Insurance companies need a lot of cash on hand to cover low probability events. However, they can invest this money, so things like life insurance where risks increase over time but the premiums are fixed, can end up with a higher average payout than insurance premium, the difference being time value of money. In other words you end up paying the opportunity cost, but not nessisarily a nominal cost in the long term.
Re:Mercury Spill
by cronjobber on Friday October 09, 2015 @06:14AM
(#10359120)
If money has diminishing marginal utility (to the insured) then insurance can have both positive expected utility for the insured and positive expected profit for the insurer.
I'm curious how this math works. In my (quite likely incomplete) mental model of insurance, there are only a few terms: premiums, payouts, profits. It would seem that they have to balance. So if you pool risk, you are summing the payouts. Those payouts are covered by the sum of premiums. Any profit is the sum of premiums minus the sum of payouts.
Profits = Premiums - Payouts
Is this right so far?
Because then it seems that the expected value of insurance to the customer is the negated value of the expected profit of the insurer. Put another way: if the expected value of insurance is not negative, shouldn't the insurer raise premiums or exit the business?
Again, I know next to nothing about insurance and I'm asking to learn.