Question

An insurance company sells an insurance policy for $1000. If there is no claim on a policy, the company makes a profit of $1000. If there is a claim on a policy, theȱȱcompany faces a large loss onȱȱthat policy. The expected value to the company, per policy, is $250. Which of the following statements is (are) true? A: The most likely outcome on any single policy is a profit for the company of $250. B: If the company sells only a few policies, its profit is hard to predict. C: If the company sells a large number of policies, the average profit per policy will be close to $250. A) B only

B) A and C

C) B and C

D) C only

Answer 1

The business model of an insurance company is different from that of most other kinds of business companies. An insurance company makes payment of a claim only after and when the insured incident happens whereas policy premiums are collected upfront. Thus, a substantial majority of insurance liabilities are not liable to unexpected claims. Also, the price charged by way of premium for insurance is set based on estimates of sales and the level of claims in future.

Therefore, here, the insurance company makes an average profit close to $ 250 per policy if it sells a large number of policies. However, if the insurance company sells only a few policies, its profit is hard to predict.

Thus, option C) is the correct answer.