Question

Question 3

Table 2 shows some data related to crime in different areas of England. When answering the questions that follow, assume that the rates of offences in each area in the year ending March 2019 are valid indicators of the current annual risks of these offences.

Table 2 Rates of police recorded crime for burglary and bicycle theft for selected areas of England, year ending March 2019

Region	Burglary	Bicycle Theft
North East	7.1 per thousand of population	1.4 per thousand of population
West Midlands	0.0079	0.0010
South East	0.54%	0.16%
Wales	1 in 109 of population	1 in 417 of population

Source: adapted from ONS (2019)

3.1 Transform the figures in Table 2 into one comparable measure of risk by expressing each probability as a decimal, rounded to four decimal places.

3.2 If occurrences of bicycle theft and burglary are statistically independent, what is the chance of suffering both a bicycle theft and a burglary in London during the next year? Express your answer as a percentage and show all your workings.

3.3 Give two reasons why a particular household in the West Midlands may in fact be at a higher risk of burglary than the probability shown in the table.

3.4 Briefly explain in your own words the meaning of moral hazard, and identify two ways in which an insurer can design a policy covering bicycle theft to reduce the risk of moral hazard.

Answer 1

Given

Region	Burglary	Bicycle Theft
North East	7.1 per thousand of population	1.4 per thousand of population
West Midlands	0.0079	0.0010
South East	0.54%	0.16%
Wales(London)	1 in 109 of population	1 in 417 of population

3.1)

Here We require the values to be converted into comparable form so we can compare them easily:

We want them in form of probability so we will have to put it in decimals

Now We will convert all of them Region wise

North East:

Burglary: 7.1 per thousand of population = 7.1/1000 = 0.0071

(Here we have 7.1 per thousand so we just converted them into decimal and solved it)

Bicycle Theft: 1.4 per thousand of population = 1.4/1000 = 0.0014

West Midlands:

Burglary: 0.0079 (Already in form of probability)

Bicycle Theft: 0.001 (Already in form of probability)

South East:

Burglary: 0.54% 0.54/100 = 0.0054

As we know percentage can be converted into probability just by dividing it by 100

Bicycle Theft: 0.16% = 0.16/100 = 0.0016

London:

Burglary : 1 in 109 of population can be written as 1/109 = 0.00917 = 0.0092

Bicycle Theft: 1 in 417 of population = 1/417 = 0.002398 = 0.0024

Here we have just converted the words into formula and we get probability values.

3.2)

Since,  bicycle theft and a burglary are independent

So, P( bicycle theft and a burglary in London ) = P( bicycle theft in London) * (a burglary in London)

0.0092 * 0.0024 = 0.002208%

3.4)

Moral hazard:

it is a situation in which one party to an agreement engages in risky behavior or fails to act in good faith because it knows the other party bears the consequences of that behavior In the business world.

example: government bailouts and salesperson compensation.

moral hazard occurs when an entity has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher risk knowing that its insurance will pay the associated costs

The main point of moral hazard theory is that insurance removes all or part of the incentive to restrict the use of insured services.

Moral hazard is when one party can take risks knowing the other party will bear the consequences. It describes the risk present when two parties don't have the same information about actions that take place after an agreement is in place. The situation creates a temptation to ignore the moral implications of a decision and doing what benefits you most instead of doing what is right.

The ways in which an insurer can design a policy covering bicycle theft to reduce the risk of moral hazard can be illustrated as under:

1. Use of Credit & Insurance Scores : A person's use of credit is an indicator of their potential for moral hazard. Thus how the insured is using the credit alloted to him by the insurer counts on the fact that how much can he be trusted for the policy. Also making responsibility for the first dollars of the insured, reduces the potential for insurance abuse. Hence in the policy covering bicycle theft , to reduce the moral hazard the insured should be made responsible in first place to keep proper protection of his assets.  
2. Penalize bad behavior : The insurer or insurance companies should prosecute any fraud on the part of the insured in order to mitigate losses to moral hazards. In this method, all the fraudulent activity or bad behavior abusing moral hazard by the insured must be penalized according to the policy he has undertaken. The insurer must design its policy in such a way that it reduces moral hazard.

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