Please enable JavaScript.
Coggle requires JavaScript to display documents.
Insurance + Risk Pooling (Trade an unknown /uncertain loss without…
Insurance + Risk Pooling
risk pool
homogenous
one person, A
insurer
no economic value
two people, A+B
Insurer
transfer of risk has economic value
expected payout doubled but risk :arrow_down:
result
risk pool size :arrow_up:
insurer's risk :arrow_down:
eventually approach to 0
extreme outcomes
law of large number
mechanism to operate
economic value :check:
heterogeneous
A +C in the same pool: P
(A)=1; P
(B)=2
charge "break-even" premium
will they purchase for $1.5?
A- AFP=$1
If Pmax=1.25
no
B- AFP= $2
most likely will buy
Income/ Wealth Transfer in Risk Pool
Homogeneous
who don't have a loss
to those who have a loss
Heterogenous
who don't have a loss
to those who have a loss
between risk classes
los risk individuals :arrow_right: high risk ind.
IDEALY, risk pool should be
homogeneous
large
Why do firms & ind. voluntarily purchase insurance
commodity being purchased
peace of mind
promise
security
safety
certainty
eg. credit worthiness
Trade an unknown /uncertain loss without insurance for a known/certain loss with insurance
premium
known loss (Pro. =1)
certainty in loss costs
individual uncertainty still exists
insurance
risk transfer
insured :arrow_right: insurer
financial responsibility
payment for a loss
indemnify(compensate) the insured of a covered loss
fully indemnified
same position financially after the loss as initial did
not always fully ind.
moral hazard
deductible
partial ins.
Forms of Indemnification
Cash / reimbursement
after the loss occurs
amount determined
after
the loss
loss settlement rules
Replacement cost (RC)
RC new
Actual cash value(ACV)
Bluebook Value
amount determined
in advance
life insurance
one of a kind items
difficult to value at the tome of the loss
cargo lost at sea
loss=total loss
museum but it for artwork
Repair or replace an asset
e.g. cellphone
Provide services as a way of ind.
L. ins.
provide legal services rather than reimburse the cost of an attorney
Def of insurance
pools exposures to loss of ind.into a group
risk sharing arrangement
Loss premiums
No loss premiums