Toward a theory of reinsurance and retrocession

There is a natural tradeoff in insurance markets between the benefits of increasing the number of competitors, and the drawbacks of weakening the law of large numbers by diminishing the average amount of insurer reserves. In this investigation, we consider the possibility of an optimal number of reinsurance/retrocession levels — and an optimal configuration of each of these levels — in the design of the insurance industry. A general question that may be asked of all financial institutions is: What factors limit the number of “layers of paper” to be constructed?