Question

Robert Weed is considering purchasing life insurance. He must pay a $180 premium for a $100,000 life insurance policy. If he dies this year, his beneficiary will receive $100,000. If he does not die this year, the insurance company pays nothing and Robert must consider paying another premium next year. Based on actuarial tables, there is a 0.001 probability that Robert will die this year. If Robert wishes to maximize his EMV, he would not buy the policy if the EMV were negative for him. He has determined that the EMV is, negative for him, but decides to purchase the insurance anyway. Why

Answer 1

Answer: While the EMV is negative, the utility gained from purchasing the insurance is positive, and high.

Explanation:

The options to the question are:

A) He believes that the actual likelihood of his death occurring in the next twelve months is really much greater than the actuarial estimate.

B) While the EMV is negative, the utility gained from purchasing the insurance is positive, and high.

C) Mr. Weed is not rational.

D) A or C

E) None of the above

From the question, we are informed that Robert Weed is considering purchasing life insurance and that he must pay a $180 premium for a $100,000 life insurance policy.

His beneficiary will get $100,000 if he dies and get nothing of he doesn't die. Even though there's a 0.001chanve of him dying, he eventually bought the insurance.

The reason for him buying the insurance is because EMV he realized that the utility that he will derive from buying the insurance is positive, and high. He believed that paying $180 for a chance to get $100,000 was worth the risk even if he had a slim chance of dying.