Managing financial constraints: Undercapitalization and underwriting capacity in spanish fire insurance

Abstract

Reinsurance is a vital financial device for enhancing underwriting capacity, ceding risks and mitigating financial distress. By supplying financial resources and services, reinsurance can facilitate growth and expansion in the insurance business. Focusing on the insurance sector in the emerging Spanish economy and using a novel dataset on fire insurance companies, this paper examines the role of fire insurance in the capital formation, the importance of reinsurance as a vehicle for expanding the country’s domestic underwriting capacity, and how the capital import impacted on the balance of payment, from the introduction of the first comprehensive legislation regarding insurance in 1908 to the outbreak of the Civil War in 1936. Considering the situation of undercapitalization, the singularities of the insurance market, and the changes in regulatory schemes, we find that foreign reinsurance became a key financial vehicle for increasing the underwriting capacity in Spain. We also show the struggle for an emerging market to find ways to keep balance of current accounts and raise capital when the financial infrastructure is underdeveloped. The diffusion of reinsurance networks from the core of industrial Western countries towards emerging economies was one of the mechanisms for financial modernization on a global scale.