Topic 9 - Requirements of an Insurable Risk

Why are cat losses a problem to insure?

1. Difficult to predict overall p* 2. law of large number 3. creates risk of insolvency for an insurer

what is social equity?

1. Insurers should relate the amount each person should pay for insurance to their ability to pay rather than to their loss exposure or expense factor. 2. Insurers should not increase premium because of criteria that are beyond that individual's control.

How would you control adverse selection?

1. Mandate that people have to buy insurance 2. Acquire information

Why might PI > PMAX? (2)

1. PI is "too high" 2. PMAX is "too low"

What would prevent an insurer from engaging in risk based pricing?

1. Rates may be regulated, preventing risk based pricing 2. Insurer may not give correct info to the insurer 3. Insurer cannot ask the right questions or use observable information

Some possible solutions to the moral hazard problem?

1. claims investigation 2. deductibles, copayments, coinsurance 3. policy limits 4. experience rating 5. loss settlement rules

decisions made when underwriting? (2)

1. insure or nah? 2. if yes, how much do we charge?

Specific requirements of an insurable risk (5)

1. loss should be fortuitous (random) in nature 2. loss should not be catastrophic in nature to the investor 3. Loss being insured should be significant to the insured 4. Risk pool should be large and should contain homogeneous exposure units 5. Losses should be definite and determinable

Risk-based pricing is also like what?

Actuarially fair pricing

For a cat event, a single random events does what?

Causes multiple losses to occur at the same time due to that one single random event

Losses that are easy to verify:

Death, fire, property damage

How might PMAX be too low?

Individuals may underestimate the freq/sev. of the loss

Why is it important to verify/determine the value of the loss?

It becomes difficult to estimate p* accurately, RC and PI increase, and PI > PMAX

What does it mean for a risk to be insurable?

Must be supply and demand

How might PI be too high?

P* is high, risk charge is high, and admin costs are high

what is actuarial equity?

The calculation of an insurance premium based on crucial factors such as the applicant's age, gender, health, family history and the type of insurance coverage applied for.

Why is moral hazard related to the fortuitous nature of losses a problem?

causes p* and PI to increase

What is a moral hazard created by disaster relief?

charity hazard

what is adverse selection?

death spiral; becomes a problem when you have high risk people not paying high risk prems; asymmetric info problem

Solution to cat losses?

diversify

Classic examples of cat events

earthquakes, floods, hurricanes

what does it mean if a loss is determinable?

easy to place a $ value on the loss; easy to determine the amount of the loss

The insured should have no control over what?

freq/severity of a loss

A risk is not insurable if PI is _______ than PMAX

greater than

What does it mean if a loss is definite?

if a loss occurs, it should be easy to verify that a loss has occurred

Solutions to definite problem

independent verification of losses (ex. police report), "loss settlement rules"

Demand of insurance

individuals must be willing to buy the insurance for that premium (Pmax)

Supply of insurance

insurers are willing to sell insurance at a stated premium (PI = p* + RC + admin. cost)

A risk is insurable if PI is ______ than PMAX.

less than or equal to; if a market exists

How do insurers evaluate a customer's risk?

look at risk classification variables: gender, age, location, etc.

what is underwriting?

risk classification

Contemporary examples of cat events

terrorism

What is TRIA?

terrorism risk and insurance act

Losses that are difficult to verify:

theft, certain types of injuries