Chapter 14, Problem 9E

a)

To determine

To explain about the reluctant to accept a $300 payment from your neighbor to replace his house should it burn down during the coming year.

Explanation of Solution

It does not worth to insure your neighbor’s house for $300. Although you might simply collect $300, there is a good chance youcould end up paying much more than $300. That risk is not worth the $300.

b)

To determine

To explain the reason behind insurance company, make that offer.

Explanation of Solution

There are many people who have taken insurance from a insurance company. Therefore, there are lot of people who pay insurance and never have a claim. So, few customers who do have a claimare offset by the many who simply send their premiums without a claim. Hence, the relative risk to the insurance company is low.