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The Liquidity Demand for Corporate Property Insurance

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  • Arthur Hau

Abstract

This article suggests that liquidity may be an important reason for a corporation to purchase property insurance. A model of a risk-neutral producer facing an endogenously determined risk of property damage under an output contract that penalizes underproduction is formulated to exemplify such a real need of liquidity. Under the output contract, the producer may purchase full unfavorable property insurance even when postloss financing is available. Surprisingly, the conclusion may still hold when the cost of postloss financing equals that of long-term capital, provided that the rate of underproduction penalty is sufficiently high. Similar conclusions apply when postloss financing is replaced by planned internal reserve (self-insurance) that may be invested in the short run at an interest rate that is lower than the long-term cost of capital. When the capital market is perfect, however, the holding of planned internal reserve eliminates the purchase of actuarially unfavorable property insurance. Copyright The Journal of Risk and Insurance, 2006.

Suggested Citation

  • Arthur Hau, 2006. "The Liquidity Demand for Corporate Property Insurance," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 73(2), pages 261-278.
  • Handle: RePEc:bla:jrinsu:v:73:y:2006:i:2:p:261-278
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    Cited by:

    1. Emilio Venezian, 2009. "Incentive incompatibilities and arbitrage opportunities," Journal of Risk Finance, Emerald Group Publishing, vol. 10(5), pages 422-431, November.
    2. Erwann Michel-Kerjan & Paul A. Raschky & Howard C. Kunreuther, 2009. "Corporate Demand for Insurance: An Empirical Analysis of the U.S. Market for Catastrophe and Non-Catastrophe Risks," Working Papers 2009-10, Faculty of Economics and Statistics, University of Innsbruck.
    3. Jiang, Wei & Adams, Mike & Jia-Upreti, Joy, 2012. "Does managerial entrenchment motivate the insurance decision?," International Review of Financial Analysis, Elsevier, vol. 24(C), pages 117-128.
    4. Joy Jia & Mike Adams & Mike Buckle, 2012. "Insurance and ownership structure in India’s corporate sector," Asia Pacific Journal of Management, Springer, vol. 29(1), pages 129-149, March.
    5. ADACHI Daisuke & NAKATA Hiroyuki & SAWADA Yasusyuki & SEKIGUCHI Kunio, 2016. "Adverse Selection and Moral Hazard in the Corporate Insurance Market: Evidence from the 2011 Thailand floods," Discussion papers 16025, Research Institute of Economy, Trade and Industry (RIETI).
    6. Carole Bernard & Weidong Tian, 2009. "Optimal Reinsurance Arrangements Under Tail Risk Measures," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 76(3), pages 709-725.

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