ECO204Y1 Lecture Notes - Lecture 14: Insurance, Utility
Document Summary
Recall: discount due to risk = ev - ce. Insurance allows transfer of risk from risk averse individuals to less risk averse/risk loving companies. = price of a dollar of insurance. Insurance industry regulated, company required to have sufficient capital for expected payout. Insurance premium equals expected payout to policy holder. Insurance industry is competitive, long run profits are zero. E( ) = (1-p) i + p( i - i) = 0. Differentiate expected utility function with respect to i to maximize utility. Wealth when no loss = w - pl. When insured, certain wealth of w - pl. Expected value is the same, but utility increases due to certainty. Cannot charge premium so that expected value is less than ce.
