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Using participating and financial contracts to insure catastrophe risk: Implications for crop risk management

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  • Enjolras, Geoffroy
  • Kast, Robert

Abstract

High losses generated by natural catastrophes reduce the availability of insurance. Among the ways to manage risk, the subscriptions of participating and non-participating contracts respectively permit to implement the two major principles in risk allocation: the mutuality and the transfer principles. Decomposing a global risk into its idiosyncratic and systemic components, we show that: the participating contract hedges the individual losses under a variable premium and the systemic risk is covered with a non-participating contract under a fixed premium. Based on Doherty and Schlesinger (2002) and Mahul (2002) approaches, our model replaces the non-participating contract by a financial one based on an index closely correlated to the systemic risk, under a basis risk. Despite the introduction of loading factors on both participating and financial contracts, which increase final loss, we prove that the combination of policies offers an optimal coverage that eliminates the basis risk and provides a sustainable solution for the insurer and the policyholder. We also put in evidence the necessary intermediation of insurance companies in the subscription of such contracts. Therefore, potential implications for crop risk management are studied.

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Bibliographic Info

Paper provided by European Association of Agricultural Economists in its series 101st Seminar, July 5-6, 2007, Berlin Germany with number 9268.

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Date of creation: 2007
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Handle: RePEc:ags:eaa101:9268

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Keywords: Catastrophe risk; Crop insurance; Optimal hedging; Securitization; Crop Production/Industries; Risk and Uncertainty;

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  1. Arrow, Kenneth J, 1996. "The Theory of Risk-Bearing: Small and Great Risks," Journal of Risk and Uncertainty, Springer, vol. 12(2-3), pages 103-11, May.
  2. Neil A. Doherty & Harris Schlesinger, 2001. "Insurance Contracts and Securitization," CESifo Working Paper Series 559, CESifo Group Munich.
  3. Marshall, John M, 1974. "Insurance Theory: Reserves versus Mutuality," Economic Inquiry, Western Economic Association International, vol. 12(4), pages 476-92, December.
  4. Dwight M. Jaffee & Thomas Russell, 1996. "Catastrophe Insurance, Capital Markets and Uninsurable Risks," Center for Financial Institutions Working Papers 96-12, Wharton School Center for Financial Institutions, University of Pennsylvania.
  5. Raviv, Artur, 1979. "The Design of an Optimal Insurance Policy," American Economic Review, American Economic Association, vol. 69(1), pages 84-96, March.
  6. Olivier Mahul, 2001. "Managing Catastrophic Risk Through Insurance and Securitization," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 83(3), pages 656-661.
  7. Doherty, Neil A & Dionne, Georges, 1993. " Insurance with Undiversifiable Risk: Contract Structure and Organizational Form of Insurance Firms," Journal of Risk and Uncertainty, Springer, vol. 6(2), pages 187-203, April.
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Cited by:
  1. Geoffroy Enjolras & Robert Kast & Patrick Sentis, 2009. "Diversification in Area-Yield Crop Insurance : The Multi Linear Additive Model," Working Papers 09-15, LAMETA, Universtiy of Montpellier, revised Nov 2009.
  2. Robert Kast, 2011. "Managing financial risks due to natural catastrophes," Working Papers hal-00610241, HAL.

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