Upload
yael
View
20
Download
0
Embed Size (px)
DESCRIPTION
The Insurance Device. Chapter 3. Private and Social. Private (Commercial) Auto, Life etc. Social (Publicly provided) Social security, Medicare etc Quasi-social FDIC, SIPC, PBGC etc. What is insurance?. The insured exchanges a large uncertain loss for a small certain cost - PowerPoint PPT Presentation
Citation preview
The Insurance Device
Chapter 3
Private and Social
• Private (Commercial)– Auto, Life etc.
• Social (Publicly provided)– Social security, Medicare etc
• Quasi-social– FDIC, SIPC, PBGC etc.
What is insurance?
• The insured exchanges a large uncertain loss for a small certain cost
• The insured can be an individual or a corporation
What is involved in insurance?
• Risk gets transferred from individual to a group
• A group of individuals can agree to share the losses of any one member (mutual insurance)
• There is risk reduction through pooling or diversification (The law of large numbers)
Two uses of the law of large numbers
• Estimation of loss probability becomes accurate with large data sets
• Selling insurance becomes feasible when risk is pooled (diversified)
Some probability concepts
• Subjective and objective
• A priori and a posteriori
• Uncorrelated outcomes and variance of sums
Pooling and risk reduction
• Let x represent the loss from a set of policies
• Let there be many such identical sets that are uncorrelated with each other
• As a compnay adds additional sets to its portfolio, the variance increases linearly
• Standard deviation increases as the square root of n
Pooling and risk reduction
• The standard deviation per set declines (risk reduction)
• The standard deviation of losses for the portfolio increases
• Reinsurance allows the insurer take a small piece of a large pie
• Need pooling and sharing for risk reduction
Some problems
• Stability of the probability process
• Adverse selection (unobservable knowledge)
• Morale hazard (unobservable action)
• Economic feasibility
Self insurance
• Large firms may have a large number of homogenous exposure units
• May be able to do in-house pooling
• Risk divided up among shareholders
• May have to be funded adequately for legal/regulatory reasons