Chapter 2
INSURABLE LOSS
EXPOSURES
INSURABLE LOSS EXPOSURES
• Which losses are insurable?
- Gambling and stock market losses,
- Coverage for losses due to pollution is unavailable.
- Limited amounts of Insurance against Floods,
earthquakes, draughts can be purchased.
(Speculative Risk vs. Pure Risk)
- Private insurance do not offer coverage for
unemployment
- Long-term care insurance for older people is currently
evolving coverage.
Problem: The private insurance must develop coverage
constrained by the standard of ideally insurable exposures.
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Gambling and Speculative
Risk
• Gambling and Insurance are opposites.
• Gambling creates risk where
nonexisted.
• Insurance reduce risk through pooling
and operation of law of large numbers.
“There is no chance like either you win
and get the money or lose and get the
insurance”
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• The insurances are prepared and sold to
those that have legal interest.
• The insureds should not be indifferent to
losses. (This may cause rises in the premiums
as a result of losses rising)
• Insured events should represent a loss to
them personally. This doctrine is known as
insurable interest.
• Speculative losses can not be insured as this
would make the owners in a position of being
indifferent to operating results
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IDEALLY INSURABLE LOSS EXPOSURES
1. A large group of similar items exposed to the same peril.
-An insurance pool needs to have substantial number of
individual units to obtain predictive accuracy (statistical
benefit of law of large numbers)
- The items in the insurance pool, or the exposure units,
need to be similar to enable a fair premium calculation.
(Barns of farmers, brick homes and wooden homes)
- The perils faced by the exposures in the insurance pool
should be the identical perils for the same reasons
requiring the exposure to be similar to one another.
( house by a gas station faces additional peril for fire)
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2. Losses Must Be Accidental or Beyond the Insured’s Control:
- Nonaccidential, or expected, reductions of economic value such as
depreciation or wear and tear are not insurable.
-An insurance system will not pay for an insured’s deliberately caused
losses.
3. Definite losses capable of causing economic hardship.
- Losses must be definate: member’s loss must be verifiable
( insurance for fire not for mental illness)
- measurable: losses insured against should be measurable:
- the loss of a loved pet,
- loss of race horses or valuable livestock represent an
insurable exposure as damaged sustained can be
measured in economic terms.
- severity: Potential damage should cause economic hardship. For
inexpensive items, insurance are not preferred to be purchased.
Insurance can be purchased only when losses are large and
uncertain.
“ Large-Loss Principle”
4. Extremely low probability of a catastrophic
loss to the insurance pool.
- A loss extraordinary large relative to the
amounts of property in an insurance pool. If
it was insured, it will cause the insolvency of
even well-run insurers.
- Catastrophic losses from natural disasters
have two general characteristics:
1. Limited in geographic impact:
2. Not accurately predictable
- Tornados occur regularly ( in USA),
predictable with a reasonable accuracy
- Earthquakes and volcanic eruptions do
not occur regularly
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When Only the People Most Exposed to
Loss Want Coverage
• By use of law of large numbers, the pool is
able to predict losses accurately and charge a
premium appropriate to the risk.
• Attitude toward risk is to pay relatively small
premium to uncertain losses. (High premiums
will make people prefer to quit having
insurance)
• In case of highly costly losses government
either guarantees or subsidizes to insurers
against excessive losses to keep premiums
attractive and prevent the exodus of the better
situated risk
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RISK CLASSIFICATION
- Applicants for insurance have been put in classes
according to the probability of loss
- Risk Class:
- Automobile Ins: Urban, Male, under 24 and no
accidents on his driving record.
- Life Insurance: Female, 45 yrs old, average
height and weight.
- Pools should be formed by the insureds that carry
same /similar characteristics.
(Prob of Loss X $ value exposed to loss) + expenses
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RISK CLASSIFICATION (Cont.)
SUBSIDIZATION occurs if each insured does not pay
the mathematically fare price for insurance.
- if the insured is paying more than the
mathematically fair price, the insured
provides
the subsidy.
- If the insured is paying less than the fair price,
the insured receives a subsidy.
(ex: life and automobile ins)
ADVERSE SELECTION occurs when one party to a
transaction has more relevant information than
another party to the transaction, the party with the
superior information can take advantage of the
situation.
e.g. Purchasing a fire insurance after being
threatened by an arsonist.
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PRINCIPLES OF RISK CLASSIFICATION
-Insurers use risk classification to minimize subsidization and adverse
selection. (age/gender/place of residency)
Rate Classification Factors on four points:
• Separation and Class Homogeneity
Male, 20 should be in a different pool from a male, 40
•
Reliability
information about the factor should be easily obtained and should not be subject to
manipulation by the insured, otherwise independent verification from applicants such
as health certificate, etc.
•
Incentive Value
Reward good insureds (lower premium for those with below-average loss potential)
•
Social Acceptability
Most difficult underwriting criterion to handle!
Definition of “social acceptability”
What do we do when mathematically fair insurance exchange conflicts with a socially
desired outcome?
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Important Social Issues
1. AIDS: The cost of aids is very high. Subsidization
issue inevitably occurs. It can be the cause of
collapse of insurance systems but there are
arguments.
Debate on the case of AIDS:
a) Accepting the claims due to AIDS, subsidizing
some insured and spread the cost of AIDS throughout
the country.
b) The unfairness of the propose underwriting results.
High price for society to pay to solve this problem.
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Important Social Issues (Cont.)
•
•
Automobile Insurance:
- More accidents occur in the urban areas than in the rural areas.
- Medical and repair and medical costs are also higher in the city.
- City residents transfer more exposure to loss to the insurance pool.
-Young males are responsible for more accident as well as unmarried drivers
compared to married ones.
- Thus, insurance premiums for young, unmarried, inner city, male drivers are
more expensive.
- The basis of conflict between the goals of separation and homogeneity, social
acceptability and the incentive value. (Penalizing ppl. falling into that particular
group although driving carefully. High premiums also discourage people to get
insurance which is hardly socially acceptable
Pension Benefits:
The issue of whether and Individual’s gender is a legal risk classification.
Women live longer than men (as a group), counterargument is that only
15% of them. So is it fair to penalize all women for the longevity of this minority of
women?
If men and women each receive identical monthly pension checks based
on equal pension contributions. The group of women will receive more money
than the man. How about if man and the woman dies on the same month
receiving same # of pensions after retirement? Man will have received more
pension benefits than woman, if the benefits were based on gender
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BRANCHES OF INSURANCE
Various categories where insurance transactions traditionally have
been made:
GOVERNMENT
SOCIAL SECURITY
UNEMPLOYMENT
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PRIVATE
LIFE
Life
Annuity
NONLIFE
Fire
Marine
Bonding
Medical Expense
And Disability
Casualty
Automobile
Liability
Crime
Worker’s Compensation
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BRANCHES OF INSURANCE (Cont.)
•
Fire Insurance: Generally covers stationary property. Perils as
windstorm, riot and vandalism
Business Income: Indirect losses related with fire and other perils
•
Marine Insurance: Covers Mobile property, ocean marine covers ships
and their cargos.
•
Inland Marine Ins: Covers property moving on planes, trains and trucks.
•
Bonding: A special type where one party (surety) guarantees the
performance (surety bond) or the honesty (fidelity bond) of a second
party to a third party. If second party is poor and dishonest than loss to
the third party must be paid by the surety.
•
Life Insurance: It is based on the human life contingencies. If the
covered peril is death, the contract is called life insurance . If the peril is
survival, the contract is called annuity.
The annuity guaranties that the insured will not have to survive without
money.
If the covered peril is sickness or disability, the coverage is called
medical expense insurance or disability insurance.
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New Coverages
• Weather-related insurance: Payments for crop-hail damage,
rained-out concerts, or too much or too little snow.
• Change-of-law Insurance: Payments are made if new regulations
increase construction costs after contracts are signed.
• Municipal Bond Insurance: This coverage guarantees principle
and interest payments on municipal securities.
•
Motion Picture Completion Bonds: Payment made if the film is
not completed on time. Death of a star or other unforeseen
events cause the insurer to pay.
• Boiler and Machinery Insurance: Property Ins contracts
specifically exclude damage caused by exploding steam boilers.
Some insurance companies sell this type of coverage. The
insured in addition to the indemnity agreement, have to pay for
the regular inspection.
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