Question
Ellis Company owns a small office building worth $400,000. Cameron is the risk manager. Ellis faces the risk of fire which would damage their building.
Ellis Company owns a small office building worth $400,000. Cameron is the risk manager.
Ellis faces the risk of fire which would damage their building. The probability of a fire is
known to be 5%. If a fire occurs, there is a 25% chance of a full loss and a 75% chance of a
half loss ($200,000).
Cameron is considering the following risk management options to address the risk of fire to
their building:
a. Retention
b. Full Insurance for a premium of $15,000.
c. Partial Insurance with a premium of $12,000, a deductible of $2,000, and a face value of
$300,000.
d. Partial Insurance with a premium of $13,000, a deductible of $2,000, a coinsurance of
80/20, and an OOP max of $20,000.
Construct a loss matrix[4 points]
1
Ellis Company owns a small office building worth $400,000. Cameron is the risk manager.
Ellis faces the risk of fire which would damage their building. The probability of a fire is
known to be 5%. If a fire occurs, there is a 25% chance of a full loss and a 75% chance of a
half loss ($200,000).
Cameron is considering the following risk management options to address the risk of fire to
their building:
a. Retention
b. Full Insurance for a premium of $15,000.
c. Partial Insurance with a premium of $12,000, a deductible of $2,000, and a face value of
$300,000.
d. Partial Insurance with a premium of $13,000, a deductible of $2,000, a coinsurance of
80/20, and an OOP max of $20,000.
What is the expected loss for each option?[4 points]
What is the actuarially fair premium (AFP) in this case?[2 points]
2
Ellis Company owns a small office building worth $400,000. Cameron is the risk manager.
Ellis faces the risk of fire which would damage their building. The probability of a fire is
known to be 5%. If a fire occurs, there is a 25% chance of a full loss and a 75% chance of a
half loss ($200,000).
Cameron is considering the following risk management options to address the risk of fire to
their building:
a. Retention
b. Full Insurance for a premium of $15,000.
c. Partial Insurance with a premium of $12,000, a deductible of $2,000, and a coverage
limit of $300,000.
d. Partial Insurance with a premium of $13,000, a deductible of $2,000, a coinsurance of
80/20, and an OOP max of $20,000.
What worry value would make full insurance (
WV
F I
) preferable to partial insurance
with a coverage limit (
WV
IC
)? [2 points]
What worry value would make full insurance (
WV
F I
) preferable to partial insurance
with an OOP max (
WV
IO
)? [2 points]
What worry values would make retention (
WV
R
) preferable to partial insurance with an
OOP max (
WV
IO
)? [2 points]
3
Ellis Company owns a small office building worth $400,000. Cameron is the risk manager.
Ellis faces the risk of fire which would damage their building. The probability of a fire is
known to be 5%. If a fire occurs, there is a 25% chance of a full loss and a 75% chance of a
half loss ($200,000).
Cameron is considering the following risk management options to address the risk of fire to
their building:
a. Retention
b. Full Insurance for a premium of $15,000.
c. Partial Insurance with a premium of $12,000, a deductible of $2,000, and a face value of
$300,000.
d. Partial Insurance with a premium of $13,000, a deductible of $2,000, a coinsurance of
80/20, and an OOP max of $20,000.
Assume Camerons worry value for retention (
WV
R
) is $2,000, his worry value for insurance
with a coverage limit (
WV
IC
) is $1,000, and his worry value for insurance with an OOP max
(
WV
IO
) is $500.
If Cameron decides to minimize TOTAL COST, what risk management option does he
choose? [1 point]
What is Camerons PMAX for full insurance? [2 points]
During a meeting, the Chief Risk Officer (CRO) told Cameron that the most he would
pay for full insurance is $18,000. What is the CROs
WV
R
? [2 points]
Who is more risk averse, the CRO or Cameron? [2 points]
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Financial Accounting A Focus On Interpretation And Analysis
Authors: Richard F Kochanek, A Douglas Hillman
7th Edition
1111061750, 9781111061753
