Insurance and Risk

Chapter 2 Insurance and Risk 1) All of the following are characteristics of insurance EXCEPT A) risk avoidance. B) pooling of losses. C) payment of fortuitous losses. D) indemnification. Answer: A 2) Which of the following is implied by the pooling of losses? A) sharing of losses by an entire group B) inability to predict losses with any degree of accuracy C) substitution of actual loss for average loss D) increase of objective risk Answer: A 3) According to the law of large numbers, what happens as the number of exposure units increases? A) Actual results will increasingly differ from probable results. B) Actual results will more closely approach probable results. C) Nondiversifiable risk will decrease. D) Objective risk will increase. Answer: B 4) According to the law of large numbers, what should happen as an insurer increases the number of units insured? A) The amount the insurer expects to pay in claims should decrease. B) Underwriting expenses should decrease. C) Actual results will more closely approach expected results. D) The insurerʹs profitability should become more variable. Answer: C 5) Characteristics of a fortuitous loss include which of the following? I. The loss is certain to occur. II. The loss occurs as a result of chance. A) I only B) II only C) both I and II D) neither I nor II Answer: B Copyright © 2011 Pearson Education, Inc. Chapter 2 Insurance and Risk 6) From the viewpoint of the insurer, all of the following are characteristics of an ideally insurable risk EXCEPT A) The loss must be accidental. B) The loss should be catastrophic. C) The premium must be economically feasible. D) There must be a large number of exposure units. Answer: B 7) From the standpoint of the insurer, all of the following are characteristics of an ideally insurable risk EXCEPT A) The loss must be unintentional. B) The chance of loss must be calculable. C) The loss must be indeterminable. D) The loss must be measurable. Answer: C 8) Why is a large number of exposure units generally required before a pure risk is insurable? A) It prevents the insurer from losing money. B) It eliminates intentional losses. C) It minimizes moral hazard. D) It enables the insurer to predict losses more accurately. Answer: D 9) The requirement that losses should be accidental and unintentional in order to be insurable results in which of the following? I. Decrease in moral hazard II. More accurate prediction of future losses A) I only B) II only C) both I and II D) neither I nor II Answer: C 10) Which of the following is implied by the requirement that a loss should be determinable and measurable to be insurable? I. The loss must be definite as to place. II. The loss must be definite as to amount. A) I only B) II only C) both I and II D) neither I nor II Answer: C Copyright © 2011 Pearson Education, Inc. 13 11) Methods by which insurers may minimize or avoid catastrophic losses include which of the following? I. The use of reinsurance II. Concentrating coverage written in one geographic region A) I only B) II only C) both I and II D) neither I nor II Answer: A 12) Which of the following types of risks best meets the requirements for being insurable by private insurers? A) market risks B) property risks C) financial risks D) political risks Answer: B 13) Reasons why market, financial, and production risks are often uninsurable include which of the following? I. The potential to produce a catastrophic loss is great. II. The chance of loss cannot be accurately estimated. A) I only B) II only C) both I and II D) neither I nor II Answer: C 14) Which of the following types of risks is normally uninsurable by private insurers? A) personal risks B) property risks C) liability risks D) market risks Answer: D 15) Which of the following is a result of adverse selection? A) The insurerʹs financial results will be substantially improved. B) Persons most likely to have losses are also most likely to seek insurance at standard rates. C) It is unnecessary for the insurance company to use underwriting. D) Insurance can be written only by the federal government. Answer: B Copyright © 2011 Pearson Education, Inc. Chapter 2 Insurance and Risk 16) The tendency for unhealthy people to seek life or health insurance at standard rates is an example of A) moral hazard. B) fundamental risk. C) attitudinal hazard. D) adverse selection. Answer: D 17) Which of the following statements regarding insurance and gambling is (are) true? I. Insurance is used to handle existing pure risks, while gambling creates a new speculative risk. II. Insurance usually involves risk avoidance, while gambling typically involves only risk reduction. A) I only B) II only C) both I and II D) neither I nor II Answer: A 18) In addition to marketing life insurance, life insurers typically sell which of the following products? I. Retirement annuities II. Disability income insurance A) I only B) II only C) both I and II D) neither I nor II Answer: C 19) Inland marine insurance provides coverage for A) goods being shipped on land. B) premature death of members of the armed forces. C) goods being shipped on ocean-going vessels. D) liability exposures of nonprofit organizations. Answer: A 20) All of the following are classified as casualty insurance EXCEPT A) life insurance. B) general liability insurance. C) workers compensation insurance. D) burglary and theft insurance. Answer: A Copyright © 2011 Pearson Education, Inc. 15 21) Which of the following is a form of casualty insurance? A) fire insurance B) general liability insurance C) inland marine insurance D) ocean marine insurance Answer: B 22) The term ʺmultiple-line insuranceʺ is used to describe a type of insurance that combines which of the following coverages into a single contract? A) workers compensation and health insurance B) life and disability insurance C) property and casualty insurance D) pensions and annuities Answer: C 23) All of the following are benefits to society that result from insurance EXCEPT A) less worry and fear. B) elimination of moral hazard. C) indemnification for loss. D) loss prevention. Answer: B 24) Which of the following statements about the insurance industry as a source of investment funds is (are) true? I. These funds result in a lower cost of capital than would exist in the absence of insurance. II. These funds tend to promote economic growth and full employment. A) I only B) II only C) both I and II D) neither I nor II Answer: C 25) All of the following are social costs associated with insurance EXCEPT A) insurance company operating expenses. B) fraudulent claims. C) inflated claims. D) increased cost of capital. Answer: D Copyright © 2011 Pearson Education, Inc. Chapter 2 Insurance and Risk 26) A group of farmers agreed that if any farmer suffered a property loss, the loss would be spread over the entire group. In this way, each farmer is responsible for the average loss of the group rather than the actual loss that the farmer sustained. Which characteristic of insurance is embodied in this agreement? A) pooling of losses B) fortuitous losses C) risk avoidance D) indemnification Answer: A 27) XYZ Insurance Company writes coverage for most perils which can damage property. XYZ, however, does not write flood insurance on property located in flood plains. Which requirement of an ideally insurable risk might be violated if XYZ wrote flood insurance on property located in flood plains? A) There must be a large number of similar exposure units. B) The loss should not be catastrophic. C) The chance of loss must be calculable. D) The losses must be determinable and measurable. Answer: B 28) ABC Appliance offers a warranty requiring an annual fee. The warranty may be purchased at the time of sale or at any time within the first year after the appliance was purchased. The warranty fee after the date of purchase is twice the time-of-purchase fee. When asked why the fee was higher after the date of purchase, ABCʹs president said, ʺBuying a warranty is voluntary. Weʹve noted that those who buy the warranty after the purchase date have a greater need for service.ʺ Charging the same rate or a lower rate after the date of purchase would expose ABC to what problem that also impacts private insurers? A) excessive premiums B) reduced claims C) bad investments D) adverse selection Answer: D 29) Alpha Insurance Company insures a broad range of risks, including whatever is not covered by fire, marine, and life insurers. Which term best describes the wide range of risks written by Alpha Insurance? A) fidelity insurance B) casualty insurance C) social insurance D) property insurance Answer: B Copyright © 2011 Pearson Education, Inc. 17 30) LMN Insurance markets homeowners insurance. The LMN homeowners policy combines property and casualty insurance in the same contract. Insurance policies combining property and casualty coverage in the same contract are called A) mono-line policies. B) multi-year policies. C) multiple-line policies. D) manuscript policies. Answer: C 31) One branch of government insurance programs has a number of distinguishing characteristics. These programs are compulsory, they are financed by mandatory contributions rather than general tax revenues, and benefits are weighted in favor of low-income groups. These government insurance programs are called A) welfare programs. B) social insurance programs. C) casualty insurance programs. D) private insurance programs. Answer: B 32) Gina would like to buy a house. She will pay 10 percent of the cost of the house as a down payment and borrow the other 90 percent from a mortgage lender. The home will serve as collateral for the loan. The lender requires Gina to purchase property insurance on the home so that the collateral supporting the loan will be protected. This scenario illustrates which of the following benefits of insurance to society? A) enhancement of credit B) reduction of fear and worry C) source of investment funds D) incentives for loss prevention Answer: A 33) ABC Insurance Company calculated the amount that it expected to pay in claims under each policy sold. Rather than selling the insurance for the amount it expected to pay in claims, ABC added an allowance to cover the cost of doing business, including commissions, taxes, and acquisition expenses. This allowance is called a(n) A) policyowner dividend. B) premium. C) expense loading. D) rate credit. Answer: C Copyright © 2011 Pearson Education, Inc. Chapter 2 Insurance and Risk 34) JKL Insurance Company estimates that 14 out of every 100 homeowners it insures will file a claim each year. Last year, JKL insured 200 homeowners. According to the law of large numbers, what should happen if JKL insures 2,000 homeowners this year? A) The total number of claims filed by JKL policyowners should decrease. B) The total dollar value of claims will decrease. C) The average size of loss will decline in value. D) The actual results will more closely approach the expected results. Answer: D 35) Apex Insurance Company wrote a large number of property insurance policies in an area where earthquake losses could occur. When the president of Apex was asked if she feared that a severe earthquake might put the company out of business, she responded, ʺNot a chance. We transferred most of that risk to other insurance companies.ʺ An arrangement by which an insurer that initially writes insurance transfers to another insurer part or all of the potential losses associated with such insurance is called A) hedging. B) speculating. C) reinsurance. D) loss avoidance. Answer: C 36) Bronson Casualty Company sells casualty insurance only. Which of the following coverages could you purchase from Bronson Casualty Company? A) life insurance B) fire insurance C) marine insurance D) liability insurance Answer: D 37) Which of the following statements regarding insurance and hedging is (are) true? I. Insurance involves the transfer of insurable risk while hedging handles risk that is typically uninsurable. II. Both insurance and hedging rely on the law of large numbers to reduce risk. A) I only B) II only C) both I and II D) neither I nor II Answer: A Copyright © 2011 Pearson Education, Inc. 19 38) Ashley opened an all-you-can-eat buffet restaurant. The cost per-person was based upon what Ashley believed an average restaurant patron would consume. The restaurant began to lose money. Ashley concluded that her patrons had ʺabove averageʺ appetites, and were attracted to her restaurant because they could eat as much as they wanted while being charged an average price. A similar phenomenon exists in insurance markets. This problem is called A) moral hazard. B) adverse selection. C) attitudinal hazard. D) fundamental risk. Answer: B 39) Which of the following statements is (are) true concerning private insurance? I. Social insurance programs are private insurance programs. II. Both individuals and businesses purchase private insurance. A) I only B) II only C) both I and II D) neither I nor II Answer: B 40) Adverse selection occurs A) when an insurance company loses money on its investments. B) when individuals intentionally bring about a loss in order to collect from an insurer. C) when catastrophic losses occur as a result of a natural disaster. D) when applicants with a higher-than-average chance of loss seek insurance at standard rates. Answer: D Copyright © 2011 Pearson Education, Inc.