Monday 14 March 2016

Insurance markets in n-1 things

Tyler at Marginal Revolution points to interesting new insurance contracts where companies can insure against their celebrity spokesperson's potential disgrace.

Premiums run from 0.25% of the sum insured, to just under 1% of the sum insured. Presumably companies and insurers have to come up with ways of ensuring that sponsors don't start shifting to riskier celebrities, or start shirking on monitoring their celebrities' conduct.

Wellington has one chance in ten of a major earthquake over the next 100 years. The same link explains how continuing to be in Wellington after such an event would be far less pleasant than the post-quake Christchurch experience.

I would like to purchase an insurance contract paying me $1 million if there is a major Wellington earthquake.

If we assume that the one-in-ten chance is distributed evenly over that next hundred years, there is a 1/1000 risk per year.

An actuarially fair price for the insurance contract would then be $1000 per year. There is no moral hazard involved; I cannot cause earthquakes. It's effectively a life insurance contract paying out if Wellington gets a big earthquake, where we can define 'big' appropriately ex ante.

I would be happy to pay multiples over $1000 per year for that contract. I won't say how much over, but it's enough over that you'd think somebody would be willing to make a deal.

Missing markets continue to be missing.

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