Question
James estimates his total wealth at euro500(1000 +567 ). He is concerned about two risks. He is reliant on his wife's income, without which his
James estimates his total wealth at euro500(1000 +567 ). He is concerned about two risks. He is reliant on his wife's income, without which his wealth would fall by euro400,000, to euro500(200 +567 ) He may need to replace his car, which could cost euro20 000. If both these events occur, the effect is additive, so the loss of his wife and his car is equivalent to a loss of euro420 000. He calculates that, over a ve-year period, There is a probability of 2% that his wife dies There is a probability of 40% that he has to replace his car. These two events are independent. His utility function has constant relative risk aversion of 0.5 + 2*567/995. (a) Calculate the expected loss for: (i) His wife's death [2] (ii) Replacing his car [2] (b) Calculate the maximum premium James would pay to insure the full impact of: (i) His wife's death [2] (ii) Replacing his car [2] In each of these calculations, you may ignore the impact of the other risk. (c) Calculate the maximum premium James would pay for a comprehensive insurance policy covering both perils. [4] (d) Compare the two separate premiums to the combined premium and explain, in words, why the combined maximum premium is more than the sum of the single-risk maximum premiums.
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