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On the optimal management of counterparty risk in reinsurance contracts

Author

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  • Reichel, Lukas
  • Schmeiser, Hato
  • Schreiber, Florian

Abstract

We use a normative analysis and consider the optimal reinsurance coverage structure in the presence of counterparty risk. From the perspective of a risk-averse primary insurer, we derive a cost criterion that indicates the optimality of under-, over- and full hedging of the reinsurers’ counterparty risk and show how the hedging preference can define a vertical layering of the reinsurance coverage. We also determine the optimal diversification strategies between two reinsurers that differ in their counterparty risk. Our results provide evidence that the coverage is allocated either to a single reinsurer or to both in the form of a vertical (quota share) and horizontal (excess-of-loss) allocation. Finally, we demonstrate how to optimally combine hedging and diversification.

Suggested Citation

  • 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.
    • Handle: RePEc:eee:jeborg:v:201:y:2022:i:c:p:374-394
    DOI: 10.1016/j.jebo.2022.05.026
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    References listed on IDEAS

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    Cited by:

    1. Chi, Yichun & Hu, Tao & Huang, Yuxia, 2023. "Optimal risk management with reinsurance and its counterparty risk hedging," Insurance: Mathematics and Economics, Elsevier, vol. 113(C), pages 274-292.

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    More about this item

    Keywords

    Optimal reinsurance; Counterparty risk; Hedging; Diversification;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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