HW7.docx - Anthony Haines Seat E 2.12 TU ID 915323249...

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Anthony Haines Seat E 2.12 TU ID: 915323249 Homework Assignment 7 3/26/18
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Anthony Haines 915323249 1. Kruger Company owns a small office building worth $500,000. Art Vandelay is the risk manager. Kruger faces the risk of fire which would completely destroy their building – in other words, if a fire occurs it is a total loss. The probability of a fire is 2.5%. Kruger is considering the following risk management options to address the risk of fire to their building: [1] Retention [2] Full Insurance. Premium = $16,000 [3] Safety Program + Retention [4] Safety Program + Full Insurance [premium reduces to $10,000] The cost of the Safety Program is $2,000. It has the impact of lowering the probability of a fire from 2.5% to 1.5%. However, if a fire does occur it is still a total loss. a. Construct a loss matrix. [4 points] RM Options Fire No Fire Retention $500,000 $0 Full Insurance $16,000 $16,000 Safety Program + Retention $502,000 $2,000 Safety Program + Full Insurance $12,000 $12,000 b. What is the actuarially fair premium [AFP] in this case? [1 point] AFP = $500,000 * .025 = $12,500 915323249 c. What is the AFP when safety is introduced? [2 points] AFP with safety program = $500,000 * .015 = $7,500
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Assume Art’s worry value for retention (WVR) is $5,500 and his worry value for retention with safety program (WVRS) is $3,500.
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