Chapter: Basic Insurance Concepts and Principles

Which of the following insurance options would be considered a risk-sharing arrangement? a) Surplus lines b) Reciprocal c) Stock d) Mutual

Reciprocal Explanation: When insurance is obtained through a reciprocal insurer, the insureds are sharing the risk of loss with other subscribers of the reciprocal

Adverse selection is a concept best described as a) risk with higher probability of loss seeking insurance more often than other risks b) Underwriters slanting the odds in favor of the company c) Poor choices of applicants to be covered d) Only offering coverage to good risk

Risks with higher probability of loss seeking insurance more often than other risks. Explanation: Adverse selection means that there are more risk with higher probability of loss seeking to purchase and maintain insurance than the risks who present lower probability. Underwriters must guard against this.

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 the life of a lender c) a debtor has an insurable interest in the life of a lender d) business partners have an insurable interest in each other

A debtor has an insurable interest in the life of a lender Explanation: A lender has an insurable interest in the life of a debtor, but only to the extent of the debt. The debtor does not have an insurable interest in the life of the lender.

The growing tendency of individuals to file lawsuits and to claim tremendous amounts for alleged damages is known as: a) fraud b) legal hazard c) double indemnity d) legal risk

Legal Hazard Explanation: Legal hazards arise from court actions which increase the likelihood or size of a loss

A person who does not lock the door or does not repair leaks shows an indifferent attitude. This person present what type of hazard a) Moral b) Legal c) Physical d) Morale

Morale Explanation: A morale hazard is someone who has an indifferent attitude towards an insurance company. He is careless or irresponsible because he knows his loss will be covered by insurance

Which of the following individuals must have insurable interest in the insured a) Underwriter b) Producer c) Policy owner d) Beneficiary

Policy owner must have an insurable interest in the insured (his/her own life if the policy owner and the insured is the same person), or in the life of a family member or a business partner.

To achieve the profitable distribution of exposure, a) poor risk and average risk make up the majority of coverage b) a majority of coverage goes to preferred risk c) Preferred risk and poor risk are balanced with average risks in the middle d) the most coverage goes to average risk and preferred risk, while less goes to poor risk.

Preferred risk and poor risk are balanced with average risk in the middle Explanation: balancing poor risk and preferred risk with average risk in the middle created a profitable distribution of exposures

Which of the following factors is NOT considered by an underwriter when determining the premium rates for an individual seeking insurance. a) Medical history b) Sex c) Race d) Age

Race Explanation: Age, medical history, and sex provide sound statistical data for determining the probability of loss. Race, religion, sexual orientation, etc. are some of the factors that cannot be used because there is not sound statistical data to show that they effect the probability of loss; therefore, they are considered to be discriminatory

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 his diet. Which method of dealing with risk does this scenario describe? a) Reduction b) Transer c) Avoidance d) Retention

Reduction Explanation: The insured's change in lifestyle and habits would likely reduce the chance of health problems.

In case of a loss, the indemnity provision in insurance policies a) Pays the insured a percentage of the loss above and beyond the loss b) Pays the insured as much as 95% of the loss c) Restores are insured person to the same financial state as before the loss d) Allows the insured to collect 20%more than the actual loss

Restores an insured person to the same financial state as before the loss Explanation: 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

Insurance is the transfer of: a) Peril b) Risk c) loss d) hazard

Risk Explanation: Insurance is a transfer of risk of loss from an individual or a business entity to an insurance company. Hazards are conditions that increase the probability of an insured loss occurring and perils are causes of loss. Losses cannot be transferred.

Profitable distribution of exposures serves the purpose of a) helping the insurer determine payable benefits b) protecting the insurer against adverse selection c) helping the insurer select the ideally insurable risks d) preventing the insurer from being estopped

protecting the insurer against adverse selection Explanation: A profitable distribution of exposures exists when poor risks are balanced with preferred risks, with the standard risks in the "middle." The purpose behind distributing risk in this manner is to protect the insurer from adverse selection

The protection of the insurer from adverse selection is provided in part by a) A reduction in coverage b) A profitable distribution of exposures c) reducing costs d) A drop in applicants

A profitable distribution of exposures. Explanation: The profitable distribution of exposures, which balances poor risks and preferred risks with standard risks in the middle, protects insurers from adverse selection

What do individuals use to transfer their risk of loss to a larger group? a) Indemnity b) Insurance c) Insurable interest d) Exposure

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

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 insurable interest in the life of a lender d) Business partners have an insurable interest in each other

A debtor has an insurable interest in the life of a lender Explanation: A lender has na insurable interest in the life of a debtor, but only to the extent of the debt. The debtor does not have an insurable interest in the life of the lender

A contract which one part undertakes to indemnify another against loss is called: a) risk b) indemnity c) insurance d) adverse selection

Insurance Explanation: Insurance is a contract whereby one undertakes to indemnify another against loss, damage, or liability arising from a contingent or unknown event

Which of the following is NOT a characteristic of pure risk? a) the loss must be catastrophic b) the loss must be due to chance c) the loss must be measurable in dollars d) the loss exposure must be large

The loss must be catastrophic Explanation: In order to be characterized as purse risk, the loss must be due to chance, definite, measurable, and predictable, but not catastrophic

For the purpose of insurance, risk is defined as: a) An event that increases the amount of loss b) The uncertainty or chance of loss c) The certainty of loss d) The cause of loss

the uncertainty or chance of loss Explanation: Risk, or the chance of loss occurring is the basic reason for buying insurance

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

A family Explanation: A person is a legal entity which act 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 trusts.

A hazard is best described as: a) A deliberate attempt to deceive b) Something that increases the risk of loss c) The uncertainty of loss d) Neglect to communicate a material fact

Something that increases the risk of loss Explanation: Hazards are conditions or situations that increase the probability if an insured loss occurring

Installing deadbolt lock on the doors of a home is an example of which method of handling risk? a) transfer b)self- insurance c) reduction d) avoidance

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

The insurer may suspect that a moral hazard exists if the policyholder: a) is prone to depression b) is indifferent to activities that may be dangerous c) always drives over the speed limit d) is not honest about his health on an application for insurance

Is not honest about his health on an application for insurance Explanation: Moral hazards refer to those applicants that may lie on an application for insurance, or in the past, have submitted fraudulent claims against an insurer

The risk of loss may be classified as : a) Named risk and un-named risk b) High risk and low risk c) Pure risk and speculative risk d) Certain risk and uncertain risk

Pure risk and speculative risk Explanation: Pure risks involve the probability or possibility of loss with no chance for gain. Pure risks are generally insurable. Speculative risk involve uncertainty as to whether the final outcome will be gain or loss. Speculative risks are generally uninsurable

Which of the following is considered to be a morale hazard a) driving recklessly b) Smoking c) working as a firefighter d) engaging in illegal activities

driving recklessly Explanation: Morale hazards arise from a state of mind that causes indifference to loss, such as carelessness

An individual's tendency to be dishonest would be indicative of a: a) Morale hazard b) Pure hazard c) Physical hazard d) Moral hazard

Moral hazard Explanation: An applicant that is dishonest is completing an application for insurance or submitting fraudulent claims would be deemed a moral hazard and could be uninsurable from an underwriting standpoint

Not all losses are insurable, and there are certain requirements that must be met before a risk is proper subject for insurance. These requirements include all of the following EXCEPT: a) the loss produced by the risk must be definite. b) the loss may be intentional c) the loss must not be catastrophic d) there must be sufficient number of homogeneous exposure units to make losses reasonably predictable

The loss may be intentional Explanation: To insure intentional losses would be against public policy

Which insurance principle states that if a policy allows for greater compensation than the financial loss incurred, the insured may only receive benefits for the amount lost? a) Indemnity b) stop loss c) Consideration ' d) Reasonable expectations

Indemnity Explanation: The principle of indemnity stipulated that the insured can only collect for the amount of the loss even if the policy is written with greater benefit limits

Insurance is a contract by which one seeks to protect another from: a) Uncertainty b) Hazards c) Loss d) Exposure

Loss Explanation: Insurance will protect a person , business or entity from loss

The risk management technique that is used to prevent a specific loss by not exposing oneself to that activity is called a) Sharing b) Avoidance c) Transfer d) Reduction

Avoidance Explanation: risk avoidance is elimination of risk of loss by avoiding any exposure to an event that could give risk to such loss

Units with the same or similar exposure to loss are referred to as: a) Law of large numbers b) Homogeneous c) Catastrophic loss exposure d) Insurable risk

Homogeneous Explanation: The basis of insurance is sharing risk between a large homogeneous group with similar exposure to loss

Not all losses are insurable, and there are certain requirements that must be met before a risk is a proper subject for insurance. These requirements include all of the following EXCEPT a) The loss may be intentional b) the loss must mot be catastrophic c) there must be a sufficient number of homogeneous exposure units to make losses reasonably predictable d) The loss produced by the risk must be definite

The loss may be intentional Explanation: To insure intentional losses would be against public policy

Which of the following is the most common way to transfer risk a) purchase insurance b) increase control of claims c) Lessen the possibility of loss d) Name a beneficiary

Purchase insurance Explanation: The most effective way to handle risk is to transfer it so that the loss is borne by another party. Insurance is the most common method of transferring risk from an individual or group to an insurance company

Peril is most easily defined as a) the cause of loss insured against b) An unhealthy attitude about safety c) The chance of a loss occurring d) Something that increases the chance of loss

The cause of loss insured against Explanation: Perils are the causes of loss insured against in an insurance policy

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

A peril Explanation: A peril is the cause of loss insured against in an insurance policy

Which of the following is NOT an example of valid insurable interest: a) Employer in ket employee's life b) child in parents' lives c) debtor in the life of the creditor d) business partners in each other's lives

Debtor in the life of the creditor Explanation: The three recognized areas in which insurable interest exist are as follows: a policy owner insuring his or her own life, the life of a family member (relative or spouse), or the life of a business partner, key employee, or someone who has a financial obligation to them. A debtor does not have an insurable interest in the creditor.

Events or conditions that increase the chances of an insured loss occurring are referred to as a) hazard b) exposures c) risks d) perils

Hazard Explanation: conditions such as lifestyle and existing health, or activities such as scuba diving are hazards and may increase the chance of a loss occurring

Which statement regarding insurable risk is NOT correct a) Insurance cannot be mandatory b) the insurable risk needs to be statistically predictable c) AN insurable risk must involve a loss that is definite as to cause, time, place and amount d) Insureds cannot be randomly selected.

Insureds cannot be randomly selected Explanation: Granting insurance must not be mandatory, selecting insureds randomly will help the insurer to have a fair proportion of good risks to poor risks. All other statements are true

All of the following actions by a person could be described as risk avoidance EXCEPT: a) Never flying in an airplane b) Not driving after being in an accident c) Investing in the stock market d) Refusing to scuba dive

Investing in the stock market Explanation: Investing in the stock market is not an example of risk avoidance; it creates a possibility of a loss

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 a(n): a) Legal hazard b) Underwriting gamble c) Legal peril d) Fiduciary risk

Legal Hazard Explanation: Legal hazard is defined as a set of legal or regulatory conditions that affect an insurer's ability to collect premiums commensurate with the level of risk incurred

The causes of loss insured against in an insurance policy are known as a) Risk b) hazards c) Perils d) Losses

Perils Explanation: Perils are the causes of loss insured against in an insurance policy

To achieve the profitable distribution of exposures, a) Preferred risk and poor risk are balanced, with average risk in the middle b) The most coverage foes to average risk and preferred risk, while less goes to poor risk c) Poor risks and average risks make up the majority of coverage d) A majority of coverage goes to preferred risk

Preferred risk and poor risk are balanced, with average risk in the middle Explanation: Balancing poor risks and preferred risk with average risk in the middle creates a profitable distribution of exposures.

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

Premiums Explanation: Retention is a planned assumption of risk, or acceptance of responsibility for the loss by an insured through the use of deductibles, copayments, or self0 insurance

Events in which a person has both the chance of winning or losing are classified as a) retained risk b) Speculative risk c) Insurable d) Pure risk

Speculative risk Explanation: Speculative risk involves the chance of gain or loss and it not insurable

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

To minimize the insured's level of liability in the event of loss Explanation: Retention usually result from three basic desires of the insured: to reduce expenses and improve cash flow, to increase control of claim reserving and claims settlements, and to fund losses that cannnot be insured