Question

Matt's utility function is given by U = ln(C), where C is consumption. He earns $45,000 per year and races stock cars in his spare time. There's a 10% chance that he will crash on the racetrack in the next 12 months and incur medical costs of $15,000. He will also have to miss work and will lose about $5,000 in earnings. Assume he buys insurance to cover medical expenses and forgone wages. What is an actuarially fair price for this insurance policy? $600 $1,000 $2,000 $4,500

Answer 1

Answer:

$ 2000 is the right answer.

Explanation:

Given the probability of loss = 10%

Per year earning = $45000

Total medical costs = $15000

Loss of work = $2000

Here, total loss can be calculated by adding the medical costs and the amount loss by work or work loss.

Total size of loss = $15000 + $2000 = $20000

Now, calculate the fair price for insurance:

Actuarially fair price =  Probability of loss X Size of loss

= 10 % X $20000  

= $2000