General Insurance #1-2-3-4
Albaw88
chapter2lecturenotes.docxFIN 3610 General Insurance
Chapter 2: Insurance and Risk
Lecture Overview – Comments from Professor Zietz
General Risk and Insurance topics get interesting!
Here in Chapter 2, we will define and explain the basic characteristics of insurance; characterize the ideally insurable risk; explain the relationship between adverse selection and insurance; compare insurance to gambling and hedging; give examples of kinds of insurance; and expand on the benefits and costs insurance can have on society as a whole.
Let’s start with a good, thorough definition of Insurance. When I took my first insurance course, back in the middle ages (hopefully you just laughed!) the only definition I remembered from the class was that “Insurance is the Transfer of Risk.” It was only later in grad school when I was caught using that definition that I realized that Insurance does, in fact, transfer risk, but it is not THE transfer of risk. Transferring risk is just one of several risk management tools for handling risk, just like risk avoidance and risk control. The best definition of risk that includes all of the important elements is:
Note that “sharing” means to divide or distribute in shares. When one joins an insurance pool, then he or she should be consciously aware that the process assumes some responsibility for contributing toward the total losses of the pool.
The above definition of insurance is consistent with the definition in the text that states (I’ve added the information in parentheses): “Insurance is the pooling (grouping together) of fortuitous (accidental or occurring by chance) losses by transfer of such risks to insurers, who agree to indemnify (compensate or put back into a pre-loss condition) insureds for such losses, to provide other pecuniary (financial) benefits on their occurrence e, or to render services connected with the risk.”
If you recall the pooling of homes in the example from Chapter 1, you will probably note that Insurance is really a business use of the law of large numbers. Insurance provides a way to reduce risk by correctly applying the law of large numbers. The definitions used have elements that are mandatory for the concept of insurance to work.
Now that you’ve reviewed the essential processes needed to make insurance work correctly, ponder this question:
How would you respond to someone who says “I’ve never had a loss so my money was all down the drain?” Post your comments in the discussion forum!
As you continue through the chapter through the benefits and social costs of insurance as well as the probability analysis information, you will now better understand why insurance requires correct statistical, called actuarial, skills to make sure the pool of funds is sufficient to pay the claims.
