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THE INSURANCE MECHANISM

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ann raihan

on 19 January 2015

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Transcript of THE INSURANCE MECHANISM

PRIVATE INSURANCE
ADVERSE SELECTION
is the
tendency of persons with higher-than-average chance of loss
high-risk drivers who seek auto insurance at standard rates
can be controlled by: careful underwriting (selection and classification of appicants for insurance)

BASIC CHARACTERISTICS OF INURANCE
POOLING OF LOSSES:
sharing a losses incurred
by the few over the
entire group
.
prediction of future losses with some accuracy
risk reduction based on
law of large number
CHARACTERISTICS OF IDEALLY INSURABLE RISK
INSURANCE
Insurance is the pooling of fortuitous losses by transfer of such risk
to insurer, who agree indemnify for such losses
THE INSURANCE MECHANISM
1)SOCIAL INSURANCE PROGRAMS
financed entirely or in large part by contribution by employers
benefits are heavily weighted in favor of low-income gruops
eligibility and benefits are prescribed by statute
eg : social security, unemployment
PAYMENT OF FORTUITOUS LOSSES
insurance pays are
unforeseen, unexpected

the losses must be
accidental
and
occur randomly
eg: Abu slips on the icy sidewalk and break a leg
RISK TRANSFER
A pure risk is
transferred from the insured to the insurer,
who typically is in
a strong financial position
eg: premature death, disability and personal liability lawsuits
INDEMNIFICATION
the insured is
restored
his approximate financial position
eg: your home burn in fire, a homeowners policy will
indemnify you
or
restore to your previous position
LARGE NUMBER OF EXPOSURE
large group of roughly similar
, but not necessary identical, exposure units that are subject to the same peril
to predict average loss with accuracy

that loss cost can be spread over all insured the underwriting class
eg: a large number a frame dwellings in a city can be grouped together for purposed providing property insurance on the dwellings

ACCIDENTAL AND UNINTENTIONAL LOSS
unseen
and
unexpected
by the insured and outside of the insured's control
to control moral hazard
that
premiums will not rise resulting
in fewer customers
to assure randomness

eg: death is certain to occur rather than by chance but timing of death usually occur by chance
DETERMINABLE AND MEASURABLE LOSS
the loss should be definite to
cause, time, place, amount
insurer must be able to determine if the loss is covered
and if so, how much should paid
insurer must determine whether the insured satisfies the policy of insurance
eg: A and B insure disability-income contract are injured in accident and both are disabled. A can return to work and disability income benefits will be terminated. B still continue to receive the disability-income benefits.

NO CATASTROPHIC LOSS
not incur losses at the same time
to allow the pooling technique
can be managed by:- large geographic area, using reinsurance, catastrophe bonds
eg: reinsurance is a type of insurance that one insurance company purchases from another insurance company in order to transfer risk on insurance policy that ceding company issued
CALCULABLE CHANCE OF LOSS
to calculate both the average frequency and average severity of future losses
to establish an adequate premium
eg : property damaged by fire
ECONOMICALLY FEASIBLE PREMIUM
so people can afford to buy
premium must be substantially less than the face value of the policy
LIFE AND HEALTH
PROPERTY AND LIABILITY
PRIVATE INSURANCE COVERAGE CAN BE GROUPED INTO TWO MAJOR CATEGORIES
LIFE INSURANCE
LIFE INSURANCE- pay death benefits to beneficiaries when the insured dies
HEALTH INSURANCE- covers medical expenses because of sickness or injury
DISABILITY PLANS- pay income benefits
PROPERTY AND LIABILITY
PROPERTY INSURANCE- indemnifies property owners against the loss or damage of real or personal property caused by various perils
LIABILITY INSURANCE - covers the insured's legal liability arising out of property damage or bodily to others
CASUALTY INSURANCE- refer to a broad field of insurance that cover whatever is not covered by fire and others
PRIVATE INSURANCE COVERAGE
1) PERSONAL LINES:
coverage that insure the real estate
and
personal property of individuals and families
or
provide against legal ability
private passenger auto insurance
homeowner insurance
personal umbrella liability insurance
boatowners insurance
2)COMMERCIAL LINES: coverage for
business firms
,
nonprofit organization
, and
government agencies
fire insurance
commercial multiple-peril insurance
general liability insurance
credit insurance
crime insurance
GOVERNMENT INSURANCE
2) OTHER GOVERNMENT INSURANCE PROGRAMS
found at both the federal and state level
eg: federal flood insurance, state health insurance pools
SOCIAL BENEFITS OF INSURANCE
INDEMNIFICATION FOR LOSS
to restore to previous financial position
contributes to family and business stability
REDUCTION OF WORRY AND FEAR
insured are less worried about losses
SOURCE OF INVESTMENT FUNDS
premiums may be invested, promoting economic growth
LOSS PREVENTION
insurers support loss-prevention activities that reduces direct and indirect losses
ENHANCEMENT OF CREDIT
insured individuals are better credit risks than individuals without insurance
SOCIAL COST OF INSURANCE
COST OF DOING BUSINESS
insurers consume resources in providing insurance to society
an expense loading is the amount needed to pay all expenses
FRAUDULENT AND INFLATED CLAIMS
payment of fraudulent or inflated claims results in higher premiums to all insurer reducing disposable income and consumption of other goods and service
GAMBLING
INSURANCE
is technique for handing an already existing pure risk
creates a new speculative risk
is socially productive
both parties have a common interest in the prevention of loss
is socially unproductive
the winner's gain comes at the expense of the loser
restore the insured financially in whole or in part if loss occur
generally does not restore the loser to their former financial position
INSURANCE
HEDGING
involves the transfer of insurable risks
involves risk that are typically uninsurable
can reduce the objective risk of an insurer though the Law of Large Numbers
involves only risk transfer, not reduction
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