Reinsuring Group Revenue Insurance with Exchange-Provided Revenue Contracts

Building on recent work by Mirand and Glauber (1997), this report shows that it is feasible to use exchange-based contracts as a substitute for the Standard Reinsurance Agreement (SRA). The contract we analyze here is a Group Revenue Contract, which would allow producers to guarantee against reductions in county-level revenues. The insurance company would then purchase put options on an exchange-based revenue contract to protect against statewide revenue shortfalls. The analysis suggests that this reinsurance tool would eliminate most though not all of the systemic risk associated with this product. The insurance company would have to purchase supplemental reinsurance to complement the exchange-based product, but the level of reinsurance needed would not be greater than under the current SRA. The use of this procedure would greatly reduce federal exposure to losses associated with the current SRA. Also, by allowing informed speculators to impute a fair level of price-yield correlation into the revenue contract and the options based on that contract, the ultimate cost of the product to farmers would be lower.