Insurance
Insurance is an arrangement that provides a promise (//// guarantee) of compensation in case of a specified loss or damage of an existing endownment in return for an insurance premium
It is the business of accepting insurable risks, manageing them (pooling/mutualization) and providing compensation for possible losses.
Compensation takes only place if losses have occured
Insurable Risks
Faced by policy holders
non-systematic but subject to the law of large numbers (non-predictable but you can mak estimations)
non linked to economy & financial cycle
ONLY IF ALL 3 ARE MET, RISK IS INSURABLE
I vs. F
Value
actual endownment that is apriori constant in value (e.g. car)
calculated endownment, subject to permanent varation (e.g. fx rate, stock, etc.)
Risk
rare event, negative, exogenous
permanent, negative or positive, endogenous
Losse
rare, one-off, “real damage”, cannot recover by themselves
Loss = valuation change, permanent feature, does not necessarily reflect real losses, often recovered by themselves
Why do we not insure everythin @ insurance companies if we are risk avers?
practical reasons
Transaction cossts
Self insurance (through marriage, community, family, corporation,…)
Insurance premia are never fair
IC can fail
Payout is only promised but not guaranteed
Analytical reasons
Adverse selection / moral hazard
Adverse selection and how to overcome
AS is an information problem (ex ante)
Company has imperfect info about the risk profile of customers, by offering Insurance, it attracts bad risks more than good risks
How to overcome - Info gathering (Questions / Monitoring)
Moral Hazard
behavorial topic, ex post
IC try to avoid MH by
Educating insurees
bonus payments
premium can decline over time (car)
Why are insurers / banks regulated
invisible / non-tangible
finance works within systems
time-lag between contributions and payments
I neet to ensure that the IC is still there when I need it
For services, production & consumption coincide - except for INSURANCE
Insurance is a public good, bc delivery to 1 customer depends on treatment of all customers
Value at risk
Measures the potential loss in value over a defined period of time for a given confidence level
forms of insurance
self insurance
informal community insurance (family, marriage)
Formal community insurance (non-profit mutuals)
formal commercial insurance (profit oriented / stock listed)
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