2. During a meeting between Reed and the Chief Risk Officer (CRO), they were discussing two options - full insurance without safety and retention without safety. a. Based on the information you have in question 1 above, what is Reed's PMAX for full insurance without safety? [1 point] b. During the meeting, the CRO indicated that the most he would pay for full insurance without safety (as opposed to retention without safety) is $16,100. What is the CRO's worry value for retention without safety (WVR)? [1 point] C. Who is more risk averse, the CRO or Reed? Explain. [1 point] Suppose Liberty Mutual is the insurer for David Byrne. a. Construct a payout matrix from Liberty's perspective if they have David Byrne as their client - you should continue to assume that David Byrne is still considering the four risk management options above. [4 points] b. As previously noted, David Byrne is considering the purchase of full insurance without safety. What is the actuarially fair premium [AFP] for a full insurance contract without safety? [2 points] As previously noted, David Byrne is considering the purchase of full insurance with safety. What is the actuarially fair premium [AFP] for a full insurance contract with safety? [2 points] Assume that Reed's decision rule is to pick the option that minimizes total expected cost. a. Suppose Reed is offered a choice between full insurance without safety and retention without safety. What worry value for retention without safety (WVR) 3. David Byrne Co. owns a warehouse worth $250,000. Lou Reed is the risk manager. David Byrne faces the risk of fire which would completely destroy their warehouse. The probability of a fire is known to be 6%. David Byrne is considering the following risk management options to address the risk of fire to their warehouse: [1] Retention only - no Safety Program [2] [3] Full Insurance Premium = $16,000 Retention + Safety Program [4] Full Insurance + Safety Program - Premium = $11,000 The cost of the Safety Program is $4,000. It has the impact of lowering the probability of a fire from 6% to 4%. However, if a fire does occur it is still a total loss. a. Construct the loss matrix for David Byrne'. Make sure you show loss in the top row and out-of-pocket cost in the bottom row in each cell of the loss matrix. [4 points] b. Assume Reed's worry value for retention without safety (WV) is $1,200 and his worry value for retention with safety (WVRS) is $700. Calculate the total expected cost of each of the four risk management options. [4 points] C. If Reed's decision rule is to pick the option that minimizes total expected cost, what risk management option does he choose? [1 point]
