BU353 Lecture Notes - Lecture 3: Risk Management, Supply Chain, Product Liability
Document Summary
= 0. 2 [2500-500] + 0. 8 [0-500] = 1 million. Note: pooling does not change the expected cost. = 0. 64(0 - 500) + 0. 32(1250 - Once the size of pooling reaches 1000, the probability of the likelihood of the extreme outcomes is almost 0. Correlation: measures how random variables are related. Insurance companies are charging the expected value and some sort of contingency loadings. Pooling is not effective if extreme outcomes occur. Little competition - insurance is relatively more expensive. Insurers actually don"t know the loss, they just make estimations. After collecting loading, they will compare the losses at the end of year. Hard for insurers to get rid of the surplus. Low cushions and bigger losses result in less policy holders. Grow market share - eating away some surplus for so long - soft market. Raising premiums a little bit, a bit stricter when selling policies - hard market. The more insurance you have, the more exposure to volatility.
