Life Insurance

Terms in this set (10)

1. An insurance company offers doctors malpractice insurance. Assume that malpractice claims against
careful doctors cost $5,000 on average over the term of the policy and settling malpractice claims
against reckless doctors costs $30,000. Doctors are risk-neutral and know whether they are reckless or
careful, but the insurance company only knows that 10% of doctors are reckless. How much do
insurance companies have to charge for malpractice insurance to break even?

$30,000

2. An employer faces two types of employees. Regular workers are 70% of the population and generate
$100,000 in productivity. Exceptional workers are 30% of the population and generate $120,000 in
productivity. Employees know their types and reject salaries below their productivity. If the employer
offers a salary equal to the aver- age productivity in the population, what will be the employer's per-
employee profit?

$6,000

3. An all-you-can-eat buffet attracts two types of customers. Regular customers value the buffet at $20
and eat $5 of food in costs to the restaurant. Hungry customers value the buffet at $40 and eat $10 of
food. If there are 100 of each type in the market for a buffet dinner, what is the restaurant's maximum
profit?

$3,000

4. To combat the problem of adverse selection, ________________ informed parties can employ
________________ techniques.

more; signaling

5. Which of the following can be an example of a signal: An air-conditioning manufacturer offers a 50-
year warranty; A lawyer offers to be paid only if the client wins; A student pursues an MBA.

All of the Above

6. Which of the following is not an example of adverse selection: A business bets the proceeds of a bank
loan on the next NFL game; An accident-prone driver buys auto insurance; A patient suffering from a
terminal disease buys life insurance

A business bets the proceeds of a bank loan on the next NFL game.

7. The demand for insurance arises primarily from people who are

risk-averse.

8. Which of the following is a potential solution to the adverse selection problem faced by insurance
companies: Offer plans with different deductibles so that higher-risk customers accept higher
deductibles; Create a national database of customers that allows companies to look up each person's
historical risk; Mandate that every person purchase insurance

All of the above

9. An insurance company suffers from adverse selection if

safe customers are less likely to insure than risky customers.

10. Which of the following is an example of adverse selection: A safe driver taking greater risk in a rental
car than his own car; A terminally ill person purchasing life insurance; An employment contract
encourages little effort on the part of employees

A terminally ill person purchasing life insurance