Heise_Insurance Law

Heise_Insurance Law - Heise, Michael Insurance Law Holmes...

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Unformatted text preview: Heise, Michael Insurance Law Holmes & Young 3 rd edition 1 Heise, Michael Insurance Law Holmes & Young 3 rd edition 2 Heise, Michael Insurance Law Holmes & Young 3 rd edition I. Insurance Theory & Framework a. Types of Insurance and companies i. Types 1. Property/casualty 2. Life/health ii. Companies 1. Stock – shareholders own 2. Mutual – policyholders own b. Functions of insurance i. Risk transfer (Textbook 3) 1. Reduces risk by increasing predictability 2. Encourages more economic investment. 3. hypo a. potential loss X probability = cost of risk (premium) A B Potentional Loss $10k $1k Probability .01 .10 Insurance Premium $100 $100 (cost of the risk) b. Risk neutral person would perceive the two scenarios as equal, but many people are more likely to choose a smaller loss at a higher probability – which leads to potential ability to charge more for the premium on the higher potential loss – behavioral economics. c. Risk is being transferred from the client in A to the entire pool of insured – results in a much greater ability to predict the chance of the risk. Can’t charge $100 or less – that would be a wash – has to be more than $100. Worthwhile to the insured because they are transferring the risk – makes you willing to pay $105 to get rid of $100 worth of risk = margin of $5. 3 Heise, Michael Insurance Law Holmes & Young 3 rd edition ii. Risk pooling 1. central limit theorem – by pooling large numbers, insurance co can benefit form the law of large numbers. Insured can go to sleep at night, and the insurance co. (if it does its job correctly) will push the actual cost of the risk almost all the way to $100, therefore realizing its margin of $5. Insurance co. knows the market better than anyone else, but they do not know each individual insured, but by insuring large numbers, they can transform an unpredictable risk into a much more predictable loss. They can pool risk averse individuals and therefore make their profits. iii. Risk allocation (Textbook 4) 1. Insurers accept transfer of risks and pool them, then try to set price that is proportional to the degree of risk posed by each insured. 2. Insurers create incentive for insureds to optimize the degree of risk they pose even when insurance against loss is available iv. Social functions (Textbook 4) 1. It’s considered irresponsible not to have smoke detectors 2. Uninsured drivers aren’t legally entitled to drive 3. Takes money from the lucky and gives it to the unlucky 4. Big question: how do legal rules support these functions? c. Challenges to insurance i. caused by imperfect information (Textbook 5) 1. can minimize, but will almost never do away with information gaps. 2. Incentive structures a. insured would like to appear less risky b. Insurer would like to know precise information to determine whether you want the person in the pool 4 Heise, Michael Insurance Law Holmes & Young 3 rd edition i. then how that information can help to more precisely calibrate the premium given the risk presented...
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This note was uploaded on 11/28/2009 for the course LAW 6011 at Cornell.

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Heise_Insurance Law - Heise, Michael Insurance Law Holmes...

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