CAS Exam 6C Spring 2016, Question 11
Study guide: Exam 6C
A government insurance panel is considering various alternatives to improve availability of flood insurance for homeowners. A flood catastrophe model indicates the following expected loss costs for the different risk zones:
| Risk Zone | Expected Flood Loss Cost (dollars) | Number of Homes (thousands) |
|---|---|---|
| A | 50 | 855 |
| B | 300 | 100 |
| C | 3,500 | 45 |
| Total | 230 | 1,000 |
Market research revealed that homeowners would be willing to pay up to $1,000 per year for flood protection. Any price in excess of that would be regarded as unaffordable.
Part a (1 point)
Two approaches to offer flood insurance are the optional system and the bundled system. Compare and contrast these two approaches in terms of the following:
- i. moral hazard
- ii. allocation of cost
Part b (1.5 points)
Propose and justify pricing for zones A, B and C which would maximize the number of households covered and discourage development in high-risk zones. Assume no expenses, no profit margin and no competition.
Part c (0.25 points)
Identify a policy condition in part b. above which would help discourage development in high-risk zones and encourage loss control.
Answer this question and see the worked solution