1. The Civil Air Patrol (CAP) owns airplanes used for search and rescue missions. For an airplane that is worth $20 million, suppose the probability of a crash is 1%.

CAP is considering the following risk management options to address the risk of airplane crash:

1. Retention
2. Full Insurance for a premium of $220,000
3. Safety Program + Retention

The cost of the Safety Program is $30,000. It has the impact of lowering the probability of a crash from 1% to 0.8%. However, if a crash does occur it is still a total loss.

1. Construct the loss matrix from CAP’s perspective. 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.

[6 points]

2. Assume that the company’s decision rule is to pick the option that minimizes EXPECTED COST. What risk management option is chosen? Make sure that you show all calculations and clearly define EXPECTED COST in each case. [4 points]