The Demand for Equity and Reinsurance by Non-Life Insurance Companies if Consumers React and Interest Rates Change

This paper presents a model in which insurance cover is demanded by the clients of non-life insurance companies. The clients remunerate insurers at competitive market prices if the capacity of the insurer equals the demand for cover. Clients are, however, prepared to reward individual insurers for holding capacity in excess of insurance cover demanded, because this will increase the probability that their claims will be paid in full. Nevertheless, insurers do not offer an unlimited amount of capacity, because the generation of capacity from equity and reinsurance cover is costly. For plausible pricing relationships, the present value of expected losses is then shown to be relevant in determining reinsurance and equity demanded by primary insurers. This implies that interest rate elasticities exist for equity and reinsurance cover which contain the Macaulay-duration of expected losses. The model then indicates that insurers tend to substitute equity for reinsurance cover if interest rates rise, though the impact will be less in companies which insure long tail business.