FIN 230 Chapter 2 - Insurance and Risk

Definition of Insurance

The pooling of fortuitous losses by transfer of such risks to insurers, who agree to indemnity insured of such losses, to provide other pecuniary benefits on their occurrence, or to render services connected with risk

Basic Chrematistics of Insurance

• Pooling of losses

• Payment of fortuitous losses

• Risk transfer

• Indemnification

What does pooling implies

The sharing of losses by the entire group and the prediction of future losses with some accuracy based on the law of large numbers

Fortuitous Loss

One that is unforeseen and unexpected by the insured and occurs as a result of chance.

In others words, the loss must be accidental

Risk Transfer

Pure risk is transferred from the insured to the insurer

Indemnification

The insured is restored to their approximate financial position prior to the occurrence of the loss

Ex) house burn down → insurer helpes you restore you to your previous position

What are the six characteristics of an insurable risk

• There must be a large number of exposure units

• The loss must be accidental and unintentional

• The loss must be determinable and measurable

• the loss should not be catastrophic

• The chance of loss must be calculable

• The premium must be economically feasible

Adverse Selection

The tendency of persons with a higher-than-average chance of loss to seek insurance at standard (average) rates, which, if not controlled by underwriting, results in higher than expected loss level

Underwriting

The process of selecting and classifying applicants for insurance. Usually the people who meets the underwriting requirement usually get insured at standard or preferred rates

Difference between Hedging and Insurance

a

Casualty Insurance

A broad field of insurance that cover whatever is not covered by fire, marine, and life insurance; casualty lines include auto, liability, burglary and theft, workers compensation, and health insurance

Personal Line

To coverages that insure the buildings and personal property of individuals and families or provide them with protection against legal liability

Commercial Lines

To Property and casualty coverage for business firms, nonprofits organizations, and government agencies

Social Insurance

Government insurance programs with certain characteristics that distinguish them from other government insurance plan

Benefits of Insurance to Society

• Indemnification for loss

• Reduction of worry and fear

• Source of Investment Funds

• loss prevention

• Enhancement of Credit

The social costs of insurance

• Cost of doing business

• Fraudulent claims

• Inflated Claims