Topic 3: Risk Aversion and Insurance

Question 1

When the insurer’s expected profit is zero. The zero profit line has the slope …….

Answer 1

-(1-p)/p

Question 2

Increasing p (probalility) will ……….. the slope of the zero profit line. As it is a negative slope, it will make the slope less negative and therefore ………. in shape

Answer 2

increase / flatter

Question 3

The indifference curve is ……… for low risk types (lower p value individual)

Answer 3

steeper

Question 4

zero profit line, isoprofit lines and fair odd lines are all terms that can be used …………….

Answer 4

interchangeably

Question 5

Under full information, the same amount of compensation would require a ………. premium if you have low risk

Answer 5

lower

Question 6

Fair odds

Answer 6

X = pY

Question 7

Full insurance

Answer 7

Y = C

Compensation = car (asset)

Question 8

Full compensation under fair odds

Answer 8

X = pC

Premium = probability x car (asset)

Question 9

When a risk averse agent is offered insurance at fair odds, …. insurance will maximise their utility

Answer 9

full

Question 10

The 45 degree line on the space state diagram can also be called the …. ………. line.

Answer 10

full insurance

Question 11

The market average fair premium p^M, represents unfavourable odds to the low risk customers and favourable odds to the high risk ones.
*If able to choose the level of insurance coverage at those odds, the low-risk types would choose partial insurance and the high-risk types would like to choose …. than full insurance.

Answer 11

more