Question

Zoe, who is risk averse, purchased flight cancellation insurance which will cover the cost of her non-refundable $500 airline ticket if she is unable to travel due to illness. Zoe faces a 10 percent probability of becoming ill and then using the insurance.a) The fair insurance premium (i.e., selling price) for this insurance is $450.b) Zoe’s maximum willingness to pay for the insurance is $50.c) Zoe’s personal risk premium must exceed the actuarially fair price.d) None of the above.

Answer 1

Answer: Zoe’s maximum willingness to pay for the insurance is $50

Step-by-step explanation:

From the question, we are informed that Zoe, who is risk averse, bought flight cancellation insurance which will cover the cost of her non-refundable $500 airline ticket if she is unable to travel due to illness wnd also that Zoe faces a 10 percent probability of becoming ill and then using the insurance.

The expected value of the insurance will be the cost of the airline ticket multiplied by the probability of her becoming ill. This will be:

= $500 × 10%

= $500 × 0.1

= $50

Based on the calculation, it can be concluded that Zoe’s maximum willingness to pay for the insurance is $50.