# hw-9 - 1 Tax Rate = 50 RM Option Retention Loss...

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1. Tax Rate = 50% RM Option Loss No Loss Retention \$400,000 [400,000*(1-.5)]=200,000 (200,000) \$0 [0*(1-.5)]=0 (0)

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Full Insurance \$15,000 [15,000*(1-.5)]=7,500 (7,500) \$15,000 [15,000*(1-.5)]=7,500 (7,500) 2. Risk Manager wants to minimize Expected Costs (EC) a. Retention \$ Loss of Outcome P[Outcome ] Expected Cost \$0 97% \$0 \$200,000 3% \$6,000 \$6,000 Full Insurance \$ Loss of Outcome P[Outcome ] Expected Cost \$7,500 97% \$7,275 \$7,500 3% \$225 \$7,500 b. Choose Retention, EC R < EC FI 3. Retain the Exposure to losses, failure to identify exposures to loss or underestimates the loss exposure. 4. The new decision rule is to choose the risk management alternative that minimizes the total cost. 5. Retention= \$6,000 + \$3,500 = \$9,500 Full Insurance= \$7,500 + \$0 = \$7,500 The manager should choose Full Insurance because it has a lower total cost than Retention, Management is less uneasy with Full Insurance because minimizes the expected loss and worry value. With Full Insurance the worry value is always zero since there is no risk with Full Insurance. 6. WV=Pmax – EL. \$8,500 - \$7,500 = \$1,000. The Risk Manager’s Worry Value is \$1,000.
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• Fall '07
• Drennan
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