Fin 138 Exam 1

Reputation risk is a type of: A. hedging risk. B. financial risk. C. business risk. D. operational risk. E. investment risk.

C. business risk.

Glen works in the insurance industry. His new job role includes investigating the circumstances surrounding a loss, determining whether the loss is covered or excluded under the terms of the contract, deciding how much should be paid if the loss is covered, paying valid claims promptly, and resisting invalid claims. Identify Glen's profession. A. Claims adjuster B. Underwriter C. Gentrifyer D. Actuary E. Redliner

A. Claims adjuster

What is the reason the law of large numbers is necessary for insurance? A. It allows better prediction of future losses B. It allows risk pooling C. It allows risk transfer D. It eliminates risk exposures E. It is not necessary

A. It allows better prediction of future losses

Identify the process of classifying the potential insureds into the appropriate risk classification in order to charge the appropriate rate. A. Underwriting B. Actuary C. Gentrification D. Blockbusting E. Redlining

A. Underwriting

In order to try to __________ , many states have adopted model laws. A. create uniformity B. get rid of their insurance departments C. prevent fraud D. prevent lawsuits E. save money

A. create uniformity

A property and casualty insurer in which the salesperson is an employee of the insurer, not an independent contractor, is called a: A. direct writer. B. independent insurance agent. C. risk retention group agent. D. captive insurance company. E. fraternal insurance company.

A. direct writer.

Insurance is ____________ when the possible loss is relatively large compared to the amount of the premium. A. economically feasible B. regressive C. progressive D. undesirable E. under-priced

A. economically feasible

An auto insurer offers a discount for young drivers (ages 18-25) who complete a driver safety course. This is an example of: A. loss prevention, which reduces the probability of loss. B. loss reduction, which reduces the frequency of loss. C. loss reduction, which reduces the probability of loss. D. loss reduction, which reduces the severity of loss. E. loss prevention, which reduces the severity of loss.

A. loss prevention, which reduces the probability of loss.

Brenda identified all of the pure loss exposures her family faces. Then she analyzed these loss exposures, developed a plan to treat these risks, and implemented the plan. The process Brenda conducted is called: A. personal risk management. B. personal financial planning. C. personal insurance planning. D. personal estate planning. E. personal insurance programming.

A. personal risk management.

Loss frequency is defined as the: A. probable number of losses that may occur during some period. B. probability that a liability judgment may exceed a firm's net worth. C. probability that any particular piece of property may be totally destroyed. D. probable size of the losses that may occur during some period.

A. probable number of losses that may occur during some period.

Which of the following is an advantage of state regulation of insurance over federal regulation of insurance? A. quicker response to local insurance problems B. uniformity of laws C. more effective in negotiating international agreements pertaining to insurance D. greater efficiency E. it is cheaper to regulate

A. quicker response to local insurance problems

A ________ person is willing to pay a premium that is greater than the average loss in return for security. A. risk averse B. speculative C. risk seeking D. irrational E. risk neutral

A. risk averse

The bulk of the premium required by the insurer to assume risk is used to compensate those who incur covered losses. Loss sharing is accomplished through premiums collected by the insurer from all insureds—from those who may not suffer any loss to those who have large losses. In this regard, the losses are shared by all the risk exposures. This is the essence of: A. risk pooling. B. risk acceptance. C. risk reduction. D. risk mapping. E. risk transfer.

A. risk pooling.

Identify the hazard that generally exists when a person can gain from the occurrence of a loss. A. Causal hazard B. Moral hazard C. Morale hazard D. Physical hazard E. Collective hazard

B. Moral hazard

Insurers pool similar risk exposures together to compute their own risk of missing the prediction. Identify this process of evaluating a risk and classifying it with similar risks. A. Loss control B. Underwriting C. Reinsuring D. Redlining E. Gentrification

B. Underwriting

What of the following statements is true about risk assumption? A. A captive firm is independent of its parent company. B. When a business creates a subsidiary to handle the risk exposures, the business creates a captive. C. When an organization uses a highly formalized method of retention of a risk, it is said the organization has reinsured the risk. D. Many large corporations use captives, which are a form of reinsurance, to transfer their risk. E. Retention is especially attractive to small organizations.

B. When a business creates a subsidiary to handle the risk exposures, the business creates a captive.

An alien insurer is ___________. A. an unlicensed insurance company B. a non-U.S.-based insurance company C. an illegal insurance company D. an out-of-state insurance company E. a demutualized insurance company

B. a non-U.S.-based insurance company

Under ______ rate regulation, an insurer can begin using a new rate as soon as it is submitted to the insurance department. A. open competition B. file-and-use C. use-and-file D. closed-competition E. prior-approval

B. file-and-use

Parker Department Stores has been hurt in recent months by a large increase in shoplifting losses. Parker's risk manager concluded that while the frequency of shoplifting losses was high, the severity is still relatively low. What is (are) the appropriate risk management technique(s) to apply to this problem? A. loss reduction B. loss prevention C. loss retention D. loss avoidance E. loss assumption

B. loss prevention

If you want to ski in spite of the hazards involved, you can take instruction to improve your skills and reduce the likelihood of you falling down a hill or crashing into a tree. This is an example of: A. loss prevention, which reduces the severity of loss. B. loss prevention, which reduces the probability of loss. C. loss reduction, which reduces the frequency of loss. D. loss reduction, which reduces the probability of loss. E. loss reduction, which reduces the severity of loss.

B. loss prevention, which reduces the probability of loss.

Carelessness or lack of concern can be categorized as a: A. collective hazard. B. morale hazard. C. causal hazard. D. moral hazard. E. physical hazard.

B. morale hazard.

Slippery roads, which often increase the number of auto accidents is an example of: A. causal hazards. B. physical hazards. C. moral hazards. D. morale hazards. E. intangible hazards.

B. physical hazards.

In a meeting with the board of directors, the risk manager said, "Each of the product liability claims against our firm last year cost us an average of $125,000 and a total of $375,000." He is referring to the: A. perils. B. severity of losses. C. hazards. D. amortization of losses. E. frequency of losses.

B. severity of losses.

Which of the following is NOT a component of the insurance premium? A. the MFP B. taxes C. Operating expense/business overhead D. risk reserve E. investment income

B. taxes

If we compare one standard deviation with another distribution of equal mean but larger standard deviation, we could say that: A. it is impossible to tell which distribution is riskier because the mean is equal. B. the distribution with the larger standard deviation is riskier. C. the distribution with the smaller standard deviation is riskier. D. the distribution with the higher severity would be riskier. E. the risk of the distribution is equal.

B. the distribution with the larger standard deviation is riskier.

Which of the following is an example of a commercial risk? A. the risk of insufficient retirement income B. the loss of business income C. the risk of being unemployed D. the risk of premature death E. the risk of disability

B. the loss of business income

Insurance is primarily regulated by ________. A. the federal government B. the states C. the NAIC D. the treasury department E. local jurisdictions

B. the states

Which of the following is classified as casualty insurance? A. fire insurance B. workers compensation insurance C. marine insurance D. home insurance E. life insurance

B. workers compensation insurance

From the standpoint of the insurer, which of the following is a characteristic of an ideally insurable risk? A. There must be a small number of unique loss exposures. B. The loss must be intentional. C. The chance of loss must be calculable. D. The loss must be indeterminable. E. The loss should be catastrophic.

C. The chance of loss must be calculable.

Not all risks are insurable. Identify the feature that does not meet the requirement of a risk that is perfectly suited for insurance. A. Losses are definite. B. The probability distribution of losses can be determined. C. The number of similar exposure units is small. D. A catastrophe cannot occur. E. The losses that occur are accidental.

C. The number of similar exposure units is small.

If your insurance company goes bankrupt, who will pay your claim? A. Lloyd's of London B. a mutual insurance company C. a state guarantee association D. a reinsurance company E. the Office of the Insurance Commissioner

C. a state guarantee association

In order for the law of large numbers to work, the pooled exposures must have approximately the same probability of loss. Insurers must therefore: A. concentrate on tapping heterogeneous exposures. B. restrain from insuring individuals with significant differences in the probability of loss. C. classify exposures according to expected loss. D. encourage underwriters to concentrate on loss frequency rather than severity. E. encourage actuaries to concentrate on frequency of losses.

C. classify exposures according to expected loss.

Jenna opened a successful restaurant. One night, after the restaurant had closed, a fire started when the electrical system malfunctioned. In addition to the physical damage to the restaurant, Jenna lost profits that could have been earned while the restaurant was closed for repairs. The lost profits are an example of: A. direct loss B. nondiversifiable loss C. indirect loss D. hazard E. adverse selection

C. indirect loss

When we are pretty certain that the future will be similar to the past, a _________ can be used to predict future loss. A. variance in probability statistics B. average loss analysis which is frequency C. loss distribution D. loss variance E. average accounting computations

C. loss distribution

When a company purchases liability insurance this is an example of: A. risk reduction B. risk mitigation C. risk transfer D. risk avoidance E. risk retention

C. risk transfer

When a corporation insures a risk, it is: A. avoiding its risk. B. assuming its risk. C. transferring its risk. D. retaining its risk. E. retaining its risk with loss control.

C. transferring its risk.

Which of the following statements about captive insurance companies is (are) true? 1. A captive insurance company established by a U.S. company must be domiciled in the United States. 2. A captive insurance company may be owned by several parents. A. 1 only B. both 1 and 2 C. neither 1 nor 2 D. 2 only

D. 2 only

Which of the following is a correct statement about insurance? A. If we desire to supplement the benefit levels of social insurance or to buy property/casualty insurance, government insurers provide the protection. B. Most private insurance is purchased involuntarily. C. Private sector provides about one-third more personal insurance than the government. D. A private insurer can be classified as either a life/health or a property/casualty insurer. E. Our society has elected to provide certain levels of death, health, retirement, and unemployment insurance on an involuntary basis through private agencies.

D. A private insurer can be classified as either a life/health or a property/casualty insurer.

Define risk. A. Having no expectations B. Not getting what you want C. Having expectations D. Consequence of uncertainty E. Being averse to danger

D. Consequence of uncertainty

Identify the correct statement about the risk management matrix. A. It involves charting entire spectrums of risk, not individual risk "silos" from each separate business unit. B. It is also referred to as a risk map. C. It includes all important risks a firm is exposed to. D. It includes on one axis, categories of relative frequency (high and low) and on the other, categories of relative severity (high and low). E. It puts the risks a company faces into a visual medium to see how risks are clustered and to understand the relationships among risks.

D. It includes on one axis, categories of relative frequency (high and low) and on the other, categories of relative severity (high and low).

Which of the following statements is true about stock insurers? A. Profits are shared with owners as policyowners' dividends. B. They are owned and controlled by their policyowners. C. They have no stockholders and issue no capital stock. D. They are organized in the same way as other privately owned corporations E. People become owners by purchasing an insurance policy from the mutual insurer.

D. They are organized in the same way as other privately owned corporations

What is reinsurance? A. arrangement by which the insurer reassesses the insurance coverage on a regular basis B. arrangement by which an insurance company avoids all risk C. arrangement by which an insurance company absorbs all or a portion of its risk under a contract of insurance to another company D. arrangement by which an insurance company transfers all or a portion of its risk under a contract of insurance to another company E. arrangement by which an insurance company keeps all of its risk

D. arrangement by which an insurance company transfers all or a portion of its risk under a contract of insurance to another company

Reasons for regulation of insurance include which of the following? I. Maintaining insurer solvency II. Ensuring reasonable rates A. II only B. neither I nor II C. I only D. both I and II

D. both I and II

In a meeting with the board of directors, the risk manager said, "There were three instances of product liability against our firm last year." He is referring to the: A. hazards. B. severity of losses. C. perils. D. frequency of losses. E. intangibility of losses.

D. frequency of losses.

Inland marine insurance provides coverage for: A. goods being shipped on ocean-going vessels. B. liability arising out of catastrophic losses C. premature death of members of the armed forces. D. goods being shipped on land. E. liability exposures of nonprofit organizations.

D. goods being shipped on land.

Cal was just hired as XYZ Company's first risk manager. Cal would like to employ the risk management process. The first step in the process Cal should follow is to: A. evaluate potential losses faced by XYZ Company. B. formulate a treatment plan for XYZ Company's loss exposures. C. monitor the risk management implementation D. identify potential losses faced by XYZ Company. E. implement and administer a risk management plan for XYZ Company.

D. identify potential losses faced by XYZ Company.

Ben is concerned that if he injures someone or damages someone's property he could be held legally responsible and required to pay damages. This type of risk is called a: A. reputation risk. B. personal injury risk. C. disability risk. D. liability risk. E. human capital risk.

D. liability risk.

A situation or circumstance in which a loss is possible, regardless of whether a loss occurs, is called a: A. peril. B. hazard. C. probability of loss. D. loss exposure. E. premium.

D. loss exposure

Craig is a reckless driver. He is careless because his Porsche is insured and he knows that losses incurred will be covered. This is an example of a: A. physical hazard. B. causal hazard. C. moral hazard. D. morale hazard. E. collective hazard.

D. morale hazard.

Because insurers need to _________ exposures according to expected losses, a person with diabetes will be charged a higher premium than one without any medical condition. A. describe B. quantify C. not discriminate D. pool E. qualify

D. pool

The worst loss that is likely to happen is referred to as the: A. severity of loss. B. maximum possible loss. C. probability of loss. D. probable maximum loss. E. frequency of loss.

D. probable maximum loss

Loss severity is defined as the: A. probability that a liability judgment may exceed a firm's net worth. B. probability that any particular piece of property may be totally destroyed. C. probable number of losses which may occur during some period. D. probable size of the losses which may occur during some period.

D. probable size of the losses which may occur during some period.

Adverse selection occurs: A. when an insurance company loses money on its investments. B. when reinsurance cannot be implemented. C. when catastrophic losses occur as a result of a natural disaster. D. when applicants with a higher-than-average chance of loss seek insurance at standard rates. E. when insurance purchasers buy insurance but do not have a loss.

D. when applicants with a higher-than-average chance of loss seek insurance at standard rates.

This analysis is a highly specialized mathematic analysis that deals with the financial and risk aspects of insurance. This analysis takes past losses and projects them into the future to determine the reserves an insurer needs to keep and the rates to charge. Identify this analysis. A. Blockbusting analysis B. Redlining analysis C. Underwriting analysis D. Risk classification E. Actuarial analysis

E. Actuarial analysis

Which of the following statements about Lloyd's of London is true? A. It represents unincorporated mutual insurance companies B. It allows underwriters to write coverage without meeting stringent financial requirements. C. New individual members or Names who belong to the various syndicates have unlimited legal liability. D. It operates as an admitted insurer throughout the United States. E. Coverage is actually written by syndicates who belong to Lloyd's of London

E. Coverage is actually written by syndicates who belong to Lloyd's of London

Which of the following statements correctly differentiate between perils and hazards? A. Perils are consequences of losses; hazards are cause of losses B. Perils refer to the number of losses during a specified period and hazards refer to the average dollar value of a loss per occurrence. C. Perils are diversifiable risks; hazards are nondiversifiable risks. D. Both perils and hazards are causes of loss; perils are tangible, hazards are intangible. E. Perils are causes of loss; hazards are conditions that increase perils.

E. Perils are causes of loss; hazards are conditions that increase perils.

In which of the following did the Court decide that insurance was interstate commerce when conducted across state lines, and therefore was subject to federal regulation? A. the GLB Act B. Paul v. Virginia C. Financial Modernization Act D. McCarran-Ferguson Act E. South-Eastern Underwriters Association case

E. South-Eastern Underwriters Association case

Which of the following explains why insurance companies have separate divisions within its underwriting department for personal lines, group lines, and commercial business? A. The legal procedures are different in each type of insurance. B. The level of reserves needed for each type of insurance is different and should be kept separately for effective handling of funds. C. The method of forecasting and calculating frequency of losses is different in each type of insurance. D. The level of expertise in group and commercial lines are much higher than those of personal lines, which include individuals. E. The criterion to assign insureds into their appropriate risk pool for rating purposes is different for each type of insurance.

E. The criterion to assign insureds into their appropriate risk pool for rating purposes is different for each type of insurance.

All risks are not insurable. Identify the feature that does not meet the requirement of a risk that is perfectly suited for insurance. A. Losses are definite. B. The losses that occur are accidental. C. The probability distribution of losses can be determined. D. A catastrophe cannot occur. E. The number of similar exposure units is small.

E. The number of similar exposure units is small.

Identify the correct statement about independent agents. A. They usually represent a single insurance company. B. Legally, they represent the customers. C. They are compensated on a salary basis by the insurance firm. D. They have the responsibility of collecting premiums on all circumstances. E. They pay all agency expenses.

E. They pay all agency expenses.

What is the law of large numbers? Why do insurers rely on the law of large numbers? A. insurers rely on predictions, not the law of large numbers B. it is a mathematical phenomenon known to improve expected losses C. we cannot prove the law of large numbers D. as the sample size decline the standard deviation is getting smaller and insurers want to predict correctly E. as the sample size increases the standard deviation is getting smaller and insurers want to predict losses correctly

E. as the sample size increases the standard deviation is getting smaller and insurers want to predict losses correctly

Abandoning an existing loss exposure is an example of: A. reduction. B. prevention. C. insurance. D. assumption. E. avoidance.

E. avoidance

An ideal risk for an insurance company would involve a situation in which ________. A. There was no chance of a loss which is certainty B. premiums were very high C. there were only a few other similar properties insured by the company and losses are expected to occur once in 100 years D. catastrophes occurred frequently E. losses that occurred would be accidental

E. losses that occurred would be accidental

The worst loss that could ever happen to a firm is referred to as the: A. probability of loss. B. severity of loss. C. probable maximum loss. D. frequency of loss. E. maximum possible loss.

E. maximum possible loss

Which of the following types of risks best meets the requirements for being insurable by private insurers? A. political risks B. regulatory risks C. market risks D. financial risks E. property risks

E. property risks

In a small company or sole proprietorship, the owner usually hires one experienced risk manager to perform the risk management function. True or False?

False

Insurance is a common form of planned risk retention as a financing technique for individuals and most organizations. True or False?

False

Stock insurance companies are exempt from state insurance regulation. True or False?

False

The stated purpose of mutual insurers is to make a profit for stockholders rather than to provide low-cost insurance. True or False?

False

The use of deductibles to eliminate insurance reimbursement for frequent small losses makes automobile collision premiums unattractive for the insureds. True or False?

False

In the U.S., flooding is covered by the federal government, not by private insurers. True or False?

True

Income from investments is important in offsetting any unfavorable underwriting experience. True or False?

True

Insurance brokers legally represent the insured rather than the insurance company. True or False?

True

One purpose of underwriting standards is to reduce adverse selection against the insurer. True or False?

True

Producer is another name for both agents and brokers. True or False?

True

Risk management is a continuous process requiring constant monitoring of the program. True or False?

True

Risk managers avoid risks that have high frequency and high severity of losses. True or False?

True

Insurance is created by an insured that, as a professional risk-bearer, assumes the financial aspect of risks transferred to it by insurer. True or False?

false

Loss reduction efforts seek to reduce the probability of a loss occurring. True or False?

false

Pooling the exposures together permits less accurate statistical prediction of future losses. True or False?

false

State insurance guaranty funds are usually funded by general revenues of the states. True or False?

false

The risk of an insurer with more exposures is relatively higher than that of an insurer with fewer exposures under the same expected distribution of losses. True or False?

false

Utilization of a captive insurer is an example of reinsurance. True or False?

false

When summer humidity declines and temperature and wind velocity rise in heavily forested areas, the likelihood of fire increases. Conditions are such that a forest fire could start very easily and be difficult to contain. In this example, low humidity is a peril. True or False?

false

Insurers are subject to regulation by certain federal agencies and laws. True or False?

true

Risk retention groups and captives are forms of self-insurance. True or False?

true

Risks with a chance to either gain or lose are speculative risks. True or False?

true

The first step in mapping risk is to identify the firm's loss exposures and estimate and forecast the frequency and severity of each potential risk. True or False?

true