Answer Happy

Suppose you own a car worth $20,000. You have accident insurance, but your policy does not cover insurance against theft. The insurance company quotes a price of an additional $100 a year to fully insure your car against theft. a) Suppose you are a risk-neutral expected payoff maximiser who has a good estimate of the probability (p € [0,1]) that your car might be stolen next year. At what probability p would you be indifferent between insuring and not insuring your car against theft for a premium of $100 a year? (1 mark) b) How would your answer to part a) change if your preferences were characterised by Prospect Theory rather than Expected Utility Theory? (2 marks) c) The insurance company also offers a partial theft insurance that pays you 90% of the value of your car (i.e. $18,000) and this policy only costs $60 a year. What might be the reason for the partial insurance to be much cheaper than the full insurance? (2 marks)