Chapter 8, Problem 25AP

To determine

You own a house worth $400,000 that is located on a river. If the river floods moderately, the house will be completely destroyed. Moderate flooding happens about once every 50 years. If you build a seawall, the river would have to flood heavily to destroy your house, and such heavy flooding happens only about once every 200 years. What would be the annual premium for a flood insurance policy that offers full insurance? For a policy that pays only 75% of the home value, what are your expected costs with and without a seawall? Do the different policies provide an incentive to be safer (i.e., to build the seawall)?

Concept Introduction:

The amount of money that a business or an individual must pay for an insurance policy is called an Insurance premium. This premium is the income for insurance company, once it is earned, and also represents a liability in that the insurer must provide coverage for claims being made against the policy.