Karl Borch's Research Contributions to Insurance

Abstract

Abstract The late Karl Borch made pioneering and fundamental contributions to the field of insurance economics. Borch was the first insurance scholar to recognize the significance of the new paradigms for dealing with the economics of uncertainty which were developed in the 1940s and 1950s. He used these ideas to investigate the form of optimal reinsurance contracts. His results not only illuminated the problems in insurance but also provided new insights into the determinants of optimal contracts in the general area of risk sharing. Borch's use of utility theory, game theory, and paradigms from financial economics provided a fresh new approach to insurance problems. This new approach was able to provide a synthesis that was unavailable under the traditional actuarial models which until then had dominated analytical models in the insurance area. Introduction The late Karl Borch was an eclectic scholar who made research contributions to several branches of economics. However, his most significant accomplishments were to insurance economics and to the economics of uncertainty. This review will assess some of his major research achievements in the insurance field. Karl Borch's career was both interesting and unconventional. Born in Norway, he graduated in actuarial science from the University of Oslo in 1947 and spent the next 12 years in research posts with the United Nations and the Organization of European Economic Cooperation. Perhaps this experience away from a traditional academic environment heightened his awareness of the importance of practical considerations. From 1959 to 1962 he studied for his doctorate in mathematics as Oslo University and during this period started applying ideas from the economics of uncertainty to problems in insurance. In 1963 Karl Borch was appointed to the Chair in Insurance at Bergen. Although he remained based in Bergen for the remainder of his life, he maintained contact with a broad range of scholars around the world through correspondence, conferences, and academic visits abroad. When Borch started his doctoral studies in 1959, the importance of the new developments in the economics of uncertainty had been realized by researchers in economics. These new paradigms for modelling decision making under uncertainty had been developed in the 1940s and 1950s. In 1944 von Neumann and Morgenstern had published their seminal book entitled Theory of Games and Economic Behavior which provided an axiomatic foundation for the expected utility hypothesis. In the 1950s Arrow and Debreu (1954) laid the foundations of general equilibrium theory. Borch realized the potential of these new paradigms to tackle problems in the insurance area. In a series of articles he showed how the expected utility hypothesis and game theory could be used to formulate and rigorously analyze a variety of important insurance problems. These paradigms are now so deeply embedded in the study of insurance economics that it may be difficult for a modern student to appreciate that this was not always the case. Although insurance represents an important economic activity there was, until Borch's work, very little use of economic concepts in theoretical work in insurance. For example, in his famous Helsinki lectures in 1963 Arrow (1965) stated: Insurance is an item of considerable importance in the economies of advanced nations, yet it is fair to say that economic theorists have had little to say about it, and insurance theory has developed with virtually no reference to the basic economic concepts of utility and productivity (p. 45) In the notes to his Helsinki lectures Arrow recognizes the contributions being made by Karl Borch to apply economic paradigms to the study of insurance problems. In his foreword to Borch's 1974 book, Arrow pays tribute to Broch's achievements: . .Dr. Borch quickly grasped the importance of the work that has been done on the economics of uncertainty and the value of the expected-utility hypothesis. …