LLM Comparison: Why Buy Insurance?

notes
llm
insurance
Editing and tidying up transcribed text using LLMs.
Author

Stephen J. Mildenhall

Published

2024-03-20

Editing transcribed text with LLMs. Early versions of “Why Buy Insurance” notes.

Setup Instructions

The following is a transcription of a dictation of a paper about the reasons why people buy insurance. I would like you to tidy up the inevitable slips that fall into a transcription, tidy up the grammar, and make it read smoothly as possible, while retaining the original voice. Ensure a logical and consistent flow and a consistent voice, and removing any duplication. Please re-write with those goals in mind. Only change things that need changing; do not rephrase sections just to make a change. Use markdown and just output the edited text, with no other comments. OK?

GPT

Sure, please provide the transcription text that you want me to edit.

Gemini

Absolutely! To get started, please provide the text of the transcribed dictation. Here’s how I’ll approach this:

1. Transcription Errors: I’ll address obvious misspellings and garbled words resulting from potential speech-to-text mistakes.

2. Grammar and Smoothness: The focus will be on fixing grammatical errors, improving sentence structure for clarity, and refining transitions between ideas.

3. Logical Consistency: I’ll check for a logical progression of thoughts and arguments to avoid confusing jumps in the narrative.

4. Preserving Voice: I’ll be careful to primarily address mechanical errors, not stylistic choices. This is important to maintain the speaker’s unique perspective.

Let’s get to work!

Claude

Understood. Please provide the transcription you would like me to edit and refine, and I will do my best to tidy it up, improve the grammar and flow, ensure consistency, and remove duplications while preserving the original voice and only making necessary changes. I will provide the edited version in markdown format with no additional commentary.

ORIGINAL

Why do people buy insurance?

We are going to discuss this from the perspective of both individuals and corporations buying insurance. Corporations buying insurance can include insurance companies buying reinsurance.

There are five principal reasons why entities purchase insurance. Bullet number one because they are risk-averse and they want to transfer risk bullet number two because they are required to bullet number three taxes bullet number four because it helps them do something else that they want to do bullet number five because it position after a loss.

Risk of version.

The risk averse explanation, for the purchase of insurance has to be examined in the light of who exactly is risk first. And why are they risk of us. Corporation, which has no innate, which is simply a nexus of contracts with no personality. Speaking of it risk of version doesn’t make sense.we are really talking about the risk of of its managers or owners in someway. Here we are into questions of principal agent problems.

For corporation, we divide risk version into two. The first question is the risk of version of the entity caused by its institutional arrangements. For example, an insurance company has credit sensitive customers and because of information a symmetry is subject to costly capital. These act to make it appear risk of us.

Secondly, we can consider management separate objectives, around maximizing, bonuses and personal compensation, etc. which may cause a, slightly different set of reasons, why a corporation act in a risk of this way.

We take the goals of a corporation to be threefold: to grow, to increase profitability, and to decrease risk. These generally affected by either offering a better product at the same price, or the same product at a lower price. Since cost of capitalism in material component of insurance, with transfer risk factors, naturally into this given the presence of Catholic capital.

The legal requirement to purchase insurance

This requirement drives or lies behind at least 60% of insurance purchases. Principal examples include the almost universal requirement for automobile liability insurance to operate a private passenger vehicle, requirements for employer, liability or workers compensation, contractual requirements for general liability,,surety requirements, and property coverages, collateral protection requirement.

Taxes

The tax motivation to purchase insurance derives from the fact that contingent liabilities are typically not allowable as liabilities until they are “more likely than not” whereas insurance premiums are tax deductible when purchased. Thus an entity with an ongoing expectation of nutritional insurance losses can lock a certain tax deductible expense immediately rather than waiting for contingent claims to become allowable as liabilities.this motivates larger commercial enterprises to purchase very low margin, low risk, transfer insurance for tax purposes, and Lies behind their setting up insurance, captives and other risk financing mechanisms.

Because it helps and do other things they want to do

Purchasing insurance can help growth, the ergodic theory, Kelly, criteria objective. This can show how I insure and reinsurer and both be better off when the insurer pays a positive margin for reinsurance in the sense that both companies can lock in at higher expected growth rate.this is a very important example of purchasing insurance or reinsurance could make sense because he is one of the few examples which is not a loose situation, but rather a win-win between the insurer and the reinsurer

Favorable positioning after a loss

Insurance management often speak in terms of the desire capitalize on the next hard market. After a major contest with the event the purchase of catastrophe reinsurance is an obvious way to ensure they have adequate capital at the time to do so. This provides an important motivation for the purchase of reinsurance – at least in a soft market. It is questionable whether it explains why reinsurance continues to be purchased a hard market when the rational behavior might rather double down and keep all exposures net.

The foregoing suggest that, in fact, there is only one reason the people purchase insurance: in order that they may do something that they truly wish to do. However, such a classification is too cost to be useful, but a tripartite distinction between bullet number one statutory requirements for other design activities, bullets number two tax and risk financing purposes bullet number three to achieve other design aims.

Seems like an appropriate and useful separation.

GPT Re-write

Why Do People Buy Insurance?

We will explore the reasons why both individuals and corporations purchase insurance, noting that corporate insurance buyers may include insurance companies acquiring reinsurance.

Entities buy insurance for five principal reasons:

  1. They are risk-averse and want to transfer risk.
  2. They are required by law or contracts to have insurance.
  3. Tax advantages.
  4. Insurance facilitates other goals they wish to achieve.
  5. Insurance positions them favorably after a loss.

Risk Aversion

The concept of risk aversion in insurance purchasing must be scrutinized concerning who is risk-averse and why. For a corporation, which is essentially a collection of contracts with no inherent persona, discussing its risk aversion is not straightforward; we are essentially referring to the risk preferences of its managers or owners. This delves into principal-agent dynamics.

For a corporation, we categorize risk aversion into two areas. The first is the entity’s risk aversion stemming from its institutional setup. For instance, an insurance firm may appear risk-averse due to credit-sensitive customers and the cost implications of capital requirements under information asymmetry.

The second area concerns management’s personal objectives, like maximizing bonuses, which might influence the corporation’s risk-averse actions differently.

A corporation’s goals are typically to grow, increase profitability, and reduce risk, achievable by offering superior or cheaper products. Given that the cost of capital is a significant factor in insurance, transferring risk aligns with these objectives, especially in the context of volatile capital.

Legal Requirements

Legal mandates account for a substantial portion of insurance purchases. Examples include compulsory auto liability insurance for drivers, employer liability or workers’ compensation, general liability contractual obligations, surety, and property coverage mandates.

Tax Incentives

Tax motivations stem from the ability to deduct insurance premiums immediately, unlike contingent liabilities, which are not deductible until they become probable. This incentivizes entities, especially large ones, to buy low-risk insurance for tax benefits, influencing decisions to establish insurance captives and other risk financing strategies.

Facilitating Other Goals

Insurance can support growth and other objectives, as illustrated by the ergodic theory or Kelly criterion, demonstrating how both insurers and reinsurers benefit from reinsurance transactions, resulting in a mutually beneficial growth rate increase.

Positioning After a Loss

Insurance is often viewed as a strategic tool to capitalize on favorable market conditions post-major losses. Purchasing catastrophe reinsurance, especially in a soft market, is a strategy to ensure sufficient capital for seizing opportunities in a subsequent hard market, though its rationale in a hard market is debatable.

In conclusion, while one could argue that the sole reason for purchasing insurance is to enable desired activities, a more nuanced classification into statutory obligations, tax and financing considerations, and achieving other specific goals provides a clearer understanding of the motivations behind insurance purchases.

Gemini Re-write

Absolutely, here’s a revised version of the paper focusing on the goals you outlined. I’ve made edits for clarity, grammar, and flow while aiming to retain the original voice:

Why Do People Buy Insurance?

We will discuss this from the perspective of both individuals and corporations, including insurance companies buying reinsurance.

There are five principal reasons why entities purchase insurance:

  • Risk Aversion and Risk Transfer: Entities desire to transfer risk to mitigate potential losses.
  • Legal Requirements: Entities must comply with laws or contractual obligations.
  • Tax Considerations: Insurance premiums may offer tax advantages over contingent liabilities.
  • Facilitation of Desired Activities: Insurance can enable growth and strategic objectives.
  • Favorable Positioning After a Loss: Insurance helps entities prepare for future events and opportunities.

Risk Aversion

While corporations lack innate risk aversion, their managers or owners may be risk-averse. This raises questions of principal-agent problems. We can divide corporate risk aversion into two categories:

  1. Institutional Risk Aversion: An insurance company, for example, might have credit-sensitive customers. Information asymmetry can lead to costly capital requirements, making the company appear risk-averse.

  2. Managerial Risk Aversion: Managers may prioritize bonuses and personal compensation, leading to decisions influenced by their individual risk profiles.

A corporation’s goals are typically threefold: to grow, to increase profitability, and to decrease risk. Insurance aligns with these goals by potentially offering a better product at the same price or the same product at a lower price. The cost of capital is a significant component of insurance, and risk transfer factors naturally into a company’s financial strategies.

Legal Requirements

Legal mandates drive at least 60% of insurance purchases. Examples include:

  • Automobile liability insurance
  • Employer liability or workers’ compensation
  • Contractual requirements for general liability, surety, or property coverages
  • Collateral protection requirements

Taxes

Contingent liabilities are typically not tax-deductible until they are “more likely than not,” whereas insurance premiums are deductible when purchased. This motivates larger commercial enterprises to purchase low-margin, low-risk insurance for tax purposes and creates incentives for setting up captives and other risk financing mechanisms.

Facilitation of Desired Activities

Insurance can enable growth in line with the ergodic theory or Kelly criteria. A scenario where both an insurer and reinsurer benefit from a positive-margin reinsurance transaction illustrates this concept. Both companies can achieve higher expected growth rates, making this a win-win situation rather than a zero-sum game.

Favorable Positioning After a Loss

Insurance management often aims to capitalize on the next hard market. After a major catastrophic event, purchasing reinsurance is a way to ensure adequate capital for future opportunities. This provides motivation for buying reinsurance in a soft market. It remains to be seen why reinsurance purchases continue in a hard market when doubling down on net exposures might be considered more rational.

Conclusion

The reasons for purchasing insurance ultimately boil down to the desire to pursue desired activities and goals. A useful classification distinguishes between:

  1. Statutory requirements and other legally mandated activities
  2. Tax considerations and risk financing purposes
  3. The achievement of strategic aims

Let me know if you’d like any specific sections refined further!

Claude Re-write

Why do people buy insurance?

We are going to discuss this from the perspective of both individuals and corporations buying insurance. Corporations buying insurance can include insurance companies buying reinsurance.

There are five principal reasons why entities purchase insurance:

  1. Because they are risk-averse and they want to transfer risk
  2. Because they are required to
  3. Taxes
  4. Because it helps them do something else that they want to do
  5. Because it positions them after a loss

Risk Aversion

The risk averse explanation for the purchase of insurance has to be examined in the light of who exactly is risk averse and why they are risk averse. A corporation, which is simply a nexus of contracts with no personality, speaking of its risk aversion doesn’t make sense. We are really talking about the risk aversion of its managers or owners in some way. Here we are into questions of principal-agent problems.

For corporations, we divide risk aversion into two. The first question is the risk aversion of the entity caused by its institutional arrangements. For example, an insurance company has credit-sensitive customers and, because of information asymmetry, is subject to costly capital. These act to make it appear risk averse.

Secondly, we can consider management’s separate objectives, such as maximizing bonuses and personal compensation, which may cause a slightly different set of reasons why a corporation acts in a risk-averse way.

We take the goals of a corporation to be threefold: to grow, to increase profitability, and to decrease risk. These are generally affected by either offering a better product at the same price or the same product at a lower price. Since the cost of capital is a material component of insurance, risk transfer factors naturally into this, given the presence of costly capital.

Taxes

The tax motivation to purchase insurance derives from the fact that contingent liabilities are typically not allowable as liabilities until they are “more likely than not,” whereas insurance premiums are tax-deductible when purchased. Thus, an entity with an ongoing expectation of insurable losses can lock in a certain tax-deductible expense immediately rather than waiting for contingent claims to become allowable as liabilities. This motivates larger commercial enterprises to purchase very low-margin, low-risk transfer insurance for tax purposes and lies behind their setting up insurance captives and other risk financing mechanisms.

Because It Helps Them Do Other Things They Want to Do

Purchasing insurance can help growth, the ergodic theory, and the Kelly criteria objective. This can show how an insurer and reinsurer can both be better off when the insurer pays a positive margin for reinsurance in the sense that both companies can lock in a higher expected growth rate. This is a very important example of purchasing insurance or reinsurance that could make sense because it is one of the few examples which is not a lose-lose situation, but rather a win-win between the insurer and the reinsurer.

Favorable Positioning After a Loss

Insurance managers often speak in terms of the desire to capitalize on the next hard market. After a major catastrophic event, the purchase of catastrophe reinsurance is an obvious way to ensure they have adequate capital at the time to do so. This provides an important motivation for the purchase of reinsurance – at least in a soft market. It is questionable whether it explains why reinsurance continues to be purchased in a hard market when the rational behavior might rather be to double down and keep all exposures net.

The foregoing suggests that, in fact, there is only one reason why people purchase insurance: in order that they may do something that they truly wish to do. However, such a classification is too coarse to be useful, but a tripartite distinction between 1) statutory requirements for other desired activities, 2) tax and risk financing purposes, and 3) to achieve other designed aims seems like an appropriate and useful separation.

ORIGINAL from GPT’ed version

The ORIGINAL version here was created by GPT editing each transcribed block. I then ran that through each LLM to tidy it up.

ORIGINAL

Why Buy Insurance?

In this discussion, we explore the reasons why both individuals and corporations purchase insurance, highlighting that corporations’ engagement in buying insurance may also involve insurance companies acquiring reinsurance.

There are five principal reasons why entities purchase insurance:

  1. Because they are risk-averse and want to transfer risk.
  2. Because they are legally required to.
  3. Due to tax-related benefits.
  4. Because it enables them to engage in activities or pursuits they desire.
  5. Because it positions them favorably after a loss.

Risk Aversion

The explanation of risk aversion as a motive for purchasing insurance must be scrutinized in terms of identifying who exactly is risk-averse and why. A corporation, inherently devoid of personality and essentially a nexus of contracts, cannot exhibit risk aversion. Thus, when we discuss a corporation’s risk aversion, we are, in essence, referring to the risk preferences of its managers or owners. This consideration delves into the realm of principal-agent problems.

For corporations, we categorize risk aversion into two types. The first is the risk aversion of the entity, influenced by its institutional arrangements. For instance, an insurance company may have credit-sensitive customers and, due to information asymmetry, is subject to costly capital, which contributes to its apparent risk aversion.

Secondly, we consider the personal objectives of management, such as maximizing bonuses and personal compensation. These objectives might lead to a distinct set of motivations for why a corporation acts in a risk-averse manner.

The objectives of a corporation are typically threefold: to grow, to increase profitability, and to decrease risk. These goals are usually achieved by either offering a better product at the same price or the same product at a lower price. Given that the cost of capital is a significant component in insurance, risk transfer aligns naturally with these objectives, especially considering the presence of catastrophe capital.

Taxes

The incentive to purchase insurance for tax reasons stems from the fact that contingent liabilities are usually not recognized as actual liabilities until they are deemed “more likely than not” to occur. In contrast, insurance premiums are tax-deductible when paid. Therefore, an entity anticipating recurrent nominal insurance losses can secure a certain tax-deductible expense immediately, rather than waiting for contingent claims to qualify as liabilities. This encourages larger commercial enterprises to buy insurance with very low margins and low risk transfer primarily for tax benefits, influencing their decisions to establish insurance captives and other risk financing mechanisms.

To Help Achieve Other Goals

Buying insurance can facilitate growth and meet other strategic objectives. An illustrative example is how both an insurer and reinsurer can benefit when the insurer purchases reinsurance at a positive margin. In this scenario, both entities can secure a higher expected growth rate. This demonstrates a significant case where purchasing insurance or reinsurance is sensible, as it represents a win-win situation for both the insurer and reinsurer, rather than a zero-sum game.

Favorable Positioning After a Loss

Insurance management frequently discusses the strategy of capitalizing on the next hard market. After a significant catastrophic event, acquiring catastrophe reinsurance becomes a clear strategy to ensure sufficient capital availability to leverage such market conditions. This forms a crucial motivation for purchasing reinsurance, especially in a soft market. However, it raises questions about the continued purchase of reinsurance in a hard market, where a more rational behavior might be to assume greater risk and retain all exposures net, rather than transferring them.

The foregoing suggests that there is fundamentally one reason people purchase insurance: to enable them to engage in activities they truly wish to pursue. However, this classification is overly broad to be practical. A more useful distinction can be made into three categories:

  1. Statutory requirements or other mandated activities.
  2. Tax and risk financing purposes.
  3. Achieving other specific objectives.

This tripartite separation provides a more detailed and actionable understanding of the motivations behind purchasing insurance.

Under the category of insurance aiding entities in achieving their desired activities, we include goals such as growth, offloading liability, and decreasing risk. This broad category encompasses:

  1. The product theory of maximum growth.
  2. Being strategically positioned when the market shifts, which academics refer to as state-dependent utility.
  3. The substitution of quota shares, facilitating logical growth of the book and potential for expense leverage and economies.
  4. Favorable treatment by rating agencies and the ability to achieve high leverage, for instance, through catastrophe risk transfer.
  5. Protection of individual business unit bonus plans.

We now understand that risk aversion does not emerge as a “top-line” motivation for purchasing insurance or reinsurance. Instead, we often view risk aversion as a term that obscures the actual underlying motivation.

The tripartite categorization of insurance purchasing motivations is beneficial as most insurance types align predominantly with one of the three categories. Personal insurance is often bought due to statutory requirements. Corporate insurance is frequently acquired for tax and risk financing purposes. The remaining insurance is typically purchased to satisfy other needs, aligning with the specific goals and objectives of the buyer.

The derived classification is valuable to the extent that it provides a mutually exclusive and exhaustive partitioning of insurance policies, where the predominant motivation for purchase aligns with its respective category. While this aggregation isn’t absolute—since insurance contracts could be categorized in various ways—for instance, personal liability insurance could be divided into low limit or federally mandated policies, bought due to statutory requirements, versus higher limits, which are likely more prevalent in the U.S. and purchased to enable the policyholder to achieve other financial objectives with greater certainty (often framed as risk aversion).

GPT Re-write

Why Buy Insurance?

This discussion elucidates the reasons individuals and corporations acquire insurance, emphasizing that corporate insurance procurement may involve companies purchasing reinsurance.

Principal Reasons for Purchasing Insurance

Entities buy insurance primarily for five reasons:

  1. To mitigate risk due to risk aversion.
  2. To comply with legal mandates.
  3. For tax benefits.
  4. To facilitate other desired activities.
  5. To be strategically positioned after a loss.

Risk Aversion

Analyzing risk aversion requires identifying who is risk-averse and their reasons. Since corporations are entities without personal attributes, their risk aversion reflects the risk preferences of their managers or owners, particularly influenced by institutional arrangements and personal management objectives. This alignment with corporate goals—growth, profitability, and risk reduction—is essential, especially in contexts like insurance, where capital cost plays a crucial role.

Tax Considerations

Tax advantages are a compelling motive for insurance purchase, especially when considering the immediate tax deductibility of premiums compared to the deferred recognition of contingent liabilities. This dynamic prompts entities, particularly large enterprises, to purchase insurance, often influencing their strategies like setting up captives.

Achieving Strategic Objectives

Insurance enables entities to pursue strategic objectives, such as growth or market positioning. The mutual benefits for insurers and reinsurers purchasing at a positive margin exemplify a scenario where both parties achieve enhanced growth, illustrating a non-zero-sum outcome in the insurance domain.

Post-Loss Positioning

The concept of positioning for advantage post-loss, particularly in anticipating hard market opportunities, is a strategic consideration in purchasing reinsurance, highlighting the dynamic nature of risk management strategies.

A Tripartite Framework

The essence of insurance purchasing can be distilled into three core motivations:

  1. Compliance with statutory or mandated requirements.
  2. Tax and risk financing advantages.
  3. Fulfillment of strategic or operational goals.

This framework provides a nuanced perspective, acknowledging the diverse motivations behind insurance acquisition, whether personal or corporate.

Insurance’s Role in Strategic Planning

Insurance is not merely a risk aversion tool but a strategic facilitator, aiding entities in growth, risk management, and leveraging market opportunities. This perspective shifts the focus from risk aversion to proactive strategic planning, where insurance is a key enabler in achieving broader objectives.

Conclusion

Understanding the motivations for purchasing insurance through this tripartite lens offers a comprehensive view, aligning insurance decisions with broader personal or corporate strategies. This approach demystifies the conventional risk aversion narrative, positioning insurance as a strategic tool in risk management and organizational planning.

Gemini Re-write1

Why Buy Insurance?

Insurance is a vital tool for individuals and corporations to manage risk and achieve objectives. This article explores the diverse reasons why people and businesses purchase insurance.

Key Motivations

There are five primary drivers for purchasing insurance:

  1. Risk Transfer: Risk-averse individuals and corporations seek to transfer the financial burden of potential losses to an insurance provider.
  2. Legal Requirements: Many types of insurance are legally mandated, such as automobile liability insurance, workers’ compensation, and certain property coverages.
  3. Tax Benefits: Insurance premiums are tax-deductible, providing financial advantages, particularly for businesses facing recurrent nominal losses.
  4. Enabling Growth and Strategic Goals: Insurance can facilitate expansion and other objectives. For example, reinsurers can benefit by selling reinsurance at a positive margin, allowing both the insurer and reinsurer to achieve higher growth rates.
  5. Favorable Positioning After a Loss: Insurance and reinsurance purchases can position insurers to capitalize on market conditions following a major loss event.

Understanding Risk Aversion

It’s important to distinguish that corporations, as legal constructs, do not inherently possess risk aversion. The risk preferences of managers or owners influence a corporation’s apparent risk aversion. Corporate risk aversion can be driven by institutional arrangements (such as credit-sensitive customers) or by management’s personal objectives, like maximizing compensation.

A Practical Classification of Insurance Motivations

While the desire to engage in desired activities broadly explains insurance purchases, a more useful classification is:

  1. Statutory Requirements: Insurance mandated by law.
  2. Tax and Risk Financing: Insurance purchased for financial benefits.
  3. Achieving Specific Objectives: Insurance enabling growth, liability reduction, market positioning, rating agency considerations, and business unit protection.

Risk Aversion Revisited

Risk aversion often serves as a shorthand for the underlying motivations driving insurance purchases.

The Value of Categorization

This tripartite classification system offers practical insights by aligning insurance types with their predominant purchase motivations. For example:

  • Personal insurance often aligns with statutory requirements.
  • Corporate insurance is frequently driven by tax and risk financing considerations.
  • Other insurance purchases typically serve distinct goals of the buyer.

Conclusion

This analysis offers a clearer understanding of why insurance is purchased. While insurance can be classified in various ways, the tripartite system underscores that legal mandates, financial optimization, and strategic objectives all play significant roles in the decision to buy insurance.

Claude Re-write

Why Buy Insurance?

In this discussion, we explore the reasons why both individuals and corporations purchase insurance, highlighting that corporations’ engagement in buying insurance may also involve insurance companies acquiring reinsurance.

There are five principal reasons why entities purchase insurance:

  1. Because they are risk-averse and want to transfer risk.
  2. Because they are legally required to.
  3. Due to tax-related benefits.
  4. Because it enables them to engage in activities or pursuits they desire.
  5. Because it positions them favorably after a loss.

Risk Aversion

When discussing a corporation’s risk aversion, we are, in essence, referring to the risk preferences of its managers or owners. This consideration delves into the realm of principal-agent problems.

For corporations, we categorize risk aversion into two types. The first is the risk aversion of the entity, influenced by its institutional arrangements. For instance, an insurance company may have credit-sensitive customers and, due to information asymmetry, is subject to costly capital, which contributes to its apparent risk aversion. Secondly, we consider the personal objectives of management, such as maximizing bonuses and personal compensation. These objectives might lead to a distinct set of motivations for why a corporation acts in a risk-averse manner.

The objectives of a corporation are typically threefold: to grow, to increase profitability, and to decrease risk. Given that the cost of capital is a significant component in insurance, risk transfer aligns naturally with these objectives, especially considering the presence of catastrophe capital.

Taxes

The incentive to purchase insurance for tax reasons stems from the fact that contingent liabilities are usually not recognized as actual liabilities until they are deemed “more likely than not” to occur. In contrast, insurance premiums are tax-deductible when paid. Therefore, an entity anticipating recurrent nominal insurance losses can secure a certain tax-deductible expense immediately, rather than waiting for contingent claims to qualify as liabilities. This encourages larger commercial enterprises to buy insurance with very low margins and low risk transfer primarily for tax benefits, influencing their decisions to establish insurance captives and other risk financing mechanisms.

To Help Achieve Other Goals

Buying insurance can facilitate growth and meet other strategic objectives. An illustrative example is how both an insurer and reinsurer can benefit when the insurer purchases reinsurance at a positive margin. In this scenario, both entities can secure a higher expected growth rate, demonstrating a significant case where purchasing insurance or reinsurance is sensible, as it represents a win-win situation for both parties.

Favorable Positioning After a Loss

Insurance management frequently discusses the strategy of capitalizing on the next hard market. After a significant catastrophic event, acquiring catastrophe reinsurance becomes a clear strategy to ensure sufficient capital availability to leverage such market conditions. This forms a crucial motivation for purchasing reinsurance, especially in a soft market.

The foregoing suggests that there is fundamentally one reason people purchase insurance: to enable them to engage in activities they truly wish to pursue. However, a more useful distinction can be made into three categories:

  1. Statutory requirements or other mandated activities.
  2. Tax and risk financing purposes.
  3. Achieving other specific objectives.

This tripartite separation provides a more detailed and actionable understanding of the motivations behind purchasing insurance.

Under the category of insurance aiding entities in achieving their desired activities, we include goals such as growth, offloading liability, and decreasing risk. This broad category encompasses:

  1. The product theory of maximum growth.
  2. Being strategically positioned when the market shifts, which academics refer to as state-dependent utility.
  3. The substitution of quota shares, facilitating logical growth of the book and potential for expense leverage and economies.
  4. Favorable treatment by rating agencies and the ability to achieve high leverage, for instance, through catastrophe risk transfer.
  5. Protection of individual business unit bonus plans.

We now understand that risk aversion does not emerge as a “top-line” motivation for purchasing insurance or reinsurance. Instead, we often view risk aversion as a term that obscures the actual underlying motivation.

The tripartite categorization of insurance purchasing motivations is beneficial as most insurance types align predominantly with one of the three categories. Personal insurance is often bought due to statutory requirements. Corporate insurance is frequently acquired for tax and risk financing purposes. The remaining insurance is typically purchased to satisfy other needs, aligning with the specific goals and objectives of the buyer.

While this aggregation isn’t absolute—since insurance contracts could be categorized in various ways—the derived classification is valuable to the extent that it provides a mutually exclusive and exhaustive partitioning of insurance policies, where the predominant motivation for purchase aligns with its respective category.

Footnotes

  1. Gemini does not use Markdown sections. These have been added for visual consistency between the models.↩︎