For this problem, use the fact that the expected value of an event is a probability weighted average, the sum of each possible outcome multiplied by the probability of the event occurring. You own a house worth $800,000 that is located on a river. If the river floods moderately, the house will be completely destroyed. Moderate flooding happens about once every 50 years. If you build a seawall, the river would have to flood heavily to destroy your house, and such heavy flooding happens only about once every 100 years. What would be the annual premium without a seawall for a flood insurance policy that offers full insurance? Without a seawall, the annual premium is

$enter your response here. (Round your response to the nearest dollar.)

Part 2

What would be the annual premium with a seawall for a flood insurance policy that offers full insurance? With a seawall, the annual premium is $enter your response here.

(Round your response to the nearest whole number.)

Part 3

For a policy that pays only 75% of the home value, what are your expected costs without a seawall? Without a seawall, the expected cost is $enter your response here.

(Round your response to the nearest whole number.)

Part 4

For a policy that only pays 75% of the home value, what are your expected costs with a seawall? With a seawall, the expected cost is

$enter your response here.

(Round your response to the nearest whole number.)

Part 5

Do the different policies provide an incentive to be safer (i.e., to build the seawall)?

A.

Neither insurance policy is better or worse, but only in the case of seawall building.

B.

The full insurance policy is better since the expected cost each year is lower under this scenario.

C.

The partial insurance policy is better since the premiums under this scenario are lower.

D.

Neither insurance policy is better or worse because the expected costs each year are the same under both scenarios.