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IAI Actuarial Core Principles · Business Management · Decision-making process, attitude to risk and competition

An Indian reinsurer's committee must choose between Project A, with a certain profit of ₹40 crore, and Project B, with a 50% chance of ₹100 crore and a 50% chance of ₹0. The committee chooses Project A and records that it would still do so if B's chances of success rose slightly. Which statement is most accurate?

The choice is risk-averse. Project B's expected profit is ₹50 crore against ₹40 crore certain for A, yet the committee prefers certainty, accepting a lower expected value to avoid the chance of earning nothing. A risk-neutral or risk-seeking body would pick B.

  1. AThe choice is risk-averse, since A is preferred despite B's higher expected value of ₹50 croreCorrect
  2. BThe choice is risk-neutral, since A has the higher expected value
  3. CThe choice is risk-seeking, since A has no variability
  4. DThe choice is irrational under every attitude to risk
  5. The choice shows the committee is maximising expected monetary value

Explanation

Expected value of B = 0.5 × 100 + 0.5 × 0 = ₹50 crore, which exceeds A's ₹40 crore. Choosing A gives up expected value for certainty, which is risk-averse behaviour. A risk-neutral or EMV-maximising body would pick B, and a risk seeker would also prefer B.

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