Topic 2 Uncertainty Flashcards
What is a Actuarially Fair Insurance Policy?
A actually fair policy is one where the expected value of the gamble doesn’t change when insurance is introduced.
Actuarially fair game
This is where the expected value is zero - on average you’ll win nothing, or once we take into account the cost of playing, we end up with net winnings of zero.
Risk Averse
Won’t play an actuarially fair game
U(p1W1 + p2W2) > p1U(w1) +p2U(w2)
The level of utility associated with the expected wealth > expected utility of wealth
Risk Seeking
Will play actuarially fair game
U(p1W1 + p2W2)
Risk Neutral
Indifferent between playing or not
U(p1W1 + p2W2) = p1U(w1) + p2U(w2)
The Level of utility associated with the expected wealth = expected utility of wealth
Most agents are now to be of what type of risk?
Risk Aversion…
Few agents take the actuarially fair gamble
Agents tend to prefer certainty
A Insurance Contract is Actually fair when?
A Insurance contract is actuarially fair if the expected value of the gamble remains unchanged
Asymmetric Information
This involves hidden information that impacts others adversely because the information can be used to take advantage of the person on the other side of the market
Adverse Selection
Occurs when there is hidden knowledge - one party has more information than the other.
Moral Hazard
Occurs when there is hidden action - people change their behaviour once they have insurance.
The problems of assymetric information in the Insurance market
Adverse selection and Moral Hazard can create problems of rising premiums and even of insurance markets unravelling completely
Solutions for the insurance market?
Signalling and Screening but both have problems
