Question

3.7 An insurance company is looking to replace its legacy claims payment system. The Technology Steering Committee is willing to explore three alternative systems. Table EX 3.7 summarizes the cost savings for each system under potential peak claims volumes.

	Payoff: Cost Savings (in $000s) for Peak Claims Volumes
System	5,000,000 Claims	10,000,000 Claims	15,000,000 Claims
A	35	70	105
B	(50) Take negative 50 because it is in parentheses	85	170
C	10	25	75

a. The most recent system implementation was riddled with data conversion issues and end-user resistance. Accordingly, members of the Technology Steering Committee are relatively pessimistic decision makers. Which system would be selected under a Hurwitz value of 0.2?

b. Which system would be selected under minimax regret?

c. Which system would be selected using the Laplace strategy solution?

d. The company's information technology (IT) department submitted a proposal to develop an in-house solution for claims payment. This in-house solution is expected to provide cost savings of $25,000 for five million claims, $75,000 for ten million claims, and $120,000 for fifteen million claims. Determine if the system selection changes in parts (a) through (c) when the in-house system is added as an alternative

Answer 1

a.

Pessimistic decision makers select best payoff of the Minimum payoffs which is 35 here and corresponds to System A So System A is to be selected

maximum of Hurwicz payoffs is 49 which belong to System A so System A is to be selected

Formula

b.

regret table

Minimum of the maximum regrets = 65 which belongs to System A hence according to Minimax regret, System A is to be selected

Formula

c.

According to laplace strategy, System A is to be selected as System A generates highest payoff

Formula

d)

We can see selection changes for option b) and c) only

Formula