Question

er 23 for Credit Question 3 (of 3) value: 33.34 points In calculating insurance premiums, the actuarially fair insurance premium is the premium that results in a zero NPV for both the insured and the insurer. As such, the present value of the expected loss is the actuarially fair insurance premium. Suppose your company wants to insure a building worth $420 million. The probability of loss is 1.41 percent in one year, and the relevant discount rate is 3.5 percent. a. What is the actuarially fair insurance premium? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Round your answer to the nearest whole dollar amount, e.g., 32.) Insurance premium b. Suppose that you can make modifications to the building that will reduce the probability of a loss to .85 percent. How much would you be willing to pay for these modifications? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole dollar amount, e.g., 32.) Maximum payment

Answer 1

a. what is the actuarially fair insurance premium?

Insurance premium : [Asset value x probability of loss]/[1+r]

                                            $420million x 0.0141/[1+0.035] = $5,721,739

b. Suppose that you can make modifications to the buildings that will reduce the probability of loss 85 percent. how much would you willing to pay for these modifications?

Insurance premium : [Asset value x probability of loss]/[1+r]

                                            $420million x 0.0085/[1+0.035] = $3,449,275

Maximum payment for modifications : $5,721,739 -$3,449,275 =$2,272,464