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We analyze the design of insurance contracts when individual risks are correlated across risk-averse agents in a community, which generates collective risk. The community is equipped with a public insurer that supplies insurance contracts to its members and has access to costly reinsurance outside the community. When reserves are costless, risk-averse agents fully insure their individual risk and share a fraction of the collective risk by setting insurer's reserves, from which they receive dividends when collective losses are low. When reserves are costly, they only partially insure their individual risk, hence obtaining a lower indemnity in case of high collective losses than in case of low collective losses. In addition, they may receive dividends in the latter case, depending on the trade-off between reserve costs and reinsurance costs. We illustrate the emergence of these mutual insurance contracts with indemnities and dividends contingent on collective losses for the community of theCaribbean countries exposed to natural catastrophe risks.
