Introduction to Insurance

Which of the following statements BEST summarizes the function of insurance? A) It is a form of legalized gambling. B) It protects against living too long. C) It spreads financial risk over a diverse group of people who are exposed to different risks. D) It spreads financial risk over a large group so as to minimize the loss to any one individual.

Answer: D The function of insurance is to safeguard against financial loss by having the losses of a few paid by the contributions of many who are exposed to the same risk.

A flood is an example of: A) a peril. B) a moral hazard. C) a speculative risk. D) a physical hazard.

Answer: A A peril is the immediate specific event that causes loss and gives rise to risk. A peril causes risk. Therefore, when a house's basement and first floor are damaged by standing water, a flood is the peril.

The phrase "the applicant for insurance has more to gain if the insured continues to live than if the insured dies" is the rule defining: A) insurable interest. B) one's legal capacity to enter into an insurance contract. C) a legal wagering contract. D) the aleatory nature of an insurance contract.

Answer: A A person acquiring a life insurance contract must be subject to loss upon the death of the individual to be insured. This is known as insurable interest and it is required before a life insurance policy will be issued.

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

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

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

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

With regard to life insurance, all of the following statements are correct EXCEPT: A) A creditor has an insurable interest in a debtor. B) insurable interest must be maintained throughout the life of the contract. C) all individuals are considered to have insurable interests in themselves. D) spouses are automatically considered to have insurable interests in each other.

Answer: B Insurable interest is required only when a contract is issued. It does not have to be maintained throughout the life of the contract, nor is it necessary at the time of claim.

For health insurance purposes, which of the following is NOT a peril? A) Alcoholism. B) Tainted food. C) Cancer. D) A serious fall.

Answer: A In the context of accident and health insurance, a peril is an accident or illness that gives rise to a loss. A hazard is a specific condition that introduces or increases the probability of loss.

Assume there are four different mortality tables. Of these, the most reliable would be the mortality table covering: A) 500,000 lives. B) 4,000,000 lives. C) 10,000,000 lives. D) 100,000 lives.

Answer: C The larger the group, the more certain or reliable will be the amount of loss (which, in this case, is the death or mortality rate).

Bob and Tina's California neighborhood was ravaged by wildfires last summer. As a result, they installed a sprinkler system in their home to minimize damage in the event of a fire. This method of dealing with risk is called: A) risk avoidance. B) risk retention. C) risk transference. D) risk reduction.

Answer: D Installing a sprinkler system in a home is a method of reducing risk. Although the possibility that a home may catch fire cannot be avoided entirely, Bob and Tina can reduce the risk of loss due to fire by installing a sprinkler system.

Major risk factors in health insurance underwriting include the following EXCEPT: A) physical condition. B) lifestyle. C) occupation. D) marital status.

Answer: D The major risk factors in health insurance are physical condition, moral hazards, and occupation. Marital status is not a risk factor.

Insurable interest must exist between the policyowner and the beneficiary: A) at the time the contract is entered into. B) throughout the life of the contract. C) when the policyowner dies. D) when the beneficiary collects the death benefit.

Answer: A Any legally competent individual may buy an insurance contract on his life for the benefit of any person. However, buying an insurance contract on the life of someone else is prohibited unless the benefits are payable either to that individual, his personal representatives, or a person having a personal interest in the individual insured. That interest must exist at the time the contract is entered into. It is not necessary if the interest does not exist at the time the beneficiary collects the benefit.

Paul is a single father with two young daughters. He has decided to give up his two favorite hobbies--skydiving and race car driving--because they are risky pursuits that could lead to his premature death. This method of dealing with risk is called risk: A) avoidance. B) retention. C) transference. D) sharing.

Answer: A Paul has chosen to deal with the risk of dying prematurely by giving up his two favorite hobbies, race car driving and skydiving. This method of dealing with risk is called avoidance.

All forms of insurance are alike in all of the following ways EXCEPT: A) all indemnify financial loss. B) the nature of the perils covered is the same. C) all are based on the law of large numbers. D) all are implemented through a contractual agreement between the insurance owner and insurer.

Answer: B The major difference between life insurance and other forms of insurance is that life insurance covers a certain risk--death--whereas the others insure against contingencies that may or may not happen: sickness, fire, or theft. The only uncertainty about the risk of death is when it will take place.

All of the following have an insurable interest in the person insured EXCEPT: A) an employer. B) a child. C) a neighbor. D) a spouse.

Answer: C A person cannot contract for life insurance on another individual unless the benefits are payable to the individual insured, the insured's personal representative, or to a person having an insurable interest in the insured at the time the contract is made. The following individuals are deemed to have an insurable interest in an insured: individuals related closely by blood or by law, as well as a substantial interest engendered by love and affection, and persons with a lawful and substantial economic interest in having the life, health, or bodily safety of the insured individual continue. A spouse, child, and employer would therefore have an insurable interest in an insured. However, a neighbor does not have an insurable interest in a person merely because they are neighbors.

Alcoholism is an example of a: A) moral hazard. B) peril. C) physical hazard. D) morale hazard.

Answer: A A peril is the specific event causing loss. A hazard is any factor that gives rise to a peril. A moral hazard is a subjective characteristic of the insured that increases the chance of loss.

Upon the issuance of a life insurance policy, an insurable interest must exist between: A) the insured and the beneficiary. B) the agent and the applicant. C) the applicant and the insured. D) the applicant and the beneficiary.

Answer: C Upon the issuance of a life insurance policy, the applicant must have an insurable interest in the life of the individual to be insured. While an insurable interest must exist at the time of issuance, it need not exist at the time of the insured's death.

With regard to life insurance, all of the following statements are correct EXCEPT: A) a creditor has an insurable interest in a debtor. B) insurable interest must be maintained throughout the life of the contract. C) all individuals are considered to have insurable interest in themselves. D) spouses are automatically considered to have insurable interest in each other.

Answer: B For life and health insurance policies, insurable interest is required only when the contract is issued. It does not have to be maintained throughout the life of the contract nor is it necessary at the time of a claim.

Question ID: 200231 All of the following statements pertaining to risk are correct EXCEPT: A) uncertainty regarding financial loss is the definition of risk; therefore, it is characteristic of both pure and speculative risks. B) only pure risks are insurable. C) a stock market venture is an example of a pure risk. D) pure risk involves only the chance of loss; there is never a possibility of gain or profit.

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

Which of the following people would NOT have an insurable interest for a life insurance policy? A) The daughter of the insured. B) The employer of a key employee insured. C) The closest friend of the insured. D) The spouse of the insured.

Answer: C In the case of individuals who are closely related by blood or by law, an insurable interest exists. In the case of other persons, it exists by virtue of a lawful and substantial economic interest in the life, health, and bodily safety of the insured. A close friend of the insured does not have an insurable interest because a friend is not deemed to have a lawful and substantial economic interest in the personal welfare of the insured.

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

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

Which of the following situations constitutes an insurable interest? A) The policyowner must expect to suffer a loss when the insured dies or becomes disabled. B) The policyowner must expect to benefit from the insured's death. C) The beneficiary, by definition, has an insurable interest in the insured. D) The insured must have a personal or business relationship with the beneficiary.

Answer: A Insurable interest requires that the policyowner be expected to benefit from the insured's continuing to live or enjoying good health or to suffer a loss when the insured dies or is disabled. An insurable interest must exist between the applicant and the insured. It does not need to exist between the applicant and the beneficiary. For life and health insurance policies, insurable interest must exist at the inception of the policy but does not need to be maintained for the term of the policy.

An individual may purchase a life insurance policy on all of the following persons EXCEPT: A) a dependent. B) a neighbor. C) a spouse. D) a business partner.

Answer: B An individual may purchase a life or health insurance policy on a party with whom she has an insurable interest. A spouse, business partner, and dependent are people in whom the policyowner would have an insurable interest. In other words, the policyowner has a reasonable expectation of benefiting from the continuance of these people's lives or will suffer a loss from their deaths.

With a life insurance contract, an insurable interest must exist: A) at the insured's death. B) when the proceeds are paid out. C) at the inception of the contract. D) as long as the insured lives.

Answer: C With life insurance, an insurable interest is only required upon policy application and inception. It does not have to continue through the duration of the contract, nor does it have to exist at the insured's death in order to claim the policy's proceeds. This is in contrast to property and casualty insurance, which requires that an insurable interest exist at the time of the claim.

In regards to the purchase of a life insurance contract on a third party, the applicant could apply for a policy on all of the following EXCEPT: A) his partners. B) his neighbor. C) his spouse. D) his children.

Answer: B Buying an insurance contract upon the life of a third party is prohibited unless there is an insurable interest between the two parties. A person has an insurable interest if he is closely related by blood or by law to the insured person. An insurable interest also exists if a person has a lawful and substantial interest in having the life, health, or bodily safety of the individual insured continue, such as in the case of a partner and the partnership. An insurable interest does not exist between two neighbors.

An insurable interest exists between all of the following individuals EXCEPT: A) two neighbors who are not related. B) a husband and wife. C) a father and child. D) a partner and partnership.

Answer: A Buying an insurance contract upon the life of a third party is prohibited unless there is an insurable interest between the two parties. A person has an insurable interest if he is closely related by blood or by law to the insured person. An insurable interest also exists if a person has a lawful and substantial interest in having the life, health, or bodily safety of the individual insured continue, such as in the case of a partner and the partnership. An insurable interest does not exist between two neighbors.

Alan, age 39, is married and has a small son. He is employed as a sales manager by R.J. Links, a sole proprietorship that owes much of its success to Alan's efforts. He recently borrowed $50,000 from his brother-in-law, Pete, to finance a vacation home. On the basis of these facts, which of the following individuals does NOT have an insurable interest in Alan's life? A) One of his customers. B) His spouse. C) His employer. D) His brother-in-law.

Answer: A Generally, a person has an insurable interest in another if they are related by blood or marriage or if their relationship is such that the insured's continuing to live will benefit that individual or the insured's death will cause that individual financial or economic loss. Spouses are assumed to have an automatic insurable interest in each other. Thus, in this case, all 3 individuals have an insurable interest in Alan's life.

Insurable interest exists in all of the following relationships EXCEPT: A) teacher and student. B) husband and wife. C) father and daughter. D) businessowner and top sales person.

Answer: A In order to obtain insurance on the life of another individual, an insurable interest must exist between the purchaser and the insured. Insurable interest includes individuals related closely by blood or by law, such as husband and wife or father and daughter. It also includes persons with a lawful and substantial economic interest in having the life, health, or bodily safety of the insured individual continue, such as a business owner and top sales person. Finally, it covers individuals who are party to a contract or option for the purchase of an interest in a business partnership or shares of stock in a corporation. An insurable interest would not exist in a teacher-student relationship.

Who would NOT have an insurable interest for a life insurance policy? A) The employer of a key employee insured. B) The closest friend of the insured. C) The spouse of the insured. D) The daughter of the insured.

Answer: B An insurable interest is defined as interest created by love and affection for those persons closely related by blood or law. For those who are not related, an insurable interest is a lawful economic interest in having the life of the insured continue.

With regard to life insurance, all of the following statements are correct EXCEPT: A) spouses have insurable interests in each other. B) a partnership has an insurable interest in a partner. C) an insurable interest must exist at the time of the claim. D) individuals are considered to have insurable interests in themselves.

Answer: C In a valid insurance contract, the applicant must have an insurable interest in the insured, which means that the applicant must be subject to loss if the insured dies. Many relationships such as husband and wife and partner and partnership provide the basis for an insurable interest. An insurable interest is required only when a contract is issued; it does not have to be maintained throughout the life of the contract, nor is it necessary at the time of claim.

Which of the following would be considered a moral hazard in underwriting a health insurance risk? A) A hazardous occupation. B) A family history of diabetes. C) Excessive drinking. D) A serious heart ailment.

Answer: C Moral hazards are habits or lifestyles of applicants that could pose additional risk for the insurer. These hazards are evaluated carefully when underwriting health insurance policies.

Treating risk by purchasing insurance is an example of: A) reducing risk. B) retaining risk. C) transferring risk. D) avoiding risk.

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

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

Answer: C Self-insurance is a form of risk retention because the individual or business entity personally retains the risk and must accept any resulting economic loss.

Assume lightning strikes a home and starts a fire that destroys its structure and contents. By insurance definition, the fire is the: A) risk. B) hazard. C) proximate cause. D) peril.

Answer: D A peril is the immediate specific event causing loss and giving rise to risk. When a building burns, fire is the peril.

An insurable interest may be found in which of the following? A) A partner in the life of a former partner. B) A shareholder in the life of another shareholder of the same corporation. C) An employee in the life of another employee of the same company. D) An employer in the life of a key employee.

Answer: D To have an insurable interest in another person, a person or business must stand to gain by the insured's survival and/or suffer financial loss if the insured individual died. An employer has an insurable interest in the life of a key employee. A partner has an insurable interest in the life of any other current partner, but not of a former partner. Just the fact that two shareholders had invested in the same corporation or that two employees worked for the same company would not constitute an insurable interest.