In: Economics
For an auto insurance company, the average cost of collision claims is $500 per year for careful drivers and $3000 per year for poor drivers. The drivers are risk neutral and know whether they are careful or poor, but the insurance company only knows that 15% of drivers are poor. What is the insurance company's breakeven price for the collision insurance? A. $425 per year B. $450 per year C. $875 per year D. $2,625 per year
Ans: $875 per year
Explanation:
The insurance company only knows that 15% of drivers are poor means 85% drivers are careful.
The insurance company's breakeven price for the collision insurance = (0.15 * 3,000) + (0.85 * 500)
= $450 + $425
= $875