Insurance
and Risk
Agenda
Definition and Basic Characteristics of
Insurance
Characteristics of An Ideally Insurable Risk
Adverse Selection and Insurance
Insurance and Gambling Compared
Insurance and Hedging Compared
Types of Insurance
Benefits and Costs of Insurance to Society
2-2
Definition of Insurance
Insurance is the pooling of fortuitous losses
by transfer of such risks to insurers, who
agree to indemnify insureds for such losses,
to provide other pecuniary benefits on their
occurrence, or to render services connected
with the risk
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2-4
$15,000
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2-5
$10,607
2-6
Risk transfer
Indemnification
2-7
Characteristics of an Ideally
Insurable Risk
Large number of exposure units
to predict average loss based on the law
of large numbers
2-8
Characteristics of an Ideally
Insurable Risk
No catastrophic loss
to allow the pooling technique to work
exposures to catastrophic loss can be managed
by using reinsurance, dispersing coverage over a
large geographic area, or using financial
instruments, such as catastrophe bonds
2-9
Characteristics of an Ideally
Insurable Risk
Economically feasible premium
so people can afford to purchase the policy
For insurance to be an attractive purchase, the
premiums paid must be substantially less than
the face value, or amount, of the policy
2-10
2-11
2-12
2-13
Gambling
Insurance is a
technique for
handing an already
existing pure risk
Insurance is always
socially productive:
Gambling creates a
new speculative risk
Gambling is not
socially productive
2-14
Hedging
Risk is transferred by
a contract
Insurance involves
the transfer of pure
(insurable) risks
Insurance can reduce
the objective risk of
an insurer
Risk is transferred
by a contract
Hedging involves
risks that are
typically uninsurable
Hedging does not
result in reduced
risk
2-15
2-16
2-17
2-18
Exhibit 2.3
Property and
Casualty Insurance
Coverages
2-19
2-20
2-21
Fraudulent Claims
Inflated Claims
2-22