Reinsurance contracts. A utility approach vs. insurance capacity considerations

Present explanations for the existence of reinsurance are based on utility analysis and assume some sort of risk aversion in the insurer-reinsurer interface. This analogy to the insured-insurer interface stands in contrast to capital market equilibrium theory, since, unlike the isured, the insurer cannot gain from further diversification of a risk insured at the market price of risk. The existence of reinsurers must, therefore, be explained by market imperfections. The present study explains reinsurance as an outcome of the solvency regulation and capacity considerations of insurers and reinsurers. This approach enables the handling of various types of reinsurance contracts (and therefore offers also a wider perspective than earlier studies, which focused only on proportional, quota share, agreements). Interesting relationships between reinsurance pricing, solvency and capacity are observed within our framework.