An $800,000 property has 1/10 of 1 percent chance of catching fire that will cause damages of $100,000, and 1/20 of 1 percent chance of catching fire that will completely destroy the property. Management decided to insure the property and it is reviewing two possible insurance policies:
1.) A policy with $50,000 deductible: that is, the insurance company covers all damages except the initial $50,000. The annual premium for such a policy is $750.
2.) A no-deduction (fully paid) policy with an annual premium of $1,000.
If the company's objective is cost minimization, which policy should it purchase?