CPCU 500 Ch.5

Which planned retention funding measure recognizes in advance the potential for loss and supports the potential by allocating cash, securities, or other liquid assets to meet obligations?

A funded reserve

How does a large deductible plan compare with guaranteed cost in meeting various risk financing goals?

A large deductible plan minimizes the cost of risk better than a guaranteed cost insurance.

Hold-harmless agreements are commonly used to assign responsibility for losses arising out of?

A particular relationship or activity

Kendall Inc. is considering using a pool to meet its risk financing goals, one of which is maintaining liquidity. How can a pool help an organization meet this goal?

A pool that is adequately funded and managed can meet this goal

One risk financing goal is to comply with legal requirements. An example of one such legal requirement is?

A state insurance law that requires the purchase of liability insurance for vehicles.

A financial contract that derives its value from the value of another asset

Derivative

What should an organization do before using a hold-harmless agreement as a risk financing measure?

Determine whether any statutory restrictions apply

If the organization wishes to pre-fun for retained future losses, it must determine the present value of the expected future losses. Calculating the present value of a future amount is known as?

Discounting

With guaranteed cost insurance, the premium

Does not depend on losses incurred during the coverage period

A pool can meet the risk financing goal of minimizing the cost of risk through?

Economies of scale in administration.

Insurance that covers losses above an attachment point, below which there is usually another insurance policy or a self-insured retention.

Excess coverage

A level of insurance coverage above the primary layer

Excess layer

Retrospective rating plans require a large amount of administration by the insured (T/F)

False

A risk financing plan that transfers a limited (finite) amount of risk to an insurer

Finite Risk Insurance Plan

The process of creating a marketable insurance-linked security based on the cash flows that arise from the transfer of insurable risks.

Insurance securitization

A ----- is a significant expense that an organization is save by using a retrospective rating plan?

Insurer risk charges

Which type of captive allows an organization to keep its own premium and loss account separate from those of other members, and denies other members and third parties access to its assets in the event any of those members becomes insolvent?

Protected Cell Company (PCC)

Many states require a self-insurer to?

Purchase excess insurance

A self-insured organization needs a

Record keeping system to track its self-insured claims

The principal advantage of risk transfer measures is that they?

Reduce exposure to large losses

The process of creating a marketable investment security based on a financial transactions expected cash flows.

Securitization

Catastrophe bonds are used to?

Securitize insurance risk through a marketable security

That is the most important reason for the transferor in a risk transfer agreement to assess the financial strength of the transferee?

The ultimate responsibility for paying for loss remains with the transferor in a risk transfer agreement.

Do capital market solutions meet the risk financing goal of minimizing the cost of risk?

They cannot typically meet this goal because capital market solutions are expensive relative to other risk financing measures

What is considered an advantage of the use of retention as a risk financing technique

Timing of cash flows

Pools are well-suited for organizations that are?

Too small to use a captive insurer

In the context of risk management, a risk financing technique by which the financial responsibility for losses and variability in cash flow is sifted to another party

Transfer

Loss exposures that are determined to be of low frequency but high severity are best handled with which risk financing technique?

Transfer

Low frequency + High severity =

Transfer

Capital market solutions manage uncertainty and pay for the negative consequences of an event by?

Transferring the financial consequences of loss to investors

A captive collects premium, issues policies, purchases reinsurance, invest assets and pays losses, just like any other insurer. (T/F)

True

All else being equal, the more risk control an organization undertakes, the more likely its ability to fund the retention of the affected exposures. (T/F)

True

An organization must have substantial insurance premium to benefit from a retrospective rating plan. (T/F)

True

Both the amount of cash to pay for retained losses and the timing of the payments are important in deciding on an appropriate level of liquidity (T/F)

True

Guaranteed cost insurance can minimize the cost of risk, but it is not ideal because insurance premium are designed to cover not only expected losses, but also insurer administrative costs, adverse selection and moral hazard costs, premium taxes, and any social loadings (T/F)

True

It is typically more economical for an organization to retain rather than transfer loss exposures directly related to its core operations (T/F)

True

Most risk transfer measure limit the potential loss amount being transferred (T/F)

True

Self-insurance can save insurer operating expenses, profits, ad risk charges (T/F)

True

The primary benefit of transfer is certainty regarding the ability to pay losses (T/F)

True

A liability policy that provides excess coverage above underlying policies and may also provide coverage not available in the underlying policies, subject to a self insured retention

Umbrella policy

Appears as an accounting entry denoting potential liability to pay for a loss

Unfunded loss reserve

An organization can best analyze its loss control expenditures by?

Conducting a cost-benefit analysis

How does a retrospective rating plan help an organization comply with legal and regulatory requirements?

An insurer issues a policy guaranteeing that all covered claims will be paid.

High frequency + High Severity =

Avoid (if possible) Retain (last resort)

What are the major factors influencing the ability of a risk financing measure to meet an individuals or organizations risk financing goals

-The mix of retention and transfer -Loss exposure characteristics -Characteristics of the individual or organization

What characteristics can affect the selection of appropriate risk financing measures?

-Risk tolerance -Financial Condition -Core operations -Ability to diversify -Ability to control losses -Ability to administer the retention plan

What are some of the advantages of using retention as a risk financing technique?

-Cost savings -Control of claims process -Timing of cash flows -Incentives for risk control

What four planned retention funding measures are available to an organization?

-Current expensing of losses -Using an unfunded reserve -Using a funded reserve -Borrowing funds

What are some common risk financing goals?

-Pay for negative financial consequences of an event -Maintain liquidity -Manage uncertainty -Comply with legal and regulatory requirements -Minimize the "cost of risk"

What are some of the advantages of transferring risk?

-Reducing exposure to large losses -Reducing cash flow uncertainty -Providing ancillary services -Avoiding employee and public relations

What risk financing measure can reduce an organizations cost of risk over time but has significant start-up costs relative to the other measures?

A captive plan

The premium for a finite risk insurance plan is?

A very high percentage of the policy limits

What is key to an organization using self-insurance to maintain liquidity?

Accurately forecasting paid amount for retained losses

Those risk financing measures that do not fall into the category of guaranteed cost insurance

Alternative Risk Transfer (ART)

Cara, a risk management professional, advises an organization that by using a finite risk plan, it will not meet its goal of maintaining liquidity. What best explains this reason?

Because premium payments are usually paid up front

An organization should evaluate a finite risk plan's ability to meet the organizations risk financing goals..

Before adopting the finite risk plan

Bentley organization has a retrospective rating plan. It experiences $1.5 million in losses subject to the policy limit; however, Bentley's adjusted premium is limited to $1 million. This is likely because?

Bentley has a maximum premium of $1 million

When liability is assumed under a hold-harmless agreement, the indemnitor may be required to demonstrate proof of financial responsibility. What is often used to demonstrate this proof of financial responsibility?

Certificate of insurance

A level of excess insurance coverage between a primary layer and an umbrella policy

Buffer layer

What has lead to an increase in the appeal of onshore captive domiciles?

Concerns about the transparency of financial transactions

A financial market in which long-term securities are traded

Capital Market

A subsidiary formed to insure the loss exposures of its parent company and the parents affiliates

Captive insurer or captive

Shelton manufacturing is a publicly traded chemical manufacturer. It has an agreement with an investment bank that requires the bank to purchase a specified number of Shelton manufacturing shares at a predetermined price if Shelton should suffer a significant property loss at its manufacturing plant for which it was unable to acquire property insurance. This is an example of which type of capital market solutions?

Contingent Capital Arrangement

An agreement, entered into before any losses occur, that enables an organization to raise cash by selling stock or issuing debt at a prearranged terms after a loss occurs that exceeds a certain threshold.

Contingent capital arrangement

One goal of risk financing is to handle risk in a cost-effective manner. To do this, an organization seeks to minimize its total expenditures on loss control, retained losses, loss transfer costs, and administrative expenses. A composite measure encompassing all expenditures on risk is called an organizations?

Cost of risk

What is considered the primary advantage of using retention as a risk financing technique?

Cost savings

Under a finite risk insurance agreement, a large part of the insureds premium..

Creates a fund for the insureds own losses

Relies on current cash flow to cover the cost of losses

Current expensing

Which planned retention funding measure is the least formal and the least expensive to administer?

Current expensing of losses

Is supported with cash, securities, or other liquid assets allocated to meet the obligations that the reserve represents

Funded loss reserve

Insurance is a?

Funded risk transfer measure

Under a large deductible plan, the insured usually must provide the insurer with a letter of credit to?

Guarantee payment of losses up to the deductible amount

Insurance policies in which the premium and limits are specified in advance

Guaranteed cost insurance

DH Manufacturing (DHM) is a manufacturer of canned foods. Its canned goods are distributed to various retail operations by HB Distributing (HBD). The contracts include a hold-harmless agreement whereby DHM agrees to assume the liability for losses that HBD suffers as a result of distributing DHM's products. Who is the indemnitee in this agreement?

HBD

To benefit from a retrospective rating plan, an organization must?

Have a substantial insurance premium

Risk from accidental loss, including the possibility of loss or no loss

Hazard Risk

A financial transaction in which on asset is held to offset the risk associated with another asset

Hedging

What risk financing measure is well suited for a manufacturing organization that is concerned about the volatility in commodity prices?

Hedging

Self-insurance is usually used to finance?

High-frequency losses

A contractual provision that obligates one of the parties to assume the legal liability of another party

Hold-harmless agreement (or indemnity agreement)

An advantage that retention offers an individual or organization is?

Incentive for risk control

Party in a hold-harmless agreement whose legal liability is assumed by the indemnitor

Indemnitee

Party in a hold-harmless agreement who assumes the other party's liability

Indemnitor

From an investors perspective, what is an advantage of insurance linked securities?

Insurance linked securities help diversify the investors portfolio

A rating plan whereby the insured assumes a substantial per accident or per occurrence deductible, generally ranging from $100,000 up to $1 million

Large deductible plan

The structure of most pool is?

Less formal than the structure of a group captive.

Risk retention groups were formed in response to the lack of availability of what kind of insurance coverage during the mid 1980's?

Liability Insurance Coverage

Property that can be quickly and easily converted into cash

Liquid asset

The level at which a loss occurrence is limited for the purpose of calculating a retrospectively rated premium.

Loss Limit

To achieve the financial goal of maximizing market value, most publicly traded organizations should pursue risk financing goals. A common risk financing goal is?

Manage uncertainty of loss outcomes

What is the primary advantage of using retention as a risk financing measure to help an organization meet its risk financing goals?

Managing the cost of risk

A pool is made up of?

Member organizations

Capital market solutions can typically meet all of the following risk financing goals except?

Minimize the cost of risk

Through a profit-sharing feature that encourages and rewards successful risk control efforts, a finite risk plan

Minimizes the cost of risk

Retrospective rating plans require what amount of administration by the insured?

Moderate

A hold-harmless agreement is a?

Non-insurance risk transfer measure

A finite risk insurance plan often enables an insured to...

Obtain higher limits that it could get using guaranteed cost insurance.

The availability of funds to pay for losses is important to organizations in situations in which?

Operations have been disrupted

An example of an administrative expense that can minimize the cost of risk is?

Outsourcing the claim function

Self-insurance is particularly well-suited for financing losses that are?

Paid out over a period of time

A corporate entity separated into cells so that each participating company owns an entire cell but only a portion of the overall company.

Protected Cell Company (PCC)

With a large deductible plan, the insurer pays for losses as they become due, including losses less than the deductible for which the insured eventually reimburses the insurer. This is an example of how a large deductible plan..

Pays for negative financial consequences of an event

A group of organizations that band together to insure each other's loss exposures

Pool

The first level of insurance coverage above any deductible

Primary layer

An arrangement under which an organization rents capital from a captive, to which it pays premiums and receives reimbursement for its losses.

Rent-a-captive

High frequency + Low severity =

Retain

Low frequency + Low severity =

Retain

In retrospective rating plans, because the premium is adjusted upward or downward based directly on a portion of covered losses, the insured is, in effect,..

Retaining a portion of its own losses

A risk financing technique by which losses are retained by generating funds within the organization to pay for the losses

Retention

A rating plan that adjusts the insured's premium for the current policy period based on the insureds loss experience during the current period; paid losses or incurred losses may be used to determine loss experience.

Retrospective Rating Plan

A group captive formed under the requirements of the Liability Risk Retention Act of 1986 to insure the parent organizations.

Risk Retention Group (RRG)

Which group captive is formed under the requirements of the Liability Risk Retention Act of 1986 to insure the parent organizations?

Risk Retention Group (RRG)

A foundation for applying the risk management process throughout the organization

Risk management framework

Finite risk insurance combines many of the advantages of?

Risk retention and risk transfer

A form of retention under which an organization records its losses and maintains a formal system to pay for them

Self-insurance

What type of captive typically operates as a formalized retention plan rather than a transfer measure?

Single Parent Captive

Captive insurers are...

Sometimes used to insure property loss exposures that are difficult to insure in the primary market.

Each insured member of a pool contributes premium based on its loss exposures. In exchange,...

The pool pays for each insureds covered losses.

In insurance coverage, what is referred to as the working layer because it is the layer used most often to pay losses?

The primary layer

Self-insurance is usually combined with transfer, such as

an excess insurance policy