VinDiesel drives cars and is thinking about insurance. He has a 5% probability of an accident that will cost him $10,000.
His utility ftn is U(I)=√I and his income is $40k
- What is the expected income
- what is his expected utility of not buying ins.
- What is the actuarially fair premium for insurance
- What is utility of full insurance
- What is utility of 50% partial insurance?
- Should he insure?
VinDiesel drives cars and is thinking about insurance. He has a 5% probability of an accident that will cost him $10,000.
His utility ftn is U(I)=√I and his income is $40k
- EU=p*U(inc if hurt) + (1-p)U(inc.not hurt)
(Expected utility is weighted average of utilities of incomes in different future states—weights are probabilities) .05*√(40000-10000) + .95* √(40000) =198.66
- .05*10000 + .95*0=$500
- (actuarially fair premium is the premium that allows insurance company to breakeven)
- .05* √(40000-500) +.95(40000-500)=198.75
- .05* √(30000-250+5000) +.95* √(40000-250) =198.72
- yes, full
