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Risks 2017, 5(1), 3; doi:10.3390/risks5010003

The Effects of Largest Claim and Excess of Loss Reinsurance on a Company’s Ruin Time and Valuation

1
ARC Centre of Excellence for Mathematical and Statistical Frontiers, School of Mathematics and Statistics, The University of Melbourne, Parkville, VIC 3010, Australia
2
Department of Mathematics, Syracuse University, Syracuse, NY 13244-1150, USA
3
Research School of Finance, Actuarial Studies and Statistics, Australian National University, Canberra, ACT 0200, Australia
4
School of Economics and Social Science, Universität Hamburg, Von-Melle-Park 5, 20146 Hamburg, Germany
5
School of Operations Research and Information Engineering, Cornell University, Ithaca, NY 14853, USA
*
Author to whom correspondence should be addressed.
Academic Editor: Luca Regis
Received: 21 November 2016 / Revised: 22 December 2016 / Accepted: 28 December 2016 / Published: 6 January 2017
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Abstract

We compare two types of reinsurance: excess of loss (EOL) and largest claim reinsurance (LCR), each of which transfers the payment of part, or all, of one or more large claims from the primary insurance company (the cedant) to a reinsurer. The primary insurer’s point of view is documented in terms of assessment of risk and payment of reinsurance premium. A utility indifference rationale based on the expected future dividend stream is used to value the company with and without reinsurance. Assuming the classical compound Poisson risk model with choices of claim size distributions (classified as heavy, medium and light-tailed cases), simulations are used to illustrate the impact of the EOL and LCR treaties on the company’s ruin probability, ruin time and value as determined by the dividend discounting model. We find that LCR is at least as effective as EOL in averting ruin in comparable finite time horizon settings. In instances where the ruin probability for LCR is smaller than for EOL, the dividend discount model shows that the cedant is able to pay a larger portion of the dividend for LCR reinsurance than for EOL while still maintaining company value. Both methods reduce risk considerably as compared with no reinsurance, in a variety of situations, as measured by the standard deviation of the company value. A further interesting finding is that heaviness of tails alone is not necessarily the decisive factor in the possible ruin of a company; small and moderate sized claims can also play a significant role in this. View Full-Text
Keywords: largest claims reinsurance; excess of loss reinsurance; ruin probability; ruin time; compound Poisson risk model; heavy tails; Lévy insurance risk process largest claims reinsurance; excess of loss reinsurance; ruin probability; ruin time; compound Poisson risk model; heavy tails; Lévy insurance risk process
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This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. (CC BY 4.0).

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MDPI and ACS Style

Fan, Y.; Griffin, P.S.; Maller, R.; Szimayer, A.; Wang, T. The Effects of Largest Claim and Excess of Loss Reinsurance on a Company’s Ruin Time and Valuation. Risks 2017, 5, 3.

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