1 Introduction:Insurance and Its Economic Role 1
1.1 Basics and Definitions 1
1.2 Risks and Their Development Over Time 3
1.3 Macroeconomic Importance of Insurance 6
1.4 Functions of Insurance 11
1.5 Major Determinants of the Demand for Insurance 15
1.5.1 The Effects of Wealth and Income 15
1.5.2 The Effect of Price 18
1.6 System Analysis and Organization of the Book 21
1.E Exercises 23
2 Risk:Measurement,Perception,and Management 25
2.1 Definition and Measurement of Risk 26
2.1.1 Definition of Risk 26
2.1.2 Measurement of Risk 27
2.2 Subjective Perception of Risk,Risk Aversion,and the Risk Utility Function 32
2.2.1 Risk Perception as a Subjective and Cultural Phenomenon 32
2.2.2 Risk Aversion and the Risk Utility Function 34
2.3 Willingness to Pay for Certainty,Risk Aversion,and Prudence 43
2.3.1 Willingness to Pay for Certainty,Certainty Equivalent,and Risk Premium 43
2.3.2 Risk Premium and Coefficients of Risk Aversion 46
2.3.3 Prudence and Higher-Order Derivatives of the Risk Utility Function 51
2.4 Estimates of Risk Aversion 53
2.4.1 Microeconomic Evidence 54
2.4.2 Macroeconomic Evidence 55
2.5 Instruments of Risk Management 57
2.6 Effectiveness of Risk Management and Risk Policy Measures 60
2.A Appendix:Stochastic Dominance 65
2.A.1 First-Degree Stochastic Dominance 65
2.A.2 Second-Degree Stochastic Dominance 67
2.E Exercises 69
3 Insurance Demand Ⅰ：Decisions Under Risk Without Diversification Possibilities 71
3.1 The Expected Utility Maximization Hypothesis 71
3.2 Theory of Insurance Demand 76
3.2.1 The Basic Model 76
3.2.2 Insurance Demand in the Presence of Irreplaceable Assets 81
3.3 Demand for Insurance Without Fair Premiums 84
3.3.1 Optimal Degree of Coverage Without Fair Premiums 84
3.3.2 Risk Aversion as a Determinant of Insurance Demand 88
3.3.3 Premium Rate and Wealth as Determinants of Insurance Demand 89
3.3.4 Pareto-Optimal Insurance Contracts 94
3.4 Demand for Insurance with Multiple Risks 96
3.5 Relation Between Insurance Demand and Prevention 100
3.6 Critique of the Expected Utility Hypothesis and Alternatives 105
3.6.1 Anomalies of Expected Utility Theory 105
3.6.2 Alternatives to Expected Utility Theory 108
3.E Exercises 109
4 Insurance Demand Ⅱ:Deeisions Under Risk with Diversification Possibilities 111
4.1 Risk Management and Diversification 112
4.1.1 Risk Management and Internal Diversification 112
4.1.2 Risk Diversification Through the Capital Market 116
4.1.3 The Capital Asset Pricing Model(CAPM) 124
4.1.4 Arbitrage Pricing Theory (APT) 130
4.2 Risk Management,Forward Contracts,Futures,and Options 132
4.2.1 Hedging Through Forward Contracts and Options 132
4.2.2 Hedging Through Stock Options 135
4.3 Corporate Demand for Insurance 139
4.3.1 Demand for Insurance in the Light of Capital Market Theory 139
4.3.2 Empirical Studies of Corporate Demand for Insurance 143
4.3.3 Reasons for Corporate Demand for Insurance Not Related to the Capital Market 146
4.E Exercises 148
5 The Insurance Company and Its Insurance Technology 151
5.1 Financial Statements of an Insurance Company 152
5.1.1 The Balance Sheet 152
5.1.2 Operational Statement 156
5.2 Objectives of the IC 160
5.2.1 Theoretical Considerations 160
5.2.2 Empirical Evidence Concerning the Importance of IC Objectives 163
5.3 Survey of Insurance Technology of an IC 167
5.3.1 What is the Output of an IC? 167
5.3.2 Instruments of Insurance Technology 169
5.4 Choice of Distribution Channel 170
5.4.1 Main Distribution Channels for Insurance Products 170
5.4.2 The Principal-Agent R.elationship as the Underlying Problem 171
5.4.3 A Comparison of Cost of Distribution Channels Using U.S. Data 173
5.4.4 A Study Relating Performance to Incentives 175
5.5 Underwriting Policy 177
5.5.1 Instruments of Underwriting Policy 177
5.5.2 A Simple Model of Risk Selection 178
5.6 Controlling Moral Hazard Effects 180
5.7 Reinsurance 184
5.7.1 Functions of Reinsurance 184
5.7.2 Types of Reinsurance 186
5.7.3 A Model of Demand for Reinsurance Based on Option Pricing Theory 188
5.7.4 Empirical Testing of the Model 194
5.8 Capital Investment Policy 197
5.E Exercises 203
6 The Supply of Insurance 205
6.1 Traditional Premium Calculation 206
6.1.1 Claims Process and Loss Distribution 206
6.1.2 Basics of Probability Theory and Insurer's Risk 215
6.1.3 Premium Principles 219
6.2 Financial Models of Insurance Pricing 222
6.2.1 Portfolio Optimization by the IC 223
6.2.2 Pricing According to Insurance CAPM 223
6.2.3 Pricing According to Option Pricing Theory 229
6.2.4 Empirical Evidence on the Actual Behavior of IC 233
6.3 Economies of Scope 241
6.3.1 Economies of Scope and Properties of the Cost Function 241
6.3.2 Empirical Relevance of Economies of Scope 243
6.3.3 Stochastic Economies of Scope 245
6.4 Economies of Scale 246
6.4.1 Definitional Issues 246
6.4.2 Empirical Relevance of Economies of Scale in Life Insurance 249
6.4.3 Empirical Relevance of Economies of Scale inNon-life Insurance 253
6.4.4 Alternatives and Extensions 254
6.4.5 Scale Economies and Size of Market 257
6.E Exercises 259
7 Insurance Markets and Asymmetric Information 265
7.1 Asymmetric Information and Its Consequences 265
7.2 Moral Hazard 268
7.2.1 Definition and Importance of Moral Hazard 268
7.2.2 Ex-Ante Moral Hazard 270
7.2.3 Market Equilibrium with Ex-Ante Moral Hazard 277
7.2.4 Empirical Evidence on Ex-Ante Moral Hazard 281
7.2.5 Ex-Post Moral Hazard in Short-Term Disability Insurance 284
7.3 Adverse Selection 291
7.3.1 Adverse Selection in a Single-Period Framework 291
7.3.2 Empirical Relevance of Adverse Selection 299
7.3.3 Adverse Selection in aMulti-Period Context 303
7.3.4 Empirical Evidence Regarding the Experience-Rating Model 309
7.4 Adverse Selection and Moral Hazard in Combination 311
7.E Exercises 313
8 Regulation of Insurance 315
8.1 Objectives and Types of Insurance Regulation 315
8.1.1 Objectives of Insurance Regulation 315
8.1.2 Avoidance of Negative Externalities 316
8.1.3 Material Regulation 316
8.1.4 Regulation Limited to Formal Requirements 320
8.1.5 Historical Differences in Insurance Regulation Between Countries 322
8.2 Three Competing Theories of Regulation 323
8.2.1 Public Interest Theory 323
8.2.2 Capture Theory 324
8.2.3 Market for Regulation Theory 324
8.2.4 Empirically Testable Implications for Insurance 326
8.3 Effects of Insurance Regulation 328
8.3.1 Evidence from the United States 328
8.3.2 Risk-Based Capital as the U.S. Regulatory Response 335
8.3.3 Evidence from Europe 336
8.4 Recent Trends in Insurance Regulation 341
8.4.1 The Financial Crisis of 2007-2009 341
8.4.2 The Convergence of Banking and Insurance and Regulation 342
8.4.3 Systemic Risk in Insurance Markets? 343
8.4.4 Characterization of Recent Regulatory Initiatives 345
8.E Exercises 347
9 Social Insurance 349
9.1 Importance of Social Insurance 350
9.2 Why Social Insurance? 351
9.2.1 Social Insurance as an Efficiency-Enhancing Institution 352
9.2.2 Social Insurance as an Instrument Wielded by Political Decision Makers 359
9.3 Overview of the Branches of Social Insurance 361
9.3.1 Structural Characteristics of Social Insurance 361
9.3.2 Importance of Branches of Social Insurance 363
9.4 Requirements for Efficient Social Insurance 363
9.4.1 Comparing the Efficiency of Provision for Old Age 364
9.4.2 Efficiency Assessment from a Portfolio Theory Perspective 367
9.5 Macroeconomic Impacts of Social Insurance 371
9.5.1 Impacts of Provision for Old Age 373
9.5.2 Impacts of Social Health Insurance 381
9.5.3 Impacts of Unemployment Insurance 385
9.5.4 Optimal Amount of Social Insurance 386
9.E Exercises 391
10 Challenges Confronting Insurance 393
10.1 Globalization of International Economic Relations 394
10.1.1 Globalization and Corporate Insurance 394
10.1.2 Globalization and Individual Insurance 395
10.2 Changes in Science and Technology 396
10.2.1 Genetic Information 396
10.2.2 Advances in Information Technology 402
10.3 Changes in Legal Norms 405
10.3.1 Principal Elements of Insurance Contract Law 405
10.3.2 Consequences of Deregulation 406
10.4 Increased Frequency and Severity of Catastrophic Events 407
10.4.1 New Elements of Insurance Technology 408
10.4.2 Issues Linked to Reinsurance of Catastrophic Risks 413
10.4.3 Alternative Risk Transfer Through Capital Markets 413
10.5 Demographic Change 416
10.5.1 Aging of Population 416
10.5.2 Increasing Share of One-Person Households 418
10.6 Final Remarks 419
References 423
Author Index 435
Subject Index 439