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Insurance and Reinsurance Contracts as Complex Derivatives: Application to Multiple Peril Policies

36 Pages Posted: 5 Aug 1999  

Alan Robert Jung

San Francisco State University

Cyrus A. Ramezani

California Polytechnic State University, San Luis Obispo

Date Written: July 24, 1999

Abstract

Multiple peril insurance schemes (e.g., revenue and earnings insurance) provide protection against adverse movements in several named risks. Their indemnity payoff function resembles that of exotic options with complex contingencies. In this paper we show how the option-based pricing techniques from financial economics can be used to calculate fair premiums for such contracts. Using three existing revenue insurance contracts as examples, we demonstrate the usefulness of this approach. The products we consider are sold by private insurance companies, but are reinsured by US government. We show that the reinsurance contract can also be valued by the same technique. Our valuation methodology is very tractable and may be preferred to other techniques, particularly when the risks underlying the insurance products can be hedged using financial instruments. Our application provides new insights on the valuation of public reinsurance of private risks and can be extended to other areas such as the recently proposed Federal catastrophe reinsurance.

JEL Classification: G13, G22, Q14, Q18

Suggested Citation

Jung, Alan Robert and Ramezani, Cyrus A., Insurance and Reinsurance Contracts as Complex Derivatives: Application to Multiple Peril Policies (July 24, 1999). Available at SSRN: https://ssrn.com/abstract=170689 or http://dx.doi.org/10.2139/ssrn.170689

Alan Jung

San Francisco State University ( email )

CA

Cyrus A. Ramezani (Contact Author)

California Polytechnic State University, San Luis Obispo ( email )

School of Business
San Luis Obispo, CA 93407
United States

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