Determinants of Insurers' Reputational Risk

When purchasing coverage, insurance consumers are unable to observe an insurers ultimate performance on the explicit and implicit promises incorporated into their policy. As a result, these consumers must rely on an insurers reputation to evaluate the offered coverage when deciding which insurers product to purchase. In fact, others (e.g., Klein and Leffler, 1981) have demonstrated that consumers will pay a premium to purchase coverage from a highly reputable insurer. Maintaining that good reputation, however, is costly. Whether or not it is
profit maximizing to meet a consumers expectation associated with an insurers reputation, therefore, depends on a variety of factors, such as the size of expected profits from maintaining a good reputation, the discount rate into the future, and the efficiency of information sharing that would affect the speed of change in an insurers reputation. We believe these factors can help us identify determinants of reputational risk. Our empirical results indicate that the level of capital holding and the efficiency of belief updating are strongly associated with insurers reputational risk takings, which the literature suggests eventually cause loss of reputation. The results also indicate that reputational risks are more likely to be taken when market rate of return is high.