Chapter 1 and 2 (FIN 360)

Two business owners own identical buildings valued at $60,000 There is a 30 percent chance each building will be destroyed by a peril in any year; loss to either building is an independent event Expected value of the loss for each owner is:

18,000 =0.7*0+0.3*60000

Two business owners own identical buildings valued at $60,000 There is a 30 percent chance each building will be destroyed by a peril in any year; loss to either building is an independent event Standard deviation of the loss for each owner is:

27,495.4 =(0.7*(0-18000)^2+0.3*(60000-18000)^2)^(1/2)

According to the law of large numbers, what should happen as an insurer increases the number of units insured? a. Actual results will more closely approach expected results b. The insurer's profitability should become more variable c. Underwriting expenses should decrease d. The amount the insurer expects to pay in claims should decrease

a. Actual results will more closely approach expected results

Which of the following statements regarding private insurance and government insurance is (are) true? I. Private insurance programs include life and health insurance and property and liability insurance. II. Social insurance programs are government insurance programs that are voluntary and financed entirely by contributions from covered employers. a. I only b. neither I nor II c. both I and II d. II only

a. I only

Which of the following statements about a priori probabilities is correct ? a. They are objective probabilities that can be determined by deductive reasoning. b. They are subjective probabilities based on ambiguity in the way probability is perceived. c. They are subjective probabilities that may vary among individuals because of factors such as age, gender, education, and the use of alcohol. d. They are objective probabilities that can be determined by subjective reasoning.

a. They are objective probabilities that can be determined by deductive reasoning.

Loss control includes which of the following? I. Loss reduction II. Loss prevention a. both I and II b. I only c. II only d. neither I nor II

a. both I and II

Which of the following is (are) often consequences of long-term disability? I. Continuing medical expenses II. Loss or reduction of employee benefits a. both I and II b. I only c. II only d. neither I nor II

a. both I and II

Frazier Electric keeps a paper copy of business records at the company's headquarters. The company also has two back-up copies of business records stored in electronic files. The electronic files are kept in the event the paper records are damaged or destroyed. The back-up files illustrate which of the following risk control techniques? a. duplication b. loss prevention c. loss reduction d. diversification

a. duplication

A name that encompasses all of the major risks faced by a business firm is a. enterprise risk. b. financial risk c. speculative risk d. pure risk

a. enterprise risk.

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. indirect loss b. direct loss c. nondiversifiable risk d. speculative risk

a. indirect loss

Some characteristics of the judicial system and regulatory environment increase the frequency and severity of loss. This hazard is called a. legal hazard b. moral hazard c. physical hazard d. attitudinal hazard

a. legal hazard

All of the following are examples of personal risks EXCEPT a. loss of business income b. poor health c. unemployment d. premature death

a. loss of business income

Faking an accident to collect insurance proceeds is an example of a. moral hazard b. physical hazard c. objective risk d. attitudinal hazard

a. moral hazard

Which of the following statements about financial risk is (are) true? I. Enterprise risk does not include financial risk. II. Financial risk is easily addressed through the purchase of insurance. a. neither I nor II b. I only c. II only d. both I and II

a. neither I nor II

ABC Insurance Company plans to sell homeowners insurance in five Western states. ABC expects that 8 homeowners out of every 100, on average, will report claims each year. The variation between the rate of loss that ABC expects to occur and the rate of loss that actually occurs is called a. objective risk b. objective probability c. subjective probability d. subjective risk

a. objective risk

A pure risk is defined as a situation in which there is a. only the possibility of loss or no loss b. only the possibility of profit c. a possibility of neither profit nor loss d. a possibility of either profit or loss

a. only the possibility of loss or no loss

The use of fire-resistive materials when constructing a building is an example of a. risk control b. risk transfer c. risk avoidance d. risk retention

a. risk control

Uncertainty based on a person's mental condition or state of mind is known as a. subjective risk b. objective risk c. objective probability d. subjective probability

a. subjective risk

A peril is a. the cause of a loss. b. a moral hazard. c. a condition that increases the chance of a loss. d. the probability that a loss will occur.

a. the cause of a loss.

Which of the following is an example of consequential (indirect) loss? a. the cost of renting a substitute vehicle while a collision-damaged car is being repaired b. the theft of a person's jewelry c. the destruction of a firm's manufacturing plant by an earthquake d. the vandalism of a person's automobile

a. the cost of renting a substitute vehicle while a collision-damaged car is being repaired

Traditionally, risk has been defined as a. uncertainty concerning the occurrence of loss. b. any situation in which the probability of loss is one. c. any situation in which the probability of loss is zero. d. the probability of a loss occurring.

a. uncertainty concerning the occurrence of loss.

Which of the following statements concerning social insurance benefits is (are) correct? I. Social insurance benefits are heavily weighted in favor of upper-income groups because of their higher earnings. II. Social insurance benefits are financed entirely or in part by mandatory contributions by covered employers and employees, and not by general revenues of the government. a. both I and II b. II only c. I only d. neither I nor II

b. II only

Which of the following statements regarding insurance and hedging is true? a. Both insurance and hedging reduce objective risk but do not involve the transfer of risk b. Insurance reduces objective risk while hedging involves only risk transfer and not risk reduction c. Hedging reduces objective risk while insurance involves only risk reduction and not risk transfer d. Both insurance and hedging deal only with pure risks

b. Insurance reduces objective risk while hedging involves only risk transfer and not risk reduction

BBB Auto Club provides emergency road service and other services to its members. BBB Auto Club charges a higher membership fee to new members than it charges to members who are renewing their membership. When asked to explain this pricing policy, the auto club president noted, "New members often sign-up prior to taking a long road trip, so we have to charge more as first-year members have higher service utilization rates." A similar phenomenon observed in insurance markets is called a. moral hazard b. adverse selection c. risk aversion d. attitudinal hazard

b. adverse selection

Which of the following statements about the insurance industry as a source of investment funds is (are) true? I. These funds result in a lower cost of capital than would exist in the absence of insurance. II. These funds tend to promote economic growth and full employment. a. II only b. both I and II c. neither I nor II d. I only

b. both I and II

ABC Insurance Company calculated the amount that it expected to pay in claims for each policy sold. Rather than selling the insurance for the amount it expected to pay in claims, ABC added an allowance to cover the cost of doing business, including commissions, taxes, and acquisition expenses. This allowance is called a(n) a. policyowner dividend b. expense loading c. rate credit d. premium

b. expense loading

Which of the following types of risks is normally uninsurable by private insurers ? a. personal risks b. political risks c. liability risks d. property risks

b. political risks

Methods by which insurers may minimize or avoid catastrophic losses include which of the following ? I. The use of reinsurance II. Concentrating coverage written in one geographic region a. neither I nor II b. II only c. I only d. both I and II

c. I only

Which of the following statements regarding insurance and gambling is (are) true? I. Insurance is used to handle existing pure risks, while gambling creates a new speculative risk. II. Insurance usually involves risk avoidance, while gambling typically involves only risk reduction. a. II only b. both I and II c. I only d. neither I nor II

c. I only

Which of the following is a basic characteristic of insurance? a. certainty about specific losses that will occur b. payment of intentional losses c. pooling of losses d. avoidance of risk

c. pooling of losses

XYZ Insurance Company writes coverage for most perils which can damage property. XYZ, however, does not write flood insurance on property located in flood plains. Which requirement of an ideally insurable risk might be violated if XYZ wrote flood insurance on property located in flood plains? a. The losses must be determinable and measurable b. The chance of loss must be calculable c. There must be a large number of similar exposure units d. The loss should not be catastrophic

d. The loss should not be catastrophic

In addition to marketing life insurance, life insurers typically sell which of the following products? I. Retirement annuities II. Disability income insurance a. I only b. neither I nor II c. II only d. both I and II

d. both I and II

The requirement that losses should be accidental and unintentional in order to be insurable results in which of the following? I. Decrease in moral hazard II. More accurate prediction of future losses a. II only b. I only c. neither I nor II d. both I and II

d. both I and II

An insurance company that sells earthquake insurance in an area where earthquakes are possible has subjected itself to the risk of insolvency if a severe earthquake occurs. An insurer can safely sell earthquake insurance in this area if it shifts the risk of catastrophic loss to another insurer. The shifting of insured risk from one insurer to another insurer is called a. coinsurance b. casualty insurance c. underwriting d. reinsurance

d. reinsurance

Apex Insurance Company wrote a large number of property insurance policies in an area where earthquake losses could occur. When the president of Apex was asked if she feared that a severe earthquake might put the company out of business, she responded, "Not a chance. We transferred most of that risk to other insurance companies." An arrangement by which an insurer that initially writes insurance transfers to another insurer part or all of the potential losses associated with such insurance is called a. loss avoidance b. hedging c. speculating d. reinsurance

d. reinsurance

One branch of government insurance programs has a number of distinguishing characteristics. These programs are compulsory, they are financed by mandatory contributions rather than general tax revenues, and benefits are weighted in favor of low-income groups. These government insurance programs are called a. welfare programs b. casualty insurance programs c. private insurance programs d. social insurance programs

d. social insurance programs

List the Top 10 insurers in US and Top 10 all over the world (by size). Top 10 insurers in US 1. State Farm Insurance Group 2. Liberty Mutual Insurance Group (also owns Safeco) 3. Allstate Insurance Group (also owns Esurance) 4. Berkshire Hathaway Group (also owns Geico) 5. Progressive Insurance Group Top 10 insurers all over the world 1. UnitedHealth Group Incorporated 2. AXA S.A. 3. China Life Insurance (Group) Company 4. Ping An Insurance (Group) Company of China Ltd. 5. Allianz SE

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What are the differences between Diversifiable and Nondiversifiable Risk ? Diversifiable risk impacts only the individuals and small groups. For example, a CEO of a company is fired or there is a merger acquisition. Nondiversifiable risk impacts the entire economy or large numbers of individuals or groups. For example, interest rates change or oil prices change.

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What are the differences between Pure Risk and Speculative Risk ? Pure risk is when there is only the possibilities of loss or no loss. For example, premature death or fire, lightening, flood. Speculative risk is when there is possibilities of both loss and profit. For example, stock purchase or horse racing.

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What are the social benefits of insurance ? The social benefits of insurance are indemnification for loss, reduction of worry and fear, source of investment funds, loss prevention, and enhancement of credit.

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What is surety bond ? How can people use it ? A surety bond provides monetary compensation in the case of failure by bonded persons to perform certain acts. An example of this is when a contractor fails to construct a building on time.

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