3. 10.

Insurance [LO 23.4] In calculating insurance premiums, the actuarially fair insurance premium is the premium that results in a zero NPV for both the insured and the insurer. As such, the present value of the expected loss is the actuarially fair insurance premium. Suppose your company wants to insure a building worth $245 million. The probability of loss is 1.25 per cent in one year, and the relevant discount rate is 4 per cent.

1. What is the actuarially fair insurance premium?

2. Suppose that you can make modifications to the building that will reduce the probability of a loss to 0.90 per cent. How much would you be willing to pay for these modifications?