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Solution_Set_Practice_Problems_Topic_7 - Spring2007 1(a...

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RISK MANAGEMENT AND INSURANCE 001 Spring 2007 Answer Key for Practice Problems-Topic 7 1(a) Bear in mind that the figures in this loss matrix will be multiplied by (1 - tax rate) =  0.7 in order to obtain the after-tax costs. Please note that the last column and the probability rows do not have to be in the matrix  (noted here in blue).  It is acceptable to include them if this helps you to clarify the  problem.  LOSS      0     250,000 PROBABILITY    .98       .02 Retain      0     (0)    250,000   (175,000) Expected Loss After  Tax = 3500 Buy Full Insurance    1000 0   (7000 )       10000      (7000) Expected Loss After  Tax = 7000 1(b)  If P(loss) = 2%, then P(no loss) = 98% Again we refer to the loss matrix in part (a)       Under retention , the expected loss (after tax) is (0.02)($175,000) + (.98)($0) =  $3500, while under insurance , the expected loss (after tax) is $7000.       Therefore, if the decision is to minimize the expected loss, the choice would be   retention, since $3500 < $7000. 1(c) If we assume a worry value for retention of $4000, then the total cost of retention  (given by the expected loss plus the worry value) would be $3500+ $4000 = $7500.  Under full insurance, the total cost of full insurance (given by the expected loss plus  RMI 001 Spring 2007 Solution Set Practice Problems Topic 7 Page 1 of 7
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the worry value) would still be $7000.  This is the case since the worry value for full 
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  • Spring '11
  • 5th millennium, Centuries in the future, Practice Problems Topic, Solution Set Practice, Set Practice Problems

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Solution_Set_Practice_Problems_Topic_7 - Spring2007 1(a...

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