An insurance company offers doctors malpractice insurance.

Assume that malpractice claims against careful doctors cost $5,000 on average over the term of the policy and settling malpractice claims against reckless doctors costs $30,000.

Doctors are risk-neutral and know whether they are reckless or careful, but the insurance company only knows that 10% of doctors are reckless.

How much do insurance companies have to charge for malpractice insurance to break even?

A. $5,000

B. $7,500

C. $27,000

D. $30,000

D. $30,000

Explanation:

Malpractice insurance on the average cost the insurance company $5,000.

But there are reckless doctors also present on which the claims are amounting $30,000.

But since an insurance company always wants to be on insured mode, that is it will be on the safer site thus, insurance company will charge for $30,000.

This clearly reflects the break even situation on the part of insurance company.

Because insurance companies believe that in case if all doctors are reckless then the cost shall be met properly, in that case the break even will be at $30,000.