Scenario 17.4 Consider the Following Information

question 128

Multiple Choice

Scenario 17.4
Consider the following information:
StowUrStuff Storage is located slightly below sea level in a coastal town. It could build and maintain a flood control system around its property at an annual cost of $1000, and if it did so, the probability of a flood's doing $1,000,000 in damage during the year would be .005. With no flood control system, the probability of such a flood would be .01.
-Refer to Scenario 17.4. Moral hazard arises in this situation because once the firm:

• A) pays the premium that is based on the .005 probability, it has no incentive to spend the additional $1000 for the flood control system, so the true probability of loss is no longer .005.
• B) pays the premium that is based on the .01 probability, it has no incentive to spend the additional $1000 for the flood control system, so the true probability of loss is no longer .01.
• C) provides for flood control, it has less incentive to spend $5000 on premiums, leaving itself underinsured.
• D) provides for flood control, it has less incentive to spend $10,000 on premiums, leaving itself underinsured.
• E) provides for flood control, it will consider that a substitute for insurance and not be able to deal with the loss from a flood should it occur.

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Definitions:

Senate Subcommittee

A smaller division within a larger Senate committee in the United States, tasked with focusing on specific areas of policy or legislation.

Orson Welles

A pioneering American filmmaker, actor, and theatre director, best known for his film "Citizen Kane."

Carte Blanche

Complete freedom to act as one wishes or thinks best.

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