Topic 9 - Characteristics of an Insurable Risk
Price of Insurance (Pi)
= P*+Risk Charge+Loading
Adverse Selection
A high-risk person benefits more from insurance, so is more likely to purchase it.
Large number of similar objects
A large homogeneous risk pool is desirable for insurance companies
Purpose of Insurance Interest
An insured should not be able to collect more than his/her insurable interest (indemnify)
Purpose of Subrogation
Hold 3rd party accountable for negligent. Control Moral Hazard. Keep Insurance premium rates low
Losses can be determined/measured
If data is available, easier to make predictions
When must Insurable Interest Exist
In property: exist at time of loss In life insurance: at the inception of the contract only
Subrogation Issue
Insured can not impair insurers right to subrogate
Insurance Supply
Insurers are willing to sell insurance at a particular price
Large Loss Principle
Maximum possible loss needs to be sufficient (people don't buy insurance of inexpensive stuff)
Life Insurance
Must be a financial interest in the continuance of a life S= Subject O= Owner B= Beneficiary
Insurable Interest
Must demonstrate some personal loss from peril
Losses are accidental/unintentional
Needs to be fortuitous in Nature, avoid moral hazard/not gambling
Why might Pi ≥ Pmax?
Pi is too high (frequency or severity is too high) Risk charge is too high (too much uncertainty) Loading cost are too high (too much administrative cost) Pmax is too low (individuals underestimate the risk, or moral hazard created by disaster relief where insurance-like benefits exists)
A market for Insurance can only exist if
Pi ≤ Pmax
Principle of Subrogation
Substitution of the insurer in place of the insured for the purpose of claiming indemnity from a third person for a loss covered by insurance. To prevent the insured from collecting twice for the same loss, to hold the neglect person responsible for the loss, and to hold down insurance rates.
Pmax
The most an individual will pay for insurance for a particular risk
Losses should not be catastrophic
When one random event results in many losses, the insurance company has a big problem
Insurance Demand
Will individuals pay for insurance at the stated premium?
Characteristics of Insurable Risk
Wishlist: 1) Large number of similar objects 2) Losses are accidental/unintentional 3) Losses can be determined/measured 4) Losses should not be catastrophic 5) Large Loss Principle 6) Insurable Interest