- Kimberly-Clark Company owns a warehouse worth $80,000. Ray Van Eperen is the risk manager. Kimberly-Clark faces the risk of fire which would completely
destroy their warehouse. The probability of a fire is known to be 5%.
Kimberly-Clark is considering the following risk management options to address the risk of fire to their warehouse:
[1] Retention [2] Full Insurance for a premium of $4,500 [3] Safety Program + Retention [4] Safety Program + Full Insurance [premium falls to $2,800]
The cost of the Safety Program is $1,800. It has the impact of lowering the probability of a fire from 5% to 3%. However, if a fire does occur it is still a
total loss.
a. Construct the loss matrix from Kimberly-Clarkâs perspective. Make sure you show any loss amount in the top row and any out-of-pocket costs in the bottom
row in each cell of the loss matrix. [2 points]
b. Construct the payout matrix from an insurerâs perspective. [1 point]
c. What is the actuarially fair premium [AFP] for full insurance with no safety program? What is the AFP for full insurance with safety program? [2 points]
Assume Rayâs worry value for retention (WVR) is $650 and his worry value for retention with safety program (WVRS) is $420.
d. If Rayâs decision rule is to pick the option that minimizes TOTAL EXPECTED COST, what risk management option does he choose? Make sure that you show all
calculations and clearly define TOTAL EXPECTED COST in each case. [2 points]
e. What is Rayâs PMAX for full insurance with no safety program? [1 point]
f. During a meeting, the Chief Risk Officer (CRO) told Ray that the most he would pay for full insurance with no safety program is $4,720. What is the CROâs
worry value for retention (WVR)? [1 point]
g. Who is more risk-averse, the CRO or Ray? Explain. [1 point]
