Insurance market and calculate risk premium, Microeconomics

Assignment Help:

There are two individuals in town, one is high risk and the other is low risk.1 The probabilities of having an accident for the low risk individual and high risk individual are pL = 0.025 and pH = 0.050 respectively.

Assume for now that no individual will have more than one accident during the year. Each accident costs 2000 TL.

a. Suppose that the insurance company is only offering a full-coverage insurance. And also assume that high risk individual is risk neutral; and hence is willing to pay a premium equal to his expected costs, but no more. But the low risk individual is risk averse and hence willing to pay more than his expected costs to avoid the risk; and say that his risk premium is 25 TL [he is willing to pay an additional 25 TL over his expected costs just to avoid the risk]. Since the insurance company can not observe the type, it offers a single insurance contract for all. Insurance company is trying to decide on the premium to charge. Determine, which individual(s) buys the insurance, and the profits of the insurance company if the premium charged is 50; if the premium charged is 75 and if it is 100.

Premium Who buys?

Profits

Can the insurance company provide insurance to both parties without making a loss?

b. What if the risk premium of the low risk individual was lower than 25 TL? Can the insurance company serve all ensuring that it is not making any losses? What is the name of this problem? Why does it arises?

c. Suppose that now the insurance company charges a low premium of 50 TL for an individual who passes a "safe driving test". And charges a premium of 100 TL otherwise. To take a test a payment of 20 TL to the certification agency. For the low risk individual the driving test is easy, since he is slow and cautious he pass the test at his first trial. But for the high risk individual passing the test requires

at least 3 trials. Check if passing the test can act as a credible signal or not: Would risky individual take the test? What about the low risk individual? Is this a separating or a pooling equilibrium then?

d. Suppose that during the year both individual were insured. At the end of the year the insurance company checks its records and finds out that the number of accidents were quite higher than With only two individuals risk diversification is not that good for the insurance company. Mainly insurance company takes the risk onto himself. Just assume that the insurance company owner is risk-neutral by nature.

Expected for both of the individuals. They are surprised. What might be going wrong, and how can this be corrected?


Related Discussions:- Insurance market and calculate risk premium

Nature of expectations in keynes' theory, Nature of Expectations in Keynes'...

Nature of Expectations in Keynes' Theory : The above discussion on the nature of expectations in Keynes' theory may be summarised as follows: 1) In forming long-term expec

Determine the solution of the homogeneous system, The reduced row echelon f...

The reduced row echelon form of  A=    is equal to R = (a)  What can you say about row 3 of A? Give an example of a possible third row for A. (b)  Determine the values o

Define credit, Q. Define Credit? Credit:Ability to purchase something w...

Q. Define Credit? Credit:Ability to purchase something without immediately paying for it - through a credit card or bank loan, a mortgage or any other forms of credit. Creation

How are consequences of economists used, How are consequences of economists...

How are consequences of economists used? Economists generally use efficiency, information, equilibrium and incentive compatibility like focal points, and examine the consequenc

National budget, National Budget: A National Budget is a document show...

National Budget: A National Budget is a document showing estimates of expected government revenue and intended expenditure for the coming financial year. It usually consist of

Why concept of elasticity is important in economics, Why concept of Elastic...

Why concept of Elasticity is important in economics?  Elasticity is very important concept in economics because it affects the decision of individuals as well as of the whole e

Short-run and long run profits questions, Suppose you own a home remodeling...

Suppose you own a home remodeling company. You are currently earning short-run profits. The home remodeling industry is an increasing-cost industry. In the long run, what do you ex

Whata are the non-renewable resource, How does the approach of someone who ...

How does the approach of someone who has adopted the precautionary principle differ from someone with a blind faith in substitutability, when it comes to a non-renewable resource l

Wave theory , what is the energy of violet light with a frequency =7.50 x 1...

what is the energy of violet light with a frequency =7.50 x 10 to the 14 s-1

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd