Insurance_vs_Retention_Worked_Ex_S08 - Insurance vs...

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1 Insurance vs Retention: Example At the beginning of the year a small delivery firm is considering whether to insure or retain losses from liability claims for damaged packages. Their planning horizon is 2 years (damage to packages delivered this year and next). The firm anticipates the following probability distribution of total losses for each delivery year: Probability Dist Cumulative Prob Dist Probability Loss Amount Loss Amount Prob(Loss <= Amount) .5 $500 $500 .5 .3 $2,500 $2,500 .8 .15 $5,000 $5,000 .95 .05 $10,000 $10,000 1.0 Due to claim verification delays and claim disputes, the anticipates that claims will be filed and losses settled according to the following payment schedule: 70% paid in the year that the package is damaged, 20% paid in the year following the damage and 10% paid two years following the damage. The firm can fully insure this risk exposure for a premium of $2700 for a one year policy. Alternatively, it can retain the risk exposure, incurring costs of $400 per calendar year to settle
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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.

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Insurance_vs_Retention_Worked_Ex_S08 - Insurance vs...

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