Optimal Layers for Catastrophe Reinsurance
By Luyang Fu, C.K. Stan Khury
Insurers purchase catastrophe reinsurance primarily to reduce
underwriting risk in any one experience period and
thus enhance the stability of their income stream over time.
Reinsurance comes at a cost and therefore it is important to
maintain a balance between the perceived benefit of buying
catastrophe reinsurance and its cost. This study presents a
methodology for determining the optimal catastrophe reinsurance
layer by maximizing the risk-adjusted underwriting
profit within a classical mean-variance framework.
From the perspective of enterprise risk management, this paper improves the existing literature in two ways. First, it considers catastrophe and noncatastrophe losses simultaneously. Previous studies focused on catastrophe losses only. Second, risk is measured by lower partial moment which we believe is a more reasonable and flexible measure of risk compared to the traditional variance and Value at Risk (VaR) approaches.
KEYWORDS: Catastrophe reinsurance layer, downside risk, lower partial moment, semivariance, utility function, enterprise risk management