Jiandong Ren
Western University
Room: M3 3127
The optimal combination of reinsurance and index insurance
Reinsurance is the primary tool for insurance companies to manage their exposure to catastrophe (CAT) risk and underwriting capacity. However, as noted in Froot (2001), most insurers purchase relatively little CAT reinsurance because the premiums are high relative to expected losses. Index-based insurance contracts offer a viable mechanism for managing CAT risks. However, since the payout is based on the index rather than the loss itself, basis risk exists.
In this paper, we explore the optimal combination of reinsurance and index insurance to hedge an insurer's risk. By assuming that the payout functions of reinsurance and index insurance policies are piecewise linear, we provide numerical solutions to the optimal combinations. The proposed methodology yields economically intuitive results and is readily applicable to a broad class of optimal insurance and risk‑transfer problems.