De Finetti on the Insurance of Risks and Uncertainties

Abstract

In the insurance literature, it is often argued that private markets can provide insurance against ‘risks’ but not against ‘uncertainties’ in the sense of Knight ([1921]) or Keynes ([1921]). This claim is at odds with the standard economic model of risk exchange which, in assuming that decision-makers are always guided by point-valued subjective probabilities, predicts that all uncertainties can, in theory, be insured. Supporters of the standard model argue that the insuring of highly idiosyncratic risks by Lloyd's of London proves that this is so even in practice. The purpose of this article is to show that Bruno de Finetti, famous as one of the three founding fathers of the subjective approach to probability assumed by the standard model, actually made a theoretical case for uncertainty within the subjectivist approach. We draw on empirical evidence from the practice of underwriters to show how this case may help explain the reluctance of insurers to cover highly uncertain contingencies. 1 Introduction 2 Knight and Keynes on the Philosophy of Unknown Probabilities and Lloyd's of London 2.1 Knight 2.2 Keynes 3 Insuring Unique Events: The Subjectivist Viewpoint as Represented by de Finetti 4 The ‘Philosophy’ of Practitioners 5 De Finetti on Uncertainty in Knight and Keynes and on Insurability 5.1 De Finetti on Knight 5.2 De Finetti on Keynes 6 Empirical Evidence on Insurance Under Ambiguity 7 Conclusion