KR Inc.s main facility is located in Wellington. Suppose that Genentech would experience a direct loss of $450 million in the event of a major earthquake that disrupted its operations. The chance of such an earthquake is 2% per year, with a beta of 0.

a) If the risk-free interest rate is 3.5% and the expected return of the market is 10%, what is the actuarially fair insurance premium required to cover KR Inc.s loss? (2 marks)

b) Suppose the insurance company raises the premium by an additional 0.16% over the amount calculated in part (a) to cover its administrative and overhead costs. The company estimates its financial distress cost it would have to suffer if it were not insured is $65. Should the company purchase the insurance policy in this case? (Hint: calculate the NPV of the insurance policy). (3 marks)

c) Explain why beta of such event can be negative? (1 mark)

d) In your own words, discuss how moral hazard and adverse selection impact insurance premium? (2 marks)