Risk Manager Finance Assingment Help With Solution
1. “You are the Risk Manager for Intuit, the parent of the financial management company Quicken. You have heard that Quicken wants to hold a contest that will offer to pay the winner $1B dollars to pick the perfect NCAA bracket, i.e. to predict every winner of every March Madness basketball game. (See article: “Story, Suit Behind the $1 Billion ‘March Madness’ Contest”) You are concerned that no matter how small the chances are that somebody will be able to win the contest, it IS possible.”
a. “You decide to purchase an insurance policy to support this contest.” (3 points)
i. What is the purpose of this insurance policy?”
ii. “How does the insurance policy support your Risk Financing Goals?”
iii. “How much risk is associated with the contest after you have purchased the insurance policy?”
b. “The contest actually has two parts: A) The grand prize winner of $1B dollars for picking the perfect bracket and B) a smaller group of $100,000 winners if the contest participants come ‘close’ to predicting a perfect bracket, i.e. only miss one winner. As the Risk Manager, you decide NOT to purchase an insurance policy for part B) of the contest.” (4 points)
i. “After learning that the contest has two parts and making your decision not to insure part B), is there risk?”
ii. “What is your decision called for part B) of the contest (from the perspective of Topic 6)?”
iii. “Why might you make this decision from a financial point-of-view?”
iv. “What suggestions would you make to Quicken to fund part B) of their contest and to prevent a catastrophic loss?”
2. Refer to the article that can be downloaded with this homework assignment: “Do You Really Need Cell Phone Insurance?” (2 points)
a. What type of indemnification is usually offered with cell phone insurance? (1 point) [1 short sentence]
b. Explain why most of these insurance contracts contain a deductible? [e.g., $50] (1 point) [2 sentences]
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3. “What is the difference between a ‘Captive’ and a ‘Risk Retention Group’?” (1 point)
4. “We have learned that Captives and Risk Retention Groups are formed because of certain market conditions.” (2 points)
a. “What are these market conditions?”
b. “Why would one market condition support the formation of these types of Risk Financing mechanisms?”
5. “In order to reduce their tax liabilities, taxpayers and corporations often try to ‘hide’ or ‘shelter’ their income from the taxing authorities, or they claim deductible expenses that are not allowed by tax law. How has the Internal Revenue Service prevented a Captive from becoming an inappropriate tax shelter?” (1 point)
6. CASE 1: Choosing Risk Management Options for an Office Building
Assume a firm owns a small office building worth $400,000. To manage the risk of property loss, the firm can purchase full insurance for the risk of physical damage/destruction for a premium of $11,000. The firm is also considering retention as an alternative to full insurance. Assume that the probability of property loss is known to be 3%. Assume that if a loss occurs, it will be a total loss. Assume that the firm’s marginal tax rate is 50%.
a. Construct an after tax loss matrix. (1 point – entire matrix must be correct to receive credit)
b. Using the cell that represents the intersection of “no loss” and the “purchase of full insurance”. (1 point – both i. and ii. must be correct to receive credit)
i. Describe what the pre-tax number in that cell means.
ii. Describe what the after-tax number in that cell means.
c. Suppose the risk manager wants to minimize expected costs (EC) as her decision rule. (1 point – both i. and ii. must be correct to receive credit)
i. Estimate the EC (expected costs or expected expenses) for each risk management alternative. Show all EC calculations and work.
ii. What risk management alternative does she choose. Explain.
d. The firm is not considering self-insurance because the risk manager fears a loss that has too high an expected cost or that might be unpredictable. (1 point – i., ii., and iii. must be correct to receive credit)
i. If a catastrophic loss occurs, which risk financing goal could this violate? Explain.
ii. What type of risk financing transfer option could the risk manager use to manage this disadvantage of self-insurance? Explain.
iii. What cost of risk has to be considered to make the decision discussed in part ii?
e. Actuarially fair premium. Estimate the after-tax actuarially fair premium and explain what this means. (1 point)
f. Define and describe the intangible cost we will use to measure the subjective risk associated with making the risk management alternative decision. (1 point)
Now assume that the firm is trying to decide whether or not to use a safety training program (call this SP) in conjunction with retention and full insurance. The cost of the safety program is $1,500. From past data, the firm knows that if the SP is used with these risk management options it will reduce the peril probability from 3% to 2%. The insurer agrees to reduce the insurance premium from $11,000 to $9,000 if the loss control measure is used. Assume that the Worry Value for retention falls to $2000 if the SP is used in conjunction with these risk management options. Note that there are now four risk management options/alternatives under consideration.
g. What type of loss control option is the SP and what risk control goal does it meet? Explain using the case materials. (1 point)
h. Four Risk Management Options (Hint: two include retention and two include insurance.) List the four risk management options. For each risk management option, explain what type of risk financing it is and whether or not it is combined with any risk control. (1 point)
i. Design the probability distributions
i. When the SP is NOT used. What is the random variable in this distribution? (1 point)
ii. When the SP is used. Explain why this distribution is different from the one you designed in part i. (1 point)
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