Question

Spartan utilities distributes natural gas to households in South-West Michigan. Spartan has 25,000 miles of retail gas distribution pipelines. The distribution pipelines sometimes develop leaks due to weather conditions and corrosion. Spartan estimates that the probability of a gas pipeline developing a leak is 0.0002/year/mile of pipeline. Spartan also estimates that an average leaking pipe incident results in $10,000 in repair costs, $5,000 in natural gas lost, $8,000 in compensation to affected parties, $2,000 in other costs such as evacuation, fire safety, public notification etc. Further, the disruption in service results in loss of sales of $20,000 on which Spartan would have earned profits of $4000.

a. Estimate the expected annual cost to Spartan of such leakage.

b. Suppose an insurance company offer to cover all costs of such leaks except lost sales/profits. The premium is $130,000. Should Spartan utilities buy the insurance?

c. What other risk management options can Spartan consider in managing this risk?

Answer 1

(a)

Expected annual cost of leakage:

Natural gas lost = $ 5000

Compensation = $8000

Repair cost = $10000

loss of profit =$ 4000

Thus total leaking cost = $ 27000

Fire safety and other charges shall be anyhow to be paid as these charges are not only for leakage but for any accident or mishap.

(b)

The answer would depend on insurance period because the cost apart from profit for leakage is $23000 and premium is $ 130000 this suggest that such insurance shall cover more than 1 year, thus you need to provide further information.

(c) Spartan can introduce safety measure guidelines, Disaster recovery planning, guidelines regarding what should a person do when he discovers leakage.