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Risk Pooling
If n policies, each has independent probability p of a claim, then the number of claims follows the binomial distribution. The standard deviation of the fraction of policies that result in a claim is p(1 p) / n Law of large numbers: as n gets large, standard deviation approaches zero.
Aristotle on Probability
To succeed in many things, or many times, is difficult; for instance, to repeat the same throw ten thousand times with the dice would be impossible, whereas to make it once or twice is comparatively easy. (De Caelo)
Insurance as an Invention
Contract design, specifying risks, excluding risks subject to moral hazard or selection bias. Definition of loss and sufficient proof of loss Mathematical model of risk pooling Collection of statistics on risks, and evaluation of the quality of such statistics. Corporate or mutual form for the company Government verification of insurance companys ability to pay Government regulation of insurance
Invention of Insurance
In ancient Rome, burial societies and bottomry. (Burial insurance still a factor in less developed countries.) Actuarial science developed in late 1600s Modern fire insurance began in London, insurance gradually spread around the world.
Commercial Insurance
Property & Casualty Insurance, In US premiums paid 1997 $276 billion, $2760 per household Private Health Insurance: premiums paid 1996 $137 billion, $1370 per household Life insurance: In US, premiums paid 1997 $112 billion, or $1120 per household, 373 million policies, with value of $13.2 trillion in US in 1997, $132,000 per household. 1620 US life insurance companies.
Marketing of Insurance
Mutual Life Insurance of New York in 1840s: Morris Robinson trains highly-paid life insurance salesmen Equitable Life Insurance Association in late 1800s: Henry B. Hyde invents tontine life insurance policy, sweeps the nation Whole life is successor to tontine
Capital Requirements
Insurance companies risk being unable to pay if there are too many claims. Why dont insurance companies define their contracts so that they cannot fail to pay? Human factors engineering of financial contracts.