The liquidity demand for corporate property insurance

Arthur HAU

Research output: Journal PublicationsJournal Article (refereed)

13 Citations (Scopus)

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.
Original languageEnglish
Pages (from-to)261-278
Number of pages18
JournalJournal of Risk and Insurance
Volume73
Issue number2
Early online date30 May 2006
DOIs
Publication statusPublished - Jun 2006

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