1. A firm is considering self insurance for its workers compensation exposure for the next five years. From past experience, it is believed that gross claims outlays are $600 a year per employee (i.e. expected loss). These are assumed to be payable as follows: 35%, 30%, 20%, 10%, and 5% in the first through fifth years respectively. If the firm self-insures, administrative costs are $400 per employee annually. Full and complete insurance is available for a premium of $1000 per covered employee per year. The firm currently has 1000 employees for which it wishes to obtain coverage. Should self-insurance be adopted as an alternative to full insurance for the next five years? Why or why not? Other information and assumptions: Tax rate - 50% Interest rate - 7% All insurance premiums are paid at the beginning of the year. All losses and administrative costs are payable at the end of the year. Tax deductions are realizable when the tax deductible expenditures are paid. Note: Although losses will still be paid out through year 9 under the self-insurance option, administrative expenses are only paid for the first 5 years.

2. The ABC Storage Company provides warehouse facilities mainly for household goods moving companies. Up until now, ABC has fully retained all theft and burglary losses to goods stored at its facility. ABC is considering several risk management alternatives. One is to employ the services of a security company. It is estimated that the security service will have the following effect on the annual loss distribution associated with theft and burglary losses: Total Annual After-Tax Dollar Losses from Burglary and Theft Dollar Loss Probability Losses No Security With Security $ 0 0.010 0.050 500 0.030 0.120 1,000 0.080 0.200 2,000 0.150 0.300 3,000 0.200 0.150 4,000 0.280 0.090 5,000 0.180 0.050 10,000 0.050 0.030 15,000 0.014 0.010 25,000 0.005 - 50,000 0.001 - 1.000 1.000 The security company will provide the service for $1800 per year. Another alternative considered is burglary insurance. ABC has received a premium quotation of $6000 per year without the security service and $3500 per year with the security service. Assume a one-period model, a tax rate of 50% and an interest rate of 0%. a. Calculate the expected annual loss from burglary and theft with and without the security service. b. Calculate the expected annual cost using insurance with and without the security service. c. Which of the four options should be chosen?

3. XYZ Company is considering the installation of a permanent security alarm system. It currently self-insures losses up to $50,000 and purchases insurance which covers losses in excess of $50,000 for an annual premium of $6000. The cost of the proposed alarm system is $20,000 and has a useful life of ten years. Assume that the loss distributions that XYZ faces for retained losses with or without an alarm system are the same as the distributions that ABC faced with or without a security service in the previous problem. If this new alarm system is installed, it will require annual maintenance expenses of $1000 but will reduce the premium XYZ pays for excess insurance coverage by $3000 per year. Using capital budgeting techniques, determine if the purchase of the permanent alarm system is financially advantageous. Assume an interest rate of 10% and ignore any tax effects not already included in the loss distribution itself.