Ryan P. Smith
915124536
Homework Assignment 5
30 March 2015

1.)
Part A Small Warehouse worth $250,000 and tax rate of 15%

Risk Management Options

Fire
2%

No Fire
98%
Full Insurance
(Premium of $6,000)

$6,000
(6,000) x (1- .15) = $5,100
$6,000
(6,000) x (1- .15) = $5,100
Retention

$250,000
(250,000) x (1- .15) = $212,500
$0
(0) x (1-.15) = $0
Full Insurance + Loss Control
(Premium of $4,000)
(Loss Control cost $1,000)
$5,000
(5,000) x (1- .15) = $4,250
$5,000
(5,000) x (1- .15) = $4,250
Retention + Loss Control
(Loss Control cost $1,000)
$251,000
(251,000)x(1-.15) = $213,350
$1,000
(1,000) x (1- .15) = $850
Part B
Expected Losses:

Full Insurance = ($5,100) x (.02) + ($5,100) x (.98) = $5,100

Retention = ($212,500) x (.02) + ($0) x (.98) = $4,250

Full Insurance + Loss Control = ($4,250) x (.01) + ($4,250) x (.99) = $4,250

Retention + Loss Control = ($213,350) x (.01) + ($850) x (.99) = $2,975

The risk manager would choose the option of Retention and Loss Control because they desire the option with the lowest expected cost (P*).

Part C
Retention WV = $4,000
Retention with Loss Control WV = $3,000
TOTAL COST = P* + WORRY VALUE

Option 1 (Full Insurance): $5,100 + $0 = $5,100
Option 2 (Retention): $4,250 + $4,000 = $8,250
Option 3 (Full Insurance + Loss Control): $4,250 + $0 = $4,250
Option 4 (Retention + Loss Control): $2,975 + $3,000 = $5,975

The risk manager would choose the option of Full Insurance and Loss Control because it has the lowest total cost when compared to the other options. Total cost is P* plus the worry value, so full insurance is the best strategy to minimize the total cost.

2.) Part A Physical Plant is worth $1,000,000
Possible Loss in $
$0
$10,000
$70,000
$100,000
$1,000,000
Probability of Loss
0.75
0.10
0.08
0.06
0.01
Retention

$0
$10,000
$70,000
$100,000
$1,000,000
Partial Insurance
(Face Amount $70,000)
(Premium $5,000)
$5,000
$5,000
$5,000
$35,000
$935,000
Deductible Insurance
(Face Amount $100,000)
(Deductible $2,000)
(Premium $20,000)
$20,000
$22,000
$22,000
$22,000
$922,000
Full Insurance
(Face Amount