Question

Expected Value. You work for an insurance company that wants to issue a new insurance policy for young men between 20 and 30. A colleague of yours has suggested the following terms:

1) Annual fee of $3,000 dollars

2) A compensation of $5,000,000 for every death You are asked to evaluate the proposed policy. At your request your statistics department tells you that the probability that young man dies in next year is 0.0007.

A) Evaluate your colleague’s proposal. What is the expected profit per contract? Should the company make or loose money per contract and how much?

B) Can you devise a better plan? Based your market insights you think $3,000 annual fee is too high. Paying $1500 is more accessible to a large number of young men. If your company wishes to earn $700 per contract(=expected value) how much money should the company compensate a death?

Answer 1