Question

A customer buys a $250,000 life insurance policy with an annual premium of $600. Her probability of dying during the year is 0.002. If she dies, the insurance company will have to give her beneficiary $250,000.

Calculate the insurance company’s expected value for this policy. And what does the expected value represent?

Answer 1

Outcomes	Probability	Cost to company
Customer dies	0.002	-250000
Customer does not die	0.998	0

Given, premium = $600

E = 0.002(-$250000) + 0.998(-$0) + $600

E = $100

The insurance company’s expected value for this policy is $ 100

The expected value represents the insurance company's expected earning from one policy. In other words, insurance company is expected to earn $100 from one policy. Please note this is not the profit because of this, the company must pay a large percent for salaries and overhead.