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Lecture 11

BUSI 3410U Lecture Notes - Lecture 11: Casualty Insurance, Liability Insurance, Adverse Selection

4 pages72 viewsWinter 2013

Course Code
BUSI 3410U
Bin Chang

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Lecture 11: Insurance
Financial Institutions
Isurae opaies → assue the risk of their liets i retur for a fee; the preiu
- Most people purchase insurance because they are risk-averse
7 principles all insurance companies are subject to
1. There must be a relationship between the insured and the beneficiary. The beneficiary must be someone
ho ould suffer if it eret for the isurae
2. The insured must provide full and accurate information to the insurance company
3. The insured is not to profit as a result of insurance coverage
4. If a third part opesates the isured for the loss, the isurae opas oligatio is redued  the
amount of the compensation
5. The insurance company must have a large number of insured so that the risk can be spread out among
different policies
6. The loss must be quantifiable
7. The isurae opa ust e ale to opute the proailit of the losss ourrig
Adverse Selection and Moral Hazards in Insurance
- Asetri iforatio → plas a large role i the desig of isurae produts
- Aderse seletio→ iforatio asetr efore the trasatio ours
o Raises issues of which policies an insurance company should accept
Those most likely to suffer loss are more likely to apply for insurance
In the extreme, insurance companies should turn down anyone who applies for insurance
o Insurance companies have found reasonable solution to deal with this problem
Health insurance policies require a physical exam
Pre-existing conditions may be excluded from the policy
- Moral hazard → prole that the orroer a hage their deisio after reeiig the oe
o Occurs in insurance industry when the insured f ails to take proper precautions to avoid losses
Insurance companies use deductibles to help control this problem
- Not enough people purchase insurance; therefore strong sales force
o Independent agents may sell the insurance products of a number of different insurance companies
o Exclusive agents only sell the products of one company
o An underwriter reviews each policy prior to its acceptance to determine if the risk is acceptable
Growth and Organization of Insurance Companies
- Insurance companies may be organized in two different ways
o A mutual insurance company is owned by the policyholders and attempt to provide the lowest cost
o Stock company is owned by shareholders and has a profit motive
Types of Insurance
- Life isurae → opa assets ad liailities
o Derives funds from two sources
Receive premiums that must be used to payout future claims when the insured is dies
Receive premiums paid into funds managed by the life insurance company
o 75% bonds, 3% stocks, 14% loans and mortgages, Miscellaneous 8%
o 2 primary liabilities → life isurae paouts ad pesio fud paouts
- Health insurance
o Policies are highly vulnerable to the adverse selection problem
Those with known or expected health problems are more likely to seek coverage
o Reason for health insurance to be offered through group policies
Individual policies must be priced assuming adverse selection
- Property and casualty insurance → Protets usiesses ad oers fro the risk assoiated ith oership
o Named-peril poliies→ insures against any losses only from perils specifically named in the policy
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