Principles of Insurance

How is uncertainty regarding loss best described? A) Risk. B) Hazard. C) Peril. D) Insurance.

...The correct answer was - A: Risk. Explanation: In the strict insurance definition, risk is the uncertainty regarding financial loss. Insurance is used to minimize the risk of uncertainty by spreading the risk over a large enough number of similar exposures to predict the individual chance of loss.

Dishonesty on the part of an insured is an example of: A) a moral hazard. B) a morale hazard. C) a peril. D) a physical hazard.

...The correct answer was - A: a moral hazard. Explanation: A peril is the specific event that causes a loss. A hazard is any factor that increases the chance of loss. A moral hazard involves dishonesty on the part of the insured (e.g., planning arson to collect the insurance claim). A morale hazard involves carelessness or indifference, such as not using a seatbelt or not locking one's door.

Driving too fast and not wearing a seat belt are examples of: A) morale hazard. B) moral hazard. C) risk. D) physical hazard.

...The correct answer was - A: morale hazard. Explanation: Hazards may be classified as physical (a material, structural, or operational feature), moral (dishonest or character defects), or morale (relating to the attitude of the insured). Driving too fast and not wearing a seat belt indicate a thoughtless, careless, or arrogant attitude on the part of the driver. Risk is the uncertainty regarding the occurrence of financial loss.

A chance, possibility, or uncertainty of loss is known as a: A) risk. B) peril. C) hazard. D) proximate cause.

...The correct answer was - A: risk. Explanation: Risk is the uncertainty regarding the occurrence of financial loss. A peril is the actual cause of a loss and is specifically identified in the policy. A hazard is a situation or condition that may increase the possibility of a loss occurring. Proximate cause is the action that produces a loss through an unbroken chain of events.

Which one of the following hazards can be described as a careless attitude or general indifference on the part of the insured toward the occurrence of loss? A) Moral. B) Morale. C) Legal. D) Physical.

...The correct answer was - B: Morale. Explanation: A hazard is a situation or factor that increases the possibility of a loss occurring. A morale hazard is a careless attitude or general indifference on the part of the insured toward the occurrence of loss.

Which of the following is NOT an example of an insurable interest? A) Person's interest in the home she owns. B) Person's interest in property she hopes that her uncle will leave to her in his will. C) Dry cleaner's interest in his customers' clothing in his custody, care, or control. D) Person's interest in the improvements he has added to his leased apartment.

...The correct answer was - B: Person's interest in property she hopes that her uncle will leave to her in his will. Explanation: A person does not have an insurable interest in property that he neither possesses nor owns.

A condition or situation that presents a possibility of loss is a (an): A) proximate cause. B) exposure. C) law of large numbers. D) named certainty.

...The correct answer was - B: exposure. Explanation: A condition or situation that presents a possibility of loss is an exposure. Insurance policies are designed to cover loss, either a direct loss or an indirect loss.

The purpose of insurance is to: A) eliminate hazards. B) transfer risk. C) eliminate risk. D) reduce adverse selection

...The correct answer was - B: transfer risk. Explanation: The purpose of insurance is to protect against losses caused by pure risk. This is accomplished through the insurance contract, which requires one party to pay a specified sum to another if a previously identified event occurs. For the cost of a premium, a person or entity can purchase protection offered by the insurance contract and transfer risk to the insurer.

Which one of the following best defines a hazard? A) Cause of a loss. B) Unexpected loss. C) Condition that increases the chance of a loss. D) Uncertainty of a loss.

...The correct answer was - C: Condition that increases the chance of a loss. Explanation: A hazard is a condition that increases the chance of a loss.

Which one of the following is an example of a peril? A) Indifference. B) Gasoline stored on the premises. C) Earthquake. D) Illness.

...The correct answer was - C: Earthquake. Explanation: A peril is the actual cause of a loss. Examples of perils are fire, wind, hail, collision, and earthquake.

What is the actual cause of a loss? A) Proximate cause. B) Risk. C) Peril. D) Hazard.

...The correct answer was - C: Peril. Explanation: The actual cause of a loss is called a peril and is identified or referred to in the insurance policy. Perils include such events as fire, wind, hail, and collision with another car. A named peril policy provides coverage only if a loss is caused by one of the perils specifically named or identified in the policy. An open perils policy provides coverage for all and any risks, unless specifically excluded.

Faulty wiring causes a fire that destroys a building. The faulty wiring is considered to be a(n): A) peril. B) indirect cause. C) hazard. D) proximate cause.

...The correct answer was - C: hazard. Explanation: A hazard is a situation or factor that increases the possibility of a loss occurring or increases the probable size of a loss.

Fire would be an example of a: A) risk. B) hazard. C) peril. D) loss.

...The correct answer was - C: peril. Explanation: Perils include events such as fire, wind, hail, or collision with another car. A hazard is a situation or condition that increases the possibility of a loss occurring . Hazards may be classified as physical (a material, structural, or operational feature), moral (dishonest or character defects), or morale (relating to the attitude of the insured). Risk is the uncertainty regarding the occurrence of financial loss.

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

...The correct answer was - C: speculative risk. Explanation: Speculative risk involves the chance of both loss and gain. For example, the placement of a bet at a racetrack is a speculative risk.

Which one of the following statements pertaining to risk is NOT correct? A) Pure risk involves only the chance of loss; there is never a possibility of gain or profit. B) Only pure risks are insurable. C) Uncertainty regarding financial loss is the definition of risk; therefore, it is characteristic of both pure and speculative risks. D) A stock market venture is an example of a pure risk.

...The correct answer was - D: A stock market venture is an example of a pure risk. Explanation: 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 is an example of reduction as a method of handling risk? A) Reducing coverage. B) Buying insurance to reduce the risk. C) Increasing a deductible. D) Installing a burglar alarm.

...The correct answer was - D: Installing a burglar alarm. Explanation: Reduction may be accomplished through loss prevention and loss control. A burglar alarm will control or reduce the loss.

Transferring is a method of handling risk. Which of the following best describes the concept of transfer? A) Signing a hold harmless agreement to share the liability. B) Buying a car with a friend to share the risk. C) Increasing a deductible to share the loss with the insurance company. D) Purchasing insurance.

...The correct answer was - D: Purchasing insurance. Explanation: Transfer means shifting the risk of a loss to another, usually an insurance company.

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

...The correct answer was - D: uncertainty regarding loss. Explanation: Risk refers to the uncertainty of financial loss. Insurance replaces the uncertainty of risk with certain guarantees of financial stability.

Which of the following is NOT a source of information important to an underwriter? A) Employer reference. B) Agent or producer comments. C) Motor vehicle reports. D) Consumer reports.

The correct answer was - A: Employer reference. Explanation: The four primary sources of information include the agent or producer, consumer reports, government records, and financial rating services.

If John's father transfers ownership of a house to John, which one of the following statements regarding insurance on the house is CORRECT? A) John's father must retain his policy on the house. B) John must purchase the house from his father to obtain an insurable interest in it. C) John can buy insurance because he has an insurable interest. D) John's father must assign his policy to John as well.

The correct answer was - C: John can buy insurance because he has an insurable interest. Explanation: A person has an insurable interest in property when the loss of or damage to the property will result in financial loss to the person. Because John's father has transferred ownership of the house to John, he now owns and controls the property. Any loss or damage to the house will result in a financial loss to John. Therefore, John has an insurable interest in the house and should obtain insurance on the house in his name. Some companies will consider approving an assignment of an insurance policy from the old owner to the new owner, but this is not a universal practice.

Which one of the following risks is insurable? A) Speculative. B) Partial. C) Pure. D) Whole.

The correct answer was - C: Pure. Explanation: Only pure risks are insurable because they involve the chance of loss only.

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

The correct answer was - C: Retention. Explanation: Self-insurance is a form of risk retention because the individual personally retains the risk and must accept the economic loss if the risk becomes a reality.

Robert and Carolyn live in a busy city and decide that not owning a car is the solution to not experience having a car stolen. Which of the following methods describes this philosophy? A) Transfer. B) Retention. C) Loss control. D) Avoidance.

The correct answer was - D: Avoidance. Explanation: An individual may avoid the risk of a loss by not engaging in an activity or owning property. By not owning a car, Robert and Carolyn will not risk having it stolen.

Which of the following is NOT an element of an insurable risk? A) The loss must have a determinable value. B) The loss must be due to chance. C) The loss must be accidental from the insured's perspective. D) The loss must be catastrophic.

The correct answer was - D: The loss must be catastrophic. Explanation: One of the criteria for an insurable risk is that it is not catastrophic. A principle of insurance holds that only a small portion of a given group will experience loss at any one time. Risks that would adversely affect large numbers of people or large amounts of property, such as wars, are typically not insurable.

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

The correct answer was - D: 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. Explanation: 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.