Deck 1: Fundamentals and Terminology

Question 1

All of the following are perils except:

A)heart attack
B)theft
C)forgery and embezzlement
D)incorrect instructions on the label of a pesticide

Answer 1

D

Question 2

Which of the following is a false statement?

A)Risk averse people will pay an insurance premium that is greater than the mathematically fair chance of loss in order to relieve themselves of uncertainty
B)A risk seeker is willing to assume risk
C)The mathematically fair price for insurance is the objective risk for the insurer multiplied by the maximum possible loss
D)Insurance is never a mathematically fair trade because the insurer adds several operating and other costs to loss costs when it calculates the premium

Answer 2

D

Question 3

A difference between a contract issued on a "named peril" basis versus an "open peril" or "all?risk" basis is:

A)the "named peril" contract usually covers more perils
B)the "named peril" contract is usually more expensive than the "open peril" contract
C)in the "named peril" contract the insured must prove the peril is covered where in the "open peril" contract the burden of proof is on the insurer to show no coverage
D)in the "open peril" or "all risk" contract there are no exclusions to loss

Answer 3

C

Question 4

Which of the following is a true statement?

A)Insurers are significant financial intermediaries in the U.S. economy
B)Property insurers are prohibited from investing their reserve accounts in private enterprise
C)The insurance companies in the U.S. are estimated to hold approximately $5 trillion in assets
D)Both a and c above are true statements

Question 5

If an individual causes a loss intentionally,we would say that person is a:

A)physical hazard
B)moral hazard
C)morale hazard
D)politician

Question 6

All the following are direct losses except:

A)a car is stolen
B)a house suffers flood damage
C)an apartment must be rented after a house is destroyed by fire
D)a business loses $100,000 in a law suit

Question 7

Proximate cause means:

A)the first insured peril in a chain of events leading to a loss
B)the event nearest the peril in time
C)the event nearest the peril in space
D)the event nearest the loss in time and space

Question 8

Defective electrical wiring that may lead to a fire is an example of a:

A)named peril
B)morale hazard
C)speculative risk
D)physical hazard

Question 9

"Cash flow underwriting" refers to:

A)a combined ratio of 100%
B)insurance companies raising the price of insurance as long as individuals are willing to pay for it
C)refusing to sell insurance to certain geographic areas because of their expected high losses
D)selling insurance at inadequate prices and offsetting the loss with investment income

Question 10

Smoking cigarettes is an example of:

A)moral hazard
B)morale hazard
C)speculate risk
D)a peril

Question 11

Which of the following potential losses is not an example of a pure risk?

A)loss of a home by fire
B)theft of a car
C)loss of $10,000 in the stock market
D)theft of your wallet containing $100

Question 12

The aggregate increased cost to society of operating the insurance mechanism includes all of the following except:

A)cost of operating the insurance company
B)losses due to uninsured flood losses
C)the occurrence of intentional losses to collect insurance
D)the tendency for insureds to exaggerate the amount of actual losses in the claim process

Question 13

All the following are direct losses except:

A)a house is burglarized
B)a store loses $200,000 in sales because a fire closes it down for two weeks
C)a corporation must pay $1 million in ransom when its CEO is kidnapped
D)an delivery truck needs $15,000 in repairs after a collision

Question 14

Which of the following is NOT a direct social benefit of the insurance mechanism?

A)increased business and social stability
B)better allocation of society's resources
C)better choice of optimum size of business operations
D)lower federal and state income taxes

Question 15

It may be correctly claimed that insurers usually do not pay for losses because:

A)it is the insured's money that is used to pay the claims
B)most insurers do not pay claims until the insured sues them
C)almost all claims are caused by fraud
D)insurers estimate claims actuarially in advance in order to avoid payments

Question 16

A peril is defined as:

A)the proximate cause of the loss
B)the chance a loss will occur
C)a morale hazard
D)a contingency that increases the chance of a loss

Question 17

Which of the following is not a hazard?

A)storing one ton of dynamite in a garage
B)bad diet (eating lots of junk food)
C)skating on thin ice
D)getting shot accidentally while deer hunting

Question 18

All of the following are costs to society arising from an insurance system's operation except:

A)payments for losses caused by fraudulent claims
B)payments for losses caused by exaggerated claims
C)use of land, labor and capital to operate the insurance companies
D)payments for losses caused by windstorms such as tornadoes

Question 19

Which of the following factors is not considered when an insurance rate or premium is calculated?

A)the cost of the actual losses
B)the cost of the insurance salesman and other company expenses
C)investment earnings on prepaid premiums
D)McCarran-Ferguson Act

Question 20

Assume 1000 students all healthy,all age 22,and all male,form a life insurance pool to pay $500 to the beneficiaries of any member who dies in the next 365 days.The chance of loss or probability of death for the members of this group is .002.To join the pool a member must pay: (disregard interest earnings and reserves and assume expenses of operating the insurance pool are 30% of losses).

A)$1
B)$1.30
C)$3
D)$2.28

Question 21

Which of the following is not a peril?

A)Car collision
B)Vandalism
C)Earthquake
D)Faulty wiring

Question 22

If insurance did not exist in the United States,which of the following might reasonably be expected to happen?

A)Banks would lower their interest rates on home mortgages and auto loans
B)Moral hazards would decrease
C)Morale hazards would decrease
D)In general, only large businesses would be able to survive

Question 23

Warren is the president of The Huge Insurance Company. His Vice?President in charge of Finance comes to him one day and says "Warren,our combined ratio for the year is 105%." Warren replies,"Let's party!" Why isn't Warren upset about the high combined ratio?

A)The company probably made enough money on its investments to make up for the underwriting losses
B)The company has actually made a 5% profit on its insurance business
C)The combined ratio really isn't that important...it only measures the combined productivity of all regional offices the company owns
D)The combined ratio is not an important indicator of underwriting results
E)The combined ratio is an important indicator of investment results

Question 24

Billy is driving to the beach for spring break. Before leaving on his trip,he takes some cold medicine that makes him sleepy. He falls asleep at the wheel and collides with another car on the highway and breaks his leg. In this context,which of the following is the hazard?

A)spring break
B)knowing how to drive
C)taking the medicine
D)broken leg

Question 25

Which of the following is an accurate definition of "insurance?"

A)A savings account designed to protect you in the event of a rainy day
B)A financial arrangement that redistributes the costs of unexpected losses among a pool of insureds
C)A communist plot to destroy capitalist enterprise
D)A contractual agreement in which the insurer agrees to pay the insured only if the insured requests the money

Question 26

Drinking a lot of alcohol before swimming could cause a person to drown. In this context,which of the following is the hazard?

A)drinking too much
B)knowing how to swim
C)drowning
D)death
E)none of the above

Question 27

A "pure risk" is defined as a situation where there is the possibility:

A)of loss or no change
B)of profit or no change
C)of profit or loss
D)that actual losses will deviate from expected losses

Question 28

What is the fundamental function of the insurance company??? in other words,what is it the insurance company does that makes the insurance mechanism work?

A)It pools those insureds having similar risks, and predicts the losses that those in the pool will suffer
B)It pools any insureds who wish to purchase insurance, and attempts to predict the losses that those in the pool will suffer
C)It redistributes government subsidies to those who have suffered catastrophes
D)It eliminates the process of underwriting in order to sell insurance to as many people as possible, thus providing insureds with a huge quantity discount

Question 29

Examine the following list of "risks." Determine which of these are "pure risks"
I)The risk that your antique Corvette will depreciate in market value
II)The risk that you will have a collision in your Corvette,thus causing you to spend thousands of dollars in repair costs
III)The risk that someone will steal your Corvette
IV)The risk that you will buy a house and lightning will strike your roof,thus causing you to have to purchase a new roof
V) The risk that you will invest your life savings in a business venture that fails,thus causing you to lose your entire investment

A)I, II, III, IV, and V
B)I, II, and IV
C)I, II, III, and IV
D)II, III, and IV

Question 30

Under an open perils insurance policy:

A)covered perils are spelled out, usually using a numbered list
B)any piece of property not excluded is covered
C)absolutely all risks of losses are covered, those having an illegal purpose
D)all perils not excluded are covered

Question 31

The law of large numbers states that as the number of exposure units increases:

A)accuracy of predictions should improve
B)the chance of loss declines
C)objective risk increases
D)the number of perils increases

Question 32

Rusty is the president of The Huge Insurance Company. His Vice?President in charge of Finance comes to him one day and says "Rusty,our combined ratio for the year is 95%." Rusty replies,"Wooo hooo,profit sharing bonuses for everyone!" Why isn't Rusty upset about this combined ratio?

A)The company probably made enough money on its investments to make up for the underwriting losses
B)The company has actually made a profit on its insurance business
C)Rusty is not very bright and doesn't understand what the combined ratio really means
D)The combined ratio is not an important indicator of underwriting results

Question 33

If insurance did not exist in the United States,which of the following might reasonably be expected to happen?

A)Banks would lower their interest rates on car loans
B)Moral hazards would increase
C)Morale hazards would decrease
D)In general, only small businesses would be able to survive

Question 34

Which one of the following losses is an indirect loss?

A)damage to a car when a tree falls on it
B)loss caused by an arsonist who burns down a building to collect insurance proceeds
C)monetary losses due to the inability to produce and sell goods when a machine is destroyed
D)monetary losses due to a legal liability claim

Question 35

Midlands Insurance has 100 policyholders. It expects that this year's losses for all of its policyholders will total $111,000. The predicted expenses of operating the insurance pool are $46,000,expected investment earnings are $20,000,and the actuary determines that there is no need to charge for a risk reserve this year. What should the premium for each of Midland's 100 policyholders be?

A)$1,110
B)$1,370
C)$1,570
D)$1,770

Question 36

Arthur is driving home from work when he runs off the road and hits a telephone pole. These are the losses he suffers: $12,000 to repair the damage to his car,and,$800 to rent a car while his car is being repaired. What is the correct name for each of these losses?

A)The $12,000 is an indirect loss, and the $800 is a direct loss
B)The $12,000 is a direct loss, and the $800 is also a direct loss
C)The $12,000 is a direct loss, and the $800 is an indirect loss
D)The total loss of $12,800 is a direct loss

Question 37

Why are a large number of exposure units generally required for a risk to be insurable?

A)It prevents the insurer from losing money
B)It guarantees that losses will be unintentional and measurable
C)It enables the insurer to better predict the frequency and severity of losses (moderate)
D)It minimizes physical hazards

Question 38

Bodacious D,a famous singer,is performing at a concert. He does not have his body guards and security team present for the concert. A crazed fan runs up on stage,declares her love for Bodacious D,and throws herself at him. Bodacious D lands on the floor,and breaks his back. Which of these is the HAZARD(S),and which is the PERIL?

A)The peril is not having a body guard present; the hazard is the crazed fan
B)The peril is being attacked by the fan, and the hazard is not having a body guard present
C)The peril is not having a body guard present, and the hazard is being pushed to the floor
D)The peril is both the crazed fan and the lack of security; there is no hazard in this case

Question 39

There are four basic components of an insurance premium. Which of the following is not one of those components?

A)losses suffered by the members of the insurance pool
B)law of large numbers
C)an allowance for unexpected losses
D)earnings on investments

Question 40

Objective risk is defined as:

A)risk with two possible outcomes
B)risk with three possible outcomes
C)an individual's perception of risk
D)none of the above

Question 41

Increased predictability means lower objective risk.

Question 42

The expense ratio equals:

A)total underwriting expenses divided by insured losses
B)net income divided by total expenses
C)total expenses divided by net income
D)total expenses divided by premiums written

Question 43

Having 50 gallons of gasoline in your garage is a:

A)peril
B)moral hazard
C)pure risk
D)physical hazard

Question 44

Morale hazards exist because of the presence of insurance.

Question 45

Insurance increases the number of intentional losses that occur in society.

Question 46

From the insurance company's perspective,what is the difference between written premium and earned premium?

A)There is no difference; they are effectively the same thing
B)Written premiums are those that belong to the insurer; earned premiums do not belong to the insurer
C)Written premiums are the total premiums collected by the insurer; earned premiums are those that belong to the insurer.
D)Written premiums reflect the total amount of coverage provided to insureds; earned premiums reflect the net profit of the insurer.

Question 47

In banking,"pure risk" is referred to as

A)operational risk
B)speculative risk
C)subjective risk
D)pure risk

Question 48

A burglar enters Marcia's home and steals $10,000 worth of appliances. Marcia tells the insurance company that the appliances were worth $20,000. This overstatement of the loss is an example of:

A)a morale hazard
B)a peril
C)insurance fraud
D)carelessness

Question 49

Hazards may increase either the frequency or the severity of losses.

Question 50

The law of large numbers allows the insurer to predict aggregate dollar losses in advance of their occurrence.

Question 51

The combined ratio is:

A)the loss ratio plus the expense ratio
B)a measure of underwriting losses
C)the loss ratio divided by the expense ratio
D)a measure of capital gains and dividend returns

Question 52

Which statement about the mathematically fair price for insurance is true?

A) People who will pay no more than the mathematically fair price for insurance are considered to be risk neutral.
B)People who will pay no more than the mathematically fair price for insurance are considered to be risk seeking.
C)When everyone pays the mathematically fair price for insurance, subsidization is reduced or eliminated.
D)The mathematically fair price is impossible to calculate.

Question 53

In general,aggregate losses must be predictable in advance for an insurance system to work properly.

Question 54

An insurance contract creates duties for the insurer,but only the insured has contractual rights.

Question 55

Insurance creates morale hazards.

Question 56

Insurance companies utilize the law of large numbers to reduce the chance of loss for their insureds.

Question 57

If a person installs an automatic sprinkler system to prevent serious fire damage,this action can be considered "insurance" as defined in the text

Question 58

The primary reason the insurance mechanism functions successfully is the:

A)existence of adverse selection
B)ease with which underwriting results can be measured
C)predictability of losses via the law of large numbers
D)existence of many non-industrial nations

Question 59

"Loss" and "chance of loss" are terms with the same meaning.

Question 60

Which of the following best describes a pure risk?

A)an uncontrollable risk that cannot be insured
B)the outcome will either be a loss or no change
C)the outcome will be either a loss or a gain
D)a risk with three possible outcomes

Question 61

For the U.S.insurance industry,2001 was an unprofitable year in terms of underwriting,but not investments.

Question 62

The International Financial Reporting Standards definition of "insurance contract" specifically includes insurance contracts that have a low degree of risk transfer.

Question 63

What is cash flow underwriting? Why is it a concern for insurance companies?

Question 64

From 2000 to 2004,the U.S.insurance industry had only two profitable underwriting years.

Question 65

Speculative risks refer to those events which can only result in loss.

Question 66

After Hurricane Katrina it was difficult to determine whether the cause of destruction to property was wind or flood.

Question 67

What are considered the benefits and the costs to society of operating an insurance mechanism?

Question 68

What is the difference between moral hazard,morale hazard,and physical hazard?

Question 69

Explain the financial definition and the legal definition of "insurance."

Question 70

Explain briefly the law of large numbers.