THE DETERMINATION OF OPTIMAL RETENTION FOR EXCESS OF LOSS REINSURANCE SCHEME (CASE STUDY: EARTHQUAKE REINSURANCE IN WEST JAVA PROVINCE)

• Main Author: Saragih, Raymond
• Format: Final Project
• Language: Indonesia
• Online Access: https://digilib.itb.ac.id/gdl/view/84136
• Institution: Institut Teknologi Bandung

Indonesia is an archipelago located at the meeting point of four major tectonic plates: the Indo-Australian, the Eurasian, the Pacific, and the Philippine Sea Plates. This positioning resulting in Indonesia to be highly susceptible to tectonic earthquakes. For example, the presence of the Indo-Australian tectonic plate to the south of West Java province makes the region particularly vulnerable to tectonic earthquake disasters. Earthquakes could cause many losses of lives as well as damages to properties. According to the Fiscal Policy Agency of the Indonesia Ministry of Finance, the average financial losses due to earthquakes in Indonesia, amounts to IDR 7.56 trillion per year. Therefore, a financial instrument to mitigate the financial losses due to earthquake disasters is essential; one such instrument is an earthquake insurance/reinsurance. This Final Project (Tugas Akhir) briefly discusses the Earthquake Catastrophe (CAT) Model, which consists of four modules: Hazard, Inventory, Vulnerability, and Loss Modules. It also explores the Excess-of-Loss Reinsurance scheme and the determination of an optimal retention by minimizing the Value-at-Risk of the insurance company’s Total Cost. The data used as a case study is the Average Annual Loss (AAL) data from seven “Kota/Kabupaten” (Districts) in West Java Province: Kabupaten Sukabumi, Kabupaten Bogor, Kabupaten Bandung, Kabupaten Cianjur, Kabupaten Tasikmalaya, Kota Bandung, and KabupatenWest Bandung. Several scenarios for determining optimal retentions are conducted based on four assumed probability distributions for the Aggregate Financial Losses: Lognormal, Gamma, Inverse Gaussian, and Pareto; various values of the Coefficient of Variation (CV); and several loading factor values for the reinsurance risk premiums. The reinsurance risk premium is determined using the Expected Value Premium Principle.