Chapter 1 basic insurance concepts and principles

The protection of the insurer from adverse selection is provided in part by 1 A reduction in coverage. 2 A drop in applicants. 3 A profitable distribution of exposures. 4 Reducing costs.

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

All of the following are insurable events as defined in the Insurance Code EXCEPT 1 An insured is sued for libel and slander. 2 A guest trips and breaks his leg in the insured's house. 3 An insured loses a large sum in a poker game. 4 An insured goes to the hospital for a broken arm.

An insured loses a large sum in a poker game- Any event, whether past or future, which may damnify a person having an insurable interest, or create a liability against him/her, may be insured against. Speculative losses are uninsurable.

Which of the following is considered to be a morale hazard? 1 Driving recklessly 2 Working as a firefighter 3 Engaging in illegal activities 4 Smoking

Driving recklessly- Morale hazards arise from a state of mind that causes indifference to loss, such as carelessness.

Which insurance principle states that if a policy allows for greater compensation than the financial loss incurred, the insured may only receive benefits for the amount lost? 1 Indemnity 2 Consideration 3 Reasonable expectations 4 Stop-loss

Indemnity- The principle of indemnity stipulates that the insured can only collect for the amount of the loss even if the policy is written with greater benefit limits.

A contract which one party undertakes to indemnify another against loss is called 1 Risk. 2 Insurance. 3 Adverse Selection. 4 Indemnity.

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

What do individuals use to transfer their risk of loss to a larger group? 1 Insurance 2 Insurable interest 3 Indemnity 4 Exposure

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

All of the following actions by a person could be described as risk avoidance EXCEPT 1 Not driving after being in an accident. 2 Never flying in an airplane. 3 Refusing to scuba dive. 4 Investing in the stock market.

Investing in the stock market- Reasoning Investing in the stock market is not an example of risk avoidance; it creates a possibility of a loss.

A person who does not lock the doors or does not repair leaks shows an indifferent attitude. This person presents what type of hazard? 1 Morale 2 Legal 3 Physical 4 Moral

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

The causes of loss insured against in an insurance policy are known as 1 Perils 2 Risks 3 Losses 4 Hazards

Perils- Perils are the causes of loss insured against in an insurance policy.

Which of the following individuals must have insurable interest in the insured? 1 Policyowner 2 Underwriter 3 Producer 4 Beneficiary

Policyowner- The policyowner must have an insurable interest in the insured (or in their own life if the policyowner is also the insured), in the life of a family member, or a business partner.

To achieve the profitable distribution of exposures, 1 The most coverage goes to average risks and preferred risks, while less goes to poor risks. 2 Preferred risks and poor risks are balanced, with average risks in the middle. 3 A majority of coverage goes to preferred risks. 4 Poor risks and average risks make up the majority of coverage.

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

Which of the following is the most common way to transfer risk? 1 Lessen the possibility of loss 2 Purchase insurance 3 Increase control of claims 4 Name a beneficiary

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

The risk of loss may be classified as 1 Pure risk and speculative risk. 2 Named risk and un-named risk. 3 High risk and low risk. 4 Certain risk and uncertain risk.

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

Events in which a person has both the chance of winning or losing are classified as 1 Pure risk. 2 Speculative risk. 3 Insurable. 4 Retained risk.

Speculative risk- speculative risk involves the chance of gain or loss and is not insurable.

Peril is most easily defined as 1 An unhealthy attitude about safety. 2 Something that increases the chance of loss. 3 The chance of a loss occurring. 4 The cause of loss insured against.

The cause of loss insured against- Reasoning Perils are the causes of loss insured against in an insurance policy.

Not all losses are insurable, and there are certain requirements that must be met before a risk is a proper subject for insurance. These requirements include all of the following EXCEPT 1 There must be a sufficient number of homogeneous exposure units to make losses reasonably predictable. 2 The loss must not be catastrophic 3 The loss produced by the risk must be definite. 4 The loss may be intentional.

The loss may be intentional- To insure intentional losses would be against public policy.

For the purpose of insurance, risk is defined as 1 The uncertainty or chance of loss. 2 The certainty of loss. 3 The cause of loss. 4 An event that increases the amount of loss.

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

Which of the following is NOT a goal of risk retention? 1 To fund losses that cannot be insured 2 To minimize the insured's level of liability in the event of loss 3 To reduce expenses and improve cash flow 4 To increase control of claim reserving and claims settlements

To minimize the insured's level of liability in the event of loss- Retention usually results from three basic desires of the insured: to reduce expenses and improve cash flow, to increase control of claim reserving and claims settlements, and to fund losses that cannot be insured.

The insurer must be able to rely on the statements in the application, and the insured must be able to rely on the insurer to pay valid claims. In the forming of an insurance contract, this is referred to as 1 Reasonable expectations. 2 Implied warranty. 3 Utmost good faith. 4 A warranty.

Utmost good faith- The insurer must be able to rely on the statements given by the insured in the application. The insured must be able to rely on the insurer's promise to pay covered losses.

The risk management technique that is used to prevent a specific loss by not exposing oneself to that activity is called 1 Reduction. 2 Transfer. 3 Avoidance. 4 Sharing.

avoidence- Risk avoidance is elimination of risk of loss by avoiding any exposure to an event that could give rise to such loss.

Which of the following statements is NOT true concerning insurable interest as it applies to life insurance? 1 A debtor has an insurable interest in the life of a lender. 2 A married person has an insurable interest in their spouse. 3 An individual has an insurable interest in their own life. 4 Business partners have an insurable interest in each other.

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

Which of the following statements is NOT true concerning insurable interest as it applies to life insurance? 1 An individual has an insurable interest in their own life. 2 A debtor has an insurable interest in the life of a lender. 3 Business partners have an insurable interest in each other. 4 A married person has an insurable interest in their spouse.

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

The legal definition of "person" would NOT include which of the following? 1 An individual human being 2 A corporation 3 A family 4 A business entity

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

All of the following are insurable events as defined in the Insurance Code EXCEPT 1 An insured is sued for libel and slander. 2 A guest trips and breaks his leg in the insured's house. 3 An insured goes to the hospital for a broken arm. 4 An insured loses a large sum in a poker game.

An insured loses a large sum in a poker game. Reasoning Any event, whether past or future, which may damnify a person having an insurable interest, or create a liability against him/her, may be insured against. Speculative losses are uninsurable.

When must insurable interest exist in a life insurance policy? 1 When there is a change of the beneficiary 2 At the time of loss 3 At the time of application 4 At the time of policy delivery

At the time of application- In life insurance, insurable interest must exist at the time of application.

An individual was involved in a head-on collision while driving home one day. His injuries were not serious, and he recovered. However, he decided that in order to never be involved in another accident, he would not drive or ride in a car ever again. Which method of risk management does this describe? 1 Sharing 2 Avoidance 3 Reduction 4 Retention

Avoidance- Avoidance is a method of risk management by which a person tries to eliminate risk of loss by avoiding any exposure to an event that could give rise to such loss. Risk avoidance is effective but seldom practical.

Events or conditions that increase the chances of an insured loss occurring are referred to as 1 Hazards. 2 Perils. 3 Exposures. 4 Risks.

Hazards- Conditions such as lifestyle and existing health, or activities such as scuba diving are hazards and may increase the chance of a loss occurring.

Units with the same or similar exposure to loss are referred to as 1 Insurable risks. 2 Catastrophic loss exposure. 3 Law of large numbers. 4 Homogeneous.

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

Which insurance principle states that if a policy allows for greater compensation than the financial loss incurred, the insured may only receive benefits for the amount lost? 1 Reasonable expectations 2 Stop-loss 3 Indemnity 4 Consideration

Indemnity- The principle of indemnity stipulates that the insured can only collect for the amount of the loss even if the policy is written with greater benefit limits.

A contract which one party undertakes to indemnify another against loss is called 1 Indemnity. 2 Risk. 3 Adverse Selection. 4 Insurance. Reasoning Insurance is a contract whereby one undertakes to indemnify another against loss, damage, or liability arising from a contingent or unknown event.

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

Which statement regarding insurable risks is NOT correct? 1 Insureds cannot be randomly selected. 2 The insurable risk needs to be statistically predictable. 3 Insurance cannot be mandatory. 4 An insurable risk must involve a loss that is definite as to cause, time, place and amount.

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

The insurer may suspect that a moral hazard exists if the policyholder 1 Always drives over the speed limit. 2 Is prone to depression. 3 Is indifferent to activities that may be dangerous. 4 Is not honest about his health on an application for insurance.

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

For the reported losses of an insured group to become more likely to equal the statistical probability of loss for that particular class, the insured group must become 1 More active. 2 Larger. 3 Older. 4 Smaller.

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

Which law is the foundation of the statistical prediction of loss upon which rates for insurance are calculated? 1 Law of averages 2 Law of masses 3 Law of group evaluation 4 Law of large numbers

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

The growing tendency of individuals to file lawsuits and to claim tremendous amounts for alleged damages is known as 1 Double indemnity. 2 Fraud. 3 Legal hazard. 4 Legal risk.

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

Insurance is a contract by which one seeks to protect another from 1 Loss. 2 Hazards. 3 Exposure. 4 Uncertainty.

Loss- Insurance will protect a person, business or entity from loss.

An individual's tendency to be dishonest would be indicative of a 1 Moral hazard. 2 Pure hazard. 3 Physical hazard. 4 Morale hazard.

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

An individual's tendency to be dishonest would be indicative of a 1 Physical hazard. 2 Morale hazard. 3 Moral hazard. 4 Pure hazard.

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

All of the following are examples of risk retention EXCEPT 1 Copayments. 2 Deductibles. 3 Self-insurance. 4 Premiums

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

All of the following are examples of risk retention EXCEPT 1 Copayments. 2 Self-insurance. 3 Deductibles. 4 Premiums.

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

What describes a situation when poor risks are balanced with preferred risks, and average risks are in the middle? 1 Profitable distribution of exposures 2 Adverse selection 3 Ideally insurable risk 4 Equitable spread of risk

Profitable distribution of exposures- The profitable distribution of exposures is achieved when poor risks are balanced with preferred risks, and average risks are in the middle.

A situation in which a person can only lose or have no change represents 1 Hazard. 2 Adverse selection. 3 Pure risk. 4 Speculative risk.

Pure risk- Pure risk refers to situations that can only result in a loss or no change. Pure risk is the only type insurance companies are willing to accept.

According to California Insurance Code, which of the following can be classified as an insurable event? A. Speculative risks B. Pure risks C. Extreme levels of loss D. Unpredictable losses

Pure risk- Any event, whether past or future, which may damnify a person having an insurable interest, or create a liability against him/her, may be insured against. The more predictable a loss, the more insurable it becomes. Only pure risks are insurable. Speculative losses are uninsurable.

A situation in which a person can only lose or have no change represents 1 Hazard. 2 Pure risk. 3 Adverse selection. 4 Speculative risk.

Pure risk- Pure risk refers to situations that can only result in a loss or no change. Pure risk is the only type insurance companies are willing to accept.

Which of the following factors is NOT considered by an underwriter when determining the premium rates for an individual seeking insurance? 1 Age 2 Sex 3 Medical history 4 Race

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

Installing deadbolt locks on the doors of a home is an example of which method of handling risk? 1 Transfer 2 Self-insurance 3 Avoidance 4 Reduction

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

Following a career change, an insured is no longer required to perform many physical activities, so he has implemented a program where he walks and jogs for 45 minutes each morning. The insured has also eliminated most fatty foods from his diet. Which method of dealing with risk does this scenario describe? 1 Avoidance 2 Transfer 3 Reduction 4 Retention

Reduction- The insured's change in lifestyle and habits would likely reduce the chances of health problems.

Insurance is the transfer of 1 Risk. 2 Loss. 3 Hazard. 4 Peril.

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

Adverse selection is a concept best described as 1 Risks with higher probability of loss seeking insurance more often than other risks. 2 Only offering coverage to good risks. 3 Poor choices of applicants to be covered. 4 Underwriters slanting the odds in favor of the company.

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

Hazard is best defined as 1 The uncertainty of loss. 2 Neglect to communicate a material fact. 3 Something that increases the risk of loss. 4 A deliberate attempt to deceive.

Something that increases the risk of loss.- Hazards are conditions or situations that increase the probability of an insured loss occurring.

Events in which a person has both the chance of winning or losing are classified as 1 Retained risk. 2 Insurable. 3 Pure risk. 4 Speculative risk.

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

When an individual purchases insurance, what risk management technique is he or she practicing? 1 Transfer 2 Avoidance 3 Sharing 4 Retention

Transfer- Insurance is a transfer of the risk of financial loss from a covered peril from the insured to the insurance company.

The insurer must be able to rely on the statements in the application, and the insured must be able to rely on the insurer to pay valid claims. In the forming of an insurance contract, this is referred to as 1 A warranty. 2 Implied warranty. 3 Utmost good faith. 4 Reasonable expectations.

Utmost good faith- The insurer must be able to rely on the statements given by the insured in the application. The insured must be able to rely on the insurer's promise to pay covered losses.

If an applicant for a life insurance policy and person to be insured by the policy are two different people, the underwriter would be concerned about 1 Which individual will pay the premium. 2 Whether an insurable interest exists between the individuals. 3 The type of policy requested. 4 The gender of the applicant.

Whether an insurable interest exists between the individuals- An insurable interest must exist at the time the policy is issued. Some relationships are automatically presumed to qualify as an insurable interest, e.g., spouses, parents, children and certain business relationships.

Which of the following is NOT an example of a valid insurable interest? 1 Debtor in the life of the creditor 2 Business partners in each other's lives 3 Employer in key employee's life 4 Child in parents' lives

debtor in the life of the creditor- The three recognized areas in which insurable interest exists are as follows: a policyowner insuring their own life, the life of a family member (relative or spouse), or the life of a business partner, key employee, or someone who has a financial obligation to the policyowner. A debtor does not have an insurable interest in the creditor.

A set of legal or regulatory conditions that affect an insurer's ability to collect premiums commensurate with the level of risk incurred would be considered a(n): 1 Underwriting gamble. 2 Legal hazard. 3 Fiduciary risk. 4 Legal peril.

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

A tornado that destroys property would be an example of which of the following? 1 A pure risk 2 A loss 3 A peril 4 A physical hazard

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

Which of the following insurance options would be considered a risk-sharing arrangement? 1 Stock 2 Reciprocal 3 Mutual 4 Surplus lines

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