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The Demand For Insurance
Transcript of The Demand For Insurance
Risk Premium- additional amount of money compared to the expected wealth Aversion to risk- implies that the possible loss hurts more then the possible gain Mr. Grace is asked whether or not he would accept a 50-50 chance of winning $1,000 and losing $1,000. The expected value of the gamble is $0 (0.5 * 1,000 + 0.5*1,000). Would he accept the gamble? What if he was offered 60% chance at winning and a 40% at losing? Find expected value. Other Factors Affecting an Individual’s Demand for Insurance Premium loading The extent to which risk-averse people purchase insurance depends on the policy’s premium loading. Income and wealth a. more wealth = more assets which are subject to loss = increase in the total amount of insurance purchased b. People who do not have the sufficient income to afford large amounts of insurance coverage. c. The degree of risk aversion may decline as a person’s wealth increases. d. Limited liability often induces people with little wealth to purchase relatively little insurance against liability risk. Information The demand for insurance will depend on the information that the individual has about the loss distribution. The effect of information on the demand for insurance assumes that both the policyholder and the insurer view their information as correct. Other sources of Indemnity Nonmonetary losses Example: pain and suffering from injuries or grief when someone dies Can be provided implicitly through the court system, through compensation (Ex. Lawnmowers) Business Risk Management and Demand for Insurance Shareholder Diversification Diversification reduces risk. Corporate insurance contracts and shareholder diversification diversify pure risk for shareholders. individual portfolio diversification vs. corporate insurance purchases Which has the lower cost? Marginal Cost of portfolio diversification = 0 Insurance Contracts typically increase a firm’s value even when shareholders are diversified Business insurance is beneficial to risk-averse owners that are not diversified Small Businesses and privately held businesses Why Purchase Insurance when Shareholders Are Diversified? Insurer Services Claims processing and loss control can be purchased at a lower cost. Reducing the Expected Cost of Financing Losses Reducing financing costs for new investment opportunities Cost of capital factor Reducing the likelihood of financial distress and improving contractual terms Bankruptcy or close to it = Financial Distress Better contract terms with insurance = Bargaining tool Employees, suppliers, and customers also incur costs when their relationships with a firm are interrupted due to financial distress Shareholders benefit by reducing the probability of distress because they end up increasing product prices and decreasing input prices. Reducing expected tax payments Corporate tax rates are progressive Insurance companies are taxed differently Tax treatment of depreciated property is different. The tax shield from interest payments How much do you trust insurance comanies? Financial institutions? Compared with their more socioeconomically advantaged counterparts, poor whites, uninsured blacks, and some uninsured Hispanics are more likely to perceive that racial and ethnic bias operates in the health care they receive. Stepanikova, I., & Cook, K. S. (2008). Effects of Poverty and Lack of Insurance on Perceptions of Racial and Ethnic Bias in Health Care. Health Services Research, 43(3), 915-930. doi:10.1111/j.1475-6773.2007.00816.x The End