Nguyễn Tấn Dũng – BABAIU18041

CHAPTER 4

ADVANCED TOPICS IN RISK MANAGEMENT

1. Traditionally, --------------a------------ risks were handled by the risk manager through risk
retention, risk transfer, and loss control. -------------b-------------- were handled through
using capital market instruments.
a. Property risks, liability risks, personnel risks
b. Commodity price risk, interest rate risk, currency exchange risk
2. In a company, “pure risks” are handled by Risk managers through Risk Retention, Loss
Control and Risk Transfer instruments. Besides, “speculative risks” are handled by
Finance divisions through Contractual provisions and Capital Market instruments
a. Contractual provisions
b. Risk managers
c. Risk Transfer
d. Finance divisions
e. Capital Market
f. Risk Retention
g. Loss Control
3. Which of the following is an example of contractual provisions used to handle risks?
a. Transfer risks to another party
b. Buy Bonds with high coupon rate and short maturity time
c. Buy Forward Contracts
d. Buy future Contracts
4. What are “call Option” and “put option”?
A call option gives the owner the right to buy 100 shares of stock at a given price during
a specified period. A put option gives the owner the right to sell 100 shares of stock at a
given price during a specified period.
5. What is Double-Trigger Option? What is the objective of using the Double- Trigger
Option by a firm?
A double-trigger option is a provision that provides for payment only if two specified
losses occur. The objective is making sure payments would be made only if a large
property claim and a large exchange rate loss occurred. The cost of such coverage is less
than the cost of treating each risk separately

6. By packaging all of the kinds of risk into a single risk management program, a firm can
offset one risk against another, and in the process, reduces its overall risk. Which of the
following pair of goods that a firm can choose to sell to offset one risk against another?
a. Gas and Gas Cookers
b. Gas Cookers and Electrical Cookers
c. Beef and Pork meat
d. Printers and ink
7. The Combined Ratio in the status of the underwriting cycle:
 The combined ratio is the ratio of paid losses and loss adjustment expenses plus
underwriting expenses to premiums.

In what conditions do we say underwriting operations are unprofitable?

a. The Combined Ratio is greater than one (or 100%)

b. The Combined Ratio is less than one (or 100%)

What does it mean if the Combined Ratio is 118%

It indicates that for every $1.00 that insurers collected in premiums, they paid out $1.18 in claims
and expenses.

8. In 2007, paid loses were $300,000; Loss adjustment expenses were totally $18,000;
underwriting expenses were $3,000; Premiums collected during the year were $325,000.
Are the underwriting operations said to be profitable in 2007 or not?
Since the combine ratio is equal 0.987692 <1, thus the underwriting operations said to be
profitable in 2007
9. What is the term an Insurer’s Surplus used to refer to Insurance Industry Capacity?
a. Surplus = Total Liability
b. Surplus = Total Assets – Total Liability
c. Surplus = Total Assets
d. Surplus = Total Revenue – Total Costs
10. Explain how the Insurance Industry Capacity and Investment Returns can help to reduce
the premium rate and loose underwriting standards in the insurance market.
a. If Surplus increases, an insurer may (reduce/increase) the premiums charged to its
clients and/or (loosing/tying) its underwriting standards.
b. If Competition increases an insurer may (reduce/increase) the premiums charged to
its clients and/or (loosing/tying) its underwriting standards.
c. If “Clash Loss” occurs the insurer’s surplus will (increase / reduce) sharply.
d. An insurer uses premiums collected to invest in financial markets or in business. If
the investment returns (ROI) reduce, the insurer may (reduce/increase) the premiums
charged to its clients and/or (loosing/tying) its underwriting standards.
11. Probable analysis: A vehicle fleet has 600 vehicles. And on average, 80 vehicles suffer
physical damage each year. The probability that a physical damage happens during a year
is 13.3 %
12. Probability of two independent events: Firm has two plants in California and Arizona.
The probability of fire at the California plant is 6% and at the Arizona plant is 10%. The
probability that the fire occurs at the same time at two plants will be 0.06%. .
13. Two buildings are located close together and one building caches on fire. The probability
that the other building will burn is increased. The probability of fire loss of each building
is 4%. The probability of the second building will have fire in the case the first building
has fire is 50%. What is the probability that both building are on fire? 2%
14. Mutually Exclusive Events: the probability that the building is destroyed by fire is 5%.
And the probability that this building is destroyed by flood is 6%. What is the probability
that the building is destroyed by either fire or flood? 11%
 15. Analyzing Insurance Coverage Bids:

Tom would like to purchase property insurance on his house. He is analyzing two Insurance
Coverage Bids offered by two insurers A and B. Two offers have the same coverage amount.
However they have different premiums and deductibles:

- Insurer A’s coverage requires an annual premium of $120,000 with $7,000 per-claim
deductible.
- Insurer B’s coverage requires an annual premium of $45,000 with $12,000 per-claim
deductible.
Using various loss forecasting methods, Tom came up with the following results:
Expected umber of Losses Expected Size of Losses
(Frequency) X
14 $6,000
8 $ 11,000
6 > $ 13,000
Total expected number of losses = 28
Given the discount rate of r = 5%, which coverage bid should Tom select?

For insurer A, the expected cash outflows in one year would be =6000*14 + 7000*14 =
$182000

The present value of these payments is 182000/(1+5%) = $173333.3

The total value of total expected payments = 173333.3+120000 = $193333.3

For insurer B, the expected cash outflows in one year would be = 6000*14 + 11000*8 +
12000*6 = $244000

The present value of these payments is 244000/(1+5%) = $232381

The total value of total expected payments = 232381 + 45000 = $277381

Because the present values calculated represent the present values of cash outflows, the risk
manager should select the bid from Insurer B because it minimizes the present value of the
cash outflows.