RMI 2101
I
NTRODUCTION
TO
R
ISK
M
ANAGEMENT
H
OMEWORK
ASSIGNMENT
6
A
NSWER
K
EY
F
ALL
2007
1.
Using the after tax equation ~ expected loss*(1 – Tax Rate) ~ we get the
following After Tax Loss Matrix:
a.
b.
First we calculate the
after tax expected loss
for each alternative:
Full Insurance: 14,300*(.03) + 14,300*(.97) = $14,300
Retention: 455,000*(.03) + 0*(.97) = $13,650
(Note in the alternatives with Loss Control the prob. of loss falls to 2%)
Full Insurance w/ LC: 13,000*(.02) + 13,000*(.98) = $13,000
Retention w/ LC: 456,950*(.02) + 1,950*(.98) = $11,050
The risk manager’s decision rule is to minimize expected loss and in this case that
alternative would be Retention w/ LC.
Loss(700,000)
No Loss
Probability
3%
97%
Full Insurance
22,000
After Tax
= 22,000(1-.35)
= 14,300
22,000
After Tax
=
22,000(1-.35) = 14,300
Retention
700,000
After Tax
=
700,000(1-.35) = 455,000
0
After Tax
= 0(1-.35) = 0
New Probability With
Loss Control
2%
98%
Full Insurance with LC
17,000 + 3,000 = 20,000