Question

November 21, 1980, was the day of a tragic fire in the MGM Grand Hotel in Las Vegas. At the time of the fire, the hotel had only $30 million of liability insurance. One month after the fire, the hotel bought an extra $170 million of liability coverage for a premium of $37.5 million, retroactive to November 1, 1980 (before the fire). Based on your knowledge of present value concepts, why would insurers be willing to issue insurance to MGM under these conditions?

Answer 1

As per time value of money concept, holds that money in the present is worth more than the same sum of money to be received in the future. This is true because money that you have right now can be invested and earn a return, thus creating a larger amount of money in the future.

Here, the insurers have provided the insurance on the same grounds. First the Loss assessment Due to Fire has not been done yet. That Loss is going to be paid in the Future, and Insurers are getting the Money know. Also the insurers must be having an apprehension that as the Hotel has Liability insurance of 30 at the time of Incidence, and max they might end up paying 30 hence their saving would be 7.5.

So, before commenting properly, it is advisable to get the Loss assessment of Fire. Otherwise, insurers are correct in receiving 37.5 Today, rather to pay in lieu of a Loss at a future date.