Question

A potential customer for a $60,000 fire insurance policy possesses a home in an area that, according to experience, may sustain a total loss in a given year with probability of 0.001 and a 50% loss with probability 0.01. Ignoring all other partial losses, what premium should the insurance company charge for a yearly policy in order to break even on all $60,000 policies in this area?

Answer 1

$360

Explanation:

A potential customer for a $60,000 fire insurance policy possesses a home in an area that, according to experience, may sustain a total loss in a given year with probability of 0.001 and a 50% loss with probability 0.01. Ignoring all other partial losses, the insurance company should charge $360 for a yearly policy in order to break even on all $60,000 policies in this area.

Answer 2

$360

Explanation:

The expected loss in a year is ...

0.001 × $60,000 + 0.01 × (50%·$60,000)

= $60 + 300

= $360

In order to break even, the company should charge $360 per year.