Financial Contagion and Diversification of Insurance Activities
Authors: Christian Kubitza (Goethe University) and Fabian Regele (Goethe University)
Title: Financial Contagion and Diversification of Insurance Activities
Abstract: Insurance companies are important counterparties in numerous financial transactions and thus might contribute to financial contagion. Since the core insurance activities, life and non- life business, naturally exhibit a low degree of correlation, they enable diversification of business activities. We motivate the impact of this diversification effect on financial contagion both the- oretically and empirically. Our results imply that, on average, a fraction of roughly 60% life business minimizes contagion risk. This fraction tends to increase with an insurer’s investment volatility, leverage ratio, and the scope of active reinsurance assumed. We argue that business diversification effects are more pronounced for insurers compared to banks since different insur- ance claims are loosely correlated. Our findings have important implications for the design of macro-prudential policies.