BU353 Lecture 7: Risk Retention and Reduction Decisions
Document Summary
Risk retention: decision to accept the uncertainty associated with a particular risk exposure. Benefits of increased retention (1) savings on premium loadings. Ability to save on some of the administrative expense and profit loadings in insurance premiums, thus reducing the expected cash outflows for these loadings (2) reducing exposure to insurance market volatility. Reducing vulnerability to annual savings in insurance prices due to the effects of shocks to insurer capital on the supply of insurance and/or the insurance underwriting cycle (3) reducing moral hazard. Deductibles and other copayments reduce moral hazards; without these provisions, expected claim costs would be higher and therefore so would insurance premiums. Consequently, when moral hazard is more of a problem, firms tend to retain more risk (4) avoiding high premiums that may accompany asymmetric information. Inability of insurers to estimate claim costs precisely for all potential buyers causes some buyers to face prices that are relatively high compared to their true, unobservable expected claim costs.
