companies became more aware of risk management because of increases in interest rate and exchange rate risk.
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advantages of purchasing insurance for purchaser are certainty of premiums and pooling which lowers likelihood of correlated claims and thus insolvency (value of coverage exceeds premium paid to it). can reconcile because for very safe companies, it may make more sense to just notbuy insurance, can keep more money for business purposes. D. Read “When the walls came tumbling down” (Item 9.2) and answer the following questions:i. The article seems to suggest that “slashing prices to the point that claims were bound to exceed premium income” was evidence of “reckless competition.” Is this so?No such thing as reckless competition - if price is “too low” you’ll go out of business, so efficiency means minimum price maximizes profitable transactions - companies get the money back (reach profitability) through investmentLike finance companies (sometimes did not profit on making loans, made overall profit in end bc they enabled customers to purchase their goods)that is what we started with! premiums should be less than expected loss bc profit is made from investing the premiums!if there is a bigger difference between premiums and expected loss this is just bc interest rates are higher so companies can charge lower premiums now. ii. What are the barriers to entry in the German insurance industry? How does the article expect them to be circumvented?Most German households are happiest buying insurance from local agent who offers plenty of personal service, though not best prices. fixed bc foreigninsurers buying local insurers. There is an agent network – marketing problem. Can try to overcome by buying an already existing company – easier than convincing people to switch. iii. Automobile insurance policies are ‘one size fits all’—i.e. not varying by age and gender. Can you think of an explanation for this practice?Maybe don’t have access to info to assess risk of each driver. Companies are colluding – evidence of cartel – easier to collude on one price.Risk evened out by pooling - they’re analyzing big picture data
Chapter 9:Insurance increases individual welfare directly by increasing security. Can promote innovations by protecting insuring risk The Economics of Insurance Pricing of PremiumsToo low and you will make a loss, too high and no one will buy your policies, necessary for profitabilityPure premium- present value of the expected cost of a claim: includes amount of loss plus expected cost of processing the claimLoss adjustment- process of determining the amount of a lossEXPECTED COST= probability of loss x pure premium Since loss will be incurred after premium is paid you take the present value of the expected lossPRESENT VALUE OF EXPECTED COSTS= Expected cost / (1+ interest rate) ^.5o.5 is the year (so half a year)
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