Insurance Company Payout Probabilities

Insurance Company Payout Probabilities

Instructions/Descriptions

Lydia’s Insurance Company Payout Probabilities

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Question Description

1. Write separately the probabilities that Lydia’s insurance company will have to:(i) Payout at the end of the first year of a policy.(ii) Payout at the end of the second year of a policy.

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2.  

   (iii) Not have to pay out a policy at all.

   b. Draw a detailed contingent cash flow diagram that models this income protection policy from the perspective of Lydia’s insurance company.

   c. Calculate the premium $P that Lydia’s insurance company should charge for this income protection policy.

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Lydia works for an insurance company. Her company wishes to provide an income protection policy to employed persons, which will provide the policyholders with a single payout of $10 000 in the event that they become unemployed within the next two years.

The premium $P for this policy would be paid at the beginning of the two-year period, and the payout, if required, would occur at the end of whichever one-year period during the policy that the policyholder became unemployed. Lydia’s insurance company would have to pay administrative costs of $60 at the start of the policy.

The interest rate is j1 = 9%. Suppose government statistics indicate the probability an employed person becomes unemployed within any one-year period is 1%. Further, suppose that Lydia’s insurance company wishes to earn on average a net 0.05P profit per policy (where P is the premium of the policy) as measured at the end of the two years.

Lydia’s Insurance Company Payout Probabilities

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