Original practice · fully worked
Original variant: coinsured repair layer
Equipment repair loss X is uniform from 0 to 1000. A contract pays 80% of the portion of a loss between 200 and 700, so its payment is Y=0.8 min((X-200)+,500). Calculate the variance of Y.
- A
162.07 - B
26,266.67 - C
41,041.67 - D
48,400.00 - E
74,666.67
Answer and calculation
Before coinsurance, the layer payment has first moment 275 and second moment 350000/3. Its variance is 123125/3, and multiplying by 0.8² gives Var(Y)=78800/3=26266.67, so choice B is correct.
Setup
Setup
Separate the three-part contract design into an underlying layer amount Z and the 80% coinsurance factor.
Z=min((X−200)+,500) Model
Model
For losses between 200 and 700, Z increases continuously from zero to 500. Losses at or above 700 produce a point mass at the layer maximum.
Pr(X≥700)=0.30 Compute
Compute
Calculate the first two layer moments, form its variance, and then square the coinsurance factor.
E[Z]=∫05001000zdz+500(0.30)=275 E[Z2]=∫05001000z2dz+5002(0.30)=3350000 Var(Y)=0.82(3350000−2752)=378800=26266.6667… Answer
Answer
The contract-payment variance is approximately 26,266.67 square currency units.
26266.67(B)