Page 1 > of 2 ZOOM + 1. Assume a firm owns a small warehouse. The warehouse is subject to the risk of a fire. Below is the probability distribution for losses: Loss ($) P(Loss) 0 0.70 4,500 0.15 8,250 0.08 9,900 0.05 12,000 0.02 . The firm has four current risk management options it can use to manage this risk: [1] Retention with a worry value of $750. [2] Insurance policy with a face amount (FA) of $8,250, a premium cost of $1,500 and a deductible of 200. Implement a loss prevention program that costs $50 and changes the probability of a $0 loss to 80%, a $4,500 loss to 10%, an $8,250 loss to 6%, a $9,900 loss to 3%, and a $12,000 loss to 1%. This option has a worry value of $400. [3] Insurance of $12,000 with a premium cost of $2,400. [4] Insurance policy with a FA of $12,000, a premium of $2,000, and a deductible of 400. This option has a worry value of $60. a. Construct a loss matrix. What is the expected cost for each option? (4 points each) b. Assume that the risk manager makes decisions based on total cost. What option would she choose? (2 points) 2. A clothing manufacturer is considering the following 4 options to handle the risk it faces with the following respective costs: Page of 2 ZOOM + 2 A clothing manufacturer is considering the following 4 options to handle the risk it faces with the following respective costs: Retention Expected cost of 550 Partial Insurance Expected cost of 775 Deductible Insurance Expected cost of 830 Full Insurance Expected cost of 1050 If the risk manager makes decisions by minimizing TOTAL COST, show what conditions on the WVs would make: A. Full insurance preferred to Partial Insurance? Show all work and explain the numerical answer. (3 points) B. Retention preferred to Deductible Insurance? Show all work and explain the numerical answer. (3 points) For ease of exposition call the WVs: WV. (retention) WV. (partial insurance) WV. (deductible insurance) WV (full insurance) Page 1 > of 2 ZOOM + 1. Assume a firm owns a small warehouse. The warehouse is subject to the risk of a fire. Below is the probability distribution for losses: Loss ($) P(Loss) 0 0.70 4,500 0.15 8,250 0.08 9,900 0.05 12,000 0.02 . The firm has four current risk management options it can use to manage this risk: [1] Retention with a worry value of $750. [2] Insurance policy with a face amount (FA) of $8,250, a premium cost of $1,500 and a deductible of 200. Implement a loss prevention program that costs $50 and changes the probability of a $0 loss to 80%, a $4,500 loss to 10%, an $8,250 loss to 6%, a $9,900 loss to 3%, and a $12,000 loss to 1%. This option has a worry value of $400. [3] Insurance of $12,000 with a premium cost of $2,400. [4] Insurance policy with a FA of $12,000, a premium of $2,000, and a deductible of 400. This option has a worry value of $60. a. Construct a loss matrix. What is the expected cost for each option? (4 points each) b. Assume that the risk manager makes decisions based on total cost. What option would she choose? (2 points) 2. A clothing manufacturer is considering the following 4 options to handle the risk it faces with the following respective costs: Page of 2 ZOOM + 2 A clothing manufacturer is considering the following 4 options to handle the risk it faces with the following respective costs: Retention Expected cost of 550 Partial Insurance Expected cost of 775 Deductible Insurance Expected cost of 830 Full Insurance Expected cost of 1050 If the risk manager makes decisions by minimizing TOTAL COST, show what conditions on the WVs would make: A. Full insurance preferred to Partial Insurance? Show all work and explain the numerical answer. (3 points) B. Retention preferred to Deductible Insurance? Show all work and explain the numerical answer. (3 points) For ease of exposition call the WVs: WV. (retention) WV. (partial insurance) WV. (deductible insurance) WV (full insurance)
