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Chap009

# Chap009 - Chapter 9 Risk Aversion and Risk Management by...

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Chapter 9 Risk Aversion and Risk Management by Individuals and Corporations I. Multiple Choice 1. The major underlying force that motivates individuals to purchase insurance even though insurance premiums exceed expected claim costs is: a. profit b. risk aversion c. expected losses d. premium loadings Answer: b Type: K 2. An individual’s demand for insurance depends on all of the following factors except : 3. Suppose that you have \$20,000 in wealth and face a 20% chance of losing \$10,000. Without insurance, your possible wealth outcomes are: 4. Using the same scenario in Question #3, what is the expected value of your wealth without insurance? 53

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5. Using the same scenario in Question #3, if you purchase \$10,000 in insurance coverage for a price of \$2,500, what are your possible wealth outcomes? (Assume that the premium would be paid at the end of the year and that the loss would occur at the end of the year so that you can ignore the time value of money.) a. \$20,000, \$10,000 b. \$17,500 c. \$17,500, \$7,500 d. \$18,000 Answer: b Type: A 6. An example of a non-monetary loss is: 7. Suppose that an insurance company views Jennifer as having the following distribution for the present value of losses: Loss = \$10,000 with probability .10 \$2,000 with probability .20 \$500 with probability .50 \$0 with probability .20 What is the fair premium for full coverage if the insurer’s competitive loading for administrative costs and capital costs is 10% of expected discounted claims? 54

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