Using participating and financial contracts to insure catastrophe risk: Implications for crop risk management

Abstract

This paper proposes a combination of participating and financial contracts in order to hedge catastrophic risk. Assuming unfair policies and the existence of a basis risk, we prove the optimal coverage is realized using: first, a participating contract, which covers the idiosyncratic part of the risk under a variable premium; second, a financial contract, which hedges the systemic part of the risk under a fixed premium. The necessary intermediation of insurance companies in the conception of such contracts is emphasized as well as the impact of unfair premia. From then, potential implications for crop risk management are examined.