A public reinsurance facility for uncertain risk layers:A modest proposal?

Michael R Carter

NBER & Department of Agricultural & Resource EconomicsBASIS Assets & Market Access Innovation Lab &

I4 Index Insurance Innovation InitiativeUniversity of California, Davis

http://basis.ucdavis.edu

GAN Meeting, London

April 28, 2015

M.R. Carter Public Reinsurance

Leveraging Public Sector Uncertainty (Tail-risk) Neutrality

If we accept the notion that the private sector has excesssensitivity to tail risk (or to uncertainty about tail risk), thenwhat are the implications for public sector policy?That is, how can public dollars intended to offset ’past publicgood failures’ (and tail risk uncertainty) be mostcost-effectively employed in this context?

M.R. Carter Public Reinsurance

Recall our prior example

What if the public sector can value the tail risk (severe losses)at its expected actuarially fair price without concern forshareholder time horizons, internal promotion ladders, and anincreasing cost of capital?

M.R. Carter Public Reinsurance

Alternative Public-Private Partnership Models

Model ALet the private sector price the full contract (all risk layers)Have the public sector provide a subsidy to bring the pricedown to “reasonable levels” (140% of pure premium) so thatdemand is not squashedNote that the money spent on this subsidy is gone and willnever be recouped by the public sector

Model BPublic sector reinsures the severe risk layer at the expectedactuarially fair priceHave the private sector reinsure the moderate risk layer at(non-penalized) actuarially fair price)

Model CSame as B, except the public sector spends the equivalentsubsidy as A on lowering the price of the severe risk layer

What would this look like in our hypothetical model?

M.R. Carter Public Reinsurance

Alternative Public-Private Partnership Models

M.R. Carter Public Reinsurance

Further Considerations

Arguments hinges on the idea that private sector pricing ofuncertain tail end risk creates an arbitrage opportunity for anuncertainty neutral public sector entityAllows for a 50% mark-up for administration and other costsfor public and private sectorsWould such an arrangement crowd in private sector interest forless severe risk layers in the knowledge that private liability issharply limited?This approach could be seen as a transitional strategy asbetter data and product familiarity increase over timeMost importantly, takes the debilitating weight of past publicgood failures off the shoulders of small scale farmers, hopefullyopening the doors to improved investment and livelihoodimpacts

M.R. Carter Public Reinsurance