FIN 360 Exam 1 Exercise

A condition that increases the chance of loss is called a(n)

hazard

An earthquake is an example of a

peril.

Dense fog that increases the chance of an automobile accident is an example of a

physical hazard.

A risk that affects the entire economy, or a large number of persons or groups within the economy, is called a(n)

nondiversifiable risk

Dean's Discount Store has been experiencing problems with shoplifting losses. Dean decided to install a camera monitoring system and to use magnetic price tags on products. If a tag is not demagnetized before the product bearing the tag leaves the store, an alarm bell sounds. These measures are examples of

loss control

Taylor Tobacco Company is concerned that the company may be held liable in a court of law and ordered to pay a large damage award. The characteristics of the judicial system that increase the frequency and severity of losses are known as

legal hazard.

All of the following are characteristics of the liability risk that most people face EXCEPT

owning liability insurance eliminates the possibility of being held legally liable.

An individual may commit an act that results in bodily injury or damage to someone's property. A court of law may order the person responsible for the wrongful act to pay damages to the party who was injured. This type of risk is called the

liability risk

Kyle opened a sporting goods store. After a fire damaged the store, Kyle was forced to close the business for four weeks while repairs were completed. The loss of profits that could have been earned if the business had remained open is best described as a(n)

indirect (consequential) loss

Which of the following statements is (are) true with respect to pure risks? I. Pure risks may produce either a profit or a loss. II. Premature death and damage to property caused by a fire are pure risks.

II only

The spreading of losses incurred by a few individuals over a larger group, so that average loss is substituted for actual loss, is known as

pooling of losses

The first step in the risk management process is to

identify loss exposures.

All of the following risk treatment techniques are classified as risk control methods EXCEPT

insurance.

Tindall Company manufactures electronic components. Managers of the company are considering several diversification options. One possibility is production of prescription drugs. When Tindall Company managers learned of the potential legal liability that could result from the manufacture and sale of prescription drugs, the managers rejected the idea and decided to consider other diversification options. How did Tindall Company choose to deal with the risk of legal liability arising from the manufacture and sale of prescription drugs?

risk avoidance

All of the following statements about avoidance are true EXCEPT

It can be used for any loss exposure facing a firm.

Harris Petroleum, a fuel storage and delivery business, occasionally has difficulty in obtaining affordable pollution liability insurance. Jane Elmore, Risk Manager of Harris Petroleum, decided to form an insurance subsidiary for the purpose of writing pollution liability insurance for Harris Petroleum, as well as other insurance coverages. The insurance subsidiary will be based in Bermuda for regulatory reasons. What is such a subsidiary called?

a captive insurance company

All of the following are methods used to pay retained losses EXCEPT

insurance.

Each accounting period, Harris Company Department Store charges a bookkeeping account for its estimated shoplifting losses. The method that Harris Company Department Store uses to fund its retained shoplifting losses is a(n)

unfunded reserve.

Which of the following statements is (are) true with respect to identifying potential loss exposures? I. A physical inspection of company plants and operations can help to identify major loss exposures. II. Historical claims data can help to identify major loss exposures.

both I and II

Risk managers must consider the range of outcomes that could occur. The worst loss that is likely to happen is called

the probable maximum loss.

Rather than purchasing computers and software, ABC Company entered into a lease agreement with Computer Solutions Company (CSC). Under terms of the lease, CSC provides computers and software and is responsible for damage to the computers and software. ABC uses the lease to shift responsibility for hardware and software losses to CSC. ABC's use of the lease illustrates which method of dealing with risk?

noninsurance transfer

According to the law of large numbers, what should happen as an insurer increases the number of units insured?

Actual results will more closely approach expected results.

Loss control includes which of the following? I. Loss reduction II. Loss prevention

both I and II

All of the following statements about captive insurers are true EXCEPT

They increase the volatility of the parent company's earnings.

All of the following are potential advantages of retention EXCEPT

protection from catastrophic losses.

All of the following are disadvantages of noninsurance transfers EXCEPT

The only potential losses that can be transferred are those that are not commercially insurable.

All of the following are disadvantages of using insurance in a risk management program EXCEPT

It results in considerable fluctuations in earnings after losses occur.

Ryan decided to review his personal risk management program. His car is 10 years old, and he would receive little money from his insurer if the car was damaged or destroyed. Ryan decided to drop the physical damage insurance on the car. From a risk management perspective, dropping the physical damage insurance on the car is best described as

increasing the use of retention in the risk management program.

Parker Department Stores has been hurt in recent months by a large increase in shoplifting losses. Parker's risk manager concluded that while the frequency of shoplifting losses was high, the severity is still relatively low. What is (are) the appropriate risk management technique(s) to apply to this problem?

loss control and retention

The production facility for ABC Manufacturing is located in a flood plain. Although the risk of flood is low, ABC's risk manager is concerned that a flood could damage the plant and equipment. He got bids on flood insurance from two insurance agents, but decided the cost of coverage was too high relative to the risk. So he did not purchase flood insurance. Which risk management technique is ABC using with respect to the risk of flood?

active retention

A special form of planned retention by which part or all of a given loss exposure is retained by the firm is called

self-insurance.

A publishing company solicits manuscripts for publication. The publishing company is concerned that an author might plagiarize material and that the person who was plagiarized might sue the publisher. To address this risk, the contract with the author includes a hold-harmless agreement. Through this agreement, the author, rather than the publisher, is held liable for plagiarism. In this situation, the publisher is using the hold-harmless agreement as what type of risk treatment measure?

risk transfer

Williams Company installed smoke detectors, a sprinkler system, and fire extinguishers in its new manufacturing facility. These devices are all examples of

risk control.

Which of the following statements about hedging is (are) true? I. Hedging is a form of risk transfer. II. Hedging is used to address the risk of unfavorable price fluctuations.

both I and II

Which of the following is least likely to occur during a \"hard\" insurance market period?

loosening underwriting standards

Which of the following statements concerning the selection of risk management techniques and insurance market conditions is (are) true? I. It's easier to purchase affordable insurance during a \"soft\" market than during a \"hard\" market. II. Retention is used more during a \"soft\" market than during a \"hard\" market.

I only

All of the following are ideal characteristics for a risk to be privately insurable EXCEPT

the loss should be within the insured's control

All of the following risks are privately insurable EXCEPT

adverse commodity price movements

Which of the following is a fundamental purpose of the principle of indemnity?

to reduce moral hazard

All of the following are exceptions to the principle of indemnity EXCEPT

actual cash value property insurance.

David owns a liquor store in a high-crime area. In order to obtain a reduced insurance premium, David promised to have a burglar alarm operating at the store when the store was closed. This agreement, which was incorporated into the insurance contract, is an example of

warranty.

Kyle purchased collision insurance on his new car. While Kyle was driving home from work, another driver failed to stop at a stop sign and hit Kyle's car. Kyle phoned his insurance agent and reported the accident. The agent said, "Don't worry, Kyle, we'll pay to get your car fixed. And after we pay for the damage to your car, we will try to collect from the driver who damaged your car." The process the agent described is called

subrogation.

Which of the following statements about the principle of insurable interest is (are) true? I. In life insurance, the insurable interest requirement must be met only at the time of the loss to receive life insurance proceeds after the insured has died. II. The insurable interest requirement helps to reduce the problem of moral hazard.

II only

When Maria applied for a life insurance policy, she answered "No" in response to the question "Have you visited a doctor for any reason during the previous 12 months?" In fact, Maria visited a doctor five weeks ago after experiencing chest pains. She was referred to a specialist who determined that Maria has severe heart disease. If Maria dies shortly after the life insurance policy is issued, on what grounds will the insurer be successful in denying the claim

misrepresentation

A contract in which the values exchanged are not equal because chance is involved is called a(n)

aleatory contract.

An insurance contract must be accepted in its entirety and any ambiguity in the contract is construed against the insurer. Because of these characteristics, we can describe insurance contracts as

contracts of adhesion.

Property insurance contracts have all of the following distinct legal characteristics EXCEPT

they are bilateral contracts.

Insurers use a process of selecting and classifying insurance applicants to prevent individuals who have a higher-than-average probability of loss from obtaining insurance at average rates. This process is called

Underwriting