Moral Hazard in Reinsurance Markets |
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| Authors: | Neil Doherty Kent Smetters |
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| Affiliation: | Neil Doherty and Kent Smetters work at the Department of Insurance and Risk Management, The Wharton School, University of Pennsylvania. The authors can be contacted via e-mail: and . We thank three anonymous referees as well as Richard Phillips and participants of the Catastrophe Risk Workshop at the University of Pennsylvania and the February 2000 NBER Insurance Workshop for helpful comments. |
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| Abstract: | This article attempts to identify moral hazard in the traditional reinsurance market. We build a multiperiod principal–agent model of the reinsurance transaction from which we derive predictions on premium design, monitoring, loss control, and insurer risk retention. We then use panel data on U.S. property liability reinsurance to test the model. The empirical results are consistent with the model's predictions. In particular, we find evidence for the use of loss‐sensitive premiums when the insurer and reinsurer are not affiliates (i.e., not part of the same financial group), but little or no use of monitoring. In contrast, we find evidence for the extensive use of monitoring when the insurer and reinsurer are affiliates, where monitoring costs are lower. |
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