Default Risk, Demand for Insurance, andOptimal Corporate Risk Strategy of Insurance Companies

There is considerable empirical and experimental evidence that insurance demand issignificantly influenced by an insurance firm’s solvency level. For example, Sommer (1996)and Cummins and Danzon (1997) empirically show that a firm’s financial distress isaccompanied by a decrease in insurance premium income and vice versa. This relationship isfurther confirmed in a study by Epermanis and Harrington (2006) regarding the influence ofinsurer financial strength ratings on insurers’ premium growth. That insurance demand is verysensitive to the insurer’s default situation is further demonstrated by a few experimentalstudies on how consumers react to default risk. For example, Wakker et al. (1997), Albrechtand Maurer (2000), and Zimmer et al. (2009) show that people dislike insurance contractswith default risk...