You consider selling an insurance policy to a 21-year-old friend. The probabilit
ID: 3240138 • Letter: Y
Question
You consider selling an insurance policy to a 21-year-old friend. The probability that a man aged 21 will die in the next year is about 0.0015. You decide to charge $2000 for a policy that will pay $1,000,000 if your friend dies.
a. What is your expected profit on the policy?
b. Although you expect to make a good profit, you would be foolish to sell a single policy only to your friend. Why?
c. True or false:
A large insurance company that sells thousand of policies would do well selling policies on the given terms, because according to the law of large numbers, the average profit on many policies will be much larger than the expected value.
b. Although you expect to make a good profit, you would be foolish to sell a single policy only to your friend. Why?
The probability that you would have to pay $1,000,000 is very high. If this were to happen, it would be financially disastrous. The expected profit of the policy is too small. Although the probability that you will have to pay $1,000,000 is very small, if this were to happen, it would be financially disastrous.c. True or false:
A large insurance company that sells thousand of policies would do well selling policies on the given terms, because according to the law of large numbers, the average profit on many policies will be much larger than the expected value.
Explanation / Answer
a) expected profit on the policy =(1-0.0015)*2000-0.0015*1000000=497~500
b)
The probability that you would have to pay $1,000,000 is very high. If this were to happen, it would be financially disastrous.
c)false
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