Question

1. Consider Ms. Pangolin who pays $1,500 in auto insurance premiums for the year. Assume that she is in accident and the insurance company has to pay $35,000 to cover liability and repair the car. The insurance company expects to pay a total of $750,000 in claims for the year with respect to the group of policy owners of which this individual is a member. Business expenses for the year are 175,000. Investment earnings on premium received are $35,000. How many insurance policies must the insurance company sell to break even (that is, to earn $0 in profit)? Assume that all policies are sold for a $1,500 premium [6 pts] (Show your calculations).

2. Consider the loss from fire damage of furniture which cost $6,000 three years ago and has an expected life of ten years. This furniture would cost $9,000 to purchase today. Under a replacement cost policy, how much would the insurance company pay you for this loss? [2 pts] (Show your calculations).

Answer 1

Answer 1

Total Claim expected by insurace company for the year to the group = $750,000

of policy owners of which Ms. Pangolin is a member

Add: Total Business Expenses expected = $175,000

Less: Investment earnings on premium received    = $35,000

Total Cash Outflow (After adjusting investment earnings) = $890,000

Now, to break even at $0 profit, Total Cash Outflow (After adjusting investment earnings)

will be divided by amount of premium received per policy

Number of insurance policy to be sold to break even = 890,000 / 1500

= 594*

Note for *: Answer is 593.33 has been rounded off to next natural number

Insurance policies must the insurance company sell to break even is 594 policies

Answer 2

A Replacement cost policy provides you with a payment equal to that which would be required to

replace the lost items.

In this case, $9,000 required to replace the damaged furniture.

Under a replacement cost policy, the insurance company pay you for this loss is $9,000