Lecture 19 - Insurance Pricing Apr 9

Lecture 19 - Insurance Pricing Apr 9 - Insurance Pricing...

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    Insurance Pricing Risk pooling principles tell us: E(X) = E(X) Var(X) gets small as more people added to pool So, with large numbers of identical and independent risks, insurer’s best guess of average claim payout per policy is E(X)
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    Insurance Premiums (Pricing) Determinants of Insurance Premium Expected Claim Costs Timing of Claims Payments Administrative Costs Expected Investment Income Profit Loading
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    Insurer Cash Flows Why does timing matter? Premiums are collected in advance of loss payments Loss payments may extend far into the future for some insurance policies (“claims payout tail”) Policy Sold Policy Expires Final Losses Paid
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    0% 20% 40% 60% 80% 100% 10 9 8 7 6 5 4 3 2 1 Year Cumulative % Homeowners Auto Liability Workers' Comp Other Liability Cumulative Percentage of Total Losses Paid Over Time for Accidents in Year t
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    Expected Investment Income In a competitive insurance market: Insurance Premium will be based on present value of expected claims costs Present value reflects (expected value of) investment income that can be made by investing the premiums collected from consumers Investment income depends on Length of claims payout tail Rate of return on investments
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  Example: Investment Income Premium (P) = $100 Investment return (r) = 10% per year Initial Amount Invest for 1 year Invest for 2 years Invest for 3 years $100 $110 $121 $133.10 ($100*1.1) ($110*1.1) ($121*1.1)
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Lecture 19 - Insurance Pricing Apr 9 - Insurance Pricing...

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