Prelim_2_Practice_Key_S08 - 3 ) Overall, E(cost) = 1533 +...

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PAM 423 Risk Management and Policy Spring 2008 Study Aid for Prelim 2 – Suggested Answers to problems 1. A. E(L) = 3200; Var(L) = 50,560,000 B. E(Avg L) = 3200; Var(Avg L) = 50,560,000/400 = 126,400 C. Capital holdings would increase because the variance of average losses per policyholder increases; thus, the insurer needs more capital per policy to ensure its solvency. 2. A. E(L) = 3600; Premium = $4860. E(cost) = 4860 - .3(4860)/1.05 = $3741 B. Claims occurring this year will be paid over three calendar years. In year 1 E(claims)=.5(3600); in year 2 E(claims)=.3(3600); in year 3 E(claims)=.2(3600). In each calendar year administrative costs=500. Year 1 E(cost) = (1800+500)(1-.3)/1.05 Year 2 E(cost) = (1080+500)(1-.3)/(1.05 2 ) Year 3 E(cost) = (720+500)(1-.3)/ (1.05
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Unformatted text preview: 3 ) Overall, E(cost) = 1533 + 1003 + 738 = $3274 C. This analysis suggests that retention should be used (lower expected cost) 3. A. E(cost) of insurance = $2000 - .25(2000)/1.10 = $1545 Retention costs occur over two years. Year 1 E(cost) = (750+400)(1-.25)/1.10 Year 2 E(cost) = (750+400)(1-.25)/ (1.10 2 ) Overall, E(cost) = 784+713 = $1497 B. This analysis suggests that the firm should retain costs (lower expected cost) 4. See Problem Set 3 solutions. 5. These requirements are mainly to combat adverse selection [(1), (2), (5)] and moral hazard [(2), (3), (4)]. Some provisions may also reduce catastrophic losses to the program [(2), (3)], reduce fraud [(2), (4)] and increase the ability to predict the probability distribution of losses [(2)]....
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This note was uploaded on 05/19/2008 for the course PAM 4230 taught by Professor Tennyson during the Spring '07 term at Cornell University (Engineering School).

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