The liquidity demand for corporate property insurance
Document Type
Journal article
Source Publication
Journal of Risk and Insurance
Publication Date
6-1-2006
Volume
73
Issue
2
First Page
261
Last Page
278
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.
DOI
10.1111/j.1539-6975.2006.00173.x
Print ISSN
00224367
Publisher Statement
Copyright © The Journal of Risk and Insurance. Access to external full text or publisher's version may require subscription.
Full-text Version
Publisher’s Version
Language
English
Recommended Citation
Hau, A. (2006). The liquidity demand for corporate property insurance. Journal of Risk and Insurance, 73(2), 261-278. doi: 10.1111/j.1539-6975.2006.00173.x