1. Principles of insurance

Which one of the following hazards can be described as a careless attitude or general indifference on the part of the insured toward the occurrence of loss? A) Morale. B) Physical. C) Moral. D) Legal.

Answer: A A hazard is a situation or factor that increases the possibility of a loss occurring. A morale hazard is a careless attitude or general indifference on the part of the insured toward the occurrence of loss.

Which of the following is NOT an example of an insurable interest? A) Person's interest in property she hopes that her uncle will leave to her in his will. B) Person's interest in the improvements he has added to his leased apartment. C) Person's interest in the home she owns. D) Dry cleaner's interest in his customers' clothing in his custody, care, or control.

Answer: A A person does not have an insurable interest in property that he neither possesses nor owns.

Which one of the following risks is insurable? A) Partial. B) Pure. C) Speculative. D) Whole.

Answer: B Only pure risks are insurable because they involve the chance of loss only.

If John's father transfers ownership of a house to John, which one of the following statements regarding insurance on the house is CORRECT? A) John can buy insurance because he has an insurable interest. B) John must purchase the house from his father to obtain an insurable interest in it. C) John's father must retain his policy on the house. D) John's father must assign his policy to John as well.

Answer: A A person has an insurable interest in property when the loss of or damage to the property will result in financial loss to the person. Because John's father has transferred ownership of the house to John, he now owns and controls the property. Any loss or damage to the house will result in a financial loss to John. Therefore, John has an insurable interest in the house and should obtain insurance on the house in his name. Some companies will consider approving an assignment of an insurance policy from the old owner to the new owner, but this is not a universal practice.

With regard to insurance, risk can be defined as: A) uncertainty regarding loss. B) certainty regarding loss. C) uncertainty regarding financial gain. D) certainty regarding financial gain.

Answer: A Risk refers to the uncertainty of financial loss. Insurance replaces the uncertainty of risk with certain guarantees of financial stability.

Sharing is a method of handling risk. Which of the following phrases best describes the concept of sharing? A) Purchasing insurance. B) Increasing a deductible to share the loss with the insurance company. C) Signing a hold harmless agreement to share the liability. D) Buying a car with a friend to share the risk.

Answer: A Sharing (also known as transfer) is the method of risk being distributed among a number of persons. Each person bears a portion of the risk in relation to what he has invested.

The risk that involves the chance of both loss and gain is: A) speculative risk. B) pure risk. C) impure risk. D) whole risk.

Answer: A Speculative risk involves the chance of both loss and gain. For example, the placement of a bet at a racetrack is a speculative risk.

The law of large numbers states that the: A) larger the number of risks combined into one group, the less uncertainty there will be as to the amount of loss that will be incurred. B) smaller the number of risks combined into one group, the less uncertainty there will be as to the amount of loss that will be incurred. C) smaller the number of risks combined into one group, the larger the loss will be to any one individual in that group. D) larger the number of risks combined into one group, the smaller the loss will be to any one individual in that group.

Answer: A The law of large numbers operates under the principle that the larger the number of similar risks combined into one group, the less uncertainty there will be as to the amount of loss that group will incur. Thus, an insurance company is able to determine in advance the approximate number of claims it will receive in a given time period for a given risk and place its business on a nonspeculative basis.

Faulty wiring causes a fire that destroys a building. The faulty wiring is considered to be a(n): A) proximate cause. B) hazard. C) peril. D) indirect cause.

Answer: B A hazard is a situation or factor that increases the possibility of a loss occurring or increases the probable size of a loss.

Which one of the following is an example of a peril? A) Illness. B) Earthquake. C) Gasoline stored on the premises. D) Indifference.

Answer: B A peril is the actual cause of a loss. Examples of perils are fire, wind, hail, collision, and earthquake

Which one of the following statements pertaining to risk is NOT correct? A) Only pure risks are insurable. B) A stock market venture is an example of a pure risk. C) Pure risk involves only the chance of loss; there is never a possibility of gain or profit. D) Uncertainty regarding financial loss is the definition of risk; therefore, it is characteristic of both pure and speculative risks.

Answer: B A stock market venture involves the chance of both gain and loss and is, therefore, a speculative risk. Pure risk involves only the chance of loss.

Robert and Carolyn live in a busy city and decide that not owning a car is the solution to not experience having a car stolen. Which of the following methods describes this philosophy? A) Loss control. B) Avoidance. C) Retention. D) Transfer.

Answer: B An individual may avoid the risk of a loss by not engaging in an activity or owning property. By not owning a car, Robert and Carolyn will not risk having it stolen.

How is uncertainty regarding loss best described? A) Peril. B) Risk. C) Insurance. D) Hazard.

Answer: B In the strict insurance definition, risk is the uncertainty regarding financial loss. Insurance is used to minimize the risk of uncertainty by spreading the risk over a large enough number of similar exposures to predict the individual chance of loss.

Which of the following is NOT an element of an insurable risk? A) The loss must have a determinable value. B) The loss must be catastrophic. C) The loss must be due to chance. D) The loss must be accidental from the insured's perspective.

Answer: B One of the criteria for an insurable risk is that it is not catastrophic. A principle of insurance holds that only a small portion of a given group will experience loss at any one time. Risks that would adversely affect large numbers of people or large amounts of property, such as wars, are typically not insurable.

What is the actual cause of a loss? A) Risk. B) Peril. C) Hazard. D) Proximate cause.

Answer: B The actual cause of a loss is called a peril and is identified or referred to in the insurance policy. Perils include such events as fire, wind, hail, and collision with another car. A named peril policy provides coverage only if a loss is caused by one of the perils specifically named or identified in the policy. An open perils policy provides coverage for all and any risks, unless specifically excluded.

Which of the following is NOT a source of information important to an underwriter? A) Motor vehicle reports. B) Employer reference. C) Agent or producer comments. D) Consumer reports.

Answer: B The four primary sources of information include the agent or producer, consumer reports, government records, and financial rating services.

The purpose of insurance is to: A) reduce adverse selection. B) transfer risk. C) eliminate risk. D) eliminate hazards.

Answer: B The purpose of insurance is to protect against losses caused by pure risk. This is accomplished through the insurance contract, which requires one party to pay a specified sum to another if a previously identified event occurs. For the cost of a premium, a person or entity can purchase protection offered by the insurance contract and transfer risk to the insurer.

A condition or situation that presents a possibility of loss is a (an): A) law of large numbers. B) named certainty. C) exposure. D) proximate cause.

Answer: C A condition or situation that presents a possibility of loss is an exposure. Insurance policies are designed to cover loss, either a direct loss or an indirect loss.

Which one of the following is considered a hazard? A) Fire. B) Explosion. C) Trash. D) Lightning.

Answer: C A hazard is a situation or factor that increases the possibility of a loss.

Dishonesty on the part of an insured is an example of: A) a physical hazard. B) a morale hazard. C) a moral hazard. D) a peril.

Answer: C A peril is the specific event that causes a loss. A hazard is any factor that increases the chance of loss. A moral hazard involves dishonesty on the part of the insured (e.g., planning arson to collect the insurance claim). A morale hazard involves carelessness or indifference, such as not using a seatbelt or not locking one's door.

A chance, possibility, or uncertainty of loss is known as a: A) hazard. B) peril. C) proximate cause. D) risk.

Answer: D Risk is the uncertainty regarding the occurrence of financial loss. A peril is the actual cause of a loss and is specifically identified in the policy. A hazard is a situation or condition that may increase the possibility of a loss occurring. Proximate cause is the action that produces a loss through an unbroken chain of events.

Fire would be an example of a: A) loss. B) risk. C) peril. D) hazard.

Answer: C Perils include events such as fire, wind, hail, or collision with another car. A hazard is a situation or condition that increases the possibility of a loss occurring . Hazards may be classified as physical (a material, structural, or operational feature), moral (dishonest or character defects), or morale (relating to the attitude of the insured). Risk is the uncertainty regarding the occurrence of financial loss.

Which of the following is an example of reduction as a method of handling risk? A) Reducing coverage. B) Buying insurance to reduce the risk. C) Installing a burglar alarm. D) Increasing a deductible.

Answer: C Reduction may be accomplished through loss prevention and loss control. A burglar alarm will control or reduce the loss.

Self-insurance is an example of what kind of risk treatment? A) Reduction. B) Transference. C) Retention. D) Avoidance.

Answer: C Self-insurance is a form of risk retention because the individual personally retains the risk and must accept the economic loss if the risk becomes a reality.

Which one of the following best defines a hazard? A) Uncertainty of a loss. B) Cause of a loss. C) Unexpected loss. D) Condition that increases the chance of a loss.

Answer: D A hazard is a condition that increases the chance of a loss.

Driving too fast and not wearing a seat belt are examples of: A) physical hazard. B) risk. C) moral hazard. D) morale hazard.

Answer: D Hazards may be classified as physical (a material, structural, or operational feature), moral (dishonest or character defects), or morale (relating to the attitude of the insured). Driving too fast and not wearing a seat belt indicate a thoughtless, careless, or arrogant attitude on the part of the driver. Risk is the uncertainty regarding the occurrence of financial loss.

Treating risk by purchasing insurance is an example of what type of risk management? A) Avoidance. B) Reduction. C) Retention. D) Transfer.

Answer: D Purchasing insurance is the most common method of transferring risk. The burden of carrying the risk and indemnifying the financial or economic loss is transferred from the individual to the insurance company through the insurance contract.