Mid-Term

Annual dividends

Dividends on life insurance policies generally are received income-tax free. However, interest on dividends retained under the dividend accumulations option is taxable to the policyholder.

Explain the meaning of enterprise risk.

a term that encompasses all major risks faced by a business firm, which include pure risk, speculative risk, strategic risk, operational risk, and financial risk.

Briefly describe the following insurance company operations: Information systems

Information systems have changed the insurance industry by speeding up the processing of information and by eliminating many routine tasks. Computers are used in accounting, policy processing, premium notices, information retrieval, telecommunications, simulation studies, market analysis, forecasting sales, and training and education. Information can be obtained quickly with respect to premium volume, claims, loss ratios, investments, and underwriting results.

In the context of rate making, explain the meaning of: gross premium

the gross rate multiplied by the number of exposure units. The gross rate, in turn, is the pure premium plus the loading for expenses, profit, and other contingencies.

In the context of rate making, explain the meaning of: rate

the price per unit of insurance.

underwriting.

the process of selecting and classifying applicants for insurance.

How does objective risk differ from subjective risk?

the relative variation of actual loss from expected loss. As the number of exposure units under observation increases, objective risk declines. Subjective risk is uncertainty based on one's mental condition or state of mind. Accordingly, objective risk is measurable and statistical; subjective risk is personal and not easily measured.

What is systemic risk?

the risk of collapse of an entire system or entire market due to the failure of a single entity or group of entities that can result in the breakdown of the entire financial system.

What is financial risk?

the uncertainty of loss because of adverse changes in commodity prices, interest rates, foreign exchange rates, and the value of money.

In the context of rate making, explain the meaning of: exposure unit

the unit of measurement used in insurance pricing. For example, in fire insurance, the exposure unit is $100 of coverage.

Describe the major social and economic burdens of risk on society.

(a) The size of an emergency fund must be increased. (b) Society may be deprived of needed goods and services. (c) Worry and fear are present.

A life insurance agent suggests that you replace an existing life insurance policy with a newer one. Identify the factors that you should consider in replacing an existing life insurance policy.

. Some factors to consider in replacement of an existing life insurance policy include the following: · Your present state of health. You may be unhealthy and rated up under the new policy. · Surrender charges for older policy. You may have substantial surrender charges if you replace an existing policy with a new policy. · Substantial front-end expense charges for the new policy. You will be paying acquisition charges and commissions a second time. The new policy may have little or no cash values during the early years of the policy. · The incontestable clause and suicide clause must be considered. The original policy may not be contestable if it is more than 2 years old. Likewise, the suicide clause only applies for the first 2 years. The existing policy may be more than 2 years old.

Describe the following types of deductibles: calendar-year deductible

A calendar-year deductible is typically present in individual and group medical expense policies. Eligible medical expenses are accumulated during the calendar year, and once they exceed the deductible amount, the insurer pays the promised benefits. Once the deductible is satisfied during the calendar year, no additional deductibles are imposed on the insured.

Explain the difference between a direct loss and an indirect or consequential loss.

A direct loss is a financial loss that results from the physical damage, destruction, or theft of property. Indirect loss results from or is the consequence of a direct loss. For example, if a student's car is stolen (direct loss), he or she will lose the use of the car until it is replaced or recovered (indirect loss).

Briefly describe the major types of rating laws. State-Made Rates

A few states make rates that apply to specific lines of insurance, such as title insurance.

Multiple distribution systems

A multiple distribution system describes a marketing system in which more than one distribution system is used. For example, some independent insurers also sell directly to consumers over the Internet or by television.

Describe the basic features of mutual insurers.

A mutual insurer is a corporation owned by the policyholders. The policyholders elect the board of directors who appoint the executives to manage the company. Because relatively few policyholders bother to vote, the board of directors has effective management control of the company. A mutual insurer may pay a dividend or give a rate reduction in advance. In life insurance, a dividend is largely a refund of a redundant premium that can be paid if the mortality, investment, and operating experience of the company is favorable. Dividends, however, cannot be guaranteed.

Primary and contingent beneficiary

A primary beneficiary is the party who is first entitled to receive the policy proceeds upon the insured's death. A contingent beneficiary is entitled to the proceeds if the primary beneficiary dies before receiving the guaranteed number of payments under an installment settlement option

Insurance contracts have certain legal characteristics that distinguish them from other contracts. Explain the following legal characteristics of insurance contracts: Personal contract

A property insurance contract is personal. Personal characteristics of the insured influence the insurer's willingness to issue a policy. Accordingly, these contracts can be validly assigned only with the consent of the insurer. A life insurance policy is not a personal contract and can be freely assigned

Public adjustors

A public adjustor represents the insured rather than the insurance company and is paid a fee based on the amount of the settlement. A public adjustor may be employed by the insured in a complex loss situation and in those cases where the insured and insurer cannot resolve a claim dispute.

Describe the basic characteristics of a reciprocal exchange.

A reciprocal exchange can be defined as an unincorporated organization in which insurance is exchanged among the members (called subscribers). In its purest form, insurance is exchanged among the members; each member of the reciprocal insures the other members, and in turn is insured by them. Thus there is an exchange of insurance promises, hence the name reciprocal exchange. In addition, the reciprocal is managed by an attorney-in-fact, usually a corporation that is authorized to seek new members, pay losses, collect premiums, and perform other administrative duties.

Briefly explain the following types of reinsurance methods for sharing losses: Reinsurance pool

A reinsurance pool is an organization of insurers that underwrites insurance on a joint basis. Pools are formed because a single insurer alone may not have the financial capacity to write large amounts of insurance; the insurers as a group, however, can combine their financial resources to obtain the necessary capacity. Each pool member agrees to pay a certain percentage of every loss. Another arrangement is similar to the excess-of-loss reinsurance treaty. Pool members are responsible for their own losses below a certain amount. Losses exceeding that amount are shared by all pool members

Revocable and irrevocable beneficiary

A revocable beneficiary designation means that the policyholder can change the beneficiary without the beneficiary's consent. An irrevocable beneficiary designation is one that cannot be changed without the beneficiary's consent.

Specific and class beneficiary

A specific beneficiary means the beneficiary is specifically named and identified. In contrast, under a class beneficiary, a specific person is not named but is a member of a group designated as beneficiary, such as "children of the insured."

Staff claims representatives

A staff claims representative is usually a salaried employee who represents only one company. After notice of the loss is received, the staff claims representative will investigate the claim, determine the amount of loss, and arrange for payment.

Describe the basic characteristics of stock insurers.

A stock insurer is a corporation owned by stockholders who participate in the profits and losses of the company. The stockholders elect a board of directors who appoint the executive officers to run the company. The board of directors has the ultimate responsibility for the company's financial success.

What is a valued policy law?

A valued policy law requires payment of the face amount of insurance if a total loss to real property occurs from a peril specified in the law.

What is a valued policy? Why is it used?

A valued policy pays the face amount of insurance in the event of a total loss. Valued policies are used to insure valuable property, such as antiques, fine arts, rare paintings, and family heirlooms. Because of the difficulty of determining the actual value of the property at the time of loss, the insured and insurer both agree on the value of the property when the policy is first issued.

Briefly describe the major types of rating laws. Use and File Law

A variation of file and use is a use-and-file law. Under this law, insurers can put any rate changes into effect immediately, but the rates must be filed with the regulatory authorities within a certain period after first being used, such as 15 to 60 days.

Explain the following legal doctrines: Warranty

A warranty is a statement that becomes part of the insurance contract and is guaranteed by the maker to be true in all respects. For example, a bank may warrant that a guard will be on the premises 24 hours a day. In the past, under the common law, any breach of the warranty, even if slight, permitted the insurer to deny liability for the claim. However, this harsh doctrine has been substantially modified by court decisions and legislation.

Identify some methods that insurers use to control for adverse selection.

Adverse selection can be controlled by careful underwriting, by charging higher premiums to substandard applicants for insurance, and by certain policy provisions.

What is the meaning of adverse selection?

Adverse selection is the tendency of persons with a higher-than-average chance of loss to seek insurance at standard (average) rates, which, if not controlled by underwriting, results in higher-than-expected loss levels.

Explain the major arguments for federal regulation of the insurance industry.

Advocates of federal regulation present the following arguments in support of their position: (1) Uniform state laws and regulations (2) More effective negotiation of international insurance agreements (3) More effective treatment of systemic risk (4) Greater efficiency of insurers

Describe the major types of exclusions typically found in insurance contracts.

All policies contain one or more exclusions. There are three major types of exclusions: (1) Excluded perils (2) Excluded losses (3) Excluded property

Name three ways in which the assets of a life insurance company differ from the assets of a property and casualty insurance company.

Although the assets of a life insurance company are quite similar to the assets of a property and casualty insurance company, there are three important differences. First, an important asset for many life insurance companies is policy loans. Policyholders who own cash-value life insurance products may borrow the cash value from the insurer. Life insurance policy loans are an interest-earning asset for a life insurance company. The second difference between a life insurance company's investments and the investments of a property and casualty insurance company is investment duration. Life insurers tend to invest with a longer time horizon, matching the maturity of the contracts offered with the investments backing the contracts. Finally, life insurers have "separate account" assets. Some insurers sell products that are interest-sensitive (e.g. variable life insurance, variable annuities, and private pension benefits). The assets backing these products are held separate from the insurer's general assets in a different account.

Explain the legal distinction between an agent and a broker.

An agent is someone who legally represents the insurer and has the authority to act on the insurer's behalf. In contrast, a broker is someone who legally represents the insured.

Agents

An agent typically has the authority to settle small first-party claims up to some maximum limit. This type of claim settlement is speedy, reduces adjustment expenses, and preserves the policyholder's good will.

If an endorsement conflicts with a policy provision, how is this problem resolved?

An endorsement normally has precedence over any conflicting terms in the contract to which the endorsement is attached

What is an endorsement or rider?

An endorsement or rider is a written provision that adds to, deletes, or modifies the provisions in the original contract.

The needs approach is widely used for determining the amount of life insurance to purchase. Describe the following needs for a typical family head: Cash needs

An estate clearance fund is immediately needed when a family head dies. Cash is needed for burial expenses, uninsured medical bills, installment debts, estate administration expenses, and estate, inheritance, and income taxes.

Briefly explain the following types of reinsurance methods for sharing losses: Excess-of-loss reinsurance

An excess-of-loss treaty is designed largely for a catastrophe loss. Losses in excess of the primary company's retention limit are paid by the reinsurer up to some maximum limit.

Independent adjustors

An independent adjustor is a firm or individual that adjusts claims and is compensated by a fee. An independent adjuster may be used when a catastrophic loss occurs. An insurer may also use an independent adjustor in certain geographical areas where the volume of claims is too low to justify a branch office with a staff of full-time employees.

Why is an insurable interest required in every insurance contract?

An insurable interest is required in every insurance contract to prevent gambling, to reduce moral hazard, and to measure the amount of the insured's loss in property insurance.

What is the major limitation of ordinary life insurance?

Because of higher premiums that are required, some people may still be underinsured after an ordinary life policy is purchased. For the same premium, substantially higher amounts of term insurance could be purchased.

The Federal Insurance Office (FIO) has made a number of recommendations for modernizing insurance regulation. Briefly describe the FIO's recommendations for each of the following: Areas for direct federal involvement in regulation

Areas for direct federal involvement in insurance regulation include the following: (1) mortgage insurers, (2) uniform treatment of reinsurers, (3) financial stability of large national and international insurers, (4) auto insurance for military personnel, (5) rate regulation, (6) personal information, (7) Native Americans, (8) collection of surplus lines taxes, and (10) state guaranty funds.

Explain the major arguments against repeal of the McCarran-Ferguson Act.

Arguments against repeal of the McCarran Act include the following: (1) The insurance industry is already highly competitive. (2) Small insurers would be harmed. (3) Insurers may be prevented from developing common coverage forms.

Explain the major arguments for repeal of the McCarran-Ferguson Act.

Arguments for repeal of the McCarran Act include the following: (1) The insurance industry no longer needs broad antitrust exemption. (2) Federal legislation is needed because of the defects in state legislation.

What is the balance sheet equation?

Assets = Liabilities + Owners' Equity

Describe the following types of deductibles: aggregate deductible

Commercial insurance contracts may contain an aggregate deductible. An aggregate deductible means that all losses that occur during a specified time period, usually a policy year, are accumulated to satisfy the deductible amount. Once the deductible is met, the insurer pays losses in excess of the deductible

Indemnification

Compensation is given to the victim of a loss, in whole or in part, by payment, repair, or replacement

Explain the following legal doctrines: Concealment

Concealment is the intentional failure of the applicant for insurance to reveal a material fact to the insurer. The legal effect of a material concealment is the same as a misrepresentation—the contract is voidable at the insurer's option.

Define the term "conditions."

Conditions are provisions inserted in the policy that qualify or place limitations on the insurer's promise to perform.

Describe the shortcomings of state regulation.

Critics claim that state regulation has several shortcomings, which include the following: (1) Inadequate protection of consumers (2) Improvements needed in handling complaints (3) Inadequate market conduct examinations (4) Insurance availability studies conducted only in a minority of states (5) Regulators overly responsive to the insurance industry

Identify the sources from which dividends can be paid.

Dividends are paid from three principal sources: (1) the difference between expected and actual mortality experience, (2) excess interest earnings on the assets required to maintain legal reserves, and (3) the difference between expected and actual operating expenses.

Describe the basic features of current assumption whole life insurance.

Current assumption whole life insurance is a nonparticipating whole life policy in which the cash values are based on the insurer's current mortality, investment, and expense experience. The policy has an accumulation account that reflects the cash value under the policy. If the policy is surrendered, a surrender charge is deducted from the accumulation account. The policy also has a guaranteed minimum interest rate and a higher interest rate based on current market conditions and company experience. A fixed death benefit and maximum premiums are stated in the policy at the time of issue. Under the low-premium product, premiums are guaranteed only for a fixed period, such as three to five years. After that time, the insurer can change the premiums.

How does diversifiable risk differ from non-diversifiable risk?

Diversifiable risk is a risk that affects only individuals or small groups and not the entire economy. It is a risk that can be reduced or eliminated by diversification. In contrast, nondiversifiable risk is a risk that affects the entire economy or large numbers of persons or groups within the economy. It is a risk that cannot be reduced or eliminated by diversification.

Estoppel

Estoppel is a representation of fact made by one person to a second person that is reasonably relied upon by that second person to such an extent that it would be inequitable to allow the first person to deny the truth of the representation. Based on the legal doctrine of estoppel, an insurer legally may be required to pay a claim that it ordinarily would not have to pay.

Why are exclusions used by insurers?

Exclusions are necessary for several reasons. The peril may be uninsurable by private insurers, extraordinary hazards may be present, coverage may be provided by other contracts, moral hazard may be present to a high degree, and coverage may not be needed by the typical insureds

Identify the various expense charges that policy-holders must pay under a variable universal life insurance policy.

Expense charges may include a front-end load, back-end surrender charge, state's premium and federal taxes, investment management fee, mortality and expense (M&E) charges, and administrative fees.

The Federal Insurance Office (FIO) has made a number of recommendations for modernizing insurance regulation. Briefly describe the FIO's recommendations for each of the following: Areas for reform at the state level

FIO recommendations for modernizing insurance regulation at the state level include the following areas: (1) material solvency decisions, (2) consistency of solvency regulation, (3) transparency in transferring risk to insurance captives, (4) adoption of best practices and uniform standards, (5) principles-based reserving, (6) corporate governance, (7) group supervision , and (8) supervisory colleges.

Distinguish between facultative reinsurance and treaty reinsurance.

Facultative reinsurance is an optional, case-by-case method used when the ceding company receives an insurance application that exceeds its retention limit. Reinsurance is not automatic. The primary insurer negotiates a separate contract with a reinsurer for each loss exposure for which reinsurance is desired. However, the primary insurer is under no obligation to cede insurance and the reinsurer is under no obligation to accept the insurance. If a willing reinsurer is found, the primary insurer and reinsurer can then enter into a valid contract

List the four requirements that must be met to form a valid insurance contract.

Four requirements must be met for a valid insurance contract: (a) There must be an offer and acceptance. (b) There must be consideration to support the contract. (c) There must be competent parties. (d) To be enforced, the contract must be for a lawful purpose.

Explain the basic objectives in the settlement of claims

From the insurer's viewpoint, there are several basic objectives in settling claims: (a) Verification of a covered loss (b) Fair and prompt payment of claims (c) Personal assistance to the insured

Cash-value option

If a cash value policy is purchased, the policyholder pays more than is actuarially necessary for the life insurance protection. Thus if the insurance is no longer needed, the policyholder should get something back. This payment to a withdrawing policyholder is known as a cash surrender value. The cash values during the early policy years are relatively small, but over a long period, the cash values can be sizable. The policy can be surrendered for its cash value, at which time all benefits under the policy cease.

Explain the federal estate-tax treatment of life insurance death proceeds.

If the insured has any incidents of ownership in the policy at the time of death, the entire proceeds are included in the gross estate of the deceased for federal estate-tax purposes. A federal estate is payable if the decedent's taxable estate exceeds certain limits.

Briefly explain the significance of the following legal cases and legislative acts with respect to insurance regulation: a. Paul v. Virginia

In Paul V. Virginia, the court held that insurance was not interstate commerce and that the states rather than the federal government had the right to regulate the insurance industry. This decision stood for about 75 years until the Supreme Court reversed it in 1944.

Identify the major sources of information available to underwriters.

In determining whether to accept or reject an applicant for insurance, underwriters have several sources of information. They include the application, agent's report, inspection report, physical inspection, physical examination, attending physician's report, and a Medical Information Bureau (MIB ) report.

Explain how a coinsurance percentage clause functions in an individual or group medical expense insurance policy.

In health insurance, a typical coinsurance provision requires the insured to pay 20, 25, or 30 percent of covered medical expenses in excess of the deductible up to some maximum annual limit. The purposes are to reduce premiums and prevent overutilization of policy benefits.

What do the reserves on a life insurance company's balance sheet represent?

In life insurance, a policy reserve is defined as the difference between the present value of future benefits and the present value of future net premiums. Policy reserves or legal reserves are a formal recognition of a company's obligation to pay future benefits. Also, the reserve is a legal test of the company's solvency, since the company must hold assets equal to its legal reserves and other liabilities

What is a viatical settlement?What is a life settlement?Briefly explain the problem of stranger-owned life insurance (STOLI).

In many current waiver-of-premium provisions, total disability means that because of disease or bodily injury, the insured cannot do any of the essential duties of his or her job or of any job for which he or she is suited based on education, training, or experience. If the insured can perform some but not all of these acts and duties, the disability is not considered to be total, and premiums will not be waived. If the insured is a minor and is attending school, premiums are waived if the minor is unable to go to school. Another definition of total disability found in some policies is more liberal. Total disability is initially defined in terms of one's own occupation. For the first two years, total disability means the insured cannot work in the occupation that he or she had at the time the disability occurred. After the initial period expires, the definition becomes stricter. The insured is considered totally disabled only if he or she cannot work in an occupation for which he or she is qualified by education, training, and experience.

Risk transfer

In private insurance, a pure risk is transferred from the insured to the insurer, which is typically in a better financial position to pay the loss than the insured.

Briefly describe the following insurance company operations: Legal services

In property and casualty insurance, the legal department is often part of the claims department. The attorneys may serve as defense counsel for the company if claims are litigated. In life insurance, attorneys are widely used in advanced underwriting and estate planning. Attorneys also review insurance contracts before they are marketed to the public, provide testimony at rate hearings, and provide general legal advice concerning taxation, marketing, investments, and insurance laws. Finally, attorneys lobby for legislation favorable to the insurance industry.

Briefly explain the significance of the following legal cases and legislative acts with respect to insurance regulation: b. South-Eastern Underwriters Association Case

In the South-Eastern Underwriters Association Case in 1944, the Supreme Court ruled that insurance was interstate commerce when conducted across state lines and was subject to federal regulation.

The needs approach is widely used for determining the amount of life insurance to purchase. Describe the following needs for a typical family head: Income needs

Income needs include income during the readjustment period, income during the dependency period, and life income to a surviving spouse.

What are the two major differences between insurance and gambling?

Insurance differs from gambling in two ways. First, gambling creates a new speculative risk that did not exist before, while insurance is a technique for handling an already existing pure risk. Second, gambling is socially unproductive, since the winner's gain comes at the expense of the loser. Insurance is always socially productive, since both the insured and insurer win if the loss does not occur.

What are the two major differences between insurance and hedging?

Insurance differs from hedging. An insurance transaction usually involves the transfer of risks that are insurable, since the requirements of an insurable risk can generally be met. Hedging is a technique for handling risks that are typically uninsurable, such as protection against a substantial decline in the price of commodities. A second difference is that moral hazard and adverse selection are more severe problems for insurers than for speculators who buy or sell futures contracts.

Insurance contracts have certain legal characteristics that distinguish them from other contracts. Explain the following legal characteristics of insurance contracts: Contract of adhesion

Insurance is a contract of adhesion in that it is not bargained. Rather, the policy is offered on a "take-it-or-leave-it" basis, and any ambiguity is construed against the insurer.

Payment of fortuitous losses

Insurance plans provide for the payment of fortuitous losses. A fortuitous loss is one that is unforeseen and unexpected and occurs as a result of chance.

How does the concept of actual cash value support the principle of indemnity?

Insureds are indemnified when they are restored to approximately the same financial position they were in before the loss occurred. Actual cash value, which is defined as replacement cost less depreciation, supports the principle of indemnity because it is designed to prevent profiting from insurance.

Identify the approaches that insurers can use to deal with the problem of catastrophic loss exposures.

Insurers can deal with the problem of a catastrophe loss by (1) reinsurance, (2) avoiding the concentration of risk by dispersing coverage over a large geographical area, and (3) use of certain financial instruments in the capital markets, such as catastrophe bonds.

How is it possible for a property and casualty insurance company to be profitable if its combined ratio exceeds 1 (or 100 percent)?

It is important to remember that the combined ratio measures underwriting performance only. Insurance companies have a second source of revenues: investment income. An insurance company can lose money on its underwriting activities, but still be profitable overall if its investment income offsets the underwriting loss.

Why is subrogation used?

It is used to support the principle of indemnity by preventing an insured from collecting twice, once from the insured, and a second time from the negligent party.

Why are the liabilities of a property and casualty insurance company difficult to measure?

Liabilities are more difficult to measure because one of the largest liability items, loss reserves, is not known for certain. Loss reserves are an estimated value, but the actual loss experience could be different from the expected loss experience

Payment of premiums

Life insurance premiums paid in a lump sum to a designated beneficiary generally are received income tax free by the beneficiary.

Payment of death proceeds to a stated beneficiary

Life insurance proceeds paid in a lump sum to a designated beneficiary are generally received income-tax free by the beneficiary. If the proceeds are liquidated under a settlement option, the principal is received income-tax free, but the interest is taxable as ordinary income.

Explain the basic characteristics of Lloyd's of London.

Lloyd's of London has several important characteristics. First, Lloyd's technically is not an insurance company, but is a society of members (corporations and individuals) who underwrite insurance in syndicates. Second, as noted earlier, insurance is written by various syndicates, and members receive profits or bear losses in proportion to their share in the syndicate. Third, new individual members or Names who belong to the various syndicates now have limited legal liability. Fourth, corporations with limited legal liability can also join Lloyd's of London. In addition, individual members must meet stringent financial requirements. Finally, Lloyd's is licensed only in a small number of jurisdictions in the United States.

Pooling of losses

Losses incurred by the few are spread over the entire group so that in the process, average loss is substituted for actual loss.

Identify the major risks faced by business firms.

Major risks faced by business firms include property risks, liability risks, loss of business income, cyber security and identity theft, crime exposures, human resources exposures, foreign loss exposures, intangible property exposures, and government exposures.

Identify the major social insurance programs in the United States.

Major social insurance programs are the following: · Old-age, survivors, and disability insurance (Social Security) · Medicare · Unemployment insurance · Workers compensation · Compulsory temporary disability insurance · Railroad Retirement Act

Financial institution distribution systems

Many insurers today use commercial banks and other financial institutions as a distribution system to market life insurance and annuity products. These systems are referred to as financial institution distribution systems

What is a preferred risk policy?

Many life insurers sell life insurance at lower rates to preferred risks whose mortality experience is expected to be lower than average. The insurance is carefully underwritten and is sold only to individuals whose health, history, weight, occupation, and habits indicate more favorable than average mortality experience. Certain minimum amounts of insurance must be purchased.

What is a mass-merchandising plan in property and liability insurance?

Mass merchandising in property and liability insurance is a plan for insuring individuals in a group. Property and liability insurance is sold to individual members of a group, such as auto and homeowners. Individual underwriting is used; rate discounts are typically given; premiums are paid by payroll deduction; and employers do not usually contribute to the plan.

Identify the major types of mutual insurers.

Mutual insurers include advance premium mutuals and assessment mutuals.

Can an insurer guarantee the payment of a dividend? Explain your answer.

No. Because the operating experience of the insurer cannot be guaranteed, dividends cannot be guaranteed

What is the difference between objective probability and subjective probability?

Objective probability refers to the long-run relative frequency of an event based on the assumption of an infinite number of observations and no change in the underlying conditions. Subjective probability is the individual's personal estimate of the chance of loss.

Explain the situations that justify the purchase of ordinary life insurance.

Ordinary life insurance is appropriate when lifetime protection is desired or additional savings are desired.

Briefly explain the basic characteristics of ordinary life policies.

Ordinary life insurance provides lifetime protection. The premiums are level and payable for life. The policy develops an investment or savings element called cash surrender values, which result from the overpayment of premiums during the early years.

Other distribution systems

Other life insurance distribution systems include worksite marketing, sales by licensed stock brokers, and sales by financial planners who provide investment advice to clients

What is the purpose of other-insurance provisions?

Other-insurance provisions are typically present in many insurance contracts. These provisions apply when more than one policy covers the same loss. The purpose of these provisions is to prevent profiting from insurance and violation of the principle of indemnity. Some important other-insurance provisions include the pro-rata liability clause, contribution by equal shares, and primary and excess insurance.

What is the difference between peril and hazard?

Peril is the cause of loss. Hazard is a condition that creates or increases the chance of loss.

Personal selling systems

Personal selling distribution systems are systems in which commissioned agents solicit and sell life insurance products to prospective insureds. Agents who sell life insurance include career agents for life insurance companies, independent agents in property and casualty insurance who also sell life insurance, and agents in property and casualty insurance who represent insurers that use the exclusive agency system.

Explain the meaning of premature death.

Premature death means that a person dies with outstanding unfulfilled financial obligations, such as children to support or a mortgage to be paid off.

Briefly describe the sales and marketing activities of insurers.

Production refers to the sales and marketing activities of insurers. Agents who sell insurance are frequently referred to as producers. The key to the insurer's financial success is an effective sales force. Marketing activities include the development of a marketing philosophy and strategy, identification of short- and long-run production goals, marketing research, developing new products, and advertising the insurer's products.

Identify several property and casualty insurance coverages.

Property and casualty coverages can be divided into personal lines and commercial lines. Personal lines include private passenger auto insurance, homeowners insurance, personal umbrella liability insurance, earthquake insurance, and flood insurance.

Explain the difference between pure risk and speculative risk

Pure risk is defined as a situation in which there are only the possibilities of loss or no loss. Speculative risk is defined as a situation where either profit or loss is possible.

List the major types of pure risk that are associated with economic insecurity.

Pure risks associated with great financial and economic insecurity include the risks of premature death, insufficient income during retirement, old age, poor health, and unemployment. In addition, persons owning property are exposed to the risk of having their property damaged or lost from numerous perils. Finally, liability risks are also associated with great financial and economic insecurity.

How does rate making, or the pricing of insurance, differ from the pricing of other products?

Ratemaking differs from the pricing of other products. When other products are sold, the company generally knows in advance what its costs of production are, so that a price can be established to cover all costs and yield a profit. However, an insurer does not know in advance what its actual costs are going to be. The premium may be inadequate for paying all claims and expenses during the policy period. It is only after the period of protection has expired that an insurer can determine its actual losses and expenses.

Explain the following actions by agents that are prohibited by state law: Rebating

Rebating is giving a premium reduction or some other financial advantage not stated in the policy as an inducement to purchase the policy. An example is rebating part of the agent's commission to the policyholder. Rebating is illegal in the vast majority of states

The Federal Insurance Office (FIO) has made a number of recommendations for modernizing insurance regulation. Briefly describe the FIO's recommendations for each of the following: Market conduct recommendations

Recommendations concerning the market conduct of insurers and agents include the following areas: (1)assessment of whether marital status is an appropriate underwriting or rating consideration, (2) participation by all states in the Interstate Insurance Product Regulation Commission and expansion of products subject to approval, (3) sales of annuities to suitable purchasers, (4) market conduct regulation, (5) rate regulation, and (6) risk classification and the ways in which personal information is used for insurance rating and coverage purposes.

What is the meaning of reinsurance?

Reinsurance is an arrangement by which the primary insurer that initially writes the insurance transfers to another insurer (called the reinsurer) part or all of the potential losses associated with such insurance.

Briefly explain the reasons for reinsurance

Reinsurance is used for several reasons: (1) To increase the company's underwriting capacity (2) To stabilize profits (3) To reduce the unearned premium reserve (4) To provide protection against a catastrophic loss

What is a replacement cost policy?

Replacement cost insurance means there is no deduction for depreciation in determining the amount paid for a loss.

Explain the following legal doctrines: Misrepresentation

Representations are statements made by the applicant for insurance. A misrepresentation is a statement that is material, false, and relied on by the insurer. A material misrepresentation allows the insurer to void the policy.

Briefly explain each of the following risk-control techniques for managing risk:

Risk control techniques refer to techniques that reduce the frequency or severity of losses. They include the following (1) Avoidance. This means a certain loss exposure is never acquired, or an existing loss exposure is abandoned. For example, a drug manufacturer can avoid lawsuits associated with a dangerous drug by not producing the drug. (2) Loss prevention. Certain activities are undertaken that reduce the frequency of a particular loss. One example of loss prevention is periodic inspection of steam boilers to prevent an explosion. (3) Loss reduction. This refers to measures that reduce the severity of a loss after it occurs. One example of loss reduction is an automatic sprinkler system in a department store that can reduce the severity of a fire loss. (4) Duplication. This technique refers to have back-up or duplicate copies of important documents or property in the event a loss occurs. (5) Diversification. This technique reduces the chance of loss by spreading the loss exposure across different parties. (6) Separation. The assets exposed to loss are separated or divided to minimize the financial loss from a single event.

Briefly explain each of the following risk-financing techniques for managing risk:

Risk financing refers to techniques that provide for the payment of losses after they occur. They include the following (1) Retention. This means that an individual or business firm retains part or all of the losses that can result from a given loss exposure. For example, a motorist may retain the first $500 of a physical damage loss to his or her automobile by purchasing an auto insurance collision policy with a $500 deductible. (2) Noninsurance transfers. This means that a risk is transferred to another party other than an insurance company. For example, the risk of a defective television set can be shifted or transferred to the retailer by the purchase of a service contract by which the retailer is responsible for all repairs after the warranty expires. (3) Insurance. An auto insurance policy can be purchased covering the negligent operation of an automobile.

Explain the meaning of "securitization of risk."

Securitization of risk means that an insurable risk is transferred to the capital markets through the creation of a financial instrument, such as a catastrophe bond, futures contract, options contract, or other financial instrument. These financial instruments are used as alternatives to traditional reinsurance

Describe the steps involved in the settlement of a claim

Several steps are involved in settling a claim: (a) Notice of loss must be given to the company. (b) The claim is investigated by the company. (c) A proof of loss may be required. (d) A decision is made concerning payment.

Explain the basic characteristics of social insurance programs.

Social insurance programs are government insurance programs with certain characteristics. The programs are enacted into law to deal with social and economic problems. The programs generally are compulsory and financed by contributions from covered employers and employees; benefits are paid from specifically earmarked funds; benefits are skewed or weighted in favor of lower income groups; benefit amounts generally are related to the covered individual's earnings; and eligibility requirements and benefit rights are prescribed by statute.

The needs approach is widely used for determining the amount of life insurance to purchase. Describe the following needs for a typical family head: Special needs

Special needs include a mortgage redemption fund, educational fund, and emergency fund.

Explain the principle of subrogation.

Subrogation is taking over another person's right to recover in a legal action against a negligent third party.

What are the major limitations of term insurance?

Term insurance has several limitations. Premiums increase with age, term insurance is not suitable for lifetime protection, and because term insurance does not accumulate cash values, it is inappropriate for retirement or saving purposes

Explain the situations that justify the purchase of term insurance.

Term insurance is appropriate when income is limited or a temporary need must be met. Term insurance can also be used to guarantee future insurability.

Briefly explain the basic characteristics of term insurance.

Term insurance provides temporary protection. Most term insurance policies are renewable and convertible to some stated age with no evidence of insurance. Term insurance policies do not accumulate cash values.

Briefly explain the significance of the following legal cases and legislative acts with respect to insurance regulation: Financial Modernization Act of 1999

The Financial Modernization Act of 1999 (also called the Gramm-Leach-Bliley Act) had a significant impact on insurance regulation. The legislation changed federal law that earlier prevented banks, insurers, and investment firms from competing fully in other financial markets outside their core area. As a result, insurers can now buy banks, banks can underwrite insurance and sell securities, brokerage firms can sell insurance, and a company that wants to provide insurance, banking, and investment services through a single entity can form a new holding company for that purpose.

Briefly explain the Linton yield as a method for determining the rate of return on the saving component of a cash-value policy.

The Linton yield is the average annual rate of return on a cash value policy if it is held for a specified number of years. It is based on the assumption that a cash value policy is a combination of insurance protection and a savings fund. To determine the average annual rate of return for a given period, that part of the annual premium that is deposited into the savings fund must be determined. This can be done by subtracting the cost of the insurance protection for that year from the annual premium (less any dividend). The balance of the premium is the amount that can be deposited into the savings fund. Thus, the average annual rate of return is the compound interest rate that is required to make the savings deposits equal the guaranteed cash value in the policy at the end of a specified period.

Briefly describe the following insurance company operations: Accounting

The accounting department is responsible for the financial accounting operations of an insurer. Accountants prepare financial statements, develop budgets, analyze the company's financial operations, and keep track of the millions of dollars that flow into and out of a typical company each year. Accountants also prepare state and federal income tax returns and file an annual convention statement for review by state regulatory officials.

What are the advantages and disadvantages of rein-stating a lapsed life insurance policy?

The advantages are lower premiums based on the insured's original age, acquisition expenses do not have to be paid a second time, cash values and dividends are higher, and the suicide and incontestable clause may have already expired. The major disadvantage is that a substantial cash outlay may be required because of the premiums and interest that must be paid. Also, reinstating an older policy may be more expensive because newer policies may have lower premiums; it may cost less to purchase a new policy even though the insured is older when the new purchase is made.

Who owns the policy expirations or the renewal rights to the business under the independent agency system?

The agency owns the expirations or renewal rights to the business. If a policy comes up for renewal, the agency can place the business with another insurer if it chooses to do so.

Annual increase in the cash value

The annual increase in a cash value policy is income-tax free. However, if the policy is surrendered for its cash value, any gain is taxable as ordinary income.

What types of assets appear on the balance sheet of an insurance company?

The assets of an insurance company are primarily financial assets. An insurance company invests premium dollars and retained earnings. These assets back the insurer's liabilities and help to generate investment income. Specific assets held include bonds, common stock, preferred stock, real estate, and mortgage-backed securities. Two additional asset categories for life insurance companies are life insurance policy loans and separate account assets.

How is the combined ratio of a property and casualty insurance company calculated, and what does the combined ratio measure?

The combined ratio is the sum of the loss ratio and the expense ratio. The loss ratio is calculated by dividing the sum of losses and loss adjustment expenses by premiums earned. The expense ratio is calculated by dividing underwriting expenses by premiums written.

Insurance contracts have certain legal characteristics that distinguish them from other contracts. Explain the following legal characteristics of insurance contracts: Conditional contract

The contract is conditional. In order to collect, a number of duties must be complied with, such as giving prompt notice of loss and submitting proof of loss.

The corporate structure of mutual insurers has changed over time. Briefly describe several trends that have had an impact on the corporate structure of mutual insurers

The corporate structure of mutual insurers has changed because of three major trends. First, there has been an increase in company mergers and acquisitions over time, which has reduced the number of active insurers. Second, many mutual insurers have converted to a stock form of ownership, which is called demutualization. Finally, because demutualization is slow, some insurers have formed holding companies. A holding company is a company that directly or indirectly controls an authorized insurer, such as a stock insurer.

Direct response system

The direct response system is a marketing system by which life and health insurance is sold directly to customers without the services of an agent. Insurers use Web sites, television, telephones, mail, and other mass media to market the insurance.

Direct response system

The direct response system refers to insurers that sell through the mail or other mass media, such as newspapers, magazines, radio, or television. No agents are used to sell the insurance.

Explain the financial impact of premature death on the different types of families in the United States.

The financial impact of premature death on the family varies by type of family. Premature death can cause considerable economic insecurity if a family head dies in a single-parent family; in a family with two income earners with children; or in a traditional, blended, or sandwiched family. In contrast, if a single person without dependents dies, or an income earner in a two-income family without children dies, financial problems for the survivors are generally lower.

Describe the suggestions that consumers should follow when life insurance is purchased.

The following rules should be followed when shopping for life insurance: (a) Determine whether you need life insurance (b) Estimate the amount of life insurance needed (c) Decide on the best type of insurance for you (d) Decide whether you want a policy that pays dividends (e) Shop around for a low-cost policy (f) Consider the financial strength of the insurer (g) Deal with a competent agent

What is the fundamental purpose of a coinsurance clause?

The fundamental purpose of coinsurance is to achieve equity in rating. Most property losses are partial and not total. If everyone insures only for the partial loss rather than the total loss, the premium rate for each $100 of insurance must be higher. This would be inequitable to the insured who wishes to insure his or her property to its full value. Thus, if the insured meets the coinsurance requirement he or she will receive a rate discount, and the person who is underinsured will be penalized through application of the coinsurance formula.

Grace period

The grace period allows the policyholder a period of 31 days to pay an overdue premium. Universal life and other flexible premium policies have a longer grace period, such as 61 days. The insurance remains in force during the grace period.

Describe the steps in determining the human life value of a family head.

The human life value can be measured by the following steps: (1) Estimate the individual's average annual earnings over his or her productive lifetime. (2) Deduct federal and estate income taxes, Social Security taxes, life and health insurance premiums, and the costs of self-maintenance. (3) Determine the number of years from the person's present age to the contemplated age of retirement. (4) Using a reasonable discount rate, determine the present value of the family's share of earnings for the period determined in Step (3).

Define human life value.

The human life value is defined as the present value of the family's share of the deceased breadwinner's earnings. This approach crudely measures the economic value of a human life.

Describe the incontestable clause in a life insurance policy.

The incontestable clause states that the company cannot contest the policy after it has been in force two years during the insured's lifetime.

Insurance contracts have certain legal characteristics that distinguish them from other contracts. Explain the following legal characteristics of insurance contracts: Aleatory contract

The insurance contract is aleatory. The values exchanged are not equal. If a loss occurs, the insured may recover an amount in excess of the premiums paid. In a commutative contract, theoretically, there is an equal exchange of values.

Insurance contracts have certain legal characteristics that distinguish them from other contracts. Explain the following legal characteristics of insurance contracts: Unilateral contract

The insurance contract is unilateral since only the insurer makes a legally binding promise. Most ordinary contracts are bilateral, and either party may be sued for breach of contract.

Explain why the insurance industry is regulated.

The insurance industry is regulated for the following reasons: (a) To maintain insurer solvency (b) To compensate for inadequate consumer knowledge (c) To ensure reasonable rates (d) To make insurance available

Why is the interest-adjusted cost method a more accurate measure of the cost of life insurance?

The interest-adjusted cost method is a more accurate cost method since the time value of money is taken into consideration by the application of an interest factor to each element of cost.

Explain the law of large numbers.

The law of large numbers states that the greater the number of exposures, the more closely the actual results will approach the probable results expected from an infinite number of exposures. As the number of exposures increases, the relative variation of actual loss from expected loss will decline. Thus, the insurer can predict future losses with a greater degree of accuracy as the number of exposures increases. This is important, since an actuary must charge a premium that is adequate for paying all losses and expenses during the policy period. The lower the degree of objective risk, the more confidence an insurer has that the actual premium charged will be sufficient to pay all claims and expenses and leave a margin for profit.

Does the insurer have to pay an otherwise covered loss if the insured fails to comply with the policy conditions? Explain your answer.

The legal significance is that if the policy conditions are not met by the insured, the insurer can refuse to pay the claim.

Briefly describe the following insurance company operations: Loss control

The loss control department is responsible for helping individuals and firms reduce the frequency and severity of losses. Loss-control services include advice on alarm systems, automatic sprinklers, fire prevention, occupational safety and health, reduction of occupational exposures, prevention of boiler explosions, and other loss-prevention activities. Also, the loss control department can provide valuable advice on the construction of a new building or plant to make it safer and more resistant to damage.

List the advantages and disadvantages of a policy loan.

The major advantage of a policy loan is the relatively low rate of interest paid as compared with interest on credit cards. Also, there is no credit check and the policyholder has complete financial flexibility in determining the amount and frequency of loan repayments. The major disadvantage is that the policyholder is not legally required to repay the loan, and the policy could lapse if the total indebtedness exceeds the available cash value. Also, the face amount of insurance is reduced if the insured dies with the loan outstanding.

Explain the major arguments in support of state regulation of the insurance industry.

The major advantages claimed for state regulation are as follows: (1) Quicker response to local insurance problems; Greater responsiveness to local needs (2) Increased costs from dual regulation Uniformity of laws by NAIC (3) Poor quality of federal regulation (4) Promotion of uniform laws by NAIC (5) Greater opportunity for innovation

What are the major categories of expenses for a life insurance company?

The major expenses for a life insurance company are benefits paid (death benefits, health benefits, annuity benefits, matured endowments, and policy surrenders), claims expenses, commissions, premium taxes, and general insurance expenses.

What are the major expenses of a property and casualty insurance company?

The major expenses for a property and casualty insurance company are loss payments, loss adjustment expenses, commissions, premiums taxes, and general expenses.

Identify the major fields of private insurance.

The major fields of private insurance are life insurance, health insurance, and property and liability insurance (also called property and casualty insurance).

Identify the major types of term insurance sold today.

The major types of term insurance are yearly renewable term, 5, 10, 15, or 20-year term, term to age 65, decreasing term, reentry term, and return-of-premium term.

Explain the basic defect in the traditional net cost method for determining the cost of life insurance.

The most glaring defect is that the traditional net cost method did not consider the time value of money. Interest that the policyholder could have earned on the premiums by investing them elsewhere was not considered. As a result, the true cost of insurance was understated.

What is the meaning of "named insured"?

The named insured is the person or persons named in the declarations section of the policy.

Why is the rate of return on the saving component in most cash-value policies negative during the early years of the policy?

The negative returns during the early years can be explained by the heavy first-year acquisition and administrative expenses incurred when the policy is first sold. In recognition of the first-year load, cash value policies generally have little or no cash value at the end of the first year, and the cash values are relatively low during the first few years of the policy.

Briefly describe the net payment cost index as a method for determining the cost of life insurance.

The net payment cost index is useful if the insured intends to keep the policy in force and cash values are of secondary importance. The net payment cost index measures the relative cost of a policy if death occurs at the end of some specified time period, such as 10 or 20 years. The net payment cost index is calculated in a manner similar to the surrender index except that the cash value is not subtracted.

How is actual cash value calculated?

The normal rule for determining actual cash value is replacement cost less depreciation. However, some courts have ruled that fair market value should be used to determine the actual cash value. Finally, some states use the broad evidence rule to determine the actual cash value. The broad evidence rule means that the determination of actual cash value should include all relevant factors an expert would use to determine the value of the property.

Suicide clause

The suicide clause states that if the insured commits suicide within two years after the policy is issued, the face amount of insurance is not paid. There is only a refund of the premiums paid.

The states require life insurers to disclose certain policy information to applicants for life insurance. Describe the types of information that appear on a typical dis-closure statement.

The policy illustration contains a narrative summary that describes the basic characteristics of the policy, the elements of the policy that are not guaranteed, federal tax guidelines, and interest-adjusted cost data. The policy illustration also has a numeric summary that shows the premium outlay, value of the accumulation account, cash surrender values, and the death benefit. Three policy values must be provided based on (1) the current interest rate credited to the policy, (2) the guaranteed minimum interest rate under the policy, and (3) midpoint interest. The illustration also shows the number of years the insurance protection will remain in force under the three sets of interest assumptions.

Describe the policy loan provision that appears in a typical cash-value life insurance policy.

The policy loan provision allows the policyholder to borrow the cash value at a specified rate of interest stated in the policy. If the insured dies with the loan outstanding, the face amount of insurance is reduced.

Can other parties be insured under a policy even though they are not specifically named? Explain your answer.

The policy may cover additional insureds even though they are not specifically named in the policy. For example, in addition to the named insured, the homeowners policy also covers other persons under age 21 who are in the care of the named insured or in the care of a household resident who is a relative. Examples are a foster child, a ward of the court, or a foreign exchange student.

Life income options

The policy proceeds can be paid under a life income option. The major life income options are life income only with no-refund feature, life income with guaranteed period, life income with guaranteed total amount, and joint-and-survivor income option.

Why is interest charged on a policy loan?

The policyholder must pay interest on the loan to offset the loss of interest income to the insurer. If the loan had not been granted, the insurer could have earned interest on the funds.

Explain the meaning of primary insurance and excess insurance.

The primary insurer pays first, and the excess insurer pays only after the policy limits under the primary policy are exhausted. No more than 100 percent of the loss is paid. Thus, profiting from insurance by duplicate payment of benefits is avoided.

Identify the principal areas of insurance company operations that are regulated by the states.

The principal areas that are regulated include the following: (a) Formation and licensing of insurers (b) Solvency regulation (c) Rate regulation (d) Policy forms (e) Sales practices and consumer protection

Explain the principle of indemnity

The principle of indemnity states that the insurer agrees to pay no more than the actual amount of the loss; stated differently, the insured should not profit from a loss.

Explain the meaning of an insurable interest.

The principle of insurable interest means that the insured must stand to lose financially if a loss occurs.

Explain the economic justification for the purchase of life insurance.

The purchase of life insurance can be economically justified if a person has an earning capacity, and someone is dependent on those earnings for part or all of their financial support.

Briefly describe the following methods for determining a class rate: pure premium method

The pure premium is that portion of the gross rate needed to pay losses and loss-adjustment expenses. The pure premium can be determined by dividing the dollar amount of incurred losses and loss-adjustment expenses by the number of exposure units. A loading for expenses is then added to the pure premium to determine the gross premium.

What is the purpose of the incontestable clause?

The purpose of the incontestable clause is to protect the beneficiary from financial hardship if the company tries to deny payment of the claim on the grounds of material misrepresentation or concealment years after the policy was first issued

What are the major regulatory objectives that must be satisfied in insurance rate making?

The rates charged by insurers must meet certain regulatory objectives: they must be adequate, not excessive, and not unfairly discriminatory.

What are the major business objectives?

The rating system must also meet certain business objectives: rates should be easy to understand, stable, responsive, and encourage loss prevention.

Reinstatement clause

The reinstatement clause allows the policyholder to reinstate a lapsed policy. Certain requirements must be fulfilled

Briefly describe the surrender cost index as a method for determining the cost of life insurance.

The surrender cost index is based on the assumption that the insured will surrender the policy at the end of some time period. Under this method, the annual premiums and dividends are accumulated at 5 percent interest. The cash value at the end of the period is then subtracted from the net premiums, which results in an interest-adjusted cost for the time period under consideration. The final step is to convert the interest-adjusted cost for the entire period into an annual cost. This is done by dividing the interest-adjusted cost by the annuity due factor of $34.719, which is the amount to which $1 deposited annually will accumulate to in 20 years at 5 percent.

What are the three major sections of a balance sheet?

The three major sections of a balance sheet are the assets, liabilities, and owners' equity. Assets are items of value that the company owns. Liabilities are what the business owes. Owners' equity (called policyholders' surplus) is the difference between the assets and the liabilities. Owners' equity is the amount that would remain if a company paid off all of its liabilities using its assets. Owners' equity is not observed directly, and is the "balancing" item on the balance sheet.

What are the two major sources of revenue for a property and casualty insurance company?

The two major sources of revenue for a property and casualty insurance company are the premiums that it earns for providing insurance coverage and investment income generated from its portfolio of invested assets

Briefly explain the yearly rate-of-return method that policyholders can use to determine the rate of return on the saving component of a cash-value policy.

The yearly rate of return is based on a formula developed by Joseph M. Belth (see text for formula). Based on assumed benchmark prices per $1000 of protection for the various ages, the yearly rate of return on the saving component in a cash value policy can be calculated.

Identify the costs associated with premature death.

There are at least four costs associated with premature death. There is the loss of the human life value; additional expenses may be incurred; because of insufficient income, some families may experience a reduction in their standard of living; and noneconomic costs are incurred, such as the emotional grief of surviving dependents.

Briefly explain the basic principles of underwriting.

There are several important underwriting principles: (1) Attaining an underwriting project (2) Selecting insureds according to the company's underwriting standards (3) Providing equity among policyholders

Pure risks ideally should have certain characteristics to be insurable by private insurers. List the six characteristics of an ideally insurable risk.

There are several requirements of an ideally insurable risk: (a) There must be a large number of exposure units. (b) The loss must be accidental and unintentional. (c) The loss must be determinable and measurable. (d) The loss should not be catastrophic. (e) The chance of loss must be calculable. (f) The premium must be economically feasible.

List the various dividend options in a typical life insurance policy.

There are several ways in which dividends can be taken: (1) cash, (2) reduction of premiums, (3) accumulate at interest, (4) paid-up additions, and (5) term insurance in some policies.

Identify the basic parts of an insurance contract.

There are six basic parts to an insurance contract: (a) Declarations (b) Definitions (c) Insuring agreement (d) Exclusions (e) Conditions (f) Miscellaneous provisions

How does variable universal life insurance differ from a typical universal life insurance policy?

There are two major differences. First, under a variable universal life policy, the policyholder can invest the cash values in a wide variety of investments; a universal life policy does not have this feature. Second, there is no minimum guaranteed interest rate on the cash values; a universal life policy has a guaranteed minimum interest rate.

Explain the historical definition of risk.

There is no single definition of risk. Historically, many insurance authors have defined risk in terms of uncertainty. Risk is uncertainty concerning the occurrence of a loss.

Why are most market risks, financial risks, production risks, and political risks considered difficult to insure by private insurers?

These risks are generally uninsurable for several reasons. First, many of these risks are speculative risks, which are difficult to insure privately. Second, the potential for a catastrophic loss is great; this is particularly true for political risks, such as the risk of war. Finally, calculation of the correct premium may be difficult because the chance of loss cannot be accurately estimated.

Direct writer

This term is used in two ways. First, a direct writer refers to a company in which the salesperson is an employee of the insurer and is not an independent agent. Employees of direct writers are usually compensated on the basis of a salary plus a bonus or commission that is related to the amount of insurance sold. Second, the term "direct writer" also refers to companies who use the exclusive agency system to sell property and casualty insurance.

Explain the principal methods for regulating insurance companies.

Three principal methods are used to regulate the insurance industry: (a) Legislation (b) Courts (c) State insurance department

Identify the major techniques that regulators use to monitor insurance company solvency.

To ensure solvency, insurers must meet certain risk-based capital requirements based on the riskiness of their investments and insurance operations. Insurers are also periodically examined by insurance examiners, annual financial statements must be submitted, and there are restrictions on the types of investments that insurers can purchase.

Explain the requirements for reinstating a lapsed life insurance policy.

To reinstate a lapsed policy, the following requirements must be met: (1) Evidence of insurability must be furnished. (2) All overdue premiums plus interest must be paid from their respective due dates. (3) All policy loans must be repaid or reinstated through payment of past-due interest. (4) The policy must not have been surrendered for its cash value. (5) The policy must be reinstated within three or five years.

Briefly explain the significance of the following legal cases and legislative acts with respect to insurance regulation: McCarran-Ferguson Act

To resolve the confusion and doubt that existed after the South-Eastern Underwriters decision, Congress passed the McCarran-Ferguson Act (Public Law 15) in 1945. The McCarran Act states that continued regulation and taxation of the insurance industry by the states are in the public interest and that federal antitrust laws apply to insurance only to the extent that the insurance industry is not regulated by state law.

Explain the following actions by agents that are prohibited by state law: Twisting

Twisting is the inducement of a policyholder to drop an existing policy in another company because of misrepresentation or incomplete information by the agent. Twisting laws apply primarily to life insurance policies. The objective is to prevent policyholders from being financially harmed by replacing one life insurance policy with another.

Collateral assignment

Under a collateral assignment, the policyholder assigns a cash value policy to a creditor as collateral for the loan. Under this type of assignment, only certain rights are transferred to the creditor to protect its interest, and the policyholder retains the remaining rights.

Briefly describe the major types of rating laws. File and Sue Law

Under a file-and-use law, insurers are only required to file the rates with the state insurance department, and the rates can be used immediately.

Briefly describe the major types of rating laws. Flexi Rating Law

Under a flex-rating law, prior approval of rates is required only if the rate increase or decrease exceeds a specific predetermined range

Briefly describe the major types of rating laws. Modified-Prior Approval Law

Under a modified prior-approval law, if the rate change is based solely on loss experience, the insurer must file the rates with the state insurance department, and the rates can be used immediately (i.e., file and use). However, if the rate change is based on a change in rate classifications or expense relationships, then prior approval of the rates is necessary (i.e., prior approval).

Briefly explain the following types of reinsurance methods for sharing losses: Quota-share treaty

Under a quota-share treaty, the ceding insurer and reinsurer agree to share premiums and losses based on some agreed-on percentages. The ceding insurer's retention limit is stated as a percentage rather than as a dollar amount. Premiums are also shared based on the same agreed-on percentages. However, the reinsurer pays a ceding commission to the primary insurer to help compensate for the expenses incurred in writing the business.

Briefly explain the following types of reinsurance methods for sharing losses: Surplus-share treaty

Under a surplus-share treaty, the reinsurer agrees to accept insurance in excess of the primary insurer's retention limit, up to some maximum amount. The primary insurer and reinsurer then share premiums and losses based on the fraction of total insurance retained by each party. Premiums are also shared based on the fraction of total insurance retained by each party. However, the reinsurer pays a ceding commission to the primary insurer to help compensate for the acquisition expenses incurred in acquiring the business.

Absolute assignment

Under an absolute assignment, all ownership rights in the policy are transferred to a new owner. For example, the policyholder may wish to donate a life insurance policy to a church by an absolute assignment; the church is the new owner of the policy.

Briefly describe the major types of rating laws. Prior Approval Law

Under prior-approval law, the rates must be filed and approved by the state insurance department before they can be used. In most states, if the rates are not disapproved within a certain period, such as 30 or 60 days, they are deemed to be approved

Exclusive agency system

Under the exclusive agency system, the agent represents only one company or group of companies under common ownership. Agents under the exclusive agency system do not usually own the expirations or renewal rights to the policies.

Extended term insurance

Under the extended term insurance option, the net cash surrender value is used as a net single premium to extend the full face amount of the policy (less any indebtedness) into the future for a certain number of years and days. In effect, the cash value is used to purchase a paid-up term insurance policy equal to the original face amount (less any indebtedness) for a limited period.

Fixed-amount option

Under the fixed-amount (income of elected amount) option, a fixed amount is periodically paid to the beneficiary. The payments are made until both principal and interest are exhausted.

Fixed-period option

Under the fixed-period (income for elected period) option, the policy proceeds are paid to a beneficiary over some fixed period of time. Both principal and interest are systematically liquidated under this option.

Independent agency system

Under the independent agency system, the agent is an independent businessperson who represents several companies. The agent is authorized to write business on behalf of these companies, and in turn is paid a commission based on the amount of business produced. In addition, the agency owns the expirations or renewal rights to the business. Finally, the independent agent is compensated solely by commissions that vary by line of insurance.

Interest option

Under the interest option, the policy proceeds are retained by the insurer, and interest is paid periodically to the beneficiary. Insurers typically guarantee a minimum interest rate on the policy proceeds retained under the interest option.

Why does an ordinary life insurance policy develop a legal reserve?

Under the level-premium method, the insured pays more for the insurance protection in the early years than is actuarially needed. The redundant or excess premiums are invested and used to supplement the inadequate premiums that are being paid in the later years of the policy. In recognition of the fact that the redundant premiums paid in the early years will be needed later, the policy develops a legal reserve. As the legal reserve increases, the net amount at risk declines. Thus, lifetime protection is possible.

Briefly describe the following methods for determining a class rate: loss ratio method

Under the loss ratio method, the actual loss ratio is compared to the expected loss ratio, and the rate is adjusted accordingly. The actual loss ratio is the ratio of incurred losses and loss-adjustment expenses to earned premiums. The expected loss ratio is the percentage of the premium that is expected to be used to pay losses.

Reduced paid-up insurance

Under the reduced paid-up option, the cash surrender value is applied as a net single premium to purchase a reduced paid-up policy. The reduced paid-up policy is the same as the original policy, but the face amount is reduced.

Explain the limitations of universal life insurance

Universal life insurance has several limitations. The rates of return advertised are gross rates and not net rates and do not reflect the true rate of return on the saving component. In addition, the attractiveness of universal life to consumers may decline as interest rates decline. The insurer also has the right to increase the mortality charge to the maximum permitted under the policy. Finally, because of the flexibility in paying premiums, some policyholders do not have a firm commitment to pay premiums.

Explain the basic characteristics of universal life policies.

Universal life insurance is another form of whole life insurance. Universal life insurance has the following features: (1) Unbundling of protection, savings, and expense components (2) Two forms of universal life available (3) Relatively higher investment returns (4) Considerable flexibility (5) Cash withdrawals permitted (6) Favorable income tax treatment

Describe the basic characteristics of variable life insurance.

Variable life insurance is a policy in which the death benefit and cash surrender value vary according to the investment experience of a separate account maintained by the insurer. The entire reserve is held in a separate account and is invested in equities or other investments. The cash surrender values are not guaranteed.

What is a variable universal life insurance policy?

Variable universal life insurance allows the policyholder to invest the premiums in a wide variety of investments, such as stock funds, bond funds, or money market funds. There is no minimum guaranteed rate of interest on the cash values, and the cash values are not guaranteed. In addition, the policy has relatively high expense charges and a substantial investment risk.

Waiver

Waiver is defined as the voluntary relinquishment of a known legal right. The insurer voluntarily waives a legal right under the contract, and in so doing cannot later deny payment of a claim by the insured.

Describe the following types of deductibles: straight deductible

With a straight deductible, the insured must pay a certain number of dollars before the insurer is required to make a loss payment. Such a deductible applies typically to each loss.

Define physical hazard

a physical condition that increases the chance of loss.

Explain the general rules of agency that govern the actions of agents and their relationship to insureds

a) There is no presumption of agency. There must be evidence sufficient to establish that a person has authorized someone to act on his or her behalf. (b) The agent must have authority to bind the principal. There are three sources of such authority: (1) Expressed authority (2) Implied authority (3) Apparent authority (c) The principal is responsible for acts of an agent who is acting within the scope of his or her authority. Accordingly, the principal can be bound by contracts that the agent has entered into and is also liable for the agent's torts.

What is a loss exposure?

any situation or circumstance in which a loss is possible, regardless of whether a loss occurs.

Define chance of loss.

can be defined as the probability that an event will occur.

attitudinal hazard

carelessness or indifference to a loss.

legal hazard

characteristics of the legal system or regulatory environment that increase the frequency or severity of losses.

What is enterprise risk management?

combines into a single unified treatment program all major risks faced by the firm. These risks include pure risk, speculative risk, strategic risk, operational risk, and financial risk.

How does enterprise risk management differ from traditional risk management?

considered only major and minor pure risks faced by a corporation. Enterprise risk management considers all risks faced by a corporation as described in (a) above.

moral hazard

dishonesty or character defects in an individual that increase the chance of loss.

In the context of rate making, explain the meaning of: pure premium

refers to the portion of the rate that is needed to pay losses and loss adjustment expenses.