Question

1: Ellis Company owns a small office building worth $300,000. Cameron is the risk manager. Ellis faces the risk of fire which would completely destroy their building. The probability of a fire is known to be 3%.

Cameron is considering the following risk management options to address the risk of fire to their building:

a. Retention

b. Full Insurance for a premium of $10,000

c. Safety Program & Retention

d. Safety Program & Full Insurance (premium falls to $8,000)

The cost of the Safety Program is $1,500. It has the impact of lowering the probability of a fire from 3% to 2%. However, if a fire does occur, it is still a full loss.

Imagine the federal government instituted a $1000 “mandate" for full insurance. That is, Ellis Company must pay a penalty of $1000 if they do not purchase full insurance. How would this affect Cameron's PMAX?

Please explain how to solve this

Answer 1

A / 1	B	C	D	E	F
2	Ellis Company
3	Risk Management Options and it’s Analysis
4	Partculars	Options
5		Retention	Full Insurance	Safety Program & Retention	Safety Program & Full Insurance
6		Option-1	Option-2	Option-3	Option-4
7	Building Worth	$        300,000	$           300,000	$                 300,000	$              300,000
8	Probability of Risk of Fire	3%	3%	2%	2%
9	Risk of Fire based on probability	$            9,000	$                9,000	$                     6,000	$                   6,000
10	If there is no fire:(event-a)
11	Premium Cost	$                   -	$              10,000	$                            -	$                   8,000
12	Cost of Safety Program	$                   -	$                       -	$                     1,500	$                   1,500
13	Federal Govt Fine if full insurance is not taken	$            1,000	$                       -	$                     1,000	$                          -
14	Total Cost if fire is not occoured	$            1,000	$              10,000	$                     2,500	$                   9,500
15
16	If there is a fire:(total loss)-(event-b)
17	Risk of Fire	$        300,000	$                       -	$                 300,000	$                          -
18	Premium Cost	$                   -	$              10,000	$                            -	$                   8,000
19	Cost of Safety Program	$                   -	$                       -	$                     1,500	$                   1,500
20	Federal Govt Fine if full insurance is not taken	$            1,000	$                       -	$                     1,000	$                          -
21	Total Cost if fire is not occoured	$        301,000	$              10,000	$                 302,500	$                   9,500
22
23	If there is a fire:(based on probability of risk):(event-c)
24	Risk of Fire	$            9,000	$                9,000	$                     6,000	$                   6,000
25	Premium Cost	$                   -	$              10,000	$                            -	$                   8,000
26	Cost of Safety Program	$                   -	$                       -	$                     1,500	$                   1,500
27	Federal Govt Fine if full insurance is not taken	$            1,000	$                       -	$                     1,000	$                          -
28	Total Cost if fire is not occoured	$          10,000	$                1,000	$                     8,500	$                   3,500
29	In all the above options the last option having safety program and full insurance is better because in the above scenarios, the option is least costly in the events a & b and in the event of c, the cost is $3500, though the cost is a little bit high compared to second option, there is a mention about the risk that though the probability reduces but total loss shall be on full. Hence option 4 is better.