Econ 450sp15 assignment 6 - Econ450SP15 Assignment 6 Name This problem illustrates the so-called death spiral caused by adverse selection in insurance

# Econ 450sp15 assignment 6 - Econ450SP15 Assignment 6 Name...

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1 Econ450SP15 Assignment 6 Name_____________ This problem illustrates the so- called “death spiral” caused by adverse selection in insurance markets. Assume that people can be categorized into four different risk types Type 1 has a probability of loss equal to 1%, Type 2 has a probability of loss of 2%, etc. There are equal numbers of people of each risk type. In the event a bad event occurs, the loss is to the individual would be \$10,000. Insurers are not able to observe the risk type of a person buying insurance, and must price insurance (the insurance premium) equal to the average expected loss by all buyers purchasing insurance. (Expected loss is equal to the probability of loss times the loss, thus the expected loss of a person of type 1 is \$100, type 2 is \$200, etc.) 1) What is the insurance premium (price of an insurance policy) if insurers assume that all four risk types purchase insurance?

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