Manage Their Risk

1. Insurance companies operate to generate profit and in exchange they help consumers manage their risk. They help transfer the risk of a loss that arises from predetermined events such as a natural catastrophe, a car crash, or sickness. When you buy insurance you hedge against possible unwanted losses, and pay an insurer a fee to assume the risk. Insurance companies create value by pooling large groups of people that want to be insured against a particular risk. Since the number of insured individuals is so large, insurance companies use statistical analysis to project losses that will occur in a given period. The pooling and redistribution function lowers the total cost of risk management for everyone in the pool. There are two ways insurance companies can make money, one is underwriting and the other is investment income. First, underwriting is the income derived from the premium collected netted against money that the company pays out for claims in a given period. Secondly, insurance companies invest these premiums in the market while they are not being used to pay for claims. However, most insurance companies lose money in underwriting in order to make the policies look attractive. They charge too little but at the same time they have more capital to invest in other market securities. The ultimate goal of reinsurance is to reduce the reinsurer company’s exposure to loss and diversify the customers’ risk. Basically, reinsurance involves transferring part of the risk for which the original insurer (“reinsurer”) is liable to the ceding company. In some cases the policy is too risky or complex for a single insurance company to bear. Insurance companies need to insure themselves by transferring part of the risk to another insurance company (“ceding company”). The risk indemnified against is the risk that the reinsurer will have to pay on the underlying insured risk. Because reinsurance is a contract of indemnity, absent specific cash-call provisions, the ceding company is not required to pay under the contract until after the original insurer has paid a loss to its original insured. Finally, it is important for insurance companies to reinsure because it enables a client to get coverage that would be too risky for any one company to assume.

2. In general the expected rate of return for investing in insurance is -35%. We calculated the -35% by using the formula for insurance return, which is; pX + (1-p)*0 / 1 -1= -35%. The expected return that is expected from a single person would be enough money to cover the damages suffered by the home. It would need to be enough to fix the house if that’s the case, because most people would not be able to insure themselves. The main factors in deciding the acceptable return for a policyholder is where they live, the status of the house, and how high the price of the deductible would be. This is a big decision when it comes to insuring a house, because for the average person this includes