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February 13, 2015

Role of Risk Management Networks Analyzed in Reinsurance Decisions

College of Business Administration researchers Dr. Yijia Lin, associate professor of finance, Dr. Jifeng Yu, assistant professor of management, and Dr. Manferd Peterson, professor emeritus of finance, investigated the role of risk management networks as protection in investment decisions. They used network theory to develop a framework that delineates how the pattern of risk management linkages determines costs and characterizes a firm’s optimal network structure.

“The magnitude of the network effect on the hedging decision is statistically and economically significant,” said Lin. “We show that in the U.S. property and casualty insurance markets, transferring risk to one more reinsurer increases an insurer’s risk ceding level by 2.2 percent. For an average firm, one standard deviation increase in network cohesion is associated with a 22.9 percent increase in risk transfer if all else is equal.”

Their article, “Reinsurance Networks and Their Impact on Reinsurance Decisions: Theory and Empirical Evidence,” appeared in the March 2014 edition of the Journal of Risk and Insurance. The article was initially presented in August 2013 at the American Risk and Insurance Association Annual Meeting in Washington, D.C.

The results of their study shed new light on the role of network positions in risk management decisions. A linked network may be optimal ex ante even though linkages among reinsurers may spread significant economic changes, supporting their prediction regarding social capital benefits associated with network cohesion.

“Our analysis provides a deeper understanding of benefits and costs from increasing risk management ties,” Lin explained. “Furthermore, our research has implications for other networks including the loan sale market and over-the-counter dealer networks.”