R.M. Ch. 2

Question 1

Adverse Selection

Answer 1

is the tendency of persons with a higher-than-average chance of loss to seek insurance at standard rates

Question 2

Requirements of Insurable Risk

Answer 2

a) Large number of similar exposure units
b) accidental and unintentional loss
c) determinable and measurable loss
d) no catastrophic loss
e) calculable chance of loss
f) economically feasible premium

Question 3

Consequences of adverse selection

Answer 3

a) High proportions of insureds are bad risks compared to the population
b) Higher than expected losses
c) Increased premiums
d) Good risks begin to drop out
e) Even higher proportions of bad risks, and so on…

Question 4

Controlling adverse selection

Answer 4

a) Categorize people (Underwriting)

c) Clause or contract design

Question 5

Social Benefits of Insurance

Answer 5

Indemnification for Loss
Ex. When there is a fire, it does not have destroy that family financially

Reduction of Worry and Fear
Don’t have to constantly worry about bad things happening, because we get reimbursement from insurance

Source of Investment Funds
Insurance companies invest in capital markets and help economy grow

Loss Prevention
Insurers’ engage in a lot of research to try and reduces losses, wind, fire, etc.

Enhancement of Credit
Without insurance you cannot get a loan without having insurance on the item. W/o insurance interest rates would be much higher.

Question 6

Social Costs of Insurance

Answer 6

Deadweight Cost of Doing Business
Recognizes that without insurance industry their would not be insurance industry expenses, buildings, salaries, etc.

Moral Hazard
Certain losses that only occur do to insurance
Carelessness, arson fires