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Policy Calculations Insurers Operate

1. Assume that insurers operate in an environment where price regulation does not exist. Describe two potential benefits that this type of system provides to consumers as well as two potential costs.

2. Define agency costs and discuss whether these costs reduce business value.

3. Describe the common objectives that employers have for their firmâ??s benefits plan and indicate whether employees value the benefits package equally, and/or in the same manner as the employer.

4. How do insurers control for adverse selection problems in health insurance products?

5. What are the advantages associated with using a modeling approach (e.g., vs. using historical data) to estimate expected losses from catastrophic events?

Please show all work in an Excel file for the following questions:

6. ABC Life is interested in selling a five-year, single premium life insurance policy with the following features:

- Death benefit of $200,000.
- Death benefits are payable at the end of the year.
- Each policyholder will pay a single premium at the beginning of policy year one.
- A total of 20,000 policies will be sold to males aged 45
a. Using the mortality information provided below and a 6 percent rate of return assumption, what is the single premium ABC Life should charge each insured?
Beginning of Year Age Probability
of Death During Year
1 45 .0044
2 46 .0047
3 47 .0052
4 48 .0058
5 49 .0064

b. Calculate the level annual premium for the same policy (i.e., what amount would the insured have to pay each year, for 5 years, for this coverage?).

7. ABC Property and Casualty is interested in selling coverage to homeowners in a new development. Homes in this development are valued at $500,000. They estimate that losses per exposure (home) will follow the following discrete distribution:

Loss Amount Probability
$500,000 0.005
$100,000 0.01
$50,000 0.03
$25,000 0.05
$10,000 0.07
$5,000 0.10

a. Calculate the gross premium ABC should charge for full coverage if it includes a 15% loading for administration and profit.

b. How much should ABC charge for a policy with a $10,000 deductible?

Solution Preview

1. Assume that insurers operate in an environment where price regulation does not exist. Describe two potential benefits that this type of system provides to consumers as well as two potential costs.

No price regulation in the insurance industry would result in increased competition. Pociask (2008) provides that the insurance industry is one of the most competitive industries and this would result in two benefits to the consumer which includes lower prices and better services. Deregulated insurance markets have lower prices than regulated insurance markets due to increased competition which leads to price competition and improved efficiency in the industry and the end result is less prices for the consumer. The American Consumer Institute (2008) carried out a research on automobile insurance and found that regulation leads to increased consumer expenditures thus deregulation is better for consumers.

No price regulation would also benefit the consumer due to better services and products offered by insurance providers. Deregulation would lead to improved competition which would require insurance providers to be innovative and offer attractive products so as to attract customers from competitors.

In an inefficient market competition might not work well and structural factors lead to concentrated industries and high market power and this might lead to some providers raising prices above cost. Organizations that have adequate market power can impose large efficiency costs on the market (Access Economics, 2005). Another cost in a deregulated insurance industry is reduction in product quality and this can be increased entry in the industry and also due to inefficient competition.

2. Define agency costs and discuss whether these costs reduce business value.

Agency cost is an internal cost that is paid to an agent. An agency is a contractual ...

Solution Summary

The expert describes the potential benefits that this type of system provides to consumer as well as two potential costs.

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