There were about 126 million households and 383,974...

There were about 126 million households and 383,974 residential fires in the United States in 2017. Therefore, households faced a $0.30 \%$ chance of a fire in a year. You are looking at purchasing renters insurance that costs $\$ 100$ a year and provides you with $\$ 20,000$ a year in coverage in the event of a fire. Is this policy actuarially fair? Would you buy the policy? Why or why not?

Labs

Want to see this concept in action?

NEW

Explore this concept interactively to see how it behaves as you change inputs.

View Labs

Key Concepts

Actuarial Fairness

Actuarial fairness refers to a situation in which the premium paid for an insurance policy is exactly equal to the expected loss or claim cost. In such cases, the insurance pricing is unbiased in that it neither overcharges nor undercharges relative to the statistical risk and expected payout, meaning the insurer is breaking even over a large number of policies.

Expected Value

Expected value is a statistical concept used to calculate the average outcome of an uncertain event by multiplying each possible outcome by its probability and summing the results. In the context of insurance, it is used to estimate the average payout for a claim over time, which then helps determine whether a premium is fair compared to the risk of loss.

Risk Aversion

Risk aversion is the tendency of individuals to prefer certainty over gamble, even when the expected value of the gamble is higher. When purchasing insurance, risk-averse individuals may be willing to pay a premium that is higher than the calculated expected loss to protect themselves from the financial impact of potentially large, though unlikely, losses.

Transcript

Please give Ace some feedback