Suppose that Skipper\'s insurer views him as having the following distribution f

Question

Suppose that Skipper's insurer views him as having the following distribution for the present value of losses:

S20,000 with probability 0.02

Loss =$ 5,000 with probability 0.04

$ 1,000 with probability 0.10

$ 0 with probability 0.84

a. What is the fair premium for full coverage if the competitive loading (administrative costs and capital costs) equals 15 percent of expected claim costs?

b. Suppose that Skipper believes his probabilities of losses are one-half of what the insurer believes. What is the loading on the policy from Skipper's perspective?

Explanation / Answer

a. Expected Present value of the loss is equal to losses multiplied by probability.

i.e. 20000*0.02+5000*.04+1000*.10+0*.84=$700

Fair Premium = probability of loss - loading cost

= $700 - .15*700

=$595

b. Loading = $700*.5*.15 = $52.5

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