Reciprocal Reinsurance Treaties

In this paper we shall study the situation of two insurance companies which are negotiating with the view of concluding a reciprocal reinsurance treaty. We assume that the two companies are under no compulsion to reach an agreement. This means that if the companies conclude a treaty, the treaty must be such that both companies consider themselves better off than without any treaty. We futher assume that no third company can break into the negotiations. This means that the two companies either have to come to terms, or be without any reinsurance.How the two parties reach an agreement in a situation like this, is one of the classical problems of theoretical economics. It is usually referred to as the “Bargaining Problem”. The problem appears very simple, but this is a deception. It has proved extremely difficult to formulate generally acceptable assumptions which give the problem a determinate solution. The “Theory of Games”, developed by von Neumann and Morgenstern (10), does not give a determinate solution, but it has greatly increased our understanding of such problems, and the present paper will draw heavily on that theory.The situation which we propose to study, is very simple, may be too simple to have any bearing on reinsurance negotiations in real life. If there exists a reinsurance market, which also is a perfect market in the sense given to this term in economic theory, bartering between two companies does not make any sense. They could both do equally well or better by dealing in the market at the market price.