Past exam of the mathematics course of the University of Cambridge / 2012 / iii / Paper 40 / 2 / Solution

For a single claim $x$, quota share reinsurance with retained fraction $\alpha \in [0,1]$ makes the direct insurer pay $\alpha x$ and the reinsurer pay $(1-\alpha )x$. Under excess of loss reinsurance with retention $M\ge 0$, the direct insurer pays $\min (x,M)$ and the reinsurer pays the positive part $(x-M{)}_{+}$. Thus the concise payout pairs areThe cap in excess of loss reinsurance applies separately to every claim; it is not a cap on the entire annual aggregate.

For the following variance calculations take $\lambda >0$ and $\mathbb{E}[X^2]<\infty$, so the displayed variances are finite. For any per-claim payout $Y$, the law of total variance in a compound Poisson distribution givesThe final term is the raw second moment, not the single-claim variance. Both parties' totals are retained compound Poisson aggregates, with different payout functions of the same claims; they are generally dependent.