Reinsurance and Capital Structure: Evidence from the United Kingdom Non-Life Insurance Industry

Abstract

Using a data set consisting of statutory returns of U.K. non-life insurers from 1985 to 2002, I find that insurers with higher leverage tend to purchase more reinsurance, and insurers with higher reinsurance dependence tend to have a higher level of debt. My results are consistent with the expected bankruptcy costs argument, agency costs theory, risk-bearing hypothesis, and renting capital hypothesis. I also find that the impact of leverage on reinsurance will be weaker for insurers that use more derivatives than those that use less. Moreover, high levels of derivative use increase the leverage gains attributable to reinsurance.