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An Industrial Organization Theory of Risk Sharing

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  • M. Boyer
  • Charles Nyce

Abstract

Examining the global reinsurance market, we propose a new theory of optimal risk sharing that finds its inspiration in the economic theory of the firm. Our model offers a theoretical foundation for two empirical regularities that are observed in the reinsurance market: (1) the choice of specific attachment (the deductible) and detachment points (the policy limits or the retrocession); and (2) the vertical and horizontal tranching of reinsurance contracts. Using a two-factor cost model, we show how reinsurance should be optimally layered (with attachment and detachment points) for a given book of business in order to minimize the cost and total premium associated with catastrophic events.

Suggested Citation

  • M. Boyer & Charles Nyce, 2013. "An Industrial Organization Theory of Risk Sharing," North American Actuarial Journal, Taylor & Francis Journals, vol. 17(4), pages 283-296.
    • Handle: RePEc:taf:uaajxx:v:17:y:2013:i:4:p:283-296
    DOI: 10.1080/10920277.2013.839377
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    References listed on IDEAS

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    1. Cassandra R. Cole & David A. Macpherson & Patrick F. Maroney & Kathleen A. McCullough & James W. (Jay) Newman, Jr & Charles Nyce, 2011. "The Use of Postloss Financing of Catastrophic Risk," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 14(2), pages 265-298, September.
    2. J. Cummins & Georges Dionne & Robert Gagné & A. Nouira, 2009. "Efficiency of insurance firms with endogenous risk management and financial intermediation activities," Journal of Productivity Analysis, Springer, vol. 32(2), pages 145-159, October.
    3. Kenneth A. Froot, 1999. "The Financing of Catastrophe Risk," NBER Books, National Bureau of Economic Research, Inc, number froo99-1, March.
    4. David Cummins & Christopher Lewis & Richard Phillips, 1999. "Pricing Excess-of-Loss Reinsurance Contracts against Cat as trophic Loss," NBER Chapters, in: The Financing of Catastrophe Risk, pages 93-148, National Bureau of Economic Research, Inc.
    5. Cummins, J. David & Doherty, Neil & Lo, Anita, 2002. "Can insurers pay for the "big one"? Measuring the capacity of the insurance market to respond to catastrophic losses," Journal of Banking & Finance, Elsevier, vol. 26(2-3), pages 557-583, March.
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    Cited by:

    1. Reichel, Lukas & Schmeiser, Hato & Schreiber, Florian, 2022. "On the optimal management of counterparty risk in reinsurance contracts," Journal of Economic Behavior & Organization, Elsevier, vol. 201(C), pages 374-394.
    2. Reichel, Lukas & Schmeiser, Hato & Schreiber, Florian, 2021. "Sometimes more, sometimes less: Prudence and the diversification of risky insurance coverage," European Journal of Operational Research, Elsevier, vol. 292(2), pages 770-783.

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    More about this item

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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