A potential customer for an $85,000 fire insurance policy

Chapter 3, Problem 27E

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QUESTION:

Problem 27E

A potential customer for an $85,000 fire insurance policy possesses a home in an area that, according to experience, may sustain a total loss in a given year with probability of .001 and a 50% loss with probability .01. Ignoring all other partial losses, what premium should the insurance company charge for a yearly policy in order to break even on all $85,000 policies in this area?

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QUESTION:

Problem 27E

A potential customer for an $85,000 fire insurance policy possesses a home in an area that, according to experience, may sustain a total loss in a given year with probability of .001 and a 50% loss with probability .01. Ignoring all other partial losses, what premium should the insurance company charge for a yearly policy in order to break even on all $85,000 policies in this area?

ANSWER:

Solution 27E

Step1 of 2:

Let us consider a random variable ‘X’ it presents the payout on an individual policy A potential customer for an $85,000 fire insurance policy possesses a home in an area that, according to experience, may sustain a total loss in a given year with probability of 0.001 and a 50% loss with probability 0.01.

We need to find what premium should the insurance company charge for a yearly policy in order to break even on all $85,000 policies in this area.


Step2 of 2:

We have P(X = 85000) = 0.001 and

               P(X = 42500) = 0.01.

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