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The Design of Private Reinsurance Contracts

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  • Eslyn Jean Baptiste
  • Anthony M. Santomero

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.

Suggested Citation

  • Eslyn Jean Baptiste & Anthony M. Santomero, 1998. "The Design of Private Reinsurance Contracts," Center for Financial Institutions Working Papers 98-32, Wharton School Center for Financial Institutions, University of Pennsylvania.
    • Handle: RePEc:wop:pennin:98-32
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    File URL: http://fic.wharton.upenn.edu/fic/papers/98/9832.pdf
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    References listed on IDEAS

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    1. Allen, Franklin & Santomero, Anthony M., 1997. "The theory of financial intermediation," Journal of Banking & Finance, Elsevier, vol. 21(11-12), pages 1461-1485, December.
    2. Doherty, N A & Tinic, S M, 1981. "Reinsurance under Conditions of Capital Market Equilibrium: A Note," Journal of Finance, American Finance Association, vol. 36(4), pages 949-953, September.
    3. David F. Babbel & Anthony M. Santomero, 1997. "Risk Management by Insurers: An Analysis of the Process," Center for Financial Institutions Working Papers 96-16, Wharton School Center for Financial Institutions, University of Pennsylvania.
    4. Rubinstein, Ariel & Yaari, Menahem E., 1983. "Repeated insurance contracts and moral hazard," Journal of Economic Theory, Elsevier, vol. 30(1), pages 74-97, June.
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