Optimal Reinsurance Policies When the Interests of Both the Cedent and the Reinsurer are Taken into Account

Abstract

Optimal forms of reinsurance policies have been studied for a long time in actuarial literature. Most existing results are from the insurer's point of view, aiming at maximizing the expected utility or minimizing the risk of the insurer. However, as pointed out by Borch (1969), it is understandable that a reinsurance arrangement which might be very attractive to one party (e.g., insurer) can be quite unacceptable to the other party (e.g., reinsurer). In this paper, we follow this point of view and study forms of Pareto-optimal reinsurance policies whereby one party's risk, measured by its value-at-risk (VaR), cannot be reduced without increasing the VaR of the counter-party in the reinsurance transaction. We show that the Pareto-optimal policies can be determined by minimizing linear combinations of the VaRs of the two parties in the reinsurance transaction. Consequently, we succeed in deriving user-friendly, closed-form, optimal reinsurance policies and their parameter values.