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

High losses generated by natural catastrophes reduce the availability of insurance. Among the ways to secure risk, the subscription of participating and non-participating contracts respectively permit to implement the two major principles in risk allocation: the mutuality and the transfer principles. Decomposing a global risk in its idiosyncratic and systemic components, we show that, combined, the participating contracts cover against the individual losses under a variable premium and filters the systemic risk, which is covered with a nonparticipating contract under a fixed premium. Reunifying and improving Doherty and Schlesinger (2002) and Mahul (2002) approaches, we replace the non-participating contract by a financial one based on an index straightly correlated to the systemic risk, under a basis risk. Then, we prove that the combination of both participating and financial contracts offers an unbiased coverage that eliminates the basis risk and provides a sustainable solution for the insurer and the stakeholder. Therefore, potential applications for crop risk management are studied.