ISB Insurers is considering an insurance policy for households that possess |90 lakh worth of

movable valuables. In addition, each household owns immovable assets worth |40 lakh that

burglars cannot steal. Suppose there are two types of households. High-risk households, which

are 50% of all households, face a 40% chance of a burglary. Rest of the households are lowrisk,

facing a 20% chance of a burglary. During a burglary, all movable assets are lost. The

household's utility function is given by U(w) =

p

w, where w denotes the total wealth of the

household. The households know if they are high risk or low risk. The insurance company

knows that households have equal probability of being high risk or low risk, but they can't

distinguish between the two types.

(a) If ISB Insurers were to oer an actuarially fair insurance premium, what would it be? [2

points]

1. |45,000

2. |9 lakhs

3. |27 lakhs

(b) Will high-risk households purchase this insurance policy at the actuarially fair price? [2

points]

1. Yes

2. No

(c) Will low-risk households purchase this insurance policy at the actuarially fair price? [2

points]

1. Yes

2. No

(d) Should the ISB insurer charge the actuarially fair insurance premium as in part (a)? [4

points]

1. Yes

2. No