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Chapter 5

Chapter 5.docx

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Heather Graham

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Chapter 5Insurability of Risk Contractual Provisions and Legal DoctrinesFactors Limiting the Insurability of RiskaPremium Loadingsadministrative costs capital costsbMoral Hazardarises because insurance changes a persons incentive to take precautionscAdverse Selectionarises when policyholders are better informed about expected claim costs than insurersa Premium Loadings as the loading increases the quantity of coverage demanded is likely to decreaseany factor that increases administrative or capital costs will limit the amount of private market insurance coverage items with low value and severity are more likely to be insured if they are bundled together with other exposures due to the fixed costs associated with underwriting and distributing an individual policy when the probability of a loss is high insurance is less likely to be provided and expected claim costs are high which causes admin costs to be high as well when losses are highly correlated across potential policyholders the variance of the distribution of average losses will also be high when insurers are uncertain about the true expected losses of insured parameter uncertainty exists although this uncertainty always exists to a certain extentb Moral Hazard moral hazard arises once two conditions are meta expected losses must depend on the insureds behaviour after having obtained insuranceb must be costly for the insurer to observe precautions by policyholders and measure their impact on expected claim costsA potential solution is to make the premium or coverage contingent on the insureds behaviour during the policy periodex If a driver increases expected claim costs by driving fast the premium could be increased immediately or coverage reducedrequires the insurer to closely monitor behaviour of the insured which is costly and sometimes impossibleMajor methods of reducing moral hazard 1experience ratingmakes the premium charged contingent on the claims in prior periods 2limiting coverageuses deductibles and other provisions that require insured to bear part of the lossBoth of the above provide incentives for insured to take precautions after policies are issued by placing some risk on the insured
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