Fire309 Risk management and Insurance Exam 2

The tendency of persons with a higher-than-average chance of loss to seek insurance at standard rates is referred to as:

Adverse selection

Exclusive (captive) agents tend to receive the same flat percentage commission for renewal business that they receive for new business.

False

True or False: Insurance is the pooling of fortuitous losses by transferring such risks to insurers.

True

True or False: Insurance eliminates risk entirely

False

How many of the following are basic characteristics of insurance?
I. Pooling of losses
II. Payment of fortuitous losses
III. Risk transfer
IV. Indemnification

The spreading of losses incurred by a few over the entire group is called:

Pooling

True or False: The law of large numbers improves predictability as exposure units increase.

True

How many of the following are characteristics of an insurable risk?
I. Large number of exposure units
II. Accidental and unintentional loss
III. Loss should be catastrophic

True or False: Losses should be determinable and measurable.

True

True or False: The premium should be economically feasible.

True

How many of the following are solutions to catastrophic risk?
I. Geographic dispersion
II. Reinsurance
III. Catastrophe bonds

Reinsurance can best be described as:

Insurance for insurance companies

True or False: Adverse selection occurs when low-risk individuals seek insurance at high rates.

False

The tendency of high-risk individuals to seek insurance at standard rates is called:

Adverse selection

Underwriting is the process of determining

Risks to assume, rates to charge, and policy terms

How many of the following are underwriting alternatives?
I. Accept as is
II. Accept with modifications
III. Reject outright

True or False: The objective of underwriting is to develop a profitable book of business.

True

How many of the following are regulatory ratemaking objectives?
I. Adequate
II. Not excessive
III. Not unfairly discriminatory

True or False: Rates should ensure insurer profitability.

False

Premium equals:

Exposure x gross rate

Pure premium pays for:

Losses and loss-adjustment expenses

Loading includes:

Expenses, commissions, taxes, profit, contingencies

How many of the following are P/C ratemaking methods?
I. Judgment rating
II. Class/manual rating
III. Merit rating

True or False: Judgment rating is the most common ratemaking method.

False

Merit rating adjusts class rates based on:

Individual loss experience

True or False: A combined ratio below 100% indicates underwriting profit.

True

Combined ratio equals:

Loss ratio + Expense ratio

If the combined ratio is 105%, the insurer has:

An underwriting loss

Operating profit/loss ratio equals:

Combined ratio – Investment income ratio

True or False: Insurance is regulated primarily at the state level.

True

How many of the following are reasons for insurance regulation?
I. Maintain solvency
II. Ensure reasonable rates
III. Protect consumers
IV. Make insurance available

Stock insurers are owned by:

Shareholders

Mutual insurers are owned by:

Policyholders

True or False: Mutual insurers’ primary objective is low-cost insurance for policyholders.

True

True or False: Lloyd’s of London is an insurance company.

False

Independent agents represent:

More than one insurer

Exclusive (captive) agents represent:

One insurer

True or False: Exclusive agents receive the same commission percentage on renewals as new business.

False

Direct writers are:

Employees of the insurer

How many of the following are insurer functions?
I. Production/Marketing
II. Underwriting
III. Claims adjustment
IV. Investments

The objective of claims adjustment is:

Prompt and fair payment of legitimate claims

Claims process includes:

Validate, Investigate, Estimate, Interpret, Respond

How many of the following are benefits of insurance to society?
I. Indemnification
II. Loss prevention
III. Enhancement of credit

Indemnification means:

Restoring insured to approximate financial position prior to loss

True or False: Social insurance is voluntary.

False

How many of the following are characteristics of social insurance?
I. Mandatory contributions
II. Benefits weighted toward low-income individuals
III. Compulsory participation

The National Flood Insurance Program is an example of:

Government insurance

True or False: Losses must be fortuitous to be insurable.

true

How many of the following are reasons insurers purchase reinsurance?
I. Increase capacity
II. Stabilize profits
III. Protect against catastrophic losses

The primary insurer in a reinsurance agreement is called the:

Ceding company

The reinsurer’s share of the risk transferred is called the:

Cession

True or False: The expense ratio measures underwriting expenses divided by premiums.

True

Loss ratio equals:

Incurred losses + loss adjustment expenses divided by premiums

True or False: A combined ratio of 90% guarantees an overall operating profit.

False

Exposure unit refers to:

Unit of measurement used in pricing

Class rating places exposures with similar characteristics into:

The same underwriting class

True or False: Brokers represent insurers.

False

Brokers represent:

Insureds

How many of the following are costs of insurance to society?
I. Expense loading
II. Fraudulent claims
III. Inflated claims

True or False: Investment income can offset underwriting losses.

True

The chance of loss should be calculable in order to:

Determine average frequency and severity

True or False: Losses should be catastrophic in order to qualify as insurable risks.

False

Which of the following is NOT a characteristic of an ideally insurable risk?

A. Loss must be measurable
B. Loss must be intentional
C. Loss should not be catastrophic
D. Large number of exposure units

Loss must be intentional

What is adverse selection?

The tendency of higher-risk individuals to seek insurance more than lower-risk individuals.

Which method helps insurers handle catastrophic risk?
A. Increasing premiums only
B. Geographic diversification
C. Reducing underwriting
D. Eliminating pooling

Geographic diversification

What is the main difference between a rate and a premium?

Rate is cost per unit of exposure; premium is total cost charged

What is the main difference between a stock insurer and a mutual insurer?

Stock insurers are owned by shareholders; mutual insurers are owned by policyholders.

Who does an insurance broker represent?

The insured (client).

Who does an insurance agent represent?

The insurer.

What is an admitted insurer?

An insurer approved and regulated by the state.

What is a non-admitted (E&S) insurer?

An insurer not licensed in the state but allowed to provide coverage for high-risk situations.

What is the purpose of reinsurance?

To spread risk and reduce the chance of large losses.

What is the primary objective of underwriting?

To select and classify risks.

Why is insurance regulated?

To protect consumers and ensure insurer solvency.

Which of the following is NOT an area of insurance regulation?
A. Solvency
B. Rates
C. Marketing only
D. Policy forms

Marketing only

What is the principle of indemnity?

The insured should not profit from a loss.

What is ACV?

Replacement Cost − Depreciation

When must insurable interest exist in property insurance?

At the time of loss

When must insurable interest exist in life insurance?

At the time the policy is purchased.

What is subrogation?

The insurer’s right to recover from a third party after paying a loss.

What is the purpose of subrogation?

To prevent the insured from collecting twice and hold the responsible party accountable.

What is utmost good faith?

Both parties must disclose all material facts.

What is a material misrepresentation?

A false statement that affects the insurer’s decision.

An insurance contract where unequal values are exchanged is called what?

Aleatory contract

If policy language is unclear, how is it interpreted?

In favor of the insured (contract of adhesion)

What type of contract requires certain conditions to be met after a loss?

Conditional contract

Which of the following is NOT a benefit of insurance to society?

Loss prevention

Enhancement of credit

Reduced regulatory costs

Indemnification for loss

Reduced Regulatory Costs

How many of the following are reasons why insurers use reinsurance?

I. Reduce underwriting capacity

II. Increase profit volatility

III. Protect against catastrophic losses

One of the above