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IAI Actuarial Core Principles · Economic Modelling · Role of insurance in reducing or removing risk

A firm buys an insurance policy with a deductible (excess) on its fire loss. Which statement best describes the effect of the deductible on risk transfer?

A deductible keeps small losses with the policyholder, which reduces moral hazard, claims costs and premium, while the insurer still bears losses above the deductible. Large, potentially ruinous losses are therefore still transferred, so risk transfer is partial rather than full.

  1. AIt transfers all risk to the insurer while reducing the premium
  2. BIt leaves small losses with the policyholder, reducing moral hazard and premium, while the large-loss risk is still transferredCorrect
  3. CIt removes the insurer's exposure to large losses
  4. DIt increases adverse selection by attracting only high-risk policyholders
  5. It makes the policy equivalent to full insurance

Explanation

A deductible retains the first part of every loss with the insured, which gives incentive to take care and lowers claim handling cost and premium. The insurer still pays the excess over the deductible, so large-loss risk is transferred.

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