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Lola Lowrisk is a careful driver with a perfect driving record living in the suburbs of a major metropolitan area. Heidi Highrisk is an aggressive driver with several speeding tickets who lives in the metropolitan area near Lola. The metropolitan area is cursed with lots of traffic. Both drivers have an initial wealth level equal to $121 and measure the utility that they derive from wealth as utility = wealth0.5. The two drivers' loss distributions are shown below: Lola Lowrisk.: 1/3 probability of $120 loss and 2/3 probability of no loss Heidi Highrisk: 2/3 probability of $120 loss and 1/3 probability of no loss Based on this data, answer questions A. Determine each driver's expected utility if she is does not buy insurance protection, based on the drivers' true probability of suffering a loss. B. Determine the price that an insurer would charge each driver, assuming that the insurer knew the driver's true probability of suffering a loss. In your answer, you can assume that the insurer is basing the premium on the driver's expected loss without adding in a charge for insurance overhead and administrative expenses. C. Calculate each driver's utility level after buying insurance at the prices calculated in part B above. D. Assume that the insurer cannot differentiate between low- and high-risks in the immediate geographic area in which Lola and Heidi live. As a result, the insurer charges a pooled premium equal to the sum of the two premiums found in part B, divided by two. Calculate the pooled premium rate. E. Calculate each driver's utility level after buying insurance at the price calculated in part D. Discuss whether either Lola or Heidi will buy insurance at the price calculated in part D Lola Lowrisk is a careful driver with a perfect driving record living in the suburbs of a major metropolitan area. Heidi Highrisk is an aggressive driver with several speeding tickets who lives in the metropolitan area near Lola. The metropolitan area is cursed with lots of traffic. Both drivers have an initial wealth level equal to $121 and measure the utility that they derive from wealth as utility = wealth0.5. The two drivers' loss distributions are shown below: Lola Lowrisk.: 1/3 probability of $120 loss and 2/3 probability of no loss Heidi Highrisk: 2/3 probability of $120 loss and 1/3 probability of no loss Based on this data, answer questions A. Determine each driver's expected utility if she is does not buy insurance protection, based on the drivers' true probability of suffering a loss. B. Determine the price that an insurer would charge each driver, assuming that the insurer knew the driver's true probability of suffering a loss. In your answer, you can assume that the insurer is basing the premium on the driver's expected loss without adding in a charge for insurance overhead and administrative expenses. C. Calculate each driver's utility level after buying insurance at the prices calculated in part B above. D. Assume that the insurer cannot differentiate between low- and high-risks in the immediate geographic area in which Lola and Heidi live. As a result, the insurer charges a pooled premium equal to the sum of the two premiums found in part B, divided by two. Calculate the pooled premium rate. E. Calculate each driver's utility level after buying insurance at the price calculated in part D. Discuss whether either Lola or Heidi will buy insurance at the price calculated in part D
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To answer these questions well calculate the expected utility insurance prices and utility levels fo... View the full answer
Related Book For
Quantitative Methods for Business
ISBN: 978-0324651751
11th Edition
Authors: David Anderson, Dennis Sweeney, Thomas Williams, Jeffrey cam
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