Coursework of Risk Management and Control

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Coursework of Risk Management and Control BP CASE STUDY (a) Analyse the BP case study of Doherty and Smith in the context of the insurance market and tax environment that existed at the time. Doherty and Smith analyze why BP now insures against most smaller losses while self-insuring against the larger ones. Their analysis focuses on factors affecting the market supply of insurance as well as the corporate demand for it. On the supply-side analysis of the insurance industry, the very large public company reached the conclusion that it has a substantial comparative advantage over the insurance industry in baring the risk of its largest exposures. On the demand side, they demonstrate that the primary source of demand of insurance by widely held public companies is not to transfer risk from the corporation’s owners, but rather to take advantage of insurance companies’ efficiencies in providing risk-assessment, monitoring, and loss-settlement services. According to their analysis, we demonstrate the insurance and tax environment that BP faced when they adopted the new corporate insurance strategy. 1 Insurance market environment analysis 1.1 Coverage for losses below $10 million Insurers sell large numbers of homogenous policies with low correlation among payoffs, and expected losses are easily estimated. Since aggregate losses are fairly predictable, relatively little capital is required to ensure the solvency and maintain the creditworthiness of the insurer. All of above reasons make markets at this level competitive, thus market forces effectively eliminate expected insurer rents. 1.2 Coverage for losses between $10 million and $500 million At this level, effective competition in insurance markets is limited because it requires a large investment in the ability to provide loss assessment, prevention and claims processing. Several contractual and

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