An insurance company issued a malpractice policy to an accountant. The malpractice policy covers the accountant's liability for negligence to clients, up to the maximum $1 million face amount of the policy. The insurance company also has to pay the accountant's legal fees in the event that a claim proceeds to trial. Legal fees if the case goes to trial will be an additional $40,000.
A client has now sued the accountant for $2 million. The insurance company and the accountant believe that the odds are 50% that a jury will award a $2 million judgment against the accountant and 50% that the jury will find the accountant not liable, awarding zero.
a. How much will the insurance company lose if the case is settled right away for $1 million?
b. How much will the insurance company lose, on average, if the case proceeds to trial?
c. How much will the accountant lose, net out-of-pocket, if the case settles?
d. How much will the accountant lose, net out-of-pocket if the case goes to trial?
e. Does the insurance company have a conflict of interest?