Question

An automobile insurance company divides customers into three risk categories: Good (G), Medium (M), and Poor (P). Assume the following distribution of customers: 70% are Good risks, 20% are Medium risks, and 10% are Poor risks. Assume that the probabilities of a customer filing an accident claim (C) in the course of a year are: 0.5% for Good, 1% for Medium, and 2.5% for Poor. A customer is chosen at random.

a) What is the probability that the customer is a good risk and has filed a claim?b) What is the probability that the customer has filed a claim?c) Given that the customer has filed a claim, what is the probability that the customer is a good risk?

Answer 1

a) 0.035 = 3.5% probability that a customer is a good risk and has filed a claim.

b) 0.0395 = 3.95% probability that the customer has filed a claim.

c) 0.8861 = 88.61% probability that the customer is a good risk

Explanation:

Conditional Probability

We use the conditional probability formula to solve this question. It is

`P(B|A) = (P(A \cap B))/(P(A))`

In which

P(B|A) is the probability of event B happening, given that A happened.

`P(A \cap B)` is the probability of both A and B happening.

P(A) is the probability of A happening.

a) What is the probability that the customer is a good risk and has filed a claim?

70% are good risks.

Of those, 0.5% file a claim. So

`0.7*0.05 = 0.035`

0.035 = 3.5% probability that a customer is a good risk and has filed a claim.

b) What is the probability that the customer has filed a claim?

0.5% of 70%(good risks)

1% of 20%(medium risks)

2.5% of 10%(poor risks). So

`0.05*0.7 + 0.01*0.2 + 0.025*0.1 = 0.0395`

0.0395 = 3.95% probability that the customer has filed a claim.

c) Given that the customer has filed a claim, what is the probability that the customer is a good risk?

0.0395 = 3.95% probability that the customer has filed a claim means that
`P(A) = 0.0395`

0.035 = 3.5% probability that a customer is a good risk and has filed a claim means that
`P(A \cap B) = 0.035`

Thus

`P(B|A) = (P(A \cap B))/(P(A)) = (0.035)/(0.0395) = 0.8861`

0.8861 = 88.61% probability that the customer is a good risk