Exam 2
Section 1
- C & D
- A low frequency and a high severity
- A & C
- Adverse selection
- B & D
- The frequency of losses for the firm becomes more difficult to estimate
- Losses which are corelated
- Purchase reinsurance
- A & C are true
- The amount of risk faced by the insurer is 0.7
- Person C is charged his/her actuarially fair premium
- Adverse selection due to asymmetric information
- A & C
- An increased demand for stop loss insurance
- A & B
- B & C
- Exchanging an uncertain loss for a certain loss
- B & D
- Neither 1 nor 2
- Pay me a cash indemnification, the amount of which was determined before the loss occurred
- Adverse selection in the market for EQI in the United States
- A & B
- C & D
- Provide federal reinsurance to those insurers who provide terrorism insurance
- Allow insurers to move forward greater risk-based pricing
- C & D
- B & C
- Risk financing with external funds and planned retention
- B & C only
- A fixed known cost from year-to-year
- The firm has protection against the sum of all losses exceeding the $50,000 threshold
- Captive insurers are very inexpensive to form
- A & B only
- A & D
- B & C
Section 2 Problem
| 0 | 4,000 | 10,000 | |
| Retention | 0 | 4,000*(1-0.2) = $3,200 | 10,000* (1-0.2) = 8,000 |
| Deductible Insurance | 1,300*(1-0.2) = 1,040 | 1,300 + 300 = 1,600 1,600*(1-0.2) = 1,280 | 1,300 + 300 = 1,600 1,600*(1-0.2) = 1,280 |
| Full Insurance | 1,500*(1-0.2) = 1,200 | 1,500*(1-0.2) = 1,200 | 1,500*(1-0.2) = 1,200 |
- Retention = (0*0.75) + (4,000*0.2) + (10,000*0.05) = 1,300
- Deductible insurance = (1,040*0.75) + (1,280*0.2) + (1,280*0.05) = 1,100
- Full insurance = (1,200*0.75) + (1,200*0.2) + (1,200*0.05) = 1,200
Retention > Deductible > Full insurance, therefore the risk manager will select Deductible insurance, as it has a lower expense cost.
- Total cost of each option: P* + WV
Total cost of full insurance = 1,200 + WVfi
Total cost of retention = 1,300 + WVr
1,300 + WVr> 1,200+ WVfi
100 >WVfi – WVr
Because WVfi = 0, so 100>WVfi, then full insurance will be preferred to retention.
- Total cost of deductible insurance < Total cost of retention
1,100 + WVdi< 1,300 + WVr
Therefore, 200>WVdi – WVr, then deductible insurance is preferred to retention
- After-tax AFP=P* = $0*0.75 + 3,200*0.2 + 8,000*0.05 = $1,040
- Through out question 4, 200>WVdi-WVr. Deductible insurance has the most significant worry value.
- Pmax = WV + p*
Pmax = 500 + 1200 = 1,700
- WVr = Pmax – P* = 17,00 – 1,300 = &400
- CRO’s WV ($400)< risk manager’s WV ($500)
Risk manager is more risk averse because she has a higher worry value.
Section 3 Essay/Short Answer
- No they haven’t. The NFIP issues low rates for insurance policies due to the inaccurate structure of related risks, rates, and incentives. There are artificially low premiums that don’t represent the actual risk and loopholes that enable properties to maintain low rates. Further, there are instances of repetitive payouts for losses to high-risk assets and the incapacity to dictate future flood risk patterns.
- Floods can incur significant cat loss to an insurer. In such random events, big losses occur at a go, which depicts a correlation and lack of independence. Therefore, it’s challenging for insurers to predict the comprehensive expected losses. An increase in charge translates to an rise in the price of premiums. Further, the insurers are prone to insolvency.
- Property owners are limited to opting out, mostly because they are legally required to obtain flood insurance for mortgages. There is little individuals can do, besides elevating properties, which could, in turn, incur significant expenses. With this option, people who can’t cover their costs could lose their homes.
- The Biggers-Waters Law imposed changes on the NFIP, explicitly related to raise insurance premiums significantly. Under the law, the NFIP is required to revise various critical components like flood insurance, grants, and hazard mapping. The ultimate goal is to make the program financially stable and to bring a balance between insurance rates and the actual risk of flooding. Consequently, the U.S congress has launched various strategies to alleviate the burden on affected property owners.
- Borrowers are required to provide a written statement to the bank to confirm whether the property securing the loan is located in a flood hazard zone. The special policies are vital for contractual and compensation purposes. For instance, if an asset is damaged through a federally declared disaster, the owners can qualify for relief assistance.