Insurance Management – Case – Great West States (GWS) is a railroad company operating in the Western United States


CASE – 1      

Great West States (GWS) is a railroad company operating in the Western United States. Juanita Salazar is risk manager of GWS. At the direction of the company’s chief executive officer, she is searching for ways to handle the company’s risks in a more economical way. The CEO stressed the Juanita should consider not only pure risks but also financial risks. Juanita discovered that a significant financial risk facing the organization is a commodity price risk—the risk of a significant increase in the price of fuel oil for the company’s locomotives. A review of the company’s income and expense statement showed that last year about 16 percent of its expenses were fuel oil.

Juanita was also asked to determine whether the installation of a new sprinkler system at the corporate headquarters building would be justified. The cost of the project would by $40,000. She estimates the project would provide an after-tax net cash flow of $25,000 per year for three years, with the first of these cash flows coming one year from today.

GWS is considering expanding its routes to include Colorado, New Mexico, Texas, and Oklahoma. The company is concerned about the number of derailments that might occur. Juanita ran a regression with “thousands of miles GWS locomotives traveled” as the independent variable and “number of derailments” as the dependent variable. Results of the regression are as follows:

                    Y = 2.31 + 0.22X

With the expansion, GWS trains will travel an estimated 640,000 miles next year.

1. With regard to the fuel oil prices risk:
(1) Discuss how Juanita could use futures contracts  to hedge the price risk.
(2)  Discuss how a double-trigger, integrated risk management plan could be employed.

2. What is the net present value (NPV) of the sprinkler system project, assuming the rate of return required by GWS investors is 10 percent?

3. How many derailments should Juanita expect next year, assuming the regression results are reliable and GWS goes ahead with the expansion plan?


CASE – 2     

 Carmine purchased an automobile service station from Ben. The purchase price included the building, equipment, and other assets. The business was financed by a loan from National Bank, which held a mortgage on the building. Carmine also converted a one-car repair bay into a short-order restaurant. When Carmine applied for property insurance on the business, he did not tell the insurance company about the restaurant because his premiums would have been substantially increased. Six months after the business opened, a car caught fire and damaged the roof over a bay in the service station area.

1. Do any of the following parties have an insurable interest in the business at the time of the fire? Ben Carmine  National Bank

2. Ben told Carmine he could save money by taking over Ben’s insurance instead of buying a new policy. Would it be appropriate for Carmine to take over Ben’s insurance without notifying Ben’s insurer? Explain.

3. Investigation of the fire revealed that the car owner knew the gas tank had a leak, but this information was not disclosed to Carmine when the car was brought in for service. Explain how subrogation might apply in this case.

4. Did Carmine show utmost good faith when he applied for property insurance on the business? Explain.

5. Could Carmine’s insurer deny coverage for the fire on the basis of a material concealment? Explain.


CASE – 3

 Ben recently retired and purchased an older house near a river. Although the house needs major repairs, it will be his major residence. The river flows occasionally, which has caused substantial damage to several homes in the area. Ben lives alone, but he keeps two Rottweiler dogs on the premises as watchdogs. He also has a small 15-horsepower boat, which is used for fishing.

An insurance agent has informed Ben that the house cannot be insured under a Homeowners 3 (HO-3) policy because the underwriter would not approve the application. The agent stated he would try to get the underwriter to approve a Dwelling Property 3 policy (DP-3). If that policy cannot be obtained, the agent indicated that he would try to get Dwelling Property 1 policy (DP-1). As a last resort, the agent stated that coverage might be available through the state’s FAIR plan.

1. Assume you are a personal insurance advisor. Identify the major loss exposures that Ben faces.

2. Explain the major differences among the HO-3, DP-3 and DP-1 policies discussed by the agent.

3. To what extent will each of the coverage alternatives discussed by the agent cover the loss exposures identified in (a)?

4. Assume that Ben obtains a DP-3 policy. Do you recommend that he also purchase the personal liability supplement? Explain.

5. Assume that Ben obtains a DP-1 policy. Do you recommend that he also purchase flood insurance through the National Flood Insurance Program? Explain.


CASE – 4

Kimberly owns and operates a tennis shop in a resort area. The business is seasonal. A large part of the annual revenues are due to sales in June, July, and August. Kimberly keeps the shop open during the remaining months of the year, but the inventory carried during those months is reduced. During the summer months, the amount of inventory on hand is substantially increased. Kimberly has the business insured under the special form businessowners policy (BOP) with no special endorsements attached.

1. Assume you are a risk management consultant. Identify the major loss exposures that Kimberly faces.

2. Assume that a covered loss occurs in July, which damages part of the inventory. Does the BOP provide any protection for the increase in inventory during the summer months? Explain your answer.

3. Kimberly plans to hire an additional employee during the summer months when sales are increasing. She is concerned about possible employee theft and dishonesty. Explain to Kimberly how this loss exposure can be handled under the BOP.

4. A fire damaged the building. As a result, Kimberly incurred a business income loss because the business was closed for three months.

5. Vandals broke the exterior glass window to the business, which caused substantial damage to the building.


CASE – 5

 Sharon, age 28, is a single parent who earns $28,000 annually as a secretary at a local university. She is the sole support of her son, age 3. Sharon is concerned about the financial well-being of her son is should die. Although she finds it difficult to save, she would like to start a savings program to send her son to college. She is currently renting an apartment but would like to own a home someday. A friend has told her that life insurance might be useful in her present situation. Sharon knows nothing about life insurance, and the amount of income available for life insurance is limited. Assume you are a financial planner who is asked to make recommendations concerning the type of life insurance that Sharon should buy. The following types of life insurance policies are available:

  • Five-year renewable and convertible term
  • Life-paid-up-at-age 65
  • Ordinary life insurance
  • Universal life insurance

1. Which of these policies would best meet the need for protection of Sharon’s son if she should die prematurely? Explain your answer.

2. Which of these policies best meets the need to accumulate a college fund for Sharon’s son? Explain your answer.

3. Which of these policies best meets the need to accumulate money for a down payment on a home? Explain your answer.

4. What major obstacle does Sharon face if she tries to meet all of her financial needs by purchasing cash-value life insurance?

5. Sharon decides to purchase the five-year term policy in the amount $300,000. The policy has no cash value. Identify a basic characteristic of a typical term insurance policy that would help Sharon accumulate a fund for retirement


CASE – 6

 Acme Insurance is a medium-sized stock property and liability insurer that specializes in the writing of commercial lines of insurance. The board of directors has appointed a committee to determine the feasibility of forming a new subsidiary insurer that would sell only personal lines of insurance, primarily homeowners and auto insurance. The new insurance company would have to meet certain management objectives. One member of the board of directors believes the new insurer should be legally organized as a mutual insurer. Assume you are an insurance consultant who is asked to serve on the committee. To what extent, if any, would each of the following objectives of the board of directors be met by formation of a mutual property and liability insurer? Treat each objective separately.

1. Acme Insurance must legally own the new insurer.

2. The new insurer should be able to sell common stock periodically in order to raise capital and expand into new markets.

3. The policies sold should pay dividends to the policy owners.

4. The new insurer should be licensed to do business in all states.