The Design of Private Reinsurance Contracts

Eslyn Jean Baptiste and Anthony M. Santomero

Center for Financial Institutions Working Papers from Wharton School Center for Financial Institutions, University of Pennsylvania

Abstract: This paper examines the role of reinsurance relationships in the trading of underwriting risk when this trade takes place in an environment that is characterized by asymmetric information and in which information is revealed only over time. It begins by explaining how information problems affect the efficiency of the allocation of risk between insurer and reinsurer, and how long-term implicit contracts between insurers and reinsurers allow the inclusion of new information in the pricing of both future and past reinsurance coverage. Because of these features, the ceding company purchases a more efficient quantity of reinsurance. Specifically, such arrangements lead to more reinsurance coverage, higher insurer profits, and lower expected distress in the industry. It is, in short, Pareto improving.

Date: 1998-11
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