This document discusses the potential for a public reinsurance facility to address the private sector's excess sensitivity to tail risk and uncertainty about tail risk. It presents three alternative models for public-private partnerships in reinsurance: Model A subsidies the full private contract to lower prices, Model B has the public sector reinsure just the severe risk layer at fair price while the private sector handles moderate risk, and Model C is similar to B but spends the subsidy on lowering the severe risk layer price. The document argues that a public entity could more neutrally price uncertain tail risk, crowding in private interest for less severe layers and limiting their liability, acting as a transitional strategy as risk knowledge grows over time.

1. A public reinsurance facility for uncertain risk layers:
A modest proposal?
Michael R Carter
NBER & Department of Agricultural & Resource Economics
BASIS Assets & Market Access Innovation Lab &
I4 Index Insurance Innovation Initiative
University of California, Davis
http://basis.ucdavis.edu
GAN Meeting, London
April 28, 2015
M.R. Carter Public Reinsurance

2. Leveraging Public Sector Uncertainty (Tail-risk) Neutrality
If we accept the notion that the private sector has excess
sensitivity to tail risk (or to uncertainty about tail risk), then
what are the implications for public sector policy?
That is, how can public dollars intended to offset ’past public
good failures’ (and tail risk uncertainty) be most
cost-effectively employed in this context?
M.R. Carter Public Reinsurance

3. Recall our prior example
What if the public sector can value the tail risk (severe losses)
at its expected actuarially fair price without concern for
shareholder time horizons, internal promotion ladders, and an
increasing cost of capital?
M.R. Carter Public Reinsurance

4. Alternative Public-Private Partnership Models
Model A
Let the private sector price the full contract (all risk layers)
Have the public sector provide a subsidy to bring the price
down to “reasonable levels” (140% of pure premium) so that
demand is not squashed
Note that the money spent on this subsidy is gone and will
never be recouped by the public sector
Model B
Public sector reinsures the severe risk layer at the expected
actuarially fair price
Have the private sector reinsure the moderate risk layer at
(non-penalized) actuarially fair price)
Model C
Same as B, except the public sector spends the equivalent
subsidy 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

5. Alternative Public-Private Partnership Models
M.R. Carter Public Reinsurance

6. Further Considerations
Arguments hinges on the idea that private sector pricing of
uncertain tail end risk creates an arbitrage opportunity for an
uncertainty neutral public sector entity
Allows for a 50% mark-up for administration and other costs
for public and private sectors
Would such an arrangement crowd in private sector interest for
less severe risk layers in the knowledge that private liability is
sharply limited?
This approach could be seen as a transitional strategy as
better data and product familiarity increase over time
Most importantly, takes the debilitating weight of past public
good failures off the shoulders of small scale farmers, hopefully
opening the doors to improved investment and livelihood
impacts
M.R. Carter Public Reinsurance