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Requirement of an Insurable Risk (Specific Requirement of an Insurable…
Requirement of an Insurable Risk
what does it mean- risk to be insurable?
supply of insurance
P(I)= price of insurance
P*+RC(risk charge)+adm. cost
demand of insurance
insurable when P(I) < P(MAX)
not insurable when P(I)> P(MAX)
P(I) is too high
RC :arrow_up:
P* is high
Adm. costs are high
P(MAX) is too low
ind. underestimate F/S
NFIP
flood zone
diaster relief
charity hazard
p max is low
underestimate the risk
charity hazard
Specific Requirement of an Insurable risk
should be fortuitous
random; accidental; a matter of chance
insurance
no control over F/S
Violation
Moral Hazard
causes P* :arrow_up:
P(I) :arrow_up:
P(I) > P(Max)
Solution
deductible, coinsurance copayment
claims investigations
policy limits
loss settlement rule
experience rating
WC
premium vary directly with the past level of claims
should not be catastrophic
a single event :arrow_right: multiple losses at the same time
losses are not independent event
correlation amount the losses
contagion(connected)
eg. flood, pandemics, wildfire, earthquake
why are cats a problem?
insolvency risk (insurer)
run on the bank
dif. to predict overall expected loss
:arrow_up: RC
:arrow_up: P(I)
P(I)>P(MAX)
LLNs
Solutions
diversify geographically
diversify though insurer's product portfolio
diversify financially
reinsurance
contemporary examples
terrorist attacks
WC insurer
Employ benefits
life ins.
health ins.
TRIA "back-stop"
Be significant to insurer
significant
relatively high S
premium > loss itself
because of high adm. costs
eg. BIC pens Ins.
Large + contain homogeneous exposure units
large #
accurate estimate P*
:arrow_down: need for a RC
:arrow_down: P(I)
homogeneous
same or similar risk
Same P*
underwriting / risk classification
insure or not?
yes
how much?
premium
function of P*
risk-based pricing
2 more items...
actuarially fair pricing
actuarial equity
be definite + determinable
definte
easy to verify that a loss has occurred
ex: fire; death
ex of difficult: theft, injuries
solution
independent verification of losses
claims investigations/ inspection
in auto ins.
police report
determinalbe
easy to place $
easy to determine the amount of loss
solution
loss settement rules
determine the amount of the loss
ACV, RC replacement cost
insurer may
specify the amount of the loss before it occurs
why important?
difficult to estimate P*
:arrow_up:RC
:arrow_up:P(I)
P(I)> P(Max)
fallacy of community ratings (it is not fair)
rate :arrow_up: for everyone
penalize everyone
Adverse selection
arise when
homogeneous is violated
control
:arrow_up:gains information
careful underwriting
passage of time
compulsory insurance
ACA individual mandate
pay a fine
social security
strong mandate-
insurer- fed. gov.
monopoly insurer
Economic Issues related to insurance pricing
actuaries develop in. rating systems
dif, types of coverage matche premiums with loss exposures
underwriters ensure and classify within the rating system
function properly -pricing
adverse selection
moral hazard
actuarial equity & social equity
actuarial
cost-based pricing
identify every variable
social
relate the amount each person should pay by their abilities, not lose exposure!
insurer
:red_cross:increase an insured's ins premium due to criteria beyond one's control
to achieve
legislators identified
1 more item...
insurer solution
1 more item...
timing
if no
market failure
supply and demand doesn't match
unable to obtain L. ins. coverage at any price in mid-1980s
Reinsurance & its function
insurance for insurers
transfer from primary insurer
reinsurer
basics
reinsurance agreement
require to retain part of its original L.
insurance risk
primary insurer pays/
reinsurance premium
reinsurer pay
ceding commission to primary insurer
cover acquisition expense.
retrocession
retroceding (one reinsurer)
to another reinsurer( retrocessionarie
functions
goals
insuring large exposures
protect policyholder's surpluses from adverse selection
financing the insurer's growth
social function
assit insurers in reducing risk for society
Insurability of Commerce Loss Exposures
Property
examples
fire
pure risk
only pro. of loss
exception: Arson-for-profit
moral hazard
underwriters guard against
claim investigation
lawfully denied
fortuitous
solution
project aggregate claims
cased on experience in the past
definite and measurable
definite
timing of coverage
measurable
knowing the value of a building
before a loss occurs
exemption
additional living expenses, fair rental ,..
depend on an estimate
overall, insurable. BUT uncertainty (less ideal)
homogeneous! but depends on the location! commercial!
timing of occurrence / value of the property at the time of the loss
windstorm
could be catastrophic
adverse selection
flood
insurable char.
fortuitous
large number of similar exposure
define and measurable
depends on property location, type, and use
independent and not catasprophic
fire :check:
windstorm, flood :red_cross:
premiums are economically feasibel
fire :check:
windstorm and flood
depends on location
pure risk
definite and measuable
(Liability)
insurable char.
premiums are economically feasibel
premises and Oper :check:
products liability: depends on product
pure risk
large number of similar exposure
premises and Oper :check:
products liability: depends on product
fortuitous
definite and measureble
premises and Oper :check:
products liability: depends on product
independent and not catastrophic
premises and Oper :check:
products liability: could be catastrophic.
examples
premises and operations liability
products liability
(Personnel)
insurable char.
premiums are economically feasibel
premises and Oper :check:
products liability: N/A
premiums
moral hazard&adverse selection
pure risk
large number of similar exposure
death : depends on personnel involved
retirement : depends on personnel involved
fortuitous
retirement : depends on circumstances and personnel involved
death :check:
definite and measureble
death : depends on personnel involved
retirement : depends on personnel involved
independent and not catastrophic
example
death
retirement
Government Insurance Programs
rationale for gov. involvement
private may not always function perfectly
reasons
unable/ unwilling to supply
market failure
other reasons
fill unmet needs of insurers
provide ins. to meet legitimate public demants
ex. TRIP
compel ppl to buy particular type of ins
ex. WC
efficiently manage workplace injuries
or provide proof of self-ins.
ex. personal automibile L. ins
provide a cheaper ins. for those who can't obtain reasonable price in private market
obtain greater efficiency and provide convenience to ins. buyers
save unnecessary expenses
marketing
paying sales commission
(sales cost)
own distribution channel
Case:National Flood Ins. Program NFIP
gov. market through established ins. producers who also market other ins.
achieve collateral social purposes
make use of pooling mechanism
:arrow_down: risk to society
society& overall economy :check:
econ: positive externalities
WC
cost-benefit analysis.
too expensive
an org. don't want to purchase
BUT: laws encourage injury prevention and rehabilitation
positive externality
gov provide incentives for the purchase of ins
1 more item...
NFIP
amend and enforce building cofes
:arrow_down: loss exposure of new construction to floods
Level of Gov. Involvement
exclusive insurer
state gov-run wc
function as a reinsurer
partnership with private insurers
partner with private insurers
TRIA
NFIP
competitor to private insurers
when private insurers does not fall but operate inefficiently
EX- WC funds
Federal Compared with State Programs
Examples of property-casualty Insurance offered by
Fed. Gov
NFIP
char. of gov
meet unmet needs
serves social purposes
relationship to pri. ins.
either issue policies directly
or partner with private. ins.
private own names
while gov. reinsurance
TRIP
char. of gov
tempo. meet unmet needs
backstop
social purpose
market failure
relationship to pri. ins.
private insueres
primary insurer
fed gov.-reinsurer
Fed. Crop Ins.
char. of gov
affordable rates to reduce losses resurgent from unavoidable crop failures
covers perils
drought,disease,insectsmexcess rain, hail
relationship to pri. ins.
subsidizes and reins. private insurers
private insurers sell and services the fed crop ins.
independently offer cop ins, for certain perils (private insurer)
State Gov.
Fair access to ins. requirement plans (FAIR)
gov
basic ins for those who unable to obtain ins
property's location
private
unmet need to gov
WC
Beach and windstorm plans
residual auto plans