Risk and Insurance Exam 6

(Chapter 7) Using the Poisson probability formula above or the information in Table 7-4, what would be the probability of EXACTLY 1 loss when the average frequency is 5 losses per year? (use four decimal places in your answer)

.0337

(Chapter 6) An individual has two property insurance policies in force on property valued at $100,000. Insurer A provides $75,000 of coverage. Insurer B provides $25,000. If a pro-rata insurance clause applies and the property sustains a $20,000 loss that is covered by both policies, how much will Insurer A pay? (Numerical Answer)

15,000

(Chapter 6) A property insurance policy is written with a 90 percent coinsurance clause and a policy limit of $45,000. The actual replacement cost of the structure, less depreciation, is found to be $100,000. What amount may be collected under this policy in the event of a $50,000 loss? (Numerical Answer)

25,000

(Chapter 5) Which of the following is a requirements of a legal contract?

All of the Above

(Chapter 7) Why must risk management decisions be reviewed regularly? Select all that apply. a Many relevant factors change. b The nature of an exposure may change over time c The frequency and severity of losses may vary over time, causing estimates to become out of date.

All of the Above a Many relevant factors change. b The nature of an exposure may change over time c The frequency and severity of losses may vary over time, causing estimates to become out of date.

(Chapter 7) Which considerations should be analyzed by a business before it decides to use self-insurance? Select all that apply. a The firm should have sufficient number of units situated so that the units are not subject to simultaneous destruction b The firm must have accurate records or statistics to enable it to make adequate estimates of expected losses c The firm must make arrangements for administering the plan and managing the self-insurance fund d The general financial condition of the firm should be adequate enough to be able to deal with large and unusual losses

All of the Above a The firm should have sufficient number of units situated so that the units are not subject to simultaneous destruction b The firm must have accurate records or statistics to enable it to make adequate estimates of expected losses c The firm must make arrangements for administering the plan and managing the self-insurance fund d The general financial condition of the firm should be adequate enough to be able to deal with large and unusual losses

(Chapter 5) T or F: In property insurance, an insurable interest must only exist at the inception of the policy.

False

(Chapter 6) True or False: In a named-perils insuring agreement, the policy states that it is the insurer's intention to cover risks of accidental loss to the described property except those perils specifically excluded.

False

(Chapter 6) True or False: In most cases, actual cash value (ACV) will lead to a larger loss settlement than replacement cost.

False

(Chapter 7) Fill in the Blank: A catastrophe bond is a financial tool that transfer insurance risk to the capital markets and is an example of _______

Securitization

(Chapter 5) True or False: The principle of indemnity in insurance serves to reduce moral hazard.

True

(Chapter 5) True or False: The risk from loss of a market that is captured by a competitor with a better product is likely uninsurable.

True

(Chapter 5) True or False: The risk of a business losing money due to an economic recession is likely uninsurable.

True

(Chapter 6) True or False: Many policies exclude losses to aircraft and watercraft because coverage for those perils are usually covered elsewhere in specific policies.

True

(Chapter 6) True: Coinsurance in property insurance serves to encourage the insured to purchase coverage to value.

True

(Chapter 7) True or False: The cost that companies incur when they set aside capital for losses instead of using it for working capital in the business is the opportunity cost of funds. The capital has a value. If the capital is used in the business, then the value is often more than if it is used for paying losses. The difference between these values (opportunity cost) could affect decisions to self-insure or not. As opportunity costs rise, so does the likelihood that there will be no self-insurance.

True

(Chapter 6) An insured has the following four liability insurance policies: $300,000 with insurer A, $300,000 with insurer B, $700,000 with insurer C, and $900,000 with insurer D. Each policy apportions losses using the equal shares method.How much will each policy pay for a $200,000 loss? a $50,000 each b $0 each c $200,000 each

a $50,000 each

(Chapter 6) A property insurance policy is written with a 90 percent coinsurance clause and a policy limit of $60,000. The actual replacement cost of the structure, less depreciation, is found to be $100,000. What amount may be collected under this policy if a total loss occurs? a $60,0000 b $66,666 c $100,000 d None of the above

a $60,000

(Chapter 7) If a firm wants to have $1 million in cash available in three years, how much must it invest now at an 8 percent interest rate? a $793,832.24 b $780,832.24 c $810,832.24 d $1,000,000

a $793,832.24

(Chapter 5) Which selection accurately distinguishes between waiver and estoppel. a A waiver is a relinquishing of a known right and is based on consent and contract law. Estoppel prevents one from asserting right because of prior conduct that is inconsistent with such an assertion and is more closely associated with contact law. b An estoppel is a relinquishing of a known right and is based on consent and contract law. A waiver prevents one from asserting right because of prior conduct that is inconsistent with such an assertion and is more closely associated with contact law.

a A waiver is a relinquishing of a known right and is based on consent and contract law. Estoppel prevents one from asserting right because of prior conduct that is inconsistent with such an assertion and is more closely associated with contact law.

(Chapter 5) Distinguish between a warranty and a representation. a A warranty is a condition of the contract. A breach of a warranty can void the contract. A representation is a statement made by the insured before the contract is written and only affects the transaction if it is material. b A representation is a condition of the contract. A breach of a representation can void the contract. A warranty is a statement made by the insured before the contract is written and only affects the transaction if it is material.

a A warranty is a condition of the contract. A breach of a warranty can void the contract. A representation is a statement made by the insured before the contract is written and only affects the transaction if it is material.

(Chapter 7) What are the three steps for selecting among available risk management techniques? a Avoid risk when feasible b Implement appropriate loss control measures c Select the optimal mix of risk retention and risk transfer d Analyze past due accounts and select corresponding risks

a Avoid risk when feasible b Implement appropriate loss control measures c Select the optimal mix of risk retention and risk transfer

(Chapter 7) Explain how an investment in loss control may change the optimal mix between risk retention and risk transfer in a given situation. a Effective loss control can reduce the frequency and severity of expected losses. This reduction may provide the opportunity for a company to retain more than it would without the loss control techniques. The company may decide to take a higher deductible or self-insure. b Effective loss control can increase the frequency and severity of expected losses. This increase may provide the opportunity for a company to retain more than it would without the loss control techniques. The company may decide to take a lower deductible or self-insure.

a Effective loss control can reduce the frequency and severity of expected losses. This reduction may provide the opportunity for a company to retain more than it would without the loss control techniques. The company may decide to take a higher deductible or self-insure.

(Chapter 5) Which of the following accurately describes the effect of an honest mistake in an insurance contract? a If an honest mistake is made in a written insurance contract, it may be reformed if there is proof of mutual mistake or a mistake on one side that is known to be a mistake by the other party. b If an honest mistake is made in a written insurance contract, it may be reformed if either party submits complete paperwork to the other party within the amount of time specified in the contract. c If an honest mistake is made in a written insurance contract, it can never be reformed.

a If an honest mistake is made in a written insurance contract, it may be reformed if there is proof of mutual mistake or a mistake on one side that is known to be a mistake by the other party.

(Chapter 5) Which selection accurately explains the principle of adhesion? a In a contract of adhesion, ambiguities are construed against the insurance company. b In a contract of adhesion, ambiguities are construed against the policyholder c In a contract of adhesion, ambiguities are construed against the lessor. d In a contract of adhesion, the insurance company does not need to adhere to contractual stipulations.

a In a contract of adhesion, ambiguities are construed against the insurance company.

(Chapter 5) Which of the following are social costs of insurance? (mark all that apply) a Intentionally caused losses b Exaggerated losses c reduction of the cost of capital

a Intentionally caused losses

(Chapter 5) Name the requisites of insurable risk from the standpoint of the insurer. a Large enough number, accidental loss, determinable and measurable, and noncatastrophic in nature. b Losses perfectly predictable, probability of loss is high, severity of loss is low, all consumers face the loss c None of the above

a Large enough number, accidental loss, determinable and measurable, and noncatastrophic in nature.

(Chapter 5) Virginia expresses disappointment that a whole year has passed and, due to no accidents, she has been unable to collect anything from her car insurance policy, for which she had paid $700 in premiums. Is Virginia's disappointment based on sound insurance principles? Explain. a No. She would rejoice in not having loss. First, had an accident occurred, the policy would not have paid all her losses. Delay, inconvenience etc., would not have been reimbursed. Further, her rates might have been higher next year due to reclassification into a different rating group. Had the loss occurred, she would not have gained anything. The premium should be viewed as protection, not speculation. b Yes. First, had an accident occurred, the policy would have paid all her losses. Delay, inconvenience etc., would have been reimbursed. Further, her rates might have been lower next year due to reclassification into a different rating group. The premium should be viewed as speculation.

a No. She would rejoice in not having loss. First, had an accident occurred, the policy would not have paid all her losses. Delay, inconvenience etc., would not have been reimbursed. Further, her rates might have been higher next year due to reclassification into a different rating group. Had the loss occurred, she would not have gained anything. The premium should be viewed as protection, not speculation.

(Chapter 7) Airlines face significant risk from increases in the price of jet fuel. The failure of their computerized reservation systems also can have a materially adverse effect on their operations. How could an airline use the concepts of enterprise risk management and alternative risk transfer tools to manage these risks? a Purchase a double trigger insurance policy b Sell double trigger insurance policies to competitors c Avoid double trigger insurance policies d None of the above

a Purchase a double trigger insurance policy

(Chapter 7) What are the potential cash inflows to be considered in a net present value analysis of a loss control decision? a Reduced costs, premium savings, tax savings resulting from depreciation for loss control equipment, and salvage value of the equipment. b The costs of training and maintenance of the equipment.

a Reduced costs, premium savings, tax savings resulting from depreciation for loss control equipment, and salvage value of the equipment.

(Chapter 5) What are the social values of insurance? (mark all that apply)

a Reduces the need to accumulate funds to meet loss

(Chapter 7) Which of the following is NOT a situation where self-insurance would normally make sense for a business? a The business has faced some financial challenges and has low cash levels b The business has a relatively large number of similar exposures and the potential for simultaneous destruction is low c The business has access to relatively good data on the past loss experience of its exposures

a The business has faced some financial challenges and has low cash levels

(Chapter 7) A firm earns 25 percent interest on its invested capital. Interest available on assets that have a low degree of risk and are highly liquid is 10 percent. The firm is considering retaining a certain risk, but top managers believe that a loss reserve fund of $100,000 is necessary. Insurance against the risk is available for an annual premium of $10,000. On the basis of only these facts, do you believe that the firm should retain this risk, or do you believe that commercial insurance should be purchased? a The commercial insurance should be purchase b The firm should retain risk

a The commercial insurance should be purchase

(Chapter 5) What is the difference between the principle of insurable interest and the principle of indemnity? a The principle of insurable interest determines whether or not any loss is suffered by a person insured, whereas the principle of indemnity governs the measurement of that loss. b The principle of indemnity determines whether or not any loss is suffered by a person insured, whereas the principle of insurable interest governs the measurement of that loss. c Both principles determine any loss and the measurement. The principle of insurable interest determines loss for corporations, while the principle of indemnity determines loss for persons.

a The principle of insurable interest determines whether or not any loss is suffered by a person insured, whereas the principle of indemnity governs the measurement of that loss.

(Chapter 6) Select the major reasons for excluding certain perils from insurance contracts. Select all that apply. a They are not insurable b They are covered by other insurance c An additional premium is needed fi coverage is desired. d The probability of loss is low.

a They are not insurable

(Chapter 7) Explain the relationships of expected loss frequency and severity in the use of risk retention and risk transfer. a When expected frequency is high or low along with low expected severity, retention makes the most sense because the entity can afford to pay for or can predict those losses. Only when the expected severity is high and the expected frequency is low should trasfer be considered. When both expected severity and frequency are high, risk avoidance is recommended. b When expected frequency is high or low along with low expected severity, avoidance makes the most sense because the entity cannot afford to pay for and cannot predict those losses. Only when the expected severity is high and the expected frequency is low should avoidance be considered. When both expected severity and frequency are high, risk transfer is recommended.

a When expected frequency is high or low along with low expected severity, retention makes the most sense because the entity can afford to pay for or can predict those losses. Only when the expected severity is high and the expected frequency is low should trasfer be considered. When both expected severity and frequency are high, risk avoidance is recommended.

(Chapter 5) Can one have an insurable interest in property and still not own the property? Explain. a Yes, one can be contractually responsible for nonowned property because he or she is renting it or has the property under his or her control. b No, one cannot be contractually responsible for nonowned property because he or she is renting it or has the property under his or her control.

a Yes, one can be contractually responsible for nonowned property because he or she is renting it or has the property under his or her control.

(Chapter 5) Insurance contract are often considered "contracts of adhesion" which means that unclear language or ambiguities in the contract will be construed or interpreted in favor of a the insured b the insurer c the drafting party

a the insured

(Chapter 7) In the calculation of the present value of $500,000 available in five years presented above, how would the present value change if the interest rate was increased from 8 percent to 10 percent? a the present value would be lower b the present value would be higher c the present value would be unchanged

a the present value would be lower

(Chapter 5) Express Warranty

a specific circumstance that must exist as described in writing in the insurance contract

(Chapter 6) Fill in the Blank: A ____ deductible applies for an entire year and represents the amount of loss that the insured must absorb before the policy pays.

aggregate

(Chapter 7) Fill in the Blank: Risks that can be eliminated without an adverse effect on the goals of an individual or business probably should be ______

avoided

(Chapter 6) Tim has an auto policy that provides for primary coverage of $300,000 for bodily injury liability. He also has a personal umbrella policy that provides excess coverage of $1,000,000. In the case of a $500,000 covered liability claim, how much will the personal umbrella policy pay? a $0 b $200,000 c $300,000 d $500,000

b $200,000

(Chapter 6) An insured purchases a $60,000 property insurance policy with an 80% coinsurance rate. At the time of a $50,000 covered loss, the insured property is valued at $100,000. How much can the insured collect from its policy for the $50,000 loss? a $50,000 b $37,500 c $60,000 d $40,000

b $37,500

(Chapter 5) Dee has a house valued at $150,000. Dee takes out homeowner's insurance from two companies, each policy in the amount of $150,000. If the house is totally destroyed, can D collect in full from both companies? Why or why not? a Yes, Dee can collect the full $150,000 from each company. b No, because collecting in full from both insurers would violate the principle of indemnity.

b No, because collecting in full from both insurers would violate the principle of indemnity.

(Chapter 5) Name the requisites of insurable risk from the standpoint of the insured. a Large enough number, accidental loss, determinable and measurable, and noncatastrophic in nature. b Sufficiently severe so as to cause financial hardship and probability of loss not too high so as to drive the premium up beyond the means of the buyer. c None of the above.

b Sufficiently severe so as to cause financial hardship and probability of loss not too high so as to drive the premium up beyond the means of the buyer.

(Chapter 7) What are the potential cash outflows to be considered in a net present value analysis of a loss control decision? a Reduced costs, premium savings, tax savings resulting from depreciation for loss control equipment, and salvage value of the equipment. b The costs of training and maintenance of the equipment.

b The costs of training and maintenance of the equipment.

(Chapter 7) In selecting a deductible, how does the risk manager balance considerations of potential premium savings and the firm's ability to pay losses? a The risk manager usually determines a targeted amount of losses to exceed, such as $10,000. The risk manager is given a variety of choices of deductible levels and premium amounts from the insurance company. The objective is to obtain the optimal level of deducible and premium amount to consistently pay over that targeted amount for the policy year. The tradeoffs between lower deductible amounts and higher premiums are analyzed, and a decision is made. b The risk manager usually determines a targeted amount of losses to retain, but not exceed, such as $10,000. The risk manager is given a variety of choices of deductible levels and premium amounts from the insurance company. The objective is to obtain the optimal level of deducible and premium amount to avoid paying over that targeted amount for the policy year. The tradeoffs between higher deductible amounts and lower premiums are analyzed, and a decision is made.

b The risk manager usually determines a targeted amount of losses to retain, but not exceed, such as $10,000. The risk manager is given a variety of choices of deductible levels and premium amounts from the insurance company. The objective is to obtain the optimal level of deducible and premium amount to avoid paying over that targeted amount for the policy year. The tradeoffs between higher deductible amounts and lower premiums are analyzed, and a decision is made.

(Chapter 5) Which of the following is a reason for subrogation in insurance policies? a it allows the insured to collect twice for a loss caused by someone else b it reduces the premium that would otherwise have to be charged in the absence of a subrogation provision c in liability insurance, it doesn't require the person responsible for a loss to pay the cost of a loss

b it reduces the premium that would otherwise have to be charged in the absence of a subrogation provision

(Chapter 7) In the calculation in Table 7-1, if everything else remained the same how would the NPV change if installation costs increased and the premium savings were decreased? a the NPV would be higher b the NPV would be lower c the NPV would be unchanged

b the NPV would be lower

(Chapter 7) Installing a sprinkler system or burglar alarms are both examples of which risk management technique? a risk transfer b loss control c risk retention d avoidance

b. Loss Control

(Chapter 7) Which one of the following situations would represent a case of "natural hedging"? a A firm buys insurance to cover loss due to windstorm damage b A business rents vacation homes on the beach and runs a store that sells ice cream to beach visitors c A farmer grows two crops, one does well in wet weather and the other does well in dry weather

c A farmer grows two crops, one does well in wet weather and the other does well in dry weather

(Chapter 5) What is adverse selection? Why is underwriting necessary to control adverse selection? a Adverse selection is the tendency of insureds who have a less than average chance of loss to purchase less than the average amount of insurance. Underwriting is necessary because the insurance company does not want to write insurance only for these low risk insureds. Writing only this group would not spread the risk for the insurance company and would eventually not be profitable. The company would eventually fail. b Adverse selection is opting for risk that not standard to the average insurer. Underwriting is necessary for compliance with regulations. c Adverse selection is the tendency of insureds who have a greater than average chance of loss to purchase more than the average amount of insurance. Underwriting is necessary because the insurance company does not want to write insurance only for these high risk insureds. Writing only this group would not spread the risk for the insurance company and would eventually casue higher and higher premiums. The company would eventually fail.

c Adverse selection is the tendency of insureds who have a greater than average chance of loss to purchase more than the average amount of insurance. Underwriting is necessary because the insurance company does not want to write insurance only for these high risk insureds. Writing only this group would not spread the risk for the insurance company and would eventually casue higher and higher premiums. The company would eventually fail.

(Chapter 6) All of the following are common insurance policy conditions EXCEPT: a cancellation b notice of loss c earthquake d preservation of property

c earthquake

(Chapter 5) Of the following requisites of an insurable, which one is the most important in explaining why life insurance policies are usually not available for issue above a certain age (such as 95)? a accidental and unintentional b determinable and measurable c probability of loss not too high

c probability of loss not too high

(Chapter 5) Fill in the Blank: For an insurance policy to be a valid contract, it must meet certain elements. The payment by the insured of a premium in return for a promise by the insurer to pay certain losses if they occur is an example of ______

consideration

(Chapter 6) An insured has the following four liability insurance policies: $300,000 with insurer A, $300,000 with insurer B, $700,000 with insurer C, and $900,000 with insurer D. Each policy apportions losses using the equal shares method.How much will each policy pay for a $2 million loss? a Each will pay $300,000 b A. $0 B. $300,000 C. $0 D. $700,000 c A. $300,000 B. $0 D. $700,000 D. $0 d A. $300,000 B. $300,000 C. $700,000 D. $700,000

d A. $300,000 B. $300,000 C. $700,000 D. $700,000

(Chapter 7) WPR Corporation owns 5,000 hotels and motels throughout the world. If you were the WPR risk manager, what risks might you suggest should be treated through the risk avoidance technique? Select the most appropriate answer. a Avoid risks associated with business activities not consistent with its goals b Avoid risks associated with running homeless shelters that WPR does not have in its business plan c Avoid risks involved in using rooms for storage of expensive items d All of the above

d All of the above

(Chapter 7) Which selection below describes a specific method of reducing subjective risk? a Obtaining more information through research b Obtaining more information through education c Group discussion d All of the above

d All of the above

(Chapter 6) The mortgagee clause protects the lender's interest. Which of the following describes a way the mortgagee clause aids the mortgagee? a The mortgagee can sue in its own name b The mortgagee receives ten days notice of cancellation rather than five, as in a fire policy c If there is an increase in hazard unknown the mortgage, the mortgagee's interest is still protected d All of the above describe a way the mortgage clause aids the mortgagee.

d All of the above describe a way the mortgage clause aids the mortgagee.

(Chapter 5) An insurable interest likely exists in all of the following cases EXCEPT: a.) individual takes out a life insurance policy on his or her own life b.) a bank requires a borrower with a mortgage on his or her home to take out a homeowners' insurance policy c.) a spouse takes out a life insurance policy on the life of the other spouse d.) a friendly neighbor takes out a life insurance policy on his neighbor's life

d a friendly neighbor takes out a life insurance policy on his neighbor's life

(Chapter 6) Fill in the Blank: The ____ page is usually the first page of the policy and provides information such as the insured's name, the premium and the coverage amount (if applicable).

declarations

(Chapter 6) Which of the following reasons explains why life insurance policies are not cancellable by the insurer, although property insurance policies are? a Property insurance policies are subject to some problems with intentional losses since destroyed property can be converted to cash and spent by the insured b Life insurance policies represent policies with a long life and heavy early year expenses that must be paid by the insured c Society feels that people need to be able to depend on their life insurance being available when they get sick and die d Moral hazard on life insurance is less because one must die to collect e All of the above

e All of the above.

(Chapter 7) Fill in the Blanks: Insurance is usually best suited for addressing risks that have ______ expected frequency and ______ potential severity (hint: high or low).

low, high

(Chapter 5) Fill in the Blank: The voiding of an insurance contract due to a misrepresentation is only possible if the misrepresentation is _____

material

(Chapter 5) Implied Warranty

not in the contract but it is assumed to be - most commonly found in ocean marine insurance

(Chapter 5) Fill in the Blanks: Insurers use pooling within a large group of exposures to achieve ______ _______

risk reduction