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Do Firms Manage Catastrophe and Non-Catastrophe Risks Differently?

Recent disasters and historical insurance payouts have triggered renewed interest in how firms manage their left-tail exposure. Using a unique dataset of fully described insurance policies purchased by large U.S. firms, we provide the first consistent estimates of premium elasticity of corporate demand for insurance for both catastrophe and noncatastrophe risks. We do so by combining this dataset with financial information of the corporate clients and of the insurer provider, and by applying an IV-approach to overcome the endogeneity problem. Corporate demand for insurance is found to be rather inelastic, and more so for catastrophe risks. Impact of solvency and current ratios are tested and we find a negative relation between the solvency ratio and catastrophe risk coverage. ∗We thank George Akerlof, Neil Doherty, Marty Feldstein, Scott Harrington, Greg Nini, William Nordhaus, Jesse Shapiro, Terri Vaughan and seminar participants at the AEA annual meeting, NBER Insurance Group, NBER Economics of National Security Group, University of Pennsylvania, and the OECD for their comments and insightful discussions on an earlier version of this paper. We are indebted to John Rand at Marsh & McLennan for many fruitful discussions and for sharing with us the data that were used for our analysis. Financial support from the Wharton Risk Management and Decision Processes Center is gratefully acknowledged. †The Wharton School, University of Pennsylvania ‡Department of Economics, Monash University §The Wharton School, University of Pennsylvania and NBER.