On the optimal management of counterparty risk in reinsurance contracts

Lukas Reichel, Hato Schmeiser and Florian Schreiber

Journal of Economic Behavior & Organization, 2022, vol. 201, issue C, 374-394

Abstract: We use a normative analysis and consider the optimal reinsurance coverage structure in the presence of counterparty risk. From the perspective of a risk-averse primary insurer, we derive a cost criterion that indicates the optimality of under-, over- and full hedging of the reinsurers’ counterparty risk and show how the hedging preference can define a vertical layering of the reinsurance coverage. We also determine the optimal diversification strategies between two reinsurers that differ in their counterparty risk. Our results provide evidence that the coverage is allocated either to a single reinsurer or to both in the form of a vertical (quota share) and horizontal (excess-of-loss) allocation. Finally, we demonstrate how to optimally combine hedging and diversification.

Keywords: Optimal reinsurance; Counterparty risk; Hedging; Diversification (search for similar items in EconPapers)
JEL-codes: D81 G22 G33 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeborg:v:201:y:2022:i:c:p:374-394

DOI: 10.1016/j.jebo.2022.05.026

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