BDS Project

QUESTION
Suppose you are the CEO of a health insurance company, and you are considering whether to introduce
a new insurance plan that covers the cost of a specific cancer treatment. You have identified three
potential options: Plan A, Plan B, and Plan C. Each plan has different premiums, deductibles, and
coinsurance rates, and you are uncertain about which one will be the most profitable.
Plan A has a high premium of $500 per month, a low deductible of $500, and a high coinsurance rate of
50%. You estimate that the probability of the treatment being required by an individual is 0.2, and the
cost of the treatment is $100,000.
Plan B has a moderate premium of $350 per month, a moderate deductible of $1000, and a moderate
coinsurance rate of 30%. You estimate that the probability of the treatment being required by an
individual is 0.3, and the cost of the treatment is $100,000.
Plan C has a low premium of $200 per month, a high deductible of $2000, and a low coinsurance rate of
20%. You estimate that the probability of the treatment being required by an individual is 0.4, and the
cost of the treatment is $100,000.
Decision-making problem solved using uncertainty theories

Using the uncertainty theories, you need to decide which plan to introduce.
MaxiMin (Wald) criterion: This theory suggests selecting the alternative with the maximum worst-case
outcome. In this case, you would select the plan with the highest minimum profit margin. Using this
approach, you would choose Plan A, which has the highest minimum profit margin of $-300,000.
MaxiMax (Plunger) criterion: This theory suggests selecting the alternative with the maximum best-case
outcome. In this case, you would select the plan with the highest maximum profit margin. Using this
approach, you would choose Plan C, which has the highest maximum profit margin of $1,400,000.
Minimax Regret criterion: This theory suggests selecting the alternative that minimizes the maximum
regret. Regret is the difference between the actual outcome and the best possible outcome. In this case,
you would calculate the regret for each plan and then choose the plan with the lowest maximum regret.
Using this approach, you would choose Plan B, which has the lowest maximum regret of $-250,000.
Realism (Hurwicz) criterion: This theory suggests selecting the alternative that maximizes the expected
payoff using a coefficient of optimism. The coefficient of optimism represents the decision maker's
attitude towards risk. A high coefficient of optimism indicates a risk-taking attitude, while a low
coefficient of optimism indicates a risk-averse attitude. In this case, you would choose the plan that
maximizes the expected payoff using a coefficient of optimism between 0 and 1. For example, if you are
risk-averse and choose a coefficient of optimism of 0.3, you would select Plan A, which has the highest
expected payoff of $40,000.
Equal Likelihood (Laplace) criterion: This theory suggests selecting the alternative with the highest
expected value, assuming that all outcomes are equally likely. In this case, you would calculate the
expected value for each plan and then choose the plan with the highest expected value. Using this
approach, you would choose Plan B, which has the highest expected value of $205,000.
Overall, using the uncertainty theories, Plan B seems to be the best choice for the health insurance
company, according to the Minimax Regret criterion and the Equal Likelihood criterion. However, the
choice may vary depending on the CEO's attitude towards risk.
Decision-making problem solved using Risk theories

Expected Monetary Value (EMV) criterion:
The EMV criterion suggests selecting the alternative that has the highest expected monetary value. The
expected monetary value is calculated by multiplying the probability of each outcome by its monetary
value and then summing the results. Using this criterion, we can calculate the EMV for each plan:
Plan A: EMV = (0.2 x $500) + (0.8 x -$99,500) = -$79,600
Plan B: EMV = (0.3 x $350) + (0.7 x -$99,650) = -$69,255
Plan C: EMV = (0.4 x $200) + (0.6 x -$99,800) = -$59,880
Therefore, using the EMV criterion, we should select Plan C as it has the highest expected monetary
value.
Expected Opportunity Loss (EOL) criterion:

The EOL criterion suggests selecting the alternative that has the lowest expected opportunity loss. The
expected opportunity loss is the expected value of the regret that would be experienced if the wrong
decision was made. We can calculate the expected opportunity loss for each plan by subtracting the
EMV of each plan from the maximum EMV:
Plan A: EOL = $79,600 - $59,880 = $19,720
Plan B: EOL = $79,600 - $69,255 = $10,345
Plan C: EOL = $79,600 - (-$79,880) = $139,480
Therefore, using the EOL criterion, we should select Plan B as it has the lowest expected opportunity
loss.
Expected Value of Perfect Information (EVPI) criterion:
The EVPI criterion suggests selecting the alternative that maximizes the expected value of perfect
information. The expected value of perfect information is the difference between the expected value
under certainty and the expected value under risk. It represents the maximum amount that one would
pay for additional information. We can calculate the expected value of perfect information for each plan
as follows:
Plan A: EVPI = $79,600 - ($100,000 x 0.2) = $59,600
Plan B: EVPI = $79,600 - ($100,000 x 0.3) = $49,600
Plan C: EVPI = $79,600 - ($100,000 x 0.4) = $39,600
Therefore, using the EVPI criterion, we should select Plan A as it has the highest expected value of
perfect information.
Decision Making with Additional Information (EVSI) criterion:

The EVSI criterion suggests selecting the alternative that maximizes the expected value of perfect
information relative to the expected cost of gathering additional information. We can calculate the
expected value of perfect information for each plan using Bayes' rule and then subtract the expected
cost of gathering additional information to get the EVSI. Let's assume that the cost of gathering
additional information is $10,000. We can calculate the EVSI for each plan as follows:
Plan A: EVSI = $43,176 - $10,000 = $33,176
Plan B: EVSI = $36,843 - $10,000 = $26,843
Plan C: EVSI = $30,510 - $10,000 = $20,510
Therefore, using the EVSI criterion, we should select Plan A as it has the highest EVSI.
Decision-making problem solved using LP Model

Profit Optimization Model:
To maximize profit, we need to select the plan that will generate the highest revenue and incur the
lowest cost. The revenue for each plan is given by the product of the premium and the probability of the
treatment being required, while the cost is the product of the probability of the treatment being
required and the cost of the treatment, plus the fixed cost (deductible) for each plan. Therefore, the
profit for each plan can be calculated as:
Plan A: 0.2 * (500 - 500 * 0.5) - 500 + 0.8 * (-500) = -$100
Plan B: 0.3 * (350 - 1000 * 0.3) - 1000 + 0.7 * (-500) = $32
Plan C: 0.4 * (200 - 2000 * 0.2) - 2000 + 0.6 * (-500) = $8
Based on the profit calculation, Plan B generates the highest profit of $32. Therefore, the CEO should
select Plan B to maximize the profit.
Cost Minimization Model:
To minimize the cost, we need to select the plan that will incur the lowest cost, given the probability of
the treatment being required. Therefore, the total cost for each plan can be calculated as:
Plan A: 0.2 * (500 + 0.5 * 100000) = $10050
Plan B: 0.3 * (1000 + 0.3 * 100000) = $10350
Plan C: 0.4 * (2000 + 0.2 * 100000) = $8400
Based on the cost calculation, Plan C incurs the lowest cost of $8400. Therefore, the CEO should select
Plan C to minimize the cost.

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QUESTION

Decision-making problem solved using uncertainty theories

Decision-making problem solved using Risk theories

Plan A: EMV = (0.2 x $500) + (0.8 x -$99,500) = -$79,600

Plan B: EMV = (0.3 x $350) + (0.7 x -$99,650) = -$69,255

Plan C: EMV = (0.4 x $200) + (0.6 x -$99,800) = -$59,880

Expected Opportunity Loss (EOL) criterion:

Plan A: EOL = $79,600 - $59,880 = $19,720

Plan B: EOL = $79,600 - $69,255 = $10,345

Plan C: EOL = $79,600 - (-$79,880) = $139,480

Expected Value of Perfect Information (EVPI) criterion:

Plan A: EVPI = $79,600 - ($100,000 x 0.2) = $59,600

Plan B: EVPI = $79,600 - ($100,000 x 0.3) = $49,600

Plan C: EVPI = $79,600 - ($100,000 x 0.4) = $39,600

Decision Making with Additional Information (EVSI) criterion:

Plan A: EVSI = $43,176 - $10,000 = $33,176

Plan B: EVSI = $36,843 - $10,000 = $26,843

Plan C: EVSI = $30,510 - $10,000 = $20,510

Decision-making problem solved using LP Model

Plan A: 0.2 * (500 - 500 * 0.5) - 500 + 0.8 * (-500) = -$100

Plan B: 0.3 * (350 - 1000 * 0.3) - 1000 + 0.7 * (-500) = $32

Plan C: 0.4 * (200 - 2000 * 0.2) - 2000 + 0.6 * (-500) = $8

Cost Minimization Model:

Plan B: 0.3 * (1000 + 0.3 * 100000) = $10350

Plan C: 0.4 * (2000 + 0.2 * 100000) = $8400

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