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...reinsurance. ability test hypotheses related to the eclectic paradigm in a service industry and incorporate industry-specific factors adds to the eclectic paradigm literature which has traditionally focused primarily on manufacturing firms. In addition, the application of the eclectic paradigm to the reinsurance industry provides an empirical framework that combines several prior streams of literature which examine the reinsurer's decision to internationalize. The current study includes firm-specific factors, country-specific factors of the international markets, and factors related to the U.S. reinsurance industry. This article finds support for traditional factors impacting globalization such as host market size, loss experience, and competitiveness as well as reinsurer's ability to expand based on available capacity. Understanding the importance of firm-, country-, and industry-specific factors is key for managers, as analyzing these issues in isolation may lead to an incomplete picture of the factors impacting the internationalization decision, hindering managers' ability to make decisions that are in the best interest of the firm. With the continued interdependence of the world reinsurance marketplace, as well as the recent expansion of the European Union, internationalization issues are of critical importance not only to U.S. insurers, reinsurers, and regulators, but also to their global counterparts.
INTRODUCTION
Factors that influence the extent to which firms internationalize have been the subject of considerable academic research. Among the frameworks constructed to explain this process is the eclectic paradigm put forth by Dunning (1977). The eclectic paradigm explains the decision to internationalize as a function of ownership, location, and internalization (OLI) advantages. Sometimes referred to as the OLI paradigm, this framework has been further developed and tested in a number of studies (e.g., Dunning, 1980; Dunning, 1981; O'Farrell, Wood, and Zheng, 1996; Galan and Gonzalez-Benito, 2001; Javalgi, Griffith, and White, 2003).
Much of the empirical research related to the eclectic paradigm has focused on manufacturing firms. However, the academic literature has not reached a consensus on the transferability of the findings to service firms. (1) As such, the current study adds to the literature in this area by testing the theories of the eclectic paradigm using a service industry, specifically U.S. reinsurers. Due to the availability of detailed data on the operations of U.S. reinsurers, as well as the amount of reinsurance assumed from other countries by specific reinsurers, a refined test of the eclectic paradigm can be developed based on reinsurers' traits, traits of the countries from which business is assumed, and traits of the U.S. reinsurance market. In addition, an examination of the operations of U.S. reinsurers in the world marketplace is especially timely given the expansion of the European Union (EU) in 2004 as well as potential changes in international accounting regulations governing reinsurance. These changes in the international reinsurance market highlight the potential impact of trade barriers and regulations on the global reinsurance marketplace.
Recent reinsurance studies demonstrate the increasingly global operations of the insurance industry. For example, Weiss and Chung (2004) investigate the impact of large losses on the price and capacity of the reinsurance market, whereas Campbell, Goldberg, and Rai (2003) examine the impact of the Third Directives of the EU on the reinsurance market. Also, academic research related to the demand for reinsurance and functioning of the reinsurance marketplace generates a foundation from which to create firm-, country-, industry-specific variables to more accurately apply the eclectic paradigm to the financial services sector (e.g., Mayers and Smith, 1982, 1990; Outreville, 1995; Adiel, 1996; Garven and Lamm-Tennant, 2003; Li, Moshirian, and Sim, 2003; Weiss and Chung, 2004; Cole and McCullough, 2006).
The organization of this article is as follows. The section titled "Background on the International Reinsurance Marketplace" provides information on two common markets that are important to the U.S. reinsurance industry. The "Literature Review" section summarizes the related literature that has motivated this research. The "Hypotheses Development" section presents the factors considered in this examination of the involvement of U.S. reinsurers in foreign markets. The "Data and Methodology" section describes the various sources of data and explains the methodology. The "Results" section provides a summary of the findings, and the "Conclusion" section discusses potential implications of the study.
BACKGROUND ON THE INTERNATIONAL REINSURANCE MARKETPLACE
In recent years, the globalization of the world's insurance and reinsurance markets has become of heightened importance. Weiss and Chung (2004) investigate the international impact of large loss shocks on the reinsurance market, noting the impact of capacity changes around the world on domestic insurance prices. Estimates show that over 88 percent of reinsurance assumed by U.S. reinsurers from foreign countries is from countries that are members of the EU or the North American Free Trade Agreement (NAFTA). (2) The increase of free-trade initiatives worldwide is expected to further reduce the barriers for foreign firms to entering new markets.
The signing of the NAFTA in 1992 set the stage for a more open financial services sector on the North American continent. The main outcome of the Agreement was the gradual opening of the Mexican marketplace. Prior to NAFTA, there already were relatively few restrictions between Canada and the United States in the area of financial services trade. However, this was not necessarily the case for the United States and Mexico. (3)
The beginning of what is now referred to as the EU can be traced to the post-World War II era. By uniting the countries of Europe economically, and subsequently politically, the hope was to avoid another conflict among European neighbors. Though the EU initially had 15 members, the addition of Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia in 2004 increased the number of member countries to 25 (European Governments On-Line, 2003). Additionally, a small number of other countries, although not members of the EU, agreed to membership in the European Economic Area (EEA), making them subject to the same standards as EU member countries. (4)
A number of directives from the EU (and its predecessor, the European Economic Community) were designed to aid in the creation of a single insurance marketplace. The Third Directives for Insurance (both Life and Non-Life) produced what can be accurately described as a passport for any insurance company to sell coverage in any EU member country. (5) Prior to the adoption of these directives, the approval of the host country was required before a foreign company could supply insurance coverage. The purpose of the Third Directives was to increase competition in all countries of the EU, especially in those countries that were previously under a monopolistic insurance environment. (6) A 1996 SwissRe Report suggested that the main effects from the single market initiatives were increased competition from foreign firms, innovations from already existing domestic insurers, and possibly merger activity to gain economies of scale.
Some academic studies have empirically examined the changes in the competitive environment issue. For example, a study by Campbell, Goldberg, and Rai (2003) finds that the Third Non-Life Directive resulted in a reduction in wealth for publicly held nonlife insurers, which supports the theory that competition can be effective in controlling prices. In addition, a study by Mahlberg and Url (2003) uses data envelopment analysis to analyze the impact of the single market on the Austrian insurance industry. The study finds "considerable inefficiency," evidence of returns to scale via merger activity, and increased levels of reinsurance in the Austrian marketplace.
LITERATURE REVIEW
Several studies using survey methodology find that trade barriers, including cultural barriers, are a major consideration in the decision to enter foreign markets for insurers (e.g., Schroath and Korth, 1989; Zimmerman, 1999). In addition, Hamwi, Hudson, and Niroomand (1998) suggest "uncertainty associated with global expansion" may negatively affect an insurer's decision to enter a foreign market. Others studies point out the benefits of global operations. Katrishen and Scordis (1998) find that economies of scale can be achieved by smaller insurers through entry into foreign markets. Further, Louberge (1983) suggests that being active in foreign markets is advantageous to reinsurers because it creates greater risk-spreading. Finally, Outreville (1995) indicates that globalization allows firms to compensate for insufficient capacity in the domestic market.
The decision of firms to internationalize also has been explained using the eclectic paradigm introduced by Dunning in the 1970s (Dunning, 1977) and revised in several subsequent works (e.g., Dunning, 1981, 1988, 1995). Dunning's framework suggests that a firm's decision to internationalize is based on its ability to compete in that market generated by certain advantages. These advantages are categorized as ownership advantages, location advantages, and internalization advantages. The eclectic paradigm integrates concepts that were previously discussed in several prior streams of literature examining the decision of firms to operate globally, including factors such as barriers to entry as well as the benefits of internationalization.
Prior studies of the eclectic paradigm have generally focused on manufacturing firms. Several studies discuss whether the framework and related findings are applicable to service firms. (7) The current study extends this line of research by providing an empirical examination of the eclectic paradigm for service firms using data from the reinsurance industry. As mentioned earlier, the availability of detailed firm-level data for U.S. reinsurers makes this type of analysis possible. In addition, the industry provides a unique setting in which to test the eclectic paradigm, due in part to the nature of the service provided. Specifically, the reinsurance industry allows for an examination of the trade-offs between economies of scale and operating costs in an environment in which a physical presence in the host country is not necessarily required to conduct business. Finally, prior insurance research in the demand for reinsurance and the international insurance area provides insight into the firm-specific factors that influence the operations of U.S. reinsurers in the global marketplace. The results of these studies are used as a basis for the selection of firm-specific variables tailored to the nuances of the reinsurance industry in testing the motives for internationalization of U.S. reinsurers. (8)
HYPOTHESES DEVELOPMENT
Based on the framework created by Dunning (1977, 1981, 1988, 1995) and the subsequent testing of that framework in various studies (e.g., Dunning, 1980; O'Farrell, Wood, and Zheng, 1996; Galan and Gonzalez-Benito, 2001; Javalgi, Griffith, and White, 2003), an empirical framework for the globalization of U.S. reinsurers is developed. For the purposes of this study, the three original categories of variables suggested by Dunning (1977, 1981, 1988) are tested. The categories are (1) firm-specific factors, (2) country-specific factors, and (3) industry-specific factors.9 The variables used within each category, as well as the expected relation to the level of internationalization of U.S. reinsurers, are summarized in Table 1.
The firm-specific factors provide measures of the firm's capacity to internationalize, potential comparative advantages of internationalization, and the accumulation of assets. Country-specific factors allow tests of the impact of characteristics of various countries on the internationalization process. Issues such as competitiveness of the local reinsurance market, free-trade initiatives, effectiveness and/or corruption of the government, and the overall economic environment are considered. Finally, industry-specific factors measuring the liquidity and leverage of the U.S. reinsurance industry are examined. (10)
Firm-Specific Factors
The eclectic paradigm considers a variety of firm-specific factors that impact the firm's ability and propensity to internationalize. Both traditional factors related to the firm's potential comparative advantages, as well as firm-specific factors known to influence the operations and performance of reinsurers, are added to capture the specific nuances of firms within the reinsurance industry. These factors provide a more detailed test of the eclectic paradigm and control for potential confounding effects based on the variations across firms.
Ownership Advantages. Two of the issues considered in the examination of ownership advantages in prior works are expertise in the foreign markets and profitability of the firm. Both expertise in the foreign markets and firm profitability can affect a firm's ability to internationalize. The potential expertise of the firm is captured through both the extent of reinsurance assumed from other countries and whether the reinsurer is owned by a foreign parent. Both factors provide the reinsurer with potential advantages in selling reinsurance in a foreign market. The extent to which reinsurers are active in foreign markets increases the probability of entry in a given market due to potential economies of scale and increased comparative advantages. Galan and Gonzalez-Benito (2001) suggest that the firm's decision to enter foreign markets is...
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