Question

Robert Weed is considering purchasing life insurance. He must pay a $180 premium for a $100,000 life insurance policy. If he dies this year, his beneficiary will receive $100,000. If he does not die this year, the insurance company pays nothing and Robert must consider paying another premium next year. Based on actuarial tables, there is a 0.001 probability that Robert will die this year. If Robert wishes to maximize his EMV, he would not buy the policy if the EMV were negative for him. He has determined that the EMV is, negative for him, but decides to purchase the insurance anyway. Why?

A) He believes that the actual likelihood of his death occurring in the next twelve months is really much greater than the actuarial estimate.

B) While the EMV is negative, the utility gained from purchasing the insurance is positive, and high.

C) Mr. Weed is not rational.

D) A or C

Answer 1

Answer: Option B; while the EMV is negative, the utility gained from purchasing the insurance is positive, and high.

Explanation:

Though the EMV is negative, the utility gained through the purchase would be high while comparing to the monetary values. Based on the actuarial tables Robert has very less probability to die this year and there is no proof to believe that the actual likelihood of his death occurring in the next twelve months is really much greater than the actuarial estimate. Mr. Weed is rational because he has decided to purchase the insurance anyway though the EMV is negative based on the fact that the utility gained from the purchase may be high. Hence A, C and D are wrong and the right answer is option B.