Question

The IHateToLose Company has annual sales of $100 million. Its only production plant is valued at $50 million. There is a 1% chance of an industrial accident that would completely destroy the plant, resulting in a total loss. Partial losses do not occur. The annual premium to insure the plant with a limit of $50 million (and no deductible) would be $1,000,000. a) Would management of the IHateToLose Company choose to insure or retain the plant accident risk under the Expected Value approach to risk management? What would it choose under the Minimax Regret approach? Document each of your answers with a matrix of the kind we used in class. b) Now you are told that management of the company considers a property loss equal to or less than 15% of annual sales to be “tolerable,” i.e. it is willing to retain this amount of risk if it is economical to do so. Also, the company’s insurance broker has informed management that if it accepts a deductible on the plant insurance policy, the premium will be reduced by $20,000 for every $1 million of deductible. Recommend an insurance program that integrates the Expected Value and Minimax Regret strategies such that IHateToLose can achieve its risk management objectives at lowest cost. Again, document your answer with a matrix.

Answer 1

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