FRM Part II · FRM Exam Part II · Risk Mitigation
A bank's expected annual operational loss from a business line is USD 8 million. It considers a policy costing USD 3 million annually that reimburses 60% of losses in excess of a USD 2 million annual aggregate deductible, with no limit. Assuming annual losses are exactly USD 8 million, what is the net annual cost to the bank of the losses plus the premium?
The net annual cost is USD 7.4 million. The insurer reimburses 60% of the USD 6 million above the deductible, which is USD 3.6 million, leaving USD 4.4 million retained. Adding the USD 3 million premium gives USD 7.4 million.
- AUSD 7.4 million
- BUSD 8.4 millionCorrect
- CUSD 11.0 million
- DUSD 6.6 million
Explanation
Recovery = 0.6 x (8 - 2) = 3.6. Net loss = 8 - 3.6 = 4.4. Add premium 3 = 7.4. Check: retained is 2 + 0.4x6 = 4.4, plus 3 = 7.4. So the answer is 7.4; option 8.4 wrongly omits... Correct choice is USD 7.4 million.
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