Question

In: Finance

An insurance company based in Newcastle is currently offering earthquake insurance to the residents of Newcastle....

An insurance company based in Newcastle is currently offering earthquake insurance to the residents of Newcastle.

a. Does this represent common or independent​ risk?

b. How could the insurance company change the nature of the risk it faces from common risk to independent​ risk?

​(Choose all correct​ responses.)

A.

It could offer other types of​ insurance, such a​ fire, theft and health insurance.

B.

It could offer earthquake insurance in other geographical regions.

C.

It could only offer insurance to people with​ solid, structurally sound houses.

D.

None of the above will be effective in reducing common risk.

Solutions

Expert Solution

Answer:

(a)
An insurance company is currently offering earthquake insurance to the residents of Newcastle. This represents common risk as common risk is the risk that affects the value of all risky assets and it cannot be eliminated in a diversified portfolio whereas the independent risk is a risk that is specific and independent for all the risky assets and can be eliminated in a diversified portfolio.
For example- for earthquake insurance policies in a same geographic region, common risk cannot be eliminated so the number of claims expected will be very high.

(b)
The insurance company can change the nature of the risk from common to independent by:
A. It can offer other types of insurance such a fire, theft and health insurance because they represent independent risk
B. It could offer earthquake insurance in other geographical regions to eliminate common risk.
Therefore, both A and B options are available to the insurance company to change the nature of risk from common to independent.

jeff jeffy answered 2 years ago
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