"Reinsurance demand and liquidity creation: A Search for Bicausality"
“Reinsurance demand and liquidity creation: A Search for Bicausality”, project financed by SCOR Foundation for Science
The results of the research project
The research was conducted by the Canada Research Chair in Risk Management at HEC Montréal and the Department of Economics at the University of Montréal led by Georges Dionne, full Professor, Department of Finance, HEC Montréal.
Insurers play an important role in aggregate investment activities. By investing policyholder premiums, insurers deploy capital on lower-volatility investments that provide more resilience during crises than do those of other investors. But this source of stability can be fragile because insurers face significant aggregate insurable risks such as climate risk, digital disruptions, cyberattacks, and pandemics. Because liquidity creation is a risky activity, it may affect the demand for reinsurance.
Conversely, more reinsurance opens accessibility to liquidity creation. The main contribution to the literature of this research is to document the reciprocal roles of liquidity creation and reinsurance demand and to investigate the dual relationship between insurers’ liquidity creation and reinsurance demand, in US property-liability insurance companies. Do investing insurers buy more reinsurance, and conversely, do insurers buying reinsurance invest more in illiquid assets or create more liquidity in the economy?
The research shows there are reciprocal causal links between reinsurance demand and liquidity creation for small insurers using regularized GMM methods of estimation. The links between the two activities are not significant for large insurers and are mixed for medium insurers. Economic recessions affect the relationship between liquidity creation and reinsurance demand and the nature of the recession matters, which is an important conclusion for policy implications.