4. Suppose that an insurance company charges $1150 per year to cover a car in a...

4.   Suppose that an insurance company charges $1150 per year to cover a car in a nearby city. Suppose that there are three different scenarios that the company has to consider:
a.   There is a .0005 probability that the policy holder will cause a fatality and the company will pay $1,000,000.
b.   There is a .01 probability that the policy holder will injure someone and the company will pay $20,000.
c.   There is a .1 probability that the policy holder will be in an accident and the company will pay $2,000.
What is the expected value for the policy and is it wise for the company to continue to offer it?

Expert Solution

SOLUTION:

From given data,

( 4.) Suppose that an insurance company charges $1150 per year to cover a car in a nearby city. Suppose that there are three different scenarios that the company has to consider:

a.   There is a .0005 probability that the policy holder will cause a fatality and the company will pay $1,000,000.
b.   There is a .01 probability that the policy holder will injure someone and the company will pay $20,000.
c.   There is a .1 probability that the policy holder will be in an accident and the company will pay $2,000.

What is the expected value for the policy and is it wise for the company to continue to offer it

Expected value for the company = $1150 - (0.0005 x $1000000) - (0.01 x $20000) - (0.10 x $2000)

= 1150 - 500 - 200 - 200

= $250

Since the expected value for the company is positive, it is wise for the company to continue to offer it.

orchestra answered 2 years ago

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