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Bin Chang (14)
Lecture 11

BUSI 3410U Lecture 11: Lecture 11

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BUSI 3410U
Bin Chang

Lecture 11: Insurance Financial Institutions Insurance companies assume the risk of their clients in return for a fee; the premium Most people purchase insurance because they are riskaverse 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 who would suffer if it werent for the insurance 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 party compensates the insured for the loss, the insurance companys obligation is reduced by 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 insurance company must be able to compute the probability of the losss occurring Adverse Selection and Moral Hazards in Insurance Asymmetric information plays a large role in the design of insurance products Adverse selection information asymmetry before the transaction occurs 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 Preexisting conditions may be excluded from the policy Moral hazard problem that the borrower may change their decision after receiving the money 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 insurance o Stock company is owned by shareholders and has a profit motive Types of Insurance Life insurance company assets and liabilities 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 insurance payouts and pension fund payouts 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 Protects businesses and owners from the risk associated with ownership o Namedperil policies insures against any losses only from perils specifically named in the policy
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