1. Basic Insurance Concept and Principles

What is the unit of measurement an underwriter uses when determining the premium rates for insurance?

Exposure

An employer has decided to implement a self-funded plan. The company will pay the claims, but an insurer will administer the actual plan. What kind of contract is this?

Administrative Service Only (ASO)

Events or conditions that increase the chances of an insured loss occurring are referred to as:

Hazards

A contract which one party undertakes to indemnify another against loss is called

Insurance

What do individuals use to transfer risk of loss to a larger group?

Insurance

Loss

Insurance is a contract by which one seeks to protect another from

For the reported losses of an insured group to become more likely to equal the statistical probability of loss for that particular class, the insured group must become:

Larger. According to the law of large numbers, the larger the group becomes, the easier it is to predicts losses. Insurers use this law in order to predicts certain types of losses and set appropriate premiums.

Installing deadbolt locks on the doors of a home is an example of which method of handling risk?

Reduction. Steps taken to prevent losses from occurring are called risk reduction.

For the purpose of insurance, risk is defined as:

The uncertainty or chance of loss. Risk, or the chance of loss occurring, is the basic reason for buying insurance.

The process an insurer uses to evaluate applications and determine if a policy should be issued and on what terms, conditions, and rates is known as

Underwriting

The causes of loss insured against in an insurance policy are known as:

Perils

The loss ratio compares

Earned Premium to losses

Formula for computing a loss ratio

(incurred losses+loss adjusting expense)/earned premium

A tornado that destroys property would be an example of which of the following? a. A physical hazard b. A peril c. A pure risk d. A loss

b. A peril A peril is the cause of loss insured against in an insurance policy.

Which of the following is an insurable risk? a. Wear and tear on a valuable oriental rug b. Loss resulting from gambling c. hail damage to the roof of a car d. Fading of paint on a car

c. hail damage to the roof of a car

Which law is the foundation of the statistical prediction of loss upon which rates for insurance are calculated?

Law of large numbers. The law of large numbers, which states that the larger a group is, the more accurately losses reported will equal the underlying probability of loss, is the basis for statistical prediction of loss upon which rates for insurance are calculated.

Which rating method provides an insurer with that portion of a rate that does not include provisions of expenses (other than adjusting expense) or profit and is based on historical aggregate loss and loss adjustment expenses projected through development to their ultimate value and through trending to a future point in time?

Lost costs rating

What describes a situation when poor risks are balanced with preferred risks, and average risks are in the middle?

Profitable distribution of exposure

The most common way to transfer risk:

Purchase insurance

The risk of loss may be classified as:

Pure risk and speculative risk. Pure risk involves probability of loss with no chance for gain. Speculative risks involve uncertainty as to whether the final outcome will be gain or loss.

What would be considered a risk-sharing arrangement?

Reciprocal. When insurance is obtained through reciprocal insurer, the insureds are sharing the risk of loss with other subscribers of that reciprocal.

Adverse selection is a concept best described as

Risk with higher probability of loss seeking insurance more often than other risks.

Events in which a person has both the chance of winning or losing are classified as:

Speculative risk. Involves the chance of gain or loss and is not insurable.

Which of the following terms refers to the ability of two parties to rely on one another?

Utmost good faith

All of the following are insurable events as defined in the Insurance Code EXCEPT a. An insured loses a large sum in poker b. A guest trips and breaks his leg in the insured's house c. an insured goes to the hospital for a broken arm d. An insured is sued for libel and slander

a. An insured loses a large sum in poker

Loss potentials that are the basis for setting rates are

Loss Exposures. In general, "loss exposure" means "loss potentials which are the basis for setting rates." The specific definition varies with the type of insurance transacted.

The protection of the insurer from adverse selection is provided in part by

A profitable distribution of exposures. This balances poor risks and preferred risks with standard risk in the middle which protects insurers from adverse selection.

For the reported losses of an insured group to become more likely to equal the statistical probability of loss for that particular class, the insured group must become.... a. older b. more c. active d. larger smaller

c. larger

A set of legal or regulatory conditions that affect an insurer's ability to collect premiums commensurate with the level of risk incurred would be considered:

Legal hazard

Insurance

the mechanism whereby an insured is protected against loss by a specified future contingency or peril in return for the present payment or premium. Because many other individuals with the same or similar risk of loss are paying premiums, funds are available to indemnify those who actually suffer that loss

The growing tendency of individuals to file lawsuits and to claim tremendous amounts for alleged damages is known as:

Legal hazard. They arise from court actions which increase the likelihood or size of a loss.

The risk management technique that is used to prevent a specific loss by not exposing oneself to that activity is called

Avoidance

Installing deadbolt locks on the doors of a home is an example of which method of handling risk? a. Reduction b. transfer c. self reduction d. avoidance

reduction

When an individual purchases insurance, what risk management technique is he practicing?

Transfer

With respect to the business of insurance, a hazard is:

Any condition or exposure that increases the possibility of loss. They are classified as physical, moral or morale.

The legal definition of "person" would NOT include which of the following? a. An individual human being b. A business entity c. A corporation d. A family

d. A family A person is a legal entity which acts on behalf of itself, accepting legal and civil responsibility for the actions it performs and making contracts in its own name. Persons include individual human beings, associations, organizations, corporations, partnerships, and trust.

Which one of the following is NOT an element of insurability? a. Loss is calculable b. Risk of loss must represent a financial hardship c. loss must be expected d. Risk of loss is speculative

d. Risk of loss is speculative

Which of the following individuals would probably NOT have insurable interest in insured property? a. Home owner b. Home owner's spouse c. mortgage company d. neighbor

d. neighbor

When must insurable interest exist in a life insurance policy? A. At the time of policy delivery B. When there is a change of the beneficiary C. At the time of loss D. At the time of application

D. at the time of application

All of the following are examples of risk retention EXCEPT a. Deductibles b. Copayments c. self-insurance d. Premiums

d. Premiums Retention is a planned assumption of risk, or acceptance of responsibility for the loss by an insured through the use of deductibles, copayments, or self-insurance.

Insurance is the transfer of a. peril b. risk c. loss d. hazard

b. risk

If an applicant for a life insurance policy & person to be insured by the policy are 2 different people, the underwriter would be concerned about: a. the gender of the applicant b. the type of policy requested c. which individual will pay the premium d. whether an insurable interest exists between the individuals.

d. Whether an insurable interest exists between the individuals.

a situation in which a person can only lose or have no change represents

pure risk

According to California Insurance Code, which of the following can be classified as an insurable event? a. Unpredictable losses b. Speculative risks c. extreme levels of loss d. Pure risk

d. Pure risk

Which of the following insurance providers would be considered a risk sharing arrangement? a. Reciprocal b. Stock c. Mutual d. Surplus Lines

(A) reciprocal When insurance is obtained through a reciprocal insurer, the insureds are sharing the risk of loss with other subscribers of that reciprocal.

In property and casualty insurance, insurable interest must exist

At the time of loss.

An individual was involved in a head-on collision while driving home one day. His injuries were not serious, and recovered. However, he decided that in order to never be involved in another accident, he would not drive or ride in a car ever again. Which method of risk management does this describe?

Avoidance

In case of a loss, the indemnity provision in insurance policies A Allows the insured to collect 20% more than the actual loss. B Pays the insured a percentage of the loss above and beyond the loss. C Pays the insured as much as 95% of the loss. D Restores an insured person to the same financial state as before the loss.

D Restores an insured person to the same financial state as before the loss. Indemnity (sometimes referred to as reimbursement) is a provision in an insurance policy that states that in the event of loss, an insured or a beneficiary is permitted to collect only to the extent of the financial loss, and is not allowed to gain financially because of the existence of an insurance contract.

A person who does not lock the doors or does not repair leaks shows an indifferent attitude. This person presents what type of hazard? A. Moral B. Legal C. Physical D. Morale

D. morale

Insurance is the transfer of:

Risk. Insurance is the transfer of financial responsibility associated with a potential of loss (risk) to an insurance company.

Following a career change, an insured is no longer required to perform many physical activities, so he has implemented a program where he walks and jogs for 45 minutes each morning. The insured has also eliminated most fatty foods from diet. Which method of dealing with risk does this scenario describe?

Reduction

Which of the following is NOT a goal of risk retention? a. To reduce expenses and improve cash flow b. To increase control of claim reserving and claims settlements c. to fund losses that cannot be insured d. To minimize the insured's level of liability in the event of loss

d. To minimize the insured's level of liability in the event of loss

Which of the following is NOT a characteristic of an insurable risk? a. The loss must be due to chance b. The loss must be definite and measurable c. The loss must be predictable d. The loss must be catastrophic

d. The loss must be catastrophic To be characterized as pure risk, the loss must be due to chance, definite and measurable, and statistically predictable. The loss, however, cannot be catastrophic, that is why insurance policies usually exclude coverage for loss caused by war or nuclear events.

Which of the following statements is not true concerning insurable interest as it applies to life insurance? A: A husband or wife has an insurable interest in their spouse B: An individual has an insurable interest in his or her own life C: A debtor has an insurable interest in the life of a lender. D: Business partners have an insurable interest in each other

C. A debtor has an insurable interest in the life of a lender. A lender has an insurable intertest in the life of a debtor, but only to the extend of the debt. The debtor does not have an insurable interest in the life of the lender.