Risk financing - DRAFT.docx - A i ii Assuming SafeBuild...

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A. i & ii Assuming SafeBuild insurance company charges an actuarially fair premium for insurance, then the charge for $1 medical coverage for clumsy workers is calculated as 90%x50= $45 , where $45 is the actuarially fair premium and a $1 coverage will equal to 45/50= $0.9. For the skilled workers the actuarially fair premium is 30%x50= $15 , hence a $1 coverage will equal to 15/50= $0.3. This results provides the builders with the option to get $50 of insurance as both builders are risk adverse and the SafeBuild is providing a fair premium price. According to Ligon and Cather (1997), insurance companies will charge a different per dollar price based on the informational value they have on the insured. A. iii & iv With the fair premium price, the clumsy workers will have $ 100 $ 45 = $ 55 , left over for consumption while the skilled will have $ 100 $ 15 = $ 85 . In both case, injured or not injured, the clumsy builders will have $55 leftover for consumption, while the skilled will have $85 left over for consumption regardless of whether they are involved in an accident or not. B. Part: A - i & ii The maximum both are willing to pay for insurance is equivalent to the amount that would leave them in the same position if they did not have insurance. The calculations for this are as follows: For the clumsy builders, 0.9x (50 0.7 ) +0.1(100 0.7 ) =16.43 For the skilled builders, 0.7x (100 0.5 ) + 0.3 (50 0.5 ) = 9.12 If both builders get full insurance coverage, they would be fully compensated if injured, meaning that either way (injured or not), they would still have their full consumption amounts and their only expense would be would be the insurance coverage costs. A study by Somerville (2004) showed that when insurance is actuarially fair, even with loaded premiums, the decision for getting insurance in relation to consumption are separable.
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