Q8 Other Institutions

Question 1

Define Insurance company

Answer 1

K between the insurer and the client, where the insurer agrees to COVER LOSSES that may be suffered.
Transfer of pure risk from client to insurer (insurer pools the risk of loss and provides payment if loss occurs).

Question 2

Define Pure Risk

Answer 2

Risks in which there are TWO possible outcomes: loss or no loss.

Question 3

Define Objective Risk

Answer 3

Risk that insurers face once they have accepted the risk from the client
- deviation between ACTUAL LOSSES and EXPECTED LOSSES i.e. risk that actual payout > expected payout

Question 4

Concept of Object Risk

Answer 4

• Insurance is priced to cover expected losses and expenses

- if loss levels are predicted well, the insurance mechanism works well

Question 5

Reducing Objective Risk

Answer 5

• Law of large numbers - the larger the number of clients, the more likely expected payout will equal actual payout
• careful underwriting
• co-insurance (loss sharing provision requiring the client to pay a portion of losses)
• careful pricing (important to hold onto clients or the law of large numbers is less likely to hold)
• restrictive terms (covenants)
• reinsurance

Question 6

Define reinsurance

Answer 6

Insurance company shift some of the risk they have insured to another insurance company

Question 7

Examples of restrictive covenant

Answer 7

Car insurance does not cover drink-driving accidents

Life insurance policy does not cover suicide