Question states that: "(f) The policyholder pays a reinstatement premium of half the original premium on the date the first loss is settled." In the solution: P/2 was deducted from the claim amount when N=1. (As per (f) given in the question.) However, P/2 was also deducted from the claim amount when N = 2 or more. When the question states that the reinstatment premium would be deducted on the first loss, why P/2 was deducted from the second claim (and onwards)?
Hi, Since we are going by an expected value approach, the total claim cost paid in case of 2 or more claims would be that equal to the claim cost for 2 claims(Since the policy is limited to 2 claims). Since this includes the first claim too, we must deduct half the premium here too. i.e. though the probability is for 2 or more claims, the (2 value at 1/7/14 of claim cost) contains the amount of the 1st claim as well.
