Determinants of Derivative Usage in the Life and General Insurance Industry: The Australian Evidence

Abstract

Core business and financial market risks are not easily reduced by standard operating procedures in insurance companies. Derivatives theoretically provide a cost effective vehicle to hedge these risks. This paper provides an empirical analysis of the determinants of derivative usage as well as the extent of derivative usage in the Australian insurance industry in both life and general insurance companies for the period 1997–1999. Empirical results for the Australian life insurance industry in general confirm the findings of UK and US based research. However, the Australian general insurance industry does not appear to follow the conclusions of previous literature. Our results indicate that for life insurers, the determinants of derivative usage were size, leverage and reinsurance. For the general insurance industry the determinants were size and the extent of long tail lines of business written. As regards the determinants of the extent of derivative usage, these were size and asset-liability duration mismatches for life insurers. For the general insurance industry the determinants of the extent of derivative usage were size, the extent of long tail lines of business written, and the reporting year.