Chapter 5 Flashcards
(12 cards)
What is an insurance contract?
Insurance is conducted by means of a legal contract. The contract specifies the rights and obligations of each party.
What does indemnify mean?
“to put back in the original position”. Most insurance policies aim to pay enough to get the policyholder back to the position they would be in if the insured event had not happened
What is specified loss?
Every insurance policy will specify exactly which risks are and are not covered by the policy
What is the premium calculated on?
The premium is calculated based on the expected value of all the events that are specified in the policy, plus allowance for the insurer’s costs and profits.
Why use insurance?
Risk aversion - is a common but not universal characteristic of human beings, its describes a general preference for CERTAINTY over UNCERTAINTY
What are the guidelines for a risk being insurable
- It must be a risk
- Ideally, pure risk not speculative risk
- Ideally, static risk not dynamic risk
- Ideally, particular not fundamental
- It should be financial, quantifiable and be limited
- Small probability
- Large pools of risk
- Low moral hazard
- Past available data
What is risk-seeking behaviour?
If you prefer the uncertain outcome you show risk-seeking behaviour
Why do insurers want the risk to be pure and not speculative?
Speculative risk (gambling) involves at least one outcome that is favorable. Because speculative risks can have positive outcomes, people may seek out those risks. Pure risk such as death – the insured should try and avoid the “bad” event, and the insurer would also prefer that were as few claims as possible.
Why do insurers want the risk to be static and not dynamic?
Static risk has uncertainty and value that does not fluctuate over time. Dynamic risks change with the economy, technology and other factors.
Why do insurers want the risk to be particular and not fundamental?
The problem with fundamental risks is that they violate the law of large numbers, because the claims from those risk will not be independent from one another.
The insurer will be inundated with claims, and the cost of claims will move far away from the average no matter how large the insurer is.
What is anti-selection?
When someone has more information about the risk than the insurer, they can take advantage of the insurer. Appealing to people more at risk than the insurer knows.
What is Moral hazard?
Unethical behavior on the part of a policyholder. (Cheating)
