After rigorous field survey, the insurance company finds that the probability to have cancer is 10%...

After rigorous field survey, the insurance company finds that the probability to have cancer is 10% on average. The company offers a fixed rate policy where the premium is $1,000. Reimbursement is $9,000, which is the amount of medical expense you must pay if you get cancer. Suppose there are two types of customers: heavy smoker, who has a probability of 15% of getting cancer. Nonsmoker, who has a probability of 5% of getting cancer.

A) Assuming utility function is ?? = ?? , where x is the amount of money. Calculate utilities for both heavy smoker and nonsmoker. Who will be buying the insurance?

B) What is the expected profit for the insurance company?

Expert Solution

a)Utility for heavy smoker= 15%*9000 – 1000 = $350

Utility for non-smoker = 5%*9000 – 1000 = -550

The heavy smoker will be taking the insurance

b) The profit to insurance company will be calculated on average probability basis

=1000 - 10%*9000

=$100

jeff jeffy answered 2 years ago

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