In calculating insurance premiums, the actuarially fair insurance premium is the

Question

In calculating insurance premiums, the actuarially fair insurance premium is the premium that results in a zero NPV for both the insured and the insurer. As such, the present value of the expected loss is the actuarially fair insurance premium. Suppose your company wants to insure a building worth $260 million. The probability of loss is 1.36 percent in one year, and the relevant discount rate is 2.30 percent.

What is the actuarially fair insurance premium? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Round your answer to the nearest whole dollar amount. (e.g., 32))

Suppose that you can make modifications to the building that will reduce the probability of a loss to 0.95 percent. How much would you be willing to pay for these modifications? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole dollar amount. (e.g., 32))

In calculating insurance premiums, the actuarially fair insurance premium is the premium that results in a zero NPV for both the insured and the insurer. As such, the present value of the expected loss is the actuarially fair insurance premium. Suppose your company wants to insure a building worth $260 million. The probability of loss is 1.36 percent in one year, and the relevant discount rate is 2.30 percent.

Explanation / Answer

a)

Value of building (V) = 260,000,000

Probability of loss (P) = 1.36%

Discount rate = 2.3%

Amount of loss = V x P

                        = 260,000,000 x 1.36%

                        = 3,536,000

Amount of premium = 3,536,000/(1+0.023)

                                    =$3,456,500.49

b)

New probability (P)= 0.95%

Amount of loss = V x P

                        = 260,000,000 x 0.95%

                        = 2,470,000

Amount of premium = 2,470,000/(1+0.023)

                                    =$2,414,467.25

Maximum payment for modification = $3,456,500.49 -$2,414,467.25 =1042033.24

Related Questions

Navigate

• Browse (All)
• Browse I
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.