EconPapers    
Economics at your fingertips  
 

How Does Reinsurance Create Value to an Insurer? A Cost-Benefit Analysis Incorporating Default Risk

Ambrose Lo ()
Additional contact information
Ambrose Lo: Department of Statistics and Actuarial Science, The University of Iowa, 241 Schaeffer Hall, Iowa City, IA 52242-1409, USA

Risks, 2016, vol. 4, issue 4, 1-16

Abstract: Reinsurance is often empirically hailed as a value-adding risk management strategy which an insurer can utilize to achieve various business objectives. In the context of a distortion-risk-measure-based three-party model incorporating a policyholder, insurer and reinsurer, this article formulates explicitly the optimal insurance–reinsurance strategies from the perspective of the insurer. Our analytic solutions are complemented by intuitive but scientifically rigorous explanations on the marginal cost and benefit considerations underlying the optimal insurance–reinsurance decisions. These cost-benefit discussions not only cast light on the economic motivations for an insurer to engage in insurance with the policyholder and in reinsurance with the reinsurer, but also mathematically formalize the value created by reinsurance with respect to stabilizing the loss portfolio and enlarging the underwriting capacity of an insurer. Our model also allows for the reinsurer’s failure to deliver on its promised indemnity when the regulatory capital of the reinsurer is depleted by the reinsured loss. The reduction in the benefits of reinsurance to the insurer as a result of the reinsurer’s default is quantified, and its influence on the optimal insurance–reinsurance policies analyzed.

Keywords: marginal cost; marginal benefit; distortion; 1-Lipschitz; premium; Value-at-Risk; VaR; TVaR; comonotonicity; counterparty risk (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 M2 M4 K2 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1) Track citations by RSS feed

Downloads: (external link)
https://www.mdpi.com/2227-9091/4/4/48/pdf (application/pdf)
https://www.mdpi.com/2227-9091/4/4/48/ (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:gam:jrisks:v:4:y:2016:i:4:p:48-:d:85331

Access Statistics for this article

Risks is currently edited by Prof. Dr. J. David Cummins

More articles in Risks from MDPI, Open Access Journal
Bibliographic data for series maintained by XML Conversion Team ().

 
Page updated 2019-03-02
Handle: RePEc:gam:jrisks:v:4:y:2016:i:4:p:48-:d:85331