Expected Value | Fully insured even when the premium paid exceeds the expected value of the loss
Why
do people often want to insure fully against uncertain situations even when the
premium paid exceeds the expected value of the loss being insured against?
Risk averse people have declining marginal utility, and this means that the pain of a loss increases at an increasing rate as the size of the loss increases. As a result, they are willing to pay more than the expected value of the loss to insure against suffering the loss. For example, consider a homeowner who owns a house worth $200,000. Suppose there is a small 0.001 probability that the house will burn to the ground and be a total loss and a high probability of 0.999 that there will be no loss. The expected loss is 0.001(200,000) 0.999(0) $200. Many risk averse homeowners would be willing to pay a lot more than $200 (like $400 or $500) to buy insurance that will replace the house if it burns. They do this because the disutility of losing their $200,000 house is more than 1000 times larger than the disutility of paying the insurance premium.
because insurance assures the same income whether there is loss to not
ReplyDeletekarena premi asuransi menjamin setiap orang akan resiko terjadinya sesuatu
ReplyDeleteGuideline Answer:
ReplyDeleteRisk averse people have declining marginal utility, and this means that the pain of a loss increases at an increasing rate as the size of the loss increases. As a result, they are willing to pay more than the expected value of the loss to insure against suffering the loss. For example, consider a homeowner who owns a house worth $200,000. Suppose there is a small 0.001 probability that the house will burn to the ground and be a total loss and a high probability of 0.999 that there will be no loss. The expected loss is 0.001(200,000) 0.999(0) $200. Many risk averse homeowners would be willing to pay a lot more than $200 (like $400 or $500) to buy insurance that will replace the house if it burns. They do this because the disutility of losing their $200,000 house is more than 1000 times larger than the disutility of paying the insurance premium.