3. Insurance Company Organization

What is the definition of a fiduciary? A) A person in a position of trust and confidence who handles the affairs and funds of others. B) A person who determines policy rates at an insurance company. C) An institution that handles trust accounts for the wealthy. D) An insurance agent who sells policies worth more than $1 million in death benefits.

Answer: A A fiduciary is a person in a position of special trust and confidence charged with handling or supervising the affairs or funds of another.

In general, insurance regulators require insurance rates to be adequate, not excessive, and not unfairly discriminatory. The best reason for such regulation is to keep rates: A) stable over short periods of time. B) responsive to changing economic conditions. C) adequate enough to assure company profits. D) high enough to cover loss costs.

Answer: D Insurance rates are regulated by the states. Although insurers are seeking profitability, certain regulatory requirements must also be satisfied. Rates should be high enough to cover losses yet not excessive nor unfairly discriminatory. Loss costs are the portion of an insurance rate used to cover claims and the costs of adjusting claims. Insurance companies typically determine their rates by estimating their future loss costs (pure premium) and adding a provision (loading) for expenses, profit, and contingencies.

The goal of underwriting is to produce a profitable volume of business by following all of the following underwriting principles EXCEPT: A) selecting insureds according to the company's underwriting standards. B) balancing insureds within each rate classification. C) charging equitable rates among each group of insureds. D) reviewing available sources of underwriting information.

Answer: D Reviewing sources of underwriting information, such as the application, agent's report, inspection report, and a physical inspection of the property, is a step in the underwriting process. Basic underwriting principals include properly selecting the insured, balancing below-average and above-average insureds to assure that the class or manual rate of the whole group will be adequate to pay claims, and charging equitable rates so that one group of insureds does not unfairly subsidize another group.

According to the law of agency, which of the following statements is NOT correct? A) Knowledge of the principal is knowledge of the agent. B) The acts of an agent are the acts of the principal. C) A contract completed by the agent on behalf of the principal is a contract of the principal. D) Payments made to an agent intended for the principal are payments made to the principal.

Answer: A A fundamental rule of the law of agency states that information known to the agent is also known by the principal as long as the agency relationship exists. Information known to the principal, however, is not assumed to be known to the agent.

John and Gina met with their insurance agent who asked a series of questions that identified what they owned, what coverage they needed, how much money they wanted to spend on this coverage, and all possible sources of paying for this coverage. What analysis is the insurance agent completing? A) Needs. B) Risk transference. C) Hazard. D) Loss.

Answer: A A needs analysis is necessary to identify the family exposures and insurance needs and estimate and find the funds necessary to pay for those needs. Without a proper needs analysis John and Gina may spend their insurance dollars unwisely.

ABC Auto Club offers car insurance to its members. ABC Auto Club is an example of which of the following types of organization? A) Reciprocal insurer. B) Stock company. C) Mutual company. D) Risk retention group.

Answer: A A reciprocal insurer is an unincorporated group of people who provide insurance to each other. To purchase the insurance products that reciprocals offer, individuals or organizations must be members of the group.

Which term correctly describes an insurance company that has been organized outside the United States or its possessions? A) Alien. B) Foreign. C) Remote. D) Domestic.

Answer: A An alien company is one that is incorporated or organized under the laws of any foreign nation, province, or territory.

Which of the following types of insurance plans does a private insurance company NOT insure? A) FAIR plans. B) Industrial policies. C) Blanket policies. D) Group policies.

Answer: A FAIR plans are governed by the state to help provide economic security against property losses. Without this coverage provided or administered by government insurers, the well-being of large groups of persons in our society would suffer.

In the past, XYZ Insurance Company has allowed agents to bind coverage for auto insurance applicants. The authority given to the agents by XYZ can be called: A) implied authority. B) express authority. C) apparent authority. D) traditional authority.

Answer: A Implied authority may be established by custom or prior experience. XYZ Insurance Company has allowed agents to bind coverage in the past, and agents currently believe that they have the authority to bind coverage based on the past. The authority is implied.

Guides to insurance companies' financial integrity and claims-paying ability are published regularly by rating services. All of the following are rating services EXCEPT: A) Lloyd's. B) AM Best. C) Standard & Poor's. D) Fitch's.

Answer: A Lloyd's of London is an organization of individuals or groups who agree to share in insurance contracts. Moody's is another rating service. AM Best, for example, rates companies from Superior to Suspended, and recommends that consumers buy insurance from companies rated Superior to Excellent.

Which of the following is NOT a principal form of reinsurance? A) Generic. B) Facultative. C) Automatic. D) Treaty.

Answer: A Reinsurance is insurance purchased by insurance companies. Specific or facultative reinsurance is optional to both the insurer and the reinsurer. Treaty or automatic reinsurance exists when the insurer agrees to offer a risk to a reinsurer and the reinsurer agrees to accept that risk.

Which of the following statements pertaining to insurance companies is CORRECT? A) The primary purpose of a stock company is to earn a profit for its stockholders. B) A stock company is owned by its policyholders. C) Both mutual and stock companies have stockholders. D) Mutual insurance companies sell insurance to insurers.

Answer: A Stock companies are owned by stockholders, not policyowners, and they are organized for the purpose of making a profit for their stockholders.

The McCarran-Ferguson Act is responsible for: A) enacting legislations that stated the federal government had the right to regulate insurance if the state does not. B) requiring written consent before personal information can be released. C) requiring fair and accurate reporting of information about consumers including applicants for insurance. D) prohibiting the use of sex discrimination in the pricing of insurance.

Answer: A The McCarran-Ferguson Act specifies that continued state regulation of the insurance industry is in the public's best interest. However, the act states the federal government has the right to regulate the business of insurance when state law does not. This act led each state to revise its insurance laws to conform to the federal law, and helped eliminate conflicts between state and federal law. Today, the insurance industry is considered state regulated because of this law.

Twisting is a form of: A) misrepresentation. B) coercion. C) defamation. D) rebating.

Answer: A Twisting is the illegal act of inducing a policyholder, through misrepresentation, to cancel, lapse, forfeit, or surrender an existing policy in order to purchase a similar policy from the selling agent. It may also involve the material change of a policy through misrepresentation. In any case, the cancellation or change is not warranted.

Under contract law, what is the insurance company represented by the agent called? A) Principal. B) Reciprocal. C) Fraternal. D) Authority.

Answer: A Under contract law, the insurance company represented by the agent is considered the principal, and the actions of the agent are considered actions of the principal.

An insurer wants to increase its rates, but the Department of Insurance requires that all rates be filed and approved before they can be used. This best describes which kind of rate regulation? A) Prior approval. B) Mandatory. C) File and use. D) Approval.

Answer: A Under prior approval laws, insurance companies must file their rates with the state insurance department and await state approval before using these rates.

If an insurance company is organized in Detroit, where it maintains its home office, the company is classified in Michigan as what kind of company? A) Preferred. B) Domestic. C) Local. D) Foreign.

Answer: B A domestic insurer is incorporated in the same state where it sells insurance.

An insurance company that sells insurance only to people who meet specific membership requirements is known as what kind of insurance company? A) Stock. B) Fraternal. C) Mutual. D) Reciprocal exchange.

Answer: B A fraternal insurance company, or fraternal benefit society, provides limited insurance benefits to its members, usually restricted to life and health insurance. These organizations are formed to cover members of affiliated lodges, religious and social organizations, and similar groups. Fraternals may not be regulated as strictly as insurance companies that offer coverage to the general public.

Which type of authority does an insurer give to its agents by means of the agent's contract? A) General. B) Express. C) Implied. D) Fiduciary.

Answer: B Express authority is what the insurer intends to give to its agent through means of the agent's contract. This authority explicitly appoints the agent to act on behalf of the insurer.

A contract in which one insurer cedes all or part of a risk to another insurer is known as: A) a participating policy. B) reinsurance. C) assuming insurance. D) retro insurance.

Answer: B In a reinsurance contract, an insurer protects itself from loss or liability arising from an original contract of insurance by insuring itself through another insurer. Reinsurance is the spreading or sharing of a risk too large for one insurer by ceding part of the risk to another company or reinsurer

All of the following are characteristics of a Lloyd's association EXCEPT: A) it shares in insurance contracts. B) it is available only for groups of individuals. C) it is not an insurance company. D) it is a voluntary association.

Answer: B Lloyd's of London is an organization of individuals or groups of individuals who agree to share in insurance contracts. All individuals or groups are responsible for the amount of coverage they write.

Each of the following is a characteristic of a risk retention group EXCEPT: A) the group must be licensed by at least 1 state. B) the policyholders must be involved in diverse businesses or activities. C) it is owned by its policyholders. D) the group provides only liability insurance.

Answer: B Risk retention group members must possess similar liability risks engaged in similar businesses or activities. A risk retention group is an alternative for businesses and individuals to secure much needed insurance coverage.

Which one of the following is NOT an agent responsibility? A) Collecting the initial premium. B) Prepaying the initial premium. C) Explaining the coverage. D) Delivering the policy.

Answer: B The agent has no responsibility to pay a client's premium, in advance or at any other time.

Ralph asks his insurance agent to explain how the homeowners policy covers stolen jewelry. The agent spends some time explaining how, when, where, and what jewelry theft coverage exists in the policy. As a result, Ralph believes that his $5,000 watch is covered in full under the basic policy. After the watch is stolen, Ralph is surprised to learn that he has only limited coverage. What legal doctrine might Ralph rely upon to get full coverage for his loss? A) Adhesion. B) Reasonable expectation. C) Utmost good faith. D) Estoppel.

Answer: B The doctrine of reasonable expectation states that the insured should recover what a reasonable person would expect to recover under similar circumstances. Ralph's agent overstated the coverage and gave Ralph a false sense of what was covered.

In an insurance transaction, who does a licensed agent legally represent? A) National Association of Insurance Commissioners. B) Insurer. C) Applicant. D) State insurance department.

Answer: B Under the law of agency, agents represent insurers.

What kind of insurance company is an insurance company owned by its policyowners? A) Parent. B) Domestic. C) Mutual. D) Stock.

Answer: C A mutual insurance company is owned by its policyowners, from whom its resources are derived. Its assets and income are held for the benefit of the policyowners who, as contractual creditors, have the right to vote for directors or trustees.

Which of the following insurance carriers is a typical nonadmitted insurance company? A) Reciprocal. B) Foreign. C) Surplus lines. D) Fraternal.

Answer: C A nonadmitted, or unauthorized, insurance company has not been authorized to transact insurance business in a particular state. A surplus lines broker is used to obtain insurance when authorized, or admitted, insurance companies cannot provide the coverage. The authorized company is licensed to conduct business in the state.

The agent has many responsibilities to the applicant. One involves a trust relationship between the agent and the insured regarding the insured's finances and confidentiality. In this case the agent acts in what capacity? A) Consultant. B) Attorney-in-fact. C) Fiduciary. D) Special agent.

Answer: C Agents have the duty to act in a fiduciary capacity that requires a high degree of trust and confidence. This duty deals with the agent's dealings with both the insured and the insurer. The agent is expected to be trustworthy, act in good faith, and preserve confidential information.

An agent in the XYZ Insurance Company, equipped with business cards, sample XYZ policies, and an XYZ rate book, informs a prospect that XYZ has given him unlimited binding authority. The prospect assumes this is true. Given the prospect's assumption, which of the following correctly defines the agent's authority in this case? A) Implied. B) Binding. C) Apparent. D) Express.

Answer: C Apparent authority is what a third party (such as a member of the public) assumes an agent has, based on the actions or words of the principal. By supplying the agent with business cards, sample policies, and rate books, the insurance company has given the impression that it supports the words and actions of its agent.

An insurance company may measure its underwriting profitability by using which of the following ratios? A) Investment ratio. B) Return on equity ratio. C) Loss ratio. D) Capacity ratio.

Answer: C The loss ratio is the ratio of the annual claims paid by an insurance company to the premiums received. The numerator (losses) can be losses incurred or losses paid, and the denominator (premium) can be earned premiums or written premiums, depending on what use is going to be made of the loss ratio. The lower the ratio the better. Higher loss ratios may indicate a need for better risk management policies to guard against future large possible insurance payouts.

A person who stands in a special relationship of trust to another person is a (an): A) surety. B) bailee. C) obligee. D) fiduciary.

Answer: D A fiduciary is a person who occupies a position of special trust and confidence, as in handling or supervising the affairs or funds of another. Producers have fiduciary duties toward their clients.

What is the term for an individual who occupies a position of trust when handling the financial affairs of another? A) Trustee. B) Superior. C) Consultant. D) Fiduciary.

Answer: D A fiduciary is an individual occupying a position of trust and confidence when handling or supervising the funds or the affairs of another. A trustee is a person appointed or required by law to execute a trust to the benefit or use of another

An insurance company organized in Pennsylvania, with its home office in Philadelphia, is licensed to conduct business in New York. In New York, this company is classified as a(n) A) domestic company. B) alien company. C) regional company. D) foreign company.

Answer: D A foreign company operates within a state in which it is not chartered and in which its home office is not located.

A group of individuals who agree to share each others' losses is known as a: A) mixed group. B) reinsurer. C) service organization. D) reciprocal exchange.

Answer: D A reciprocal exchange is an unincorporated mutual organized for the mutual protection of its members.

What is an insurer of an insurer known as a: A) Mixed group. B) Reciprocal. C) Service organization. D) Reinsurer.

Answer: D A reinsurer insures part of the insurance underwritten by another insurance company to reduce the possible large loss of the latter.

Agents have certain responsibilities when dealing with applicants and insureds. All of the following are agent responsibilities EXCEPT: A) conducting a needs analysis. B) explaining coverage. C) leaving a Notice to the Applicant with the insured. D) collecting the commission from the applicant.

Answer: D Collecting the premium is a fiduciary responsibility of the insured, but the applicant does not pay the commission directly to the agent.

State Insurance Company has agents who are under a contract that allows them to sell only State Insurance Company policies. Which distribution system describes State Insurance Company's organization? A) Independent. B) Direct. C) Group. D) Exclusive.

Answer: D The exclusive agency system is one where the agent normally represents only one company. The insurer owns policies sold by exclusive agents.