Financial Markets and Institutions (2-downloads)

541

Loss

Probability (%)

$30,000

0.25

$15,000

0.75

$10,000

1.50

$5,000

2.50

$1,000

5.00

$250

15.00

$0

75.00

K E Y   T E R M S

annuity, p. 519

casualty (liability) insurance, p. 524

certainty equivalent, p. 514

coinsurance, p. 529

deductible, p. 516

defined-benefit plan, p. 532

defined-contribution plan, p. 532

Employee Retirement Income

Security Act (ERISA), p. 537

fully funded, p. 532

individual retirement accounts (IRA),

p. 539

law of large numbers, p. 519

monoline insurance companies, 

p. 531

mutual insurance companies, p. 517

named-peril policies, p. 524

open-peril policies, p. 524

overfunded, p. 532

Pension Benefit Guarantee

Corporation (Penny Benny), p. 538

pension plan, p. 531

private pension plans, p. 533

property insurance, p. 524

public pension plan, p. 534

reinsurance, p. 525

stock company, p. 517

underfunded, p. 532

underwriters, p. 517

Q U E S T I O N S

1. Why do people choose to buy insurance even if their

expected loss is less than the payments they will

make to the insurance company?

2. Why do insurance companies not allow people to buy

insurance on personally unrelated risks?

3. What is information asymmetry, and how does it

affect insurance companies?

4. Distinguish between adverse selection and moral haz-

ard as they relate to the insurance industry.

5. How do insurance companies protect themselves against

losses due to adverse selection and moral hazard?

6. Distinguish between independent agents and exclu-

sive agents.

7. Are most insurance companies organized as mutuals

or stock companies?

8. How are insurance companies able to predict their

losses from claims accurately enough to let them

price their policies such that they will make a profit?

9. What is the difference between term life insurance

and whole life insurance?

10. What risks do property and casualty insurance poli-

cies protect against?