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IAI Actuarial Core Principles · Business Economics · Relationship between economics and business

A listed Indian insurer decides to use its surplus capital to launch a new health product. Which statement best describes the economic concept of opportunity cost in this decision?

Opportunity cost is the value of the next best alternative given up when a choice is made. For the insurer, it is the benefit from the best other use of the surplus capital, not the expected premiums, accounting costs or already-paid sunk research costs.

  1. AThe premium income expected from the new health product
  2. BThe value of the next best alternative use of that capital that is given upCorrect
  3. CThe accounting cost of the capital already recorded in the balance sheet
  4. DThe total administrative expenses of launching the product
  5. The sunk cost of market research already paid before the decision

Explanation

Opportunity cost is the value of the best alternative forgone when a choice is made. Here it is the return from the next best use of the capital. Premium income and administrative costs are not forgone alternatives, and sunk costs are irrelevant to future decisions.

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