Question

The idea of insurance is that we all face risks that are unlikely but carry high cost. Think of a fire destroying your home. Insurance spreads the risk: we all pay a small amount, and the insurance policy pays a large amount to those few of us whose homes burn down. An insurance company looks at the records for millions of homeowners and sees that the mean loss from fire in a year is μ = $250 per person. (Most of us have no loss, but a few lose their homes. The $250 is the average loss.) The company plans to sell fire insurance for $250 plus enough to cover its costs and profit.

Why would it be unwise to sell only 12 policies?

• Because the probability that we would have to pay for total loss for one or more of these policies is very high.
• Because the income on 12 policies is very low.
• Because if we have to pay for total loss for one or more of these 12 policies, it would be financially disastrous.
• The statement is wrong. It is wiser to sell as few policies as possible.

Answer 1

If we sell only 12 policies it would be unwise because if we have to pay for total loss for one or more of these 12 policies, it would be financially disastrous.

So Asnwer is Option C