Continuations

So in one of my earlier posts on insurance fundamentals, I included an “exercise for the reader.” The question was to figure out how much money it would cost for the hypothetical insurance scheme in the example to buy re-insurance for those cases where they had not collected enough in premiums to cover the losses that actually occurred. I was thrilled that three people actually took the time to work through this. Andrew Parker answered in a comment, Gabriel Weinberg and Eddie Wharton sent ema...

In an earlier post in my mini series on insurance fundamentals I explained the concept of moral hazard, which refers to an information asymmetry as having insurance changes unobserved behavior which increases the risk or severity of loss. There is another information asymmetry in insurance that occurs before the insurance contract is entered based on the fact that the insurance buyer knows more about their circumstances than the insurance company. Let’s take car insurance as an example. Suppo...

In the previous post in my mini-series on insurance fundamentals I provided a numerical example that has a 1 in 100 probability of a loss of $50. I explained how the fair rate to insure this would be 50 cents, because that’s the amount at which the expected financial loss equals the premium payment. I then walked through how even at a significantly higher premium some amount of reinsurance was still required to keep this scheme solvent (so far nobody has taken me up on the homework assignment...

In the two previous posts on insurance fundamentals, I introduced a fundamental inequality relating payouts to premiums and the concept of risk aversion. Today we will look at this through a bit of a numerical example. We will look at a risk that has a 1 in 100 chance of occurring and when it does happen the damage it causes is $50. A fair premium rate for this would be 50 cents (1/100 * $50), where fair means that your expected loss is equal to your expected premium payment. Now as we saw du...

Yesterday with the NYU Stern class that I am co-teaching with Arun Sunderarajan we focused on the fundamentals of different businesses. The class is about product market fit but looking for that doesn’t mean you can ignore the economics of the market in which you operate. If you want an example of what I mean, read my post from a while back about vertical integration in on-demand services. Later today I am meeting with an executive from the insurance industry. Given that we have invested a lo...

In my first post on insurance principles I introduced the inequalityExpected payouts that has to hold for the industry as a whole and also for any one insurance company to stay solvent (yes you can collect interest on premiums, so consider this appropriately adjusted for timing of cash flows already).But what about the individual person or company seeking insurance? It follows immediately that this inequality must also bet true for many of those seeking insurance. Why? Well if the opposite we...