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