TAILIEUCHUNG - Lecture Risk management and insurance - Lecture No 16: Government regulation of insurance

This chapter’s objectives are to: Present value analysis, net present value analysis of installation of sprinkler systems, select the optimal mix of risk retention and risk transfer, the deductible decision, the self-insurance decision,. | Government Regulation of Insurance Lecture No. 16 1 2 Present Value Analysis If $1 is invested in an interest rate of i The interest earned during the first year is i × 1 = i The total in the fund at the end of the year is 1 + i Which represents the original $1 plus the $i in interest earnings If no payments are made from the fund during the second year The total amount in the fund after two years will be Principal + interest = (1 + i) × i(1 + i) = (1 + i)2 The relationship is such that an original sum of $P invested at an annual interest rate of i for N years will accumulate to a value of $Q as follows P(1 + i)N = Q 3 Present Value Analysis A slightly different way of thinking about the role of interest in these types of situations is to ask the question How much money must be invested now at interest rate i so that it accumulates to a value of $Q after N years? By rearranging the terms in the previous general formula, P is Q ÷ [(1 + i)N] = P This is referred to as the present value

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