Question

As a manager at a car insurance company, you know that out of every 100 drivers, there are 30 risky drivers and 70 safe drivers. A risky driver costs your company $5,000 per year to insure, and a safe driver costs only $500. You design a policy that you think will appeal to safe drivers and expect that out of every 100drivers insured by this policy, 20 will be risky drivers and 80 will be safe drivers. The price (premium) for this policy is $2,000 per year. The policy ends up appealing more strongly to risky drivers than expected, so that out of every 100 drivers insured, 40 are risky drivers and only 60 are safe drivers.

1. For every 100 drivers insured, what economic profit do you expect to make?

2. For every 100 drivers insured, what economic profit do you actually make?

3. Why is there a difference between the expected profit and actual profit? What changes to the insurance policy could you make to restore the policy to profitability?

Answer 1