Lecture 23 - Insurance companies

Lecture 23 - Insurance companies - Financial Markets and...

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1 Financial Markets and Institutions Insurance Companies: Economics and management th ed. Chap. 22
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2 Overview Insurance: definitions and principles Types of insurance Management of insurance (adverse selection and moral hazard) Pension funds
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3 Insurance: definition The use of contracts to reduce and redistributerisk. In an insurance contract, the insurer accepts a fixed payment ( premium ), and accepts in return to make payments if certain events occur . Three parties: insurer/insured/beneficiary.
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4 Insurance: basics Risk-averse agents would rather pay a certainty equivalent than accept the gamble. Resolves agents’ risk-aversion against an insurance premium. How? Probability properties: Law of large numbers. The average behaviour of a group of (i.i.d) individuals converges (almost) surely to their common mean as the number of individuals tends to infinity.
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5 The number of insured by a single insurance company is sufficiently large for the law of large numbers to apply. Uncertainties are (to various degrees) almost inexistent. Insurance companies are risk-neutral. The good thing: raised liquidities are reinvested in the economy, while unused otherwise: wealth improving financial intermediaries . Insurance companies hold more or less long-term assets in function of the type of insurance.
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I toss up a (biased) coin: Heads: I get 0 Proba: 99% Tails: I lose 100 Proba: 1% If you are risk-neutral, the certainty equivalent equals the expected loss, 1. If you are risk-averse, the certainty equivalent amount is larger. How much would you pay to avoid this gamble?
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Lecture 23 - Insurance companies - Financial Markets and...

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