QUESTION 4 Use the follwing information to answer Questions 4 - 6. Suppose a com

Question

QUESTION 4

Use the follwing information to answer Questions 4 - 6.

Suppose a company has a building worth $295 million. Because it is located in a high-risk area for natural disasters, the probability of a total loss in any particular is 1.25%. What is your company's expected loss per year on this building?

$3,545,673

$3,992,788

$3,687,500

$3,507,500

QUESTION 5

Suppose the relevant discount rate is 4%, what is the actuarially fair insurance premium?

$3,372,596

$3,507,500

$3,687,500

$3,545,673

QUESTION 6

Suppose that you can make modifications to the building that will reduce the probability of a loss to 0.9%. How much would you be willing to pay for these modifications?

$2,552,885

$992,788

$2,639,423

$733,173

$3,545,673

$3,992,788

$3,687,500

$3,507,500

Explanation / Answer

Ans;

d.$3,507,500

$3,372,596

$2,639,423

Justification;

a)

Value of building (V) = 260,000,000

Probability of loss (P) = 1.36%

Discount rate = 2.3%

Amount of loss = V x P

                        = 260,000,000 x 1.36%

                        = 3,536,000

Amount of premium = 3,536,000/(1+0.023)

                                    =$3,456,500.49

b)

New probability (P)= 0.95%

Amount of loss = V x P

                        = 260,000,000 x 0.95%

                        = 2,470,000

Amount of premium = 2,470,000/(1+0.023)

                                    =$2,414,467.25

Maximum payment for modification = $3,456,500.49 -$2,414,467.25 =1042033.24

$3,372,596

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