Optimal reinsurance analysis from a crop insurer's perspective

Abstract

PurposeThe purpose of this paper is to analyze the optimal reinsurance contract structure from the crop insurer's perspective.Design/methodology/approachA very powerful and flexible empirical‐based reinsurance model is used to analyze the optimal form of the reinsurance treaty. The reinsurance model is calibrated to unique data sets, including private reinsurance experience for Manitoba, and loss cost ratio (LCR) experience for all of Canada, under the assumption of the standard deviation premium principle and conditional tail expectation risk measure.FindingsThe Vasicek distribution is found to provide the best statistical fit for the Canadian LCR data, and the empirical reinsurance model stipulates that a layer reinsurance contract structure is optimal, which is consistent with market practice.Research limitations/implicationsWhile the empirical reinsurance model is able to reproduce the optimal shape of the reinsurance treaty, the model produces some inconsistencies between the implied and observed attachment points. Future research will continue to explore the reinsurance model that will best recover the observed market practice.Practical implicationsPrivate reinsurance premiums can account for a significant portion of a crop insurer's budget, therefore, this study should be useful for crop insurance companies to achieve efficiencies and improve their risk management.Originality/valueTo the best of the authors' knowledge, this is the first paper to show how a crop insurance firm can optimally select a reinsurance contract structure that minimizes its total risk exposure, considering the total losses retained by the insurer, as well as the reinsurance premium paid to private reinsurers.