim Nouira, 2006. "Efficiency of Insurance Firms with Endogenous Risk Management and Financial Intermediation Activities," Cahiers de recherche 06-06, HEC Montréal, Institut d'économie appliquée. [Downloadable!]
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  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. [Downloadable!]
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