Asked by Jyoti Goyal on Sep 24, 2024
Verified
If the company can correctly anticipate the adverse selection,what premiums would it charge?
A) $2500
B) $2600
C) $1000
D) $1100
Adverse Selection
A situation in which one party in a transaction has more or better information than the other, leading to an imbalance that can result in market inefficiency or failure.
Insurance Premium
The amount of money an individual or organization pays for an insurance policy, providing coverage against specific risks over a defined period.
Expected Loss
a calculation used in finance and insurance to estimate the average financial loss or cost associated with an investment or insurance policy over a period.
- Determine probable wealth accumulation and financial drawbacks under multiple insurance policy frameworks.
- Discern between clients with high risk and those with low risk and their treatment by insurance companies.
- Understand screening and signaling as solutions to overcome adverse selection in insurance.
Verified Answer
KM
Karan Mehra4 days ago
Final Answer :
B
Explanation :
The expected loss for Nadia would be 10% of $10,000 = $1000. She is willing to pay an additional $100, so the premium charged would be $1100.
For Samantha, the expected loss would be 25% of $10,000 = $2500. She is also willing to pay an additional $100, so the premium charged would be $2600.
Since the company can correctly anticipate the adverse selection and charge different premiums based on the risk of theft, it would charge Nadia a lower premium of $1100 and Samantha a higher premium of $2600. The average premium would be ($1100 + $2600) / 2 = $1850, which is lower than the maximum possible premium of $2500. So, option B is the correct choice.
For Samantha, the expected loss would be 25% of $10,000 = $2500. She is also willing to pay an additional $100, so the premium charged would be $2600.
Since the company can correctly anticipate the adverse selection and charge different premiums based on the risk of theft, it would charge Nadia a lower premium of $1100 and Samantha a higher premium of $2600. The average premium would be ($1100 + $2600) / 2 = $1850, which is lower than the maximum possible premium of $2500. So, option B is the correct choice.
Learning Objectives
- Determine probable wealth accumulation and financial drawbacks under multiple insurance policy frameworks.
- Discern between clients with high risk and those with low risk and their treatment by insurance companies.
- Understand screening and signaling as solutions to overcome adverse selection in insurance.