On the Determinants of Derivative Hedging by Insurance Companies: Evidence from Taiwan

There has been considerable growth in the derivatives holdings of Taiwanese insurance companies in recent years and this study examines the determinants of derivative use for both life and non-life companies. The determinants are different in the two insurance sectors. For the life sector, we find that large firms and firms exposed to either foreign exchange risk or interest rate risk (due to the duration of liabilities being greater than that of the assets) are more likely to participate in derivative hedging activities. In the case of foreign exchange risk, the greater the exposure, the greater the derivative holdings (as a proportion of the total assets of the firm). For the non-life sector, exposure to interest rate risk (as measured by net interest margin) and foreign exchange risk have a significant influence on the derivative participation decision. The level of derivative holdings is then positively related to foreign exchange exposure and negatively related to the level of reinsurance.