Risk Share

Question 1

What is the definition of risk sharing?

Answer 1

Pooling of fortuitous losses by transfer of such risk to insurers who agree to indemnify for such losses; AVG LOSS IS SUBSITUTED FOR ACTUAL LOSS

Question 2

What is the definition of insurance?

Answer 2

Usually consists of pooling of losses (spreading of the losses), payment of fortuitous (unseen/unexpected) losses , risk transfer (pure risk moved from insurer to insured), and indemnification (the insured is restored to her apprx financial state prior to loss)

Question 3

What is the Law of Large Numbers?

Answer 3

If the number of the risks in the portfolio tends to infinity, the probability that the average outcome differs from expected value is positive tends to zero.

Question 4

What is the Central Limit Theorem?

Answer 4

The average outcome approaches a normal distribution with mean—as n gets very large (goes with the Law of Large Numbers)

Question 5

Implications of the CLT for insurers?

Answer 5

1) The distribution of sample means does not depend on the population distribution
2) The standard error of the sample mean distribution declines as the sample size increase

Question 6

What is the correlation coefficient is a measure of difference between two random events?

Answer 6

Beta > 1 = positive correlation
Beta = 1 no correlation
Beta

Question 7

What is involved in pooling correlated losses?

Answer 7

• Cannot reduce volatility if perfectly correlated
• positive correlation leads to a reduction of standard deviation yet lower than without correlation
• positive correlation is very common in insurance, stock or other businesses, but perfect correlation is very rare

Question 8

What are the 6 characteristics of an insurable risk?

Answer 8

1) Large number of exposure units (to be able to estimate the size of loss, think LLN)
2) Accidental and unintentional loss
3) Determinable and measurable loss
4) No catastrophic loss / limited loss size
5) Calculable probability of loss
6) Economically feasible premium

Question 9

What is adverse selection?

Answer 9

The tendency of persons with higher than average chance of loss to seek insurance at standard rates; if not controlled by underwriting, it can result in higher-than-average risk/loss.

Question 10

What is morale hazard?

Answer 10

Insurance induced behavioral changes