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4 Auto Insurance Suppose that every driver faces a 1% probability of an automobile accident every year. An accident will, on average, cost each...
20.4 Auto InsuranceSuppose that every driver faces a 1% probability of an automobile accident every year. An accident will, on average, cost each driver $10,000. Suppose there are two types of individuals: those with $60,000 in the bank and those with $5,000 in the bank. Assume that individuals with $5,000 declare bankruptcy if they get in an accident. In bankruptcy, creditors receive only what individuals have in the bank. What is the actuarially fair price of insurance? What price are individuals with $5,000 in the bank willing to pay for the insurance? Will those with $5,000 in the bank voluntarily purchase insurance? (Hint: Remember that there are state laws forcing individuals to purchase auto liability insurance.)
