Financial Economics of Insurance

René Doff

This chapter will describe the financial functioning of the insurer as a financial institution. Equity capital has a special role within financial institutions, and thus also within insurance companies; therein, risks and risk management have a central position. Insurance supervision will also be discussed later in the chapter.

WHAT IS AN INSURER?

The insurer is a financial institution. The key product of the insurer is the promise to make financial compensation at some moment in the future, depending on the type of product. The fact that the products of financial institutions are not tangible (they do not “manufacture” anything) has resulted in their becoming the subject of academic discussion. Why do insurers actually exist? The reason why an individual needs insurance is obvious: they obtain security and are covered for certain risks – such as their house burning down. Even if there is only a small probability, an individual might not have the financial means to reconstruct the house all over again; therefore, they need to cover that risk.

Insurers pool those risks together in a portfolio. They can do this much more efficiently than individuals because they have the

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