This paper outlines the theory of risk aversion, and explains how insurance companies are successfully utilizing this theory to receive substantial amount of profit conducting their activities.
Risk aversion is a theory that explains why people are willing to buy insurance.
Risk averse means is a situation whereby individuals are willing to pay some money in order to avoid playing a risky game; this takes place even when the expected game value is in this individuals favor. A risk averse individual tends to pay more than the expected value of a game that will let him or her avoid a risk
Indemnity is a principle of insurance that states puts it clearly that an insured person will only get compensation if there is a risk occurrence. On the other hand if the event does not occur then the insured will not get any compensation whether money or property. In this case the insurance company will benefit a lot since all the premiums paid will remain as the company’s revenue.
The pay off expected by the insured is always less than the premiums he pays; this puts the insurance company in a better position making it a booming business with minimal chances of loss occurrence
The big advantage with the insurance company is that it can play games severally and leap much benefits associated with the law of large numbers. The more people the insurance company insures the more it the more it will collect money to cater for administrative costs as well as profits.
There is also a numerical illustration in the paper, that helps to bring out the meaning of the theory of risk aversion. The mathematical example makes this theory more intelligible.