Three insurance policies are offered to protect firms from a major type of hazard risk. If a loss occurs, Policy 1 pays $700,000 to the insured firm, Policy 2 pays $250,000, and Policy 3 pays $100,000. Each $1 received in the event of a loss is worth $1.35 to the insured firm due to the additional value created by insurance. Depending on the operational environment, high-risk firms have a 5% probability of loss, medium-risk firms have a 3% probability of loss, and low-risk firms have a 2% probability of loss. The insurance company estimates a 5% probability of loss for Policy 1, 3% for Policy 2, and 2% for Policy 3. That is, Policy 1 is designed for high-risk firms, Policy 2 for medium-risk firms, and Policy 3 for low-risk firms. Assume that the beta of the risk is -1.2, the expected return from the market portfolio is 8%, and the risk-free rate is 3%. Of all three policies, the insurance premium charged is 18% higher than the actuarially fair premium in order to cover administrative expenses. 1. (2 points) How much insurance premium is charged for each policy? 2. (2 points) Which policy would a high-risk firm choose? 3. (2 points) Which policy would a medium-risk firm choose? 4. (2 points) Which policy would a low-risk firm choose? 5. (2 points) Is the adverse selection problem resolved by offering a menu of these three policies? Briefly explain why or why not.