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Risk Man Multiple Choice
Financial Markets and Institutions (University of Technology Jamaica)
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Chapter 1
Risk and Its Management
Multiple Choice
1.
The major types of business risk include all of the following except:
a.
b.
c.
d.
price risk
diversification risk
pure risk
credit risk
Answer: b
Type: K
2.
Credit risk is:
a.
b.
c.
d.
the risk that a firm’s borrowers will not make promised payments.
the risk that a firm will not be able to get credit from lenders.
the risk that a firm will not have sufficient funds to make payments to their creditors.
the risk due to changes in output and input prices.
Answer: a
Type: K
3.
All of the following are types of price risk except:
a.
b.
c.
d.
commodity price risk
exchange rate risk
stock price risk
interest rate risk
Answer: c
Type: K
4.
Which of the following is not an example of a direct loss from pure risk?
a.
b.
c.
d.
loss of profit
damage to assets
cost of paying and defending liability claims
employee turnover
Answer: a
Type: A
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5.
Gallagher Winery is attempting to identify its pure risks. Which of the following is
an example of an indirect loss for Gallagher?
a.
b.
c.
d.
Loss of grapevines due to hail.
Employee health problems due to insecticide usage.
Loss of profit due to bad publicity about a liability claim.
Cost of replacing equipment after a fire.
Answer: c
Type: A
6.
Which of the following is not a method of loss financing?
a.
b.
c.
d.
diversification
retention
insurance
hedging
Answer: a
Type: K
7.
Driving at lower speeds in order to reduce the probability of having an automobile
accident is an example of:
a.
b.
c.
d.
loss financing
loss control
internal risk reduction
hedging
Answer: b
Type: A
8.
What impact does routine inspection of aircraft for mechanical problems have on the
risk of airplane crashes for United Airlines?
a.
b.
c.
d.
reduced frequency of crashes
reduced magnitude of loss if the crash occurs
eliminate airplane crashes
no impact on risk of airplane crashes
Answer: a
Type: A
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9.
An advantage of centralizing the function of risk management in the organization is:
a.
Reduced concern for risk management by managers and employees in the firm’s
various operating units.
Reduced diversification.
Economies of scale in arranging loss financing.
Less effective interaction between the risk manager and senior management.
b.
c.
d.
Answer: c
Type: K
10. Vickie’s Vanities, Inc. is a small boutique that sells expensive designer clothing.
Which one of the following is not a pure risk to the owner?
a.
b.
c.
d.
losses due to theft of inventory
loss of revenue due to recession
liability claims for customer injury in the store
risk of a liability claim for injury to an employee
Answer: b
Type: A
11. Which one of the following is not an example of a personal earnings risk?
a.
b.
c.
d.
death
stock dividends
unemployment
disability
Answer: b
Type: K
12. Ted’s Brewery imports beer from Thailand to the U.S. To facilitate the transactions
Ted’s Brewery holds large amounts of Thai currency (baht). The uncertainty that Ted
faces regarding the U.S. dollar value of his holdings of Thai currency is an example
of
a.
b.
c.
d.
price risk
credit risk
international risk
pure risk
Answer: a
Type: A
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13. Longevity is a major type of personal risk. The longevity risk refers to possibility that
a person will
a.
b.
c.
d.
hold an investment too long
be unable to retire
die before reaching retirement age
outlive his (or her) financial resources
Answer: d
Type: K
14. Which one of following is not a major method of managing risk?
a.
b.
c.
d.
loss control
loss identification
loss financing
internal risk reduction
Answer: b
Type: K
15. Prairie Flowers sells fresh flowers at a curbside outlet. The owners know the
expected level of daily sales as well as the variability of daily sales. They are trying
to decide how large of a supply to provide at the outlet each day. Too few flowers
results in lost sales, too many flowers results in spoilage (or wilting). This is an
example of
a.
b.
c.
d.
pure risk
indirect loss
credit risk
the costliness of risk
Answer: d
Type: A
I.
Fill-Ins
1.
The risk that a firm’s customers and parties to which it has lent money will fail to
make promised payments is known as
credit
risk.
2.
The three major risk management methods are
financing , and
internal risk reduction
3.
Reducing the level of risk activity and increasing precautions against the loss are the
two major approaches to
loss control .
loss control
.
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,
loss
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4.
Three methods of financing losses are:
retention
,
insurance
, and hedging
. (Answer could also include other contractual risk
transfers.)
5.
The major types of risk that produce fluctuations in cash flows and business value
pure risk.
are
price risk, credit risk, and
II. Problems and Short Answer Questions
1.
What are the most important characteristics of pure risk as compared to other types
of risk?
Answer: The most important characteristics of pure risk include: a) the losses have the
potential to be large relative to the business’ resources; b) the underlying causes
are company-specific and the firm can take actions to reduce frequency and severity;
c) they are often insurable; and d) there are not usually any offsetting gains to other
parties.
Type: K
2.
Provide a brief outline of the steps in the risk management process.
Answer: The key steps in the risk management process are: a) identify the risks; b)
evaluate the potential frequency and severity of the losses; c) select the risk
management methods to be used; d) implement the risk management methods; and e)
monitor the risk management program on a regular basis.
Type: K
3.
Rocky’s Bagels, Inc. is a small bagel sandwich restaurant. Rocky is concerned about
the risk of employees cutting themselves on the job. Assuming that Rocky has no
interest in expanding his operation, which of the major risk management methods are
likely to be most important to Rocky? Which will not be appropriate for Rocky?
Explain.
Answer: Rocky will need to focus on loss control. He can take increased precautions
such as providing employees with instruction on cutting bagels or he can invest in
equipment that does not require employees to be near the blades. Loss financing
through insurance or retention can be used to cover the cost of losses that do occur
but generally insurance for small regular losses will be too expensive. Internal risk
reduction will be the least useful, since Rocky cannot diversify away this risk and
additional information is not likely to reduce the losses.
Type: A
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4.
Explain how the two major approaches to loss control (reducing the risky activity
and increasing precautions) could reduce McDonald’s risk of customer burns due to
hot coffee.
Answer: Although McDonalds would not want to reduce coffee sales, they could reduce
the risk by reducing the temperature of the coffee they serve. Increased precautions
could include warning labels on cups and on coffee urns.
Type: A
5.
Fraternities on college campuses are exposed to significant risks from serving
alcohol at social functions. What are some of the direct and indirect costs of this
risk?
Answer: Direct costs include damage to fraternity property or guests during parties,
potential liability for injuries caused by party attendees, costs of fines imposed.
Indirect costs include potential loss of charter from national fraternity or the
sponsoring university, reduced membership if reputation of fraternity is damaged.
Type: A
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Chapter 2
Objective of Risk Management
I.
Multiple Choice
1.
The fundamental objective of risk management is:
a.
b.
c.
d.
diversification
minimize the cost of risk
hedging
loss control
Answer: b
Type: K
2.
If unexpected increases in losses from price risk are not offset by cash inflows from
insurance contracts, hedging arrangements or other contractual risk transfers, they
will result in:
a.
b.
c.
d.
an increased stock price
a reduced stock price
bankruptcy
increased diversification
Answer: b
Type: K
3.
Johnson Incorporated, located in California, had a $1 million uninsured loss due to
an earthquake in 1997. What impact is this likely to have on the firm’s value?
a.
b.
c.
d.
It will have no impact.
The firm value will increase by $1 million.
The firm value will decrease by $1 million.
The firm value will probably decrease, but the amount of decline will depend on
other factors such as the firm’s level of diversification of risk.
Answer: d
Type: A
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4.
The cost of risk may include all of the following except:
a.
b.
c.
d.
the cost of insurance.
the cost of raw materials.
the cost of increased precautions to control losses.
the cost of investments in information to reduce risk.
Answer: b
Type: A
5.
Maximizing the value of the firm is the same thing as minimizing the cost of risk if:
a.
b.
the managers are socially responsible.
the cost of risk is defined to include all risk-related costs from the perspective of the
firm’s shareholders
loss control is used effectively
the managers’ incentives are aligned with the incentives of the firm’s shareholders
c.
d.
Answer: b
Type: K
6.
Which of the following factors helps to explain why managers of large firms have an
incentive to maximize shareholder value?
a.
b.
c.
Shareholders do not do a good job of monitoring manager behavior.
Managers of large firms generally have very high salaries.
Managers are often excessively cautious in their risk management decisions,
spending too much on insurance and loss control.
Managers are often compensated with bonuses linked to the firm’s profitability or
stock price.
d.
Answer: d
Type: K
7.
The cost of risk is equal to:
a.
b.
c.
d.
the value of the firm without risk minus the value of the firm with risk.
the value of the firm with risk minus the value of the firm without risk.
the cost of direct losses that will be incurred by the firm due to the risk.
the cost of loss control plus the cost of internal risk reduction.
Answer: a
Type: K
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8.
The cost of loss control for potential fire damage to a firm’s warehouses would
include:
a.
b.
c.
d.
the cost of fire insurance.
the cost of damage to goods in the building.
the cost of installing sprinklers.
the potential loss of business that would occur if goods could not be shipped on time
due to the fire.
Answer: c
Type: A
9.
Which of the following statements is most correct.
a.
The amount of loss control that minimizes the cost of risk will generally result in a
total elimination of the risk of loss.
Increased expenditures on loss financing will also generally result in increases in
direct loss costs.
Firms should invest in risk reduction until the probability of loss is zero.
Increased expenditures on insurance will reduce the cost of residual uncertainty.
b.
c.
d.
Answer: d
Type: A
10. All of the following are important components of the cost of risk for a
pharmaceutical company which is developing a new prescription drug for the
treatment of AIDS except:
a.
b.
c.
d.
the cost of testing the product for safety.
the cost of marketing the product to doctors.
the cost of product liability insurance.
the cost of defending against and settling future liability claims.
Answer: b
Type: A
11. If the private cost of risk differs from the social cost of risk
a.
b.
c.
d.
government regulation will be ineffective
firms will tend to not maximize the value of the firm
an efficient level of societal risk will not exist
minimization of the total cost of societal risk will generally not coincide with firms
maximizing their value
Answer: d
Type: K
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12. By increasing spending on safety equipment Charly’s Meat Packing has reduced
total worker injury costs by 15%. This is an example of the
a.
b.
c.
d.
tradeoff between loss control costs and loss financing
tradeoff between loss control costs and expected direct losses
tendency of business firms to spend too little on loss control
importance of loss control
Answer: b
Type: A
13. Which one of the following is not a determinant of value of a business firm?
a.
b.
c.
d.
expected magnitude of the firm’s future cash flows
expected timing of the firm’s future cash flows
expected variability of the firm’s future cash flows
all of the above are determinants of a firm’s value
Answer: d
Type: K
14. JoPro Inc. and Thron Company both have the same level of expected cash flows,
with JoPro’s cash flows subject to greater variability. Which of the following
statement best describes how risk adverse investors will view these shares?
a.
b.
c.
d.
The investors will only be willing to purchase the shares of Thron Company.
The investors will be willing to purchase all of the shares of Thron Company but
only a few of the shares of JoPro Inc.
The investors will pay a lower price for the shares of JoPro Inc. than they will for
Thron Company’s shares, thereby increasing the expected return on the dollars
invested in JoPro shares.
The investors will pay a higher price for the shares of JoPro Inc. than they will for
Thron Company’s shares, thereby increasing the expected return on the dollars
invested in JoPro shares.
Answer: c
Type: A
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15. Which one of the following is not an example of the cost of loss financing?
a.
b.
c.
d.
expected direct/indirect losses
the loading in insurance premiums
transactions costs involved with making hedging arrangements
opportunity cost of maintaining self-insurance loss reserves
Answer: a
Type: A
II. Fill-Ins
1.
The overall objective of risk management for “for-profit” businesses is
minimize the cost of risk .
2.
The costs incurred by shareholders in monitoring managerial behavior are known as
___agency costs.
3.
The cost of risk includes the expected cost of losses, the cost of
loss
control , the cost of
loss financing
, and the cost of
internal risk
reduction
, and the cost of any residual uncertainty after the other risk reduction
methods have been implemented.
4.
In estimating the cost of risk, tradeoffs will normally exist between the expenditures
on loss control and the cost of
direct and indirect losses
.
5.
If a person facing two risky alternatives, whose expected outcomes are the same,
chooses the alternative with less variability, this person is ____risk adverse____.
to
III. Problems and Short Answer Questions
1.
Managers may have incentives to take action that benefit themselves at the expense
of the shareholders. What factors give them incentives to act consistently with
shareholder value maximization?
Answer: Factors that give managers incentives to act consistently with shareholder value
maximization include: compensation linked to performance; takeover risk for firms
that are undervalued; the potential for lower product prices when costs are not
adequately controlled by management; monitoring by other stakeholders; and
potential fiduciary liability.
Type: K
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2.
When will minimizing the cost of risk also maximize the value of the firm.
Answer: If the firm's cost of risk is defined to include all of the effects of risk and risk
management on firm value - minimizing the cost of risk will maximize shareholder
value.
Type: K
3.
Describe the most important components of the cost of risk that apply to the risk of
shoplifting at a convenience store.
Answer: The most important components of the cost of risk for the convenience store are:
a) the expected cost of lost inventory; b) the expected cost of indirect losses such as
reduction in profits; c) cost of loss control such as extra expenses of inventory
management, mirrors, additional personnel; d) the cost of insurance or retention to
cover lost inventory.
Type: A
4.
How does the overall objective of risk management differ for a non-profit
organization, such as your local food bank, which does not have shareholders?
Answer: Since non-profits do not have shareholders, they generally will be attempting to
maximize the value of products or services provided to their customers or
constituents. The cost of risk for such a firm will be the reduction in value of the
firm’s activities to their constituents. The food bank will be trying to provide the
largest amount of food to the largest number of people at the lowest cost they can.
Minimizing the risk of losses due to food spoilage, theft, or liability claims will help
to achieve this goal.
Type: A
5.
If all for-profit firms act to minimize the cost of risk and thereby maximize
shareholder value, will this also minimize the societal cost of risk? Why or why not?
Answer: If risk management decisions reflected all the costs that risk creates for other
parties, then the individual firms’ risk management activities would also minimize
societal risks. However, there are many risks that are imposed on society but are not
reflected in the cost of risk for the individual firms. Since the private cost of risk
differs from the social cost of risk, business value maximization will generally not
minimize the total cost of risk to society.
Type: K
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Chapter 3
Risk Identification and Measurement
I.
Multiple Choice
1.
A listing of a random variable’s possible outcomes and the respective probabilities of
those outcomes is called the:
a.
b.
c.
d.
expected value
standard deviation
probability distribution
correlation
Answer: c
Type: K
2.
Multiplying each possible outcome of a random variable by its probability of
occurrence, and then adding up these results will be equal to the random variable’s:
a.
b.
c.
d.
expected value
standard deviation
probability distribution
correlation
Answer: a
Type: K
Probability
B
A
Loss
3.
The graph above depicts the probability distributions for risks A and B. Based on
the graph, which of the following statements is true?
a.
The expected value of loss for risk A is larger than the expected value of loss for risk
B.
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b.
c.
d.
The expected value of loss for risk B is larger than the expected value of loss for risk
A.
The standard deviation of expected losses for risk A is larger than the standard
deviation of losses for risk B.
The standard deviation of expected losses for risk B is larger than the standard
deviation of losses for risk A.
Answer: a
Type: A
Use this table to answer questions 4 through 7:
Loss Distribution X
Outcome
Probability
$0
.60
$1,000
.25
$5,000
.15
Loss Distribution Y
Outcome
Probability
$0
.40
$1,000
.50
$5,000
.10
4.
Which distribution has the highest expected value?
a.
b.
c.
d.
Distribution X
Distribution Y
Both have the same expected value
There is not enough information to answer this question.
Answer: c
Type: A
5.
All other factors equal, which distribution is the most risky?
a.
b.
c.
d.
Distribution X
Distribution Y
Both distributions have equivalent risk
Both distributions have zero risk.
Answer: a
Type: A
6.
In which distribution is there a higher likelihood that the outcome will be close to the
expected value of $1,000?
a.
b.
c.
Distribution X
Distribution Y
The likelihood that outcomes will be close to the expected value is the same for both
distributions.
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d.
There is not enough information to answer this question.
Answer: b
Type: A
7.
Which distribution(s) exhibit(s) skewness?
a.
b.
c.
d.
Distribution X only
Distribution Y only
Both X and Y are skewed.
Neither distribution is skewed.
Answer: c
Type: A
8.
Which type of risk would you expect to have the most skewed probability
distribution? (Assume a time period of one year.)
a.
b.
c.
d.
product liability claims for a drug manufacturer
shoplifting losses for a small bookstore
collision damage to vehicles for a delivery service
employee injuries in a grocery store
Answer: a
Type: A
9.
Which of the following pairs of random variables are likely to be uncorrelated?
a.
total health care costs in New York City for 1997; total health care costs in New
York City for 1998
total property damage due to wildfires in Colorado in 1997; total property damage
due to wildfires in California in 1998.
number of people who die from cancer in the US in 1997; number of people who die
from cancer in the US in 1998.
worker injuries at a shoe manufacturing plant owned and managed by Exodus
Incorporated; worker injuries at a different shoe manufacturing plant owned and
managed by Exodus Incorporated.
b.
c.
d.
Answer: b
Type: A
10. Unidentified risk exposures will result in:
a.
b.
c.
reduced insurance premiums
increased insurance premiums
implicit retention
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d.
purchasing too much insurance
Answer: c
Type: K
11. When estimating property loss exposure, which of the following methods for valuing
property is the least relevant measure for risk managers?
a.
b.
c.
d.
book value
market value
firm specific value
replacement cost
Answer: a
Type: K
12. The number of losses in a given period of time is known as:
a.
b.
c.
d.
loss severity
loss frequency
total losses
the loss distribution
Answer: b
Type: K
13. The magnitude of loss per occurrence is known as:
a.
b.
c.
d.
loss severity
loss frequency
total losses
the loss distribution
Answer: a
Type: K
14. The expected loss per exposure is:
a.
b.
c.
d.
the expected frequency per exposure.
the expected severity per occurrence.
the expected frequency per exposure times the expected severity per occurrence all
divided by the number of exposures.
the expected frequency per exposure times the expected severity per occurrence.
Answer: d
Type: K
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15. Darunee Inc. has estimated that ½ of their twenty workers will be injured in the
coming year. The expected severity per occurrence is $1,000. What is the expected
loss per exposure?
a.
b.
c.
d.
$1,000
$10
$10,000
$500
Answer: d
Type: K
16. Which of the following is not a key feature of loss distributions that would be
considered by risk managers?
a.
b.
c.
d.
expected value
standard deviation
maximum probable loss
least probable loss
Answer: d
Type: K
II. Fill-Ins
random
1.
A
2.
A
probability distribution
identifies all the possible outcomes for a
random variable and the probability of each outcome.
3.
A common statistical measure of the risk of a random variable is the ___standard
deviation (or variance)___.
4.
If a probability distribution is not symmetrical, as in the case of liability losses, the
distribution is said to be
skewed
.
5.
A firm that is concerned about losses due to temporary shut-down of its
manufacturing facility following a fire can purchase ___business interruption___
insurance.
variable is a variable whose outcome is uncertain.
III Problems and Short Answer Questions
1.
Jack Sprat Wholesale Meats, Inc. is faced with the following probability distribution
for losses due to meat spoilage:
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Possible Losses
$0
$100
$1000
a.
b.
c.
Probability
.20
.60
.20
What is Jack Sprat’s expected loss due to meat spoilage?
What is the standard deviation of expected losses due to meat spoilage?
Draw a probability distribution for Jack Sprat’s meat spoilage losses.
Answer:
a. Expected loss due to meat spoilage = (.2)($0) + (.6)($100) + (.2)($1000) = $260
b. Standard deviation of expected loss due to meat spoilage
= [(.2)(0-260)2 + (.6)(100-260)2 + (.2)(1000-260)2]1/2 = 37
0.7
0.6
0.5
0.4
Probability
0.3
0.2
0.1
0
c.
Type: A
2.
Trumpet Manufacturing owns real estate valued at $500,000. They estimate that
their property losses have the following distribution:
Loss Equals
a.
b.
$500,000
$100,000
$25,000
$1,000
$0
with probability .001
with probability .010
with probability .050
with probability .100
with probability .839
What is the expected value of Trumpet Manufacturing’s losses?
If insurance for this loss were available for a price of $3,000 per year, do you think
that Trumpet would want to buy it? Why or why not?
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Answer:
a. The expected cost is: ($500,000)(.001) + ($100,000)(.010) + ($25,000)(.050) +
($1,000)(.1) + (0)(.839) = $2,850.
b. If insurance were available for $3,000, the company would probably want to buy it.
Although it is slightly more expensive than the expected cost of the loss, since the
firm is exposed to very high potential losses, they will probably be willing to incur a
little higher cost to reduce this risk.
Type: A
3.
Skewness measures what characteristic of a loss distribution? Why are skewed
distributions relevant to risk managers?
Answer: Skewness measures the symmetry of a distribution. The normal distribution is
symmetrical so it has zero skewness.
Skewed distributions are very relevant to risk managers simply because many
individual businesses face skewed loss distributions. A skewed loss distribution has a
higher probability of very low losses, and a lower probability of very large losses.
During a given year, most businesses experience relatively small losses, if any, while
a small number of firms will experience large losses.
Type: A
4.
Over the last 7 years, East Eagle Company has averaged 10,000 employees per year,
641 worker injuries (on the job) at an annual average cost of $134,369. Using this
data
a.
b.
c.
Compute the probability of a worker suffering an on-the-job injury
Compute the average injury severity
Compute the expected loss per worker
Answer:
 641 
a. 
  6.41%
 10,000 
 $134,369 
b. 
  $209.62
 641 
c. (.0641)($209.62)=$13.44
Type: K
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5.
Fill-in the second column of the following table to indicate if the specific variables,
or exposures, for the identified group(s) or context are most likely positively
correlated, negatively correlated, or uncorrelated.
Variables or Exposure
Unemployment amongst a group of factory workers
The number of auto accidents, in a given year, for each resident of
Omaha
Natural gas demand and winter temperatures in Minnesota
Total damage from house fires in South Dakota and total damage from
house fires in Arizona
Number of days with rainfall and volume of paying customers at a
public outdoor swimming pool.
Flood damages to homes in Southern Louisiana.
Correlation
Answer:
Variables or Exposure
Unemployment amongst a group of factory workers
The number of auto accidents, in a given year, for each resident of
Omaha
Natural gas demand and winter temperatures in Minnesota
Total damage from house fires in South Dakota and total damage from
house fires in Arizona
Number of days with rainfall and volume of paying customers at a
public outdoor swimming pool.
Flood damages to homes in Southern Louisiana.
Type: A
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Correlation
positive
uncorrelated
positive
uncorrelated
negative
positive
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Chapter 4
Pooling Arrangements and the Diversification of Risk
I.
Multiple Choice
1.
Which of the following is not a type of contracting cost associated with the creation
and operation of pooling arrangements:
a.
b.
c.
d.
distribution costs
underwriting expenses
premiums
loss adjustment expenses
Answer: c
Type: K
2.
Insurers that rely, to some degree, on exclusive agents to sell their policies are
known as:
a.
b.
c.
d.
mutuals
direct writers
independents
brokers
Answer: b
Type: K
3.
The process of identifying (or estimating) a potential insurance buyer’s expected loss
is known as:
a.
b.
c.
d.
underwriting
risk management
loss adjusting
insurance distribution
Answer: a
Type: K
4.
Insurance distribution costs may include all of the following except:
a.
b.
c.
d.
advertising and marketing expenses
agent commissions
mailing costs
underwriting expenses
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Answer: d
Type: A
5.
Under what circumstance will a pooling arrangement result in reduced risk (standard
deviation) to the participants in the pool?
a.
b.
c.
d.
only when losses are perfectly positively correlated
when losses are high
only when losses are negatively correlated
whenever losses are less than perfectly positively correlated
Answer: d
Type: K
6.
According to the effect of the law of large numbers on a pooling arrangement, the
greater the number of participants in the risk pool,
a.
the less likely the actual average loss will approach the expected (per participant)
loss
the more closely the actual average loss will approach the expected (per participant)
loss
the greater will be the skewness of the pool’s loss distribution
the greater will be the pool’s correlation
b.
c.
d.
Answer: b
Type: K
7.
Bilbo has just purchased an insurance policy (and thereby joined a risk-pool). Bilbo
paid an ex ante premium and did not give the insurer ex post assessment rights.
These means
a.
b.
Bilbo does not have the right to collect losses greater than his ex ante premium
The insurer does not have the right to deny claims that are less than the agreed upon
ex post amount.
Bilbo is not required to assess the insurer.
The insurer cannot request further premium from Bilbo should the risk-pool
experience a bad loss.
c.
d.
Answer: d
Type: K
8.
Risk-pooling arrangements
a.
b.
c.
reduce the risk faced by each member of the risk-pool
increase the likelihood of small loss events
are used only for liability exposures
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d.
will decrease expected loss for members of the risk pool
Answer: a
Type: K
Dresden and Morgan both have the following loss distribution.
Use this information to answer questions 9 through 11.
Loss Possibility
$0
$4,000
Loss Probability
.90
.10
9.
If Dresden and Morgan form a pooling arrangement to share losses, what is the
expected loss for each of them after the pool is formed?
a.
b.
c.
d.
$500
$450
$400
$360
Answer: c
Type: A
10. If Dresden and Morgan form a pooling arrangement to share losses, what is the
variance of expected losses for each of them after the pool is formed?
a.
b.
c.
d.
$28
$280
$800
$4000
Answer: c
Type: A
11. Which one of the following effects occurs when Dresden and Morgan form a riskpool to share losses?
a.
b.
c.
d.
Their individual expected loss decreases, while the variance increases
Their individual expected loss increases, while the variance decreases
Their individual expected loss stays the same, while the variance increases
Their individual expected loss stays the same, while the variance decreases
Answer: d
Type: A
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12. The formation of risk pools by insurers is the same, in principle, as:
a.
b.
c.
d.
reducing expected losses through the use of safety equipment
creating a well-diversified portfolio of stock shares
using the futures markets to hedge against fluctuations in the exchange rate of a
particular foreign currency
agreeing to an assessment premium
Answer: b
Type: A
13. Pooling arrangements are less effective when the participant’s losses are positively
correlated. Which one of the following loss exposure examples will have the greatest
positive correlation?
a.
b.
c.
d.
Flood damage to homes in southern Louisiana
Fire damage to homes in the metropolitan area of Houston
Automobile property damage in Omaha
Personal injury liability lawsuits filed in Minnesota
Answer: a
Type: A
14. The main (economic) reason for the existence of insurance companies is:
a.
b.
c.
d.
individuals need to diversify risk
insurers’ ability to predict individual losses
insurers’ ability to form efficient risk pools with minimal contracting costs
individuals inability to determine expected loss
Answer: c
Type: K
15. The contracting costs incurred when an insurer investigates and attempts to
determine the value of loss claim made against the risk-pool are called
a.
b.
c.
d.
distribution costs
premiums
underwriting expenses
loss adjustment expenses
Answer: d
Type: K
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II. Fill-Ins
1.
The process of estimating a potential insured’s expected loss is known as
underwriting .
2.
Insurers that rely on exclusive agents, employees, or direct response methods are
known as direct writers .
3.
A pooling arrangement is less effective at reducing participants risk exposure if the
participant losses are ___positively____ correlated.
4.
Their ability to operate with an efficient level of __contracting ___ costs are the
main reason that insurers exist and specialize in the formation of pooling
arrangements.
5.
The amount of risk reduction ___increases___ as more participants are added to a
pooling arrangement, provided the losses are uncorrelated across participants.
III Problems and Short Answer Questions
1.
Explain the main economic functions of insurance institutions.
Answer: The main economic function of insurance institutions is to provide an efficient
mechanism for economizing on contracting costs associated with pooling of losses.
Type: K
2.
Compare insurer pooling arrangements with a well-diversified portfolios of stock
shares.
Answer: Insurance pools and well diversified stock portfolios are, in principle, nearly
similar. Both are mechanisms for reducing risk. Predicting the outcome of a set of
pooled (and uncorrelated) risks can be done more reliably than predicting the
outcome of a single risk. The larger the number of risks in the pool, the smaller is the
variance of expected outcomes.
3.
Use the following table of information.
Loss
Outcome #1
Loss
Outcome #2
Probability of
Loss Outcomes
Chayanee
Yanisa
.15
$1,500
$1,000
.85
$0
$100
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a.
b.
c.
What is Chayanee’s expected loss and standard deviation of expected loss?
What is Yanisa’s expected loss and standard deviation of expected loss?
Chayanee’s and Yanisa’s outcomes are independent of one another, so they decide to
form a risk pool and share the losses equally. Construct a table displaying the
Chayanee’s portion of the possible outcomes of the sharing arrangement and the
probabilities thereof. What is the expected loss and standard deviation of expected
loss for Chayanee’s outcome from the sharing arrangement?
Answer:
a. For Chayanee:
Expected Losses  1,500(.15)  0(.85)  225
Standard Deviation of Losses  (1,500  225)2 (.15)  (0  225)2 (.85)  $535.61
b.
For Yanisa:
Expected Losses  1,000(.15)  100(.85)  235
Standard Deviation of Losses  (1,000  235)2 (.15)  (0  235)2 (.85)  $321.36
c.
For the pooling arrangement:
Possible
Loss Outcomes of
Pooling Arrangement
0 + 100 = $100
0 + 1000 = $1,000
1,500 + 100 = $1,600
1,500 + 1,000 = $2,500
Chayanee’s
Portion of the
Pooled Outcome
$50
$500
$800
$1,250
Probabilities of
Loss Outcomes
(.85)(.85) = .7225
(.85)(.15) = .1275
(.15)(.85) = .1275
(.15)(.15) = .0225
Chayanee’s expected loss from the pooling arrangement:
50(.7225)  500(.1275)  800(.1275)  1,250(.0225)  $230
Chayanee’s standard deviation of expected loss from the pooling arrangement:
2
2
2
2
(50  230) (.7225)  (500  230) (.1275)  (800  230) (.1275)  (1,250  230) (.0225)  $312.31
4.
Suppose that Peter Piper has a wholesale meat business similar to Jack Sprat and is
exposed to an identical loss distribution from meat spoilage as defined in Problem 1.
If Jack and Peter enter into a pooling agreement whereby they agree to split the costs
of any losses that occur.
a.
Make a table that shows the possible total loss outcomes that Jack and Peter will
have to split, with their associated probabilities.
What is the expected value of each person’s loss share?
Will the standard deviation of expected losses for each person in the pool be the
same? Why or why not?
b.
c.
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Answer:
a.
Possible Outcomes
J($0) P($0)
J($0) P($100)
J($0) P($1,000)
J($100) P($0)
J($100) P($100)
J($100) P($1,000)
J($1,000) P($0)
J($1,000) P($100)
J($1,000) P($1,000)
b.
c.
Probability
.2 x .2 = .04
.2 x .6 = .12
.2 x .2 = .04
.6 x .2 = .12
.6 x .6 = .36
.6 x .2 = .12
.2 x .2 = .04
.2 x .6 = .12
.2 x .2 = .04
Total Loss
$0
$100
$1,000
$100
$200
$1,100
$1,000
$1,100
$2,000
Loss to Each
$0
$50
$500
$50
$100
$550
$500
$550
$1,000
Expected value for each participant = .04(0) + .12(50) + .04(500) + .12(50) +
.36(100) + .12(550) + .04(500) + .12(550) + .04(1000) = $260
The standard deviation will be lower than $372 as long as Jack Sprat’s and Peter
Pipers loss distributions are not perfectly correlated with each other.
Type: A
5.
Pooling arrangements are designed to reduce the risk to members of the pool.
Explain the impact on risk reduction as the number of participants in the pool
increase, all other factors equal. What happens to the expected cost of risk per
participant as the pool size increases?
Answer: The amount of risk that can be reduced through pooling arrangements increases
as the number of participants increases, all other factors equal. The expected cost of
risk per participant will stay the same.
Type: K
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Chapter 9
Risk Aversion and Risk Management by
Individuals and Corporations
I.
Multiple Choice
1.
The major underlying force that motivates individuals to purchase insurance even
though insurance premiums exceed expected claim costs is:
a.
b.
c.
d.
profit
risk aversion
expected losses
premium loadings
Answer: b
Type: K
2.
An individual’s demand for insurance depends on all of the following factors except:
a.
b.
c.
d.
income
wealth
premium loading
portfolio return
Answer: d
Type: K
3.
Suppose that you have $20,000 in wealth and face a 20% chance of losing $10,000.
Without insurance, your possible wealth outcomes are:
a.
b.
c.
d.
$20,000, $18,000
$20,000, $10,000
$10,000, $2,000
$20,000, $18,000
Answer: b
Type: A
4.
Using the same scenario in Question #3, what is the expected value of your wealth
without insurance?
a.
b.
c.
d.
$20,000
$10,000
$18,000
$16,000
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Answer: c
Type: A
5.
Using the same scenario in Question #3, if you purchase $10,000 in insurance
coverage for a price of $2,500, what are your possible wealth outcomes? (Assume
that the premium would be paid at the end of the year and that the loss would occur
at the end of the year so that you can ignore the time value of money.)
a.
b.
c.
d.
$20,000, $10,000
$17,500
$17,500, $7,500
$18,000
Answer: b
Type: A
6.
An example of a non-monetary loss is:
a.
b.
c.
d.
children’s funeral costs
damage to your automobile which isn’t covered by your insurance
pain and suffering
loss of time at work
Answer: c
Type: A
7.
Suppose that an insurance company views Jennifer as having the following
distribution for the present value of losses:
Loss =
$10,000
$2,000
$500
$0
with probability .10
with probability .20
with probability .50
with probability .20
What is the fair premium for full coverage if the insurer’s competitive loading for
administrative costs and capital costs is 10% of expected discounted claims?
a.
b.
c.
d.
$1,815
$1,650
$825
$165
Answer: a
Type: A
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8.
(Use information from Question #7) If Jennifer believes that her true probabilities for
each possible loss outcome are half as high as the insurer has estimated, what is the
percentage loading on the policy from her perspective? (Note: This means Jennifer
believes her probability for $0 loss is .60)
a.
b.
c.
d.
10%
20%
120%
200%
Answer: c
Type: A
9.
The main reason that diversified shareholders might not want their corporate
managers to purchase insurance is that:
a.
b.
c.
d.
they like risk
they have already diversified away the risk that is being insured
they are risk averse
cash flow variability increases their return on investment
Answer: b
Type: A
10. The main tax benefit of insurance from a corporate shareholder’s perspective is due
to:
a.
b.
c.
d.
the tax deductibility of insurance payments
the different treatment of gains and losses under the tax code
the progressive nature of the corporate tax schedule
the double taxation of corporate profits
Answer: c
Type: K
11. What is the risk premium of a gamble whereby the participant has a .55 chance of
winning $1,000 or a .45 chance of losing $1,000.
a.
b.
c.
d.
$10
$15
$100
$150
Answer: c
Type: A
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12. Due to premium loading, people generally pay insurance premiums that are greater
than their expected claim costs. A risk adverse individual may be willing to pay this
additional amount because insurance reduces risk. This ‘additional amount’ that a
person is willing to pay to reduce risk is an example of a
a.
b.
c.
d.
gamble
risk premium
down payment
risk neutral transaction
Answer: b
Type: A
13. As a person’s wealth increases it is likely that their degree of risk aversion will
a.
b.
c.
d.
decline
stay the same
increase
cannot tell since wealth and risk aversion are not related
Answer: a
Type: K
14. Law of Demand: As price increases, the quantity demanded decreases. In the context
of fair insurance premiums, the relevant ‘price’ that determines quantity demanded is
a.
b.
c.
d.
premium loading
present value of expected claims costs
expected loss amount
discount rate
Answer: a
Type: A
15. Which one of the following is not a reason for a publicly held, widely traded,
business to purchase insurance?
a.
b.
c.
d.
to provide efficient claims processing and loss control services
reduce the expected cost of loss financing
reduce expected tax payments
reduce the owners’ risk
Answer: d
Type: K
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II. Fill-Ins
1.
If Mary has a preference for a definite payment of $100 over a risky gamble that has
.
an expected value of $100, she is
risk averse
2.
Even a risk averse person may choose not to buy insurance if the
loading
is too high relative to the expected loss.
3.
People who have greater
purchase insurance.
4.
If Rocky Road, Inc.’s shareholders all have
diversified
they may not want the firm’s managers to buy insurance.
5.
Even if corporate insurance does not reduce the shareholders’ risk, it may provide
,
lower
other benefits such as
more efficient claims processing
cost financing of losses , and reduced tax payments
. (Other answers
include: reduced likelihood of financial distress and better contract terms with the
firm’s stakeholders.)
income (or wealth)
premium
may be less likely to
portfolios,
III. Problems and Short Answer Questions
1.
“The purchase of insurance is not value-maximizing for firms with well-diversified
corporate shareholders.” Explain the logic of this statement.
Answer: Diversification of the portfolio is a mechanism whereby a shareholder can
reduce the variability of returns due to pure risks. Therefore, since insurance and
diversification achieve the same outcome, the use of both may be redundant and may
impose unnecessary costs on the shareholders.
Type: A
2.
Explain why a corporation might still want to purchase insurance despite the fact that
its shareholders are well-diversified.
Answer: Business insurance purchases can: a) be an efficient method of purchasing
claims processing and loss control services; b) reduce the expected cost of financing
losses; c) reduce the likelihood that the firm will have to raise costly external capital
for new investment projects and thereby increase the likelihood that it will adopt
good investment projects; d)reduce the likelihood of financial distress and thereby
improve the terms on which the firm contracts with other claimants, such as
employees, suppliers, lenders, and customers; and e) reduce expected tax payments.
Type: A
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3.
Mary Johnson, the mother of two young children, has a life-threatening health
condition, currently has a minimum wage job, and has very little savings. She is
considering the purchase of a life insurance policy since she has no other family and
her children would have no other source of income if she were to die. It’s Your Life
Insurance Co. offers a fairly expensive life insurance policy that does not require any
medical information or tests. What are some factors that might cause Mary to opt for
this policy despite it’s relatively high premium loading?
Answer: Mary’s demand for insurance will depend not only on the premium loading, but
also on her income and wealth (both low), her level of information relative to the
insurer’s (she has a high expected claims cost), the availability of other sources of
indemnity (she has none), and the nature of the loss (she is worried about her
children’s future).
Type: A
4.
Richie Rich, a millionaire, and Penny Poor, a welfare recipient, are both at high risk
for automobile accidents. Richie owns a fast sports car and he likes to drag race it
with his friends on the weekends. Penny has a small junker that has an extra
powerful engine which she regularly tests as she speeds to her part-time job every
day. Auto liability insurance is not compulsory in their state. Explain why Penny
might have less incentive to purchase liability insurance than Richie.
Answer: Wealthier people have more incentive to purchase liability insurance because
they have more to lose in the event of a claim against them. Since Penny has little or
no assets, it would take a very low claim to bring her wealth to zero, so the cost of
the insurance may actually be higher than her expected loss without insurance.
Furthermore, Penny may not have sufficient funds to be able to purchase insurance,
since her limited income is probably used totally for the purchase of necessities.
Type: A
5.
Explain why the purchase of insurance may be more beneficial to small businesses
than to large publicly-held firms.
Answer: Business insurance is beneficial to risk-averse owners of businesses in much the
same way the personal insurance is beneficial to risk-averse individuals. Since they
are not able to diversify away the risk the way that shareholder-owners can,
insurance is likely to be the most cost-efficient method of reducing their risk.
Type: K
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Chapter 10
Insurability of Risk, Contractual Provisions, and Legal Doctrines
I.
Multiple Choice
1.
Which of the following is not a factor that limits the insurability of risk?
a.
b.
c.
d.
moral hazard
adverse selection
competition
administrative and capital costs
Answer: c
Type: K
2.
The reason that higher premium loadings generally lead to lower demand for
insurance coverage is that:
a.
the fair premium becomes too large relative to the expected cost of not purchasing
insurance.
people don’t like insurers to make too much profit.
exposures with low severity always have high administrative costs.
exposures with high frequency are less likely to be insurable.
b.
c.
d.
Answer: a
Type: K
3.
Which of the following types of exposures are most likely to be insured on an
individual basis?
a.
b.
c.
d.
exposures with high severity and low frequency
exposures with low severity and low frequency
exposures with high severity and high frequency
exposures with low severity and high frequency
Answer: a
Type: K
4.
The primary limiting factor on the insurability of highly correlated loss exposures is
a.
b.
c.
d.
high administrative costs
high capital costs
the moral hazard problem
adverse selection
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Answer: b
Type: A
5.
The conditions necessary for moral hazard to arise in insurance contracts include all
of the following except:
a.
b.
c.
d.
The expected losses must depend in part on the insured’s behavior
The insurer must have some ability to impact the insured’s behavior
It must be costly for the insurer to observe policyholder behavior
It must be costly for the insurer to measure the impact of policyholder behavior on
expected claim costs
Answer: b
Type: K
6.
Which of the following is not a method of reducing the impact of moral hazard on
expected claim costs?
a.
b.
c.
d.
deductibles
experience rating
careful risk classification
careful investigation of claims
Answer: c
Type: K
7.
Insurers use deductibles to:
a.
b.
c.
d.
reduce claims processing costs
reduce moral hazard problems
mitigate adverse selection problems
all of the above
Answer: d
Type: K
8.
Health insurance policies often have coinsurance provisions that require the
policyholder to pay
a.
a minimum amount of claims in a given year before the insurance company will be
responsible for payment.
the first $500 of all claims
all of the claims that exceed the policy limits
a specified proportion of every loss
b.
c.
d.
Answer: d
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Type: A
9.
The primary limiting factor on the insurability of a high frequency, low severity loss
exposure is
a.
b.
c.
d.
high administrative costs
high capital costs
the moral hazard problem
adverse selection
Answer: a
Type: A
10. Thom and Judy, a married couple, are employed at different companies and both of
their employers provide complete family health insurance with pro rata clauses, no
deductibles, and no coinsurance. If Thom has knee surgery that costs $5,000, he can
recover
a.
b.
c.
d.
$5,000 from each insurer since the full premium has been paid for that coverage.
$5,000 from his own insurer only.
$2,500 from each insurer.
$5,000 from his own insurer who will then try to collect $2,500 from Judy’s insurer.
Answer: c
Type: A
11. An insurance contract which specifies that the insurer pay a pre-set amount upon the
occurrence of a loss is called:
a.
b.
c.
d.
a valued contract
an indemnity contract
a coinsurance contract
an insurance-to-value contract
Answer: a
Type: K
12. The legal principle which states that an insurance policy cannot pay more than the
financial loss suffered is called the principle of:
a.
b.
c.
d.
insurable interest
moral hazard
adhesion
indemnity
Answer: d
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Type: K
13. Since insurance contracts are generally standard forms with many detailed provisions
drawn up by the insurer, they are considered to be:
a.
b.
c.
d.
contracts of adhesion
unenforceable if the insured cannot negotiate terms
insurable interests
contrary to the indemnity principle
Answer: a
Type: K
14. If an insurance buyer has intentionally concealed information from the insurer, the
legal remedy in most states is that:
a.
b.
c.
d.
the policyholder can be sued for bad faith
the insurer can void the contract
the insured can void the contract
both b and c
Answer: b
Type: K
15. Janet needs to purchase property coverage on her downtown business building. The
building is worth $150,000. The insurer has an insure-to-value (coinsurance)
requirement of 80%. If Janet purchases $80,000 of property coverage what
proportion of each loss (should one occur) will the insurer pay?
a.
b.
c.
d.
3/4
2/3
8/10
10/12
Answer: b
Type: A
II. Fill-Ins
1.
The three major factors that limit insurability of risk in private insurance markets are:
,
moral hazard , and adverse selection
premium loadings
.
2.
John has full insurance on his car. John’s tendency to leave his car unlocked when he
goes to the mall is an example of
moral hazard .
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3.
Adverse selection
exists when individuals differ in their probability of loss
and insurers cannot distinguish high risk from low risk individuals. High risks will
be more likely to purchase insurance than low risks.
4.
A method of reducing the adverse selection problem for insurers is
classification
. (Other answers are possible.)
5.
A coinsurance provision in an insurance contract requires an insured to pay a
specified proportion of the loss.
6.
The insurer’s legal remedy for situations where a policyholder has misrepresented or
concealed relevant information on an insurance application is
to void the
contract .
risk
III. Problems and Short Answer Questions
1.
Suppose that an insurer offered a small business owner a policy for theft insurance
with no deductible i.e. the insurance company would pay any and all claims for
thefts of merchandise or equipment at the insured’s place of business. Explain how
moral hazard might make the total claims higher than they would be if the policy
required a deductible.
Answer: Moral hazard refers to the effect of insurance on the insured’s incentives to
reduce expected losses. If there were no deductible, then the businesses would have
no incentive to take precautions against potential thefts, such as the installation of
cameras, careful inventory monitoring, locking the building, etc. Furthermore, there
might even be incentives to pass on some normal business expenses to the insurer
such as those due to damaged inventory.
Type: A
2.
For each of the following types of insurance, provide three common examples of
moral hazard that would be expected to impact the claim costs.
a.
b.
automobile physical damage (collision) insurance
health insurance
Answer:
a. driving too fast, tailgating, failing to observe street signs, failing to lock car doors,
inflating costs of repair, etc. (Answer should not include actions that primarily
increase risk of injury to persons, such as seatbelt usage and children’s car seats.)
b. poor eating habits, failure to exercise regularly, alcohol consumption, etc.
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Type: A
3.
You are considering a homeowner’s insurance policy. The policy includes damage to
your home and its contents but limits the coverage for losses of jewelry to a total
value of $1,000. In addition, the policy has a $500 deductible. For an additional
amount, you can increase the coverage on your jewelry, subject to an appraisal. You
can also pay a higher premium to reduce the deductible to $200. Explain the purpose
of these contractual provisions from the insurer’s point of view.
Answer: The limitation on jewelry losses is to control moral hazard, since these losses
are not easily verifiable by the insurer. Without the limitation, the average premium
would have to be higher. The deductible is a method of limiting the administrative
costs associated with high frequency, low severity claims that can be budgeted for by
the homeowner. Both provisions may also help to control adverse selection, since
low risk homeowners will be more likely to purchase this policy and high risk
homeowners might opt for the more expensive, higher coverage policy.
Type: A
4.
For each of the following scenarios, indicate what law or legal principle prohibits the
scenario from occurring.
a.
You have a medical injury due to a car accident and you make claims to both your
health insurer and your automobile insurer in order to get double recovery.
You purchase life insurance on your sickly 90-year old neighbor with yourself as the
beneficiary. He dies and you make a claim.
You fail to disclose information regarding your rheumatoid arthritis condition when
you apply for health insurance. You later request coverage for a hip replacement
surgery.
You purchase automobile liability insurance. You later have an accident that was
your fault and your insurer denies the claim noting a small clause in the contract that
excludes coverage for any accidents caused by the insured.
b.
c.
d.
Answer:
a. indemnity;
b. insurable interest;
c. misrepresentation (or concealment) and the principle of utmost good faith;
d. adhesion contracts and the doctrine of reasonable expectations.
Type: A
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Use the following information to answer questions 5-8.
Happy Time Day Camp has the following distribution for its annual liability costs:
Loss =
5.
$2,000,000
$100,000
$5,000
$0
with probability .0001
with probability .001
with probability .1
with probability .8989
What are the expected claim costs for Happy Time?
Answer: ($2,000,000)(.0001) + ($100,000)(.001) + ($5,000)(.1) = $800
Type: A
6.
If an insurer offered Happy Time a policy with 50% coinsurance, what are the
expected claim costs on this policy?
Answer: ($1,000,000)(.0001) + ($50,000)(.001) + ($2,500)(.1) = $400
Type: A
7.
If an insurer offered Happy Time a policy with a $5000 annual deductible, what are
the expected claim costs on this policy?
Answer: ($1,995,000)(.0001) + ($95,000)(.001) = $294.50
Type: A
8.
If an insurer offered Happy Time a policy with a $500,000 limit, what are the
expected claim costs on this policy?
Answer: ($500,000)(.0001) + ($100,000)(.001) + ($5,000)(.1) = $650
Type: A
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Chapter 11
Loss Control
I.
Multiple Choice
1.
A particular loss control effort will be undertaken if
a.
b.
c.
the expected frequency of losses is reduced
the expected severity of losses is reduced
expected losses are reduced by an amount greater than the cost of the loss control
effort
all of the above
d.
Answer: c
Type: K
2.
Loss Prevention activities are aimed at reducing the
a.
b.
c.
d.
frequency of losses
size of a loss (for if and when a loss occurs)
probability of loss to zero
all of the above
Answer: a
Type: K
3.
FunFun Toys produces assorted toy rockets. It has discovered that its water pressure
rockets have a tendency to tip over just before take off thereby flying parallel, and
low, to the ground. FunFun has decided to quit producing this toy rocket. This is an
example of
a.
b.
c.
d.
loss control
loss prevention
loss avoidance
all of the above
Answer: d
Type: A
4.
Loss Reduction activities are aimed at reducing the
a.
b.
c.
d.
frequency of losses
size of a loss (for if and when a loss occurs)
probability of loss to zero
all of the above
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Answer: b
Type: K
5.
Segregation of exposure units can reduce
a.
b.
c.
d.
the expected frequency of losses
the expected severity of losses
both the expected frequency and expected severity of losses
only those losses that result from natural disasters
Answer: b
Type: K
6.
Insurance coverage can reduce the incentives to undertake loss control activities if
insurers
a.
b.
c.
d.
help pay for the loss control
don’t reduce insurance premiums to reflect the effects of the loss control activities
pay for losses anyway
lower premiums after loss control is implemented
Answer: b
Type: K
Use the following information to answer questions 7-10.
PTM Inc. is evaluating a loss control plan. The costs and benefits are as follows;
(Ignore the implications of possible reduced insurance premiums.)
Loss Control
Expenditures
Reduction in
Expected Losses
Today
End of
Year 1
End of
Years 2-5
$10,000
$4,000
0
0
$3,400
$3,400
7.
Using a cost of capital of 6%, what is the present value of the loss control
expenditures (rounded to the nearest dollar)?
a.
b.
c.
d.
$14,000
$13,774
$12,994
$12,755
Answer: b
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Type: A
8.
Using a cost of capital of 6%, what is the present value of the reduction in expected
losses (rounded to the nearest dollar)?
a.
b.
c.
d.
$17,000
$15,781
$14,322
$12,994
Answer: c
Type: A
9.
What decision should PTM make regarding these loss control activities?
a.
They should not undertake the loss control activities because the present value of the
cost is greater than the present value of the benefits.
They should undertake the loss control activities the present value of the cost is less
than the present value of the benefits.
They should be indifferent because the present value of costs and benefits are equal.
They need more information to make the decision
b.
c.
d.
Answer: b
Type: A
10. Using a cost of capital is 8%, what decision should PTM make regarding these loss
control activities?
a.
b.
c.
d.
They should not undertake the loss control activities because the present value of the
cost is greater than the present value of the benefits.
They should undertake the loss control activities the present value of the cost is less
than the present value of the benefits.
They should be indifferent because the present value of costs and benefits are equal.
They need more information to make the decision
Answer: a
Type: A
11. Which one of the following is not a potential benefit of loss control efforts to
improve workplace safety?
a.
b.
c.
d.
reduced expected losses
increased worker productivity
improved marginal cost of safety
reduced insurance premiums
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Answer: c
Type: K
12. Valuation of human life in loss control decisions is
a.
b.
c.
d.
never done because it is unethical
cannot be done because the computations are too complex
done implicitly and by approximation using loss control dollars spent and expected
lives saved
not allowed by regulation
Answer: c
Type: K
13. Billy Bob earns $45,000 and faces a .007 probability of dying in a workplace
accident. Jim Bob earns $41,000 and faces a .0038 probability of dying in a
workplace accident. The two require the same level of skill and training. From this
information, what is the implicit value of a person’s life?
a.
b.
c.
d.
$1,250,000
$1,052,631
$571,428
$315,000
Answer: a
Type: A
Use this data on loss control expenditures to answer questions 14 and 15.
Loss Control
Expenditures
$0
$80,000
$160,000
$240,000
$320,000
$400,000
Number of
Worker Injuries
280
238
207
182
170
165
Average
Injury
Severity
$6,500
14. What is the marginal benefit of increasing loss control expenditures from $80,000 to
$160,000?
a.
b.
c.
d.
$1,547,000
$1,345,500
$273,000
$201,500
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Answer: d
Type: A
15. What is the economically efficient level of loss control spending?
a.
b.
c.
d.
$160,000
$240,000
$320,000
$400,000
Answer: b
Type: A
II. Fill-ins
1.
Loss control refers to efforts that reduce ___expected losses___ .
2.
Loss prevention activities attempt to reduce the ___expected frequency___ of losses.
3.
Loss reduction activities attempt to reduce the ___size of a loss__ should one occur.
4.
The installation of a sprinkler system is an example of ___pre-loss (loss reduction)
activity___.
5.
___Segregation ___ of exposure units is an example of risk diversification that will
reduce the expected severity of losses.
6.
The value of a human life can be computed ___implicitly___ from assorted
decisions made by individuals and other organization.
III. Problems and Short Answer Questions
1.
Describe the similarities between ‘segregation of exposures units’ and risk pooling.
Answer: Both of these activities are a form of risk diversification. Both methods will
typically not reduce expected losses, but will reduce the expected severity of losses
by lowering the probability of very large losses. Segregation of exposure units will
divide what might otherwise be a very large loss exposure into several smaller
exposures.
Type: K
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2.
BigTime manufacturing has substantial warehousing needs for raw materials. It
currently faces the choice of building a single $12 million facility or three separate
$4 million facilities. Each facility faces the following loss distribution. (The separate
facilities are statistically independent.)
Probability
of Loss
.03
.02
.95
Percent of
Value Lost
100
50
0
a) What is the expected loss for each warehousing choice?
b) What is the probability of a $12 million loss for warehousing choice?
c) Having the three separate facilities will reduce the expected severity of losses. What
are some disadvantages to this segregation of loss exposures?
Answer:
a) Expected loss for the $12 million facility is
(.03)$12,000,000+(.02)$6,000,000+(.95)0 = $480,000
Expected loss for each of the $4 million facilities is
(.03)$4,000,000+(.02)$2,000,000+(.95)0 = $160,000
Since $4 million facilities are independent, their total expected loss is
(3)$160,000 = $480,000
b) The probability of a $12 million loss for the $12 million facility is .03. Whereas the
probability of a $12 million loss for the three segregated facilities is (.03)(.03)(.03) =
.00003.
c) Some disadvantages to having the three separate facilities might be duplication of
labor efforts, increased transportation cost of moving supplies and materials,
decreased effectiveness of communication, etc.
Type: A
3.
What effect can insurance have on loss control activities?
Answer: Insurance, by itself, can reduce the incentive to undertake loss control efforts. If
the risk is effectively transferred to an insurer, the business firm will think it has little
to gain with loss control. This moral hazard aspect of insurance can be mitigated if
the insurer reduces the business firm’s insurance premium to reflect the improved
loss probabilities.
Type: K
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4.
Using the following data determine what level of loss control spending should be
undertaken?
Loss Control
Expenditures
$0
$50,000
$100,000
$150,000
$200,000
$250,000
Number of
Worker Injuries
200
170
148
130
122
118
Average
Injury
Severity
$8,000
Answer:
Loss Control
Expenditures
$0
$50,000
$100,000
$150,000
$200,000
$250,000
Number of
Worker
Injuries
200
170
148
130
122
118
Total Cost
of Injuries
$1,600,000
$1,360,000
$1,184,000
$1,040,000
$976,000
$944,000
Marginal
Benefit
Marginal
Cost
$240,000
$176,000
$144,000
$64,000
$32,000
$50,000
$50,000
$50,000
$50,000
$50,000
The economically efficient level of loss control spending is $200,000. The next
marginal increase of $50,000 only brings $32,000 in benefits.
Type: A
5.
Most people probably agree that it is very difficult to place a dollar value on human
life. Explain what it means to implicitly place a dollar value on human life in
ordinary decisions.
Answer: Everyday decisions can affect the probabilities of death. Examples of such
decisions are an individual’s choice of automobile, some employers’ decision
regarding safety equipment, and governmental regulations regarding safety
standards. The implicit valuation of human life is found by comparing the amount of
money that one spends to reduce the probability of a death. For instance, spending
$50,000 to reduce the probability of a death by the increment of .005 implies a value
of life equal to ($50,000)/(.005) = $10,000,000.
Type: A
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Chapter 12
Legal Liability for Injuries
I.
Multiple Choice
1.
The conditions necessary for a plaintiff to show that a defendant was negligent
include all of the following except:
a.
b.
c.
d.
The defendant had a duty to the plaintiff and breached the duty
The defendant’s breach of duty was the proximate cause of the plaintiff’s injury.
The defendant intended to cause harm to the plaintiff
The plaintiff suffered a loss.
Answer: c
Type: K
2.
Under joint and several liability:
a.
b.
c.
d.
A defendant’s spouse is equally liable for the defendant’s negligence.
A defendant can be held fully responsible for losses he/she only partially caused.
A defendant has no defenses against the charge of negligence.
All of the above.
Answer: b
Type: K
3.
Which of the following is/are true about punitive damages?
a.
b.
c.
They are not designed to compensate for the plaintiff’s losses
They are intended to punish the defendant for the actions that led to the injury
They have been controversial in recent years because juries have tended to give large
awards of this type.
All of the above.
d.
Answer: d
Type: K
4.
Which of the following is not a proposed reform for the tort liability system?
a.
b.
c.
d.
limit contingency fees charged by lawyers
require that winners pay the legal fees of the losers
caps on pain and suffering damages
restrictions on the collateral source rule
Answer: b
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Type: K
5.
Which of the following is/are a defense to product liability claims in most states?
a.
b.
c.
d.
contributory negligence
assumption of the risk
both (a) and (b) defenses to product liability claims
none of the above
Answer: c
Type: K
6.
From an economic perspective, the tort system would not be necessary if:
a.
b.
consumers were uninformed about a product’s risk and transactions costs were low
consumers were fully informed about a product’s risk and transactions costs were
low
consumers were fully informed about a product’s risk and transactions costs were
high
consumers were partially informed about a product’s risk and transactions costs were
high
c.
d.
Answer: b
Type: A
7.
John was speeding into an intersection when Mary negligently was making a left
turn. Their cars collided and Mary sued John for her injuries. The jury determined
that John was negligent and that Mary was 30% responsible for her own injuries.
Mary’s actual damages were $25,000. If the contributory negligence rule applies in
that jurisdiction, how much will Mary get?
a.
b.
c.
d.
$25,000
$17,500
$7,500
nothing
Answer: d
Type: A
8.
Using the information in question #7, if the comparative negligence rule applied,
how much would Mary get?
a.
b.
c.
d.
$25,0000
$17,500
$7,500
nothing
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Answer: b
Type: A
9.
According to the collateral source rule:
a.
b.
you cannot get compensation from more than one source for the same injury.
you must try to mitigate your own damages by requesting compensation from all
possible sources
courts are precluded from reducing damages by the amount of coverage provided by
a plaintiff’s life, health, or property insurance.
none of the above.
c.
d.
Answer: c
Type: K
10. Which one of the following liability rules frequently applies to products liability
cases?
a.
b.
c.
d.
no liability
negligence
strict liability
absolute liability
Answer: c
Type: K
11. When the U.S. legal system assigns a liability rule for a general type of loss the
system is essentially
a.
b.
c.
d.
assessing fault
protecting consumers
allocating risk
measuring damages
Answer: c
Type: K
12. In business liability cases, courts may apply an economic standard for negligence –
cost-justified precautions. This standard is met if the business firm
a.
b.
c.
spent at least 10% of it revenue on safety efforts
undertook safety costs whenever the marginal benefit of the safety effort was greater
than the marginal cost
undertook safety costs whenever the marginal benefit of the safety effort was less
than the marginal cost
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d.
has purchased adequate insurance
Answer: b
Type K
13. Ted was injured in an accident that was caused by Judy’s negligence. As a result of
the accident, Ted incurred $8,000 in medical bills. He filed and won a lawsuit against
Linda, and the medical bills were paid by the judgment. These medical bills are what
type of damages?
a.
b.
c.
d.
special compensatory damages
general compensatory damages
special punitive damages
general punitive damages
Answer: a
Type: K
14. Which of the following statements is/are true regarding the objective(s) of the U.S.
tort system?
a.
b.
c.
d.
the system attempts to provide the rights incentives for safety
the system attempts to provide the right amount of compensation for accident victims
the system attempts to minimize the cost of risk to society
all of the above
Answer: d
Type: K
15. Which one of the following is not a potential source of limited liability (or being
judgment proof)?
a.
b.
c.
d.
bankruptcy laws
being elderly
lack of wealth
being incorporated (as a business)
Answer: b
Type: K
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II. Fill-Ins
1.
From an economic perspective, the two fundamental objectives of the tort system are
to provide incentives for people to engage in the optimal level of safety and to
provide optimal compensation to victims
2.
The liability rule that is most often used in defective product cases is
liability.
3.
An example of a non-monetary loss is
4.
Compensatory damages in tort liability cases compensate victims for monetary
losses such as medical expenses and lost pay .
5.
Common law is the body of law that has evolved over time as a result of
previous court decisions and not the result of specific legislative actions.
6.
The burden of proof under a negligence rule is on the plaintiff
7.
A person or firm is said to be
wealth to pay for damages
strict
pain and suffering .
judgment proof
.
if they have insufficient
III. Problems and Short Answer Questions
1.
What are the main suggestions that have been made for reforming the tort liability
system?
Answer: Some of the proposals for tort reform are designed to reduce the incentive to
bring lawsuits, e.g. limits on contingency fees charged by lawyers, requiring the
loser to pay the winner’s legal fees. Other proposals are directed at reducing
damage awards, e.g. caps on pain and suffering awards, limits on punitive damages,
restrictions on the collateral source rule. Elimination of the joint and several
liability rule has been proposed on the grounds that it does little to encourage safety.
Type: K
2.
Explain how a) consumer information and b) transactions costs imply that the private
marketplace will not provide optimal incentives in the absence of a system of legal
liability.
Answer: Without a legal liability system, transactions would be designed to ensure that
each party engages in the optimal level of loss control and payment to injured
parties. If one party to the transaction is not fully informed, then there will be
insufficient incentives. Similarly, if the transactions costs of contracting with all
parties who might cause you injury are too high, then the market will not allocate the
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costs optimally. In these cases, the tort liability system can improve incentives to
engage in loss control and to provide optimal compensation for victims.
Type: A
3.
Stinky Inc. has a factory which emits air pollutants which could have long term
effects on the environment and also smell terrible. This reduces the values of
surrounding property. Stinky has estimated that the cost of installing anti-pollution
devices is $500,000. Fines are imposed by the EPA for exceeding limits on certain
types of emissions but these are only $1,000 per year. Considering liability rules,
transaction costs and information availability, analyze the optimality of installing the
anti-pollution devices.
Answer: Since air pollution is generally contributed to by a number of sources, including
vehicles and equipment, it is difficult to assign responsibility for bad smells in the
air. Furthermore, any single consumer will be unlikely to have sufficient damage to
warrant bringing an expensive lawsuit against a company. Therefore, the
probability of a lawsuit is relatively low and the likelihood of a substantial damage
claim if a suit were brought is also fairly low. The government regulation of
pollution is not a big enough motivator in this case either. When consumers are
relatively uninformed and the legal liability system does not provide strong
deterrents, there will generally be too little investment in safety. Stinky will find it
optimal to forego the investment in the anti-pollution devices.
Type: A
4.
Make an argument that optimal safety incentives can best be imposed by government
regulation rather than by a system of tort liability.
Answer: It is more efficient for a single governmental entity to determine the optimal
level of safety expenditures since regulators can achieve economies of scale in
obtaining information about accidents, methods and technology for reducing
frequency and severity of accidents, costs of implementing safety and the willingness
of people to pay for additional safety. A tort liability system implies that private
individuals must all do this, which results in costly duplication of effort. Safety
regulation is also superior in that it is an ex ante rather than an ex post approach.
The regulation is aimed at preventing the accident before it occurs rather than
simply assigning the blame and cost after the fact.
Type: K
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5.
The J.D Trucking Company is near bankruptcy. To improve his circumstance J.D.
signs a lucrative contract to haul toxic waste. In a further effort to save money, he
also discontinues all of his insurance policies and skips truck and trailer inspections.
Discuss J.D.’s incentives and how it affects the level of risk in society.
Answer: It would appear that J.D. is taking on excessive risk because he thinks he is
judgment proof. i.e. has little to lose. If his contract to haul toxic waste is
successfully completed he will (at least temporarily) have restored his business’
good fortune. The result of J.D.’ decision to take on excessive (and uninsured) risk
increased the level of risk in society during the period of his contract. If J.D. causes
an accident while hauling the waste, it is very unlikely that he will be able to
compensate the victims.
Type: A
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Chapter 20
Risk Management and Shareholder Wealth
I.
Multiple Choice
1.
The value of a firm is:
a.
b.
c.
d.
the present value of the firm’s expected future cash flows.
impossible to estimate.
dependent on its capital structure.
all of the above.
Answer: a
Type: K
2.
Which of the following risks faced by a business firm is most likely to be
nondiversifiable?
a.
b.
c.
d.
explosion at the firm’s plant
worker injury
reduced earnings due to poor economic conditions
a product liability claim
Answer: c
Type: A
3.
Which of the following is not an advantage of purchasing insurance as compared to
retaining the risk?
a.
b.
c.
d.
Insurers can provide cheaper claim processing and loss control services.
The price of the insurance is often less than the expected claim cost.
Insurance reduces the likelihood of financial distress.
Insurance can reduce a firm’s expected tax payments.
Answer: b
Type: K
4.
Corporate insurance purchases can affect expected cash flows by:
a.
b.
c.
d.
increasing net cash flows due to premium loadings.
increasing net cash flows by providing cheaper claim processing.
decreasing net cash flows by reducing the likelihood of financial distress.
decreasing net cash flows by reducing expected tax payments.
Answer: b
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Type: K
5.
Which of the following is a likely result of the risk of bankruptcy for an airline?
a.
b.
c.
d.
Managers and employees demand higher levels of compensation.
The cost of borrowing will be higher.
Some potential customers will choose to do business with other airlines.
All of the above.
Answer: d
Type: A
6.
In estimating the net present value of a firm’s cash flows, the appropriate discount
rate will be the risk-free rate plus a risk premium that takes into account:
a.
b.
c.
d.
all the risk that the firm is subject to.
firm-specific and market risk that the firm is subject to.
diversifiable risk only.
nondiversifiable risk only.
Answer: d
Type: K
7.
Corporate risk reduction increases shareholder wealth by:
a.
b.
c.
d.
increasing expected net cash flows.
decreasing the corporate cost of capital.
increasing the corporate cost of capital.
none of the above.
Answer: a
Type: K
8.
When deciding how much insurance to purchase, a firm must compare the insurance
premium loading to:
a.
b.
c.
d.
the cost of capital
the expected loss
the expected cost of raising new funds following a loss
the costs of financial distress
Answer: c
Type: K
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9.
Financial distress:
a.
b.
c.
d.
always results in bankruptcy.
requires that a firm be legally reorganized to restructure the terms of its obligations.
often imposes costs on parties who have contractual relationships with the firm.
will not affect the firm’s expected cash flows unless it results in an actual
bankruptcy.
Answer: c
Type: K
10. Watergate Inc. has a main office that is located in a flood plain. How will its lenders
react if Watergate does not purchase flood insurance,
a.
b.
c.
d.
its lenders will be indifferent
its lenders will probably charge a lower interest rate
its lenders will structure any loans to reflect the cost of a potential underinvestment
problem
none of the above.
Answer: c
Type: A
11. Which one of the following is a fundamental factor in determining the value of a
firm?
a.
b.
c.
d.
level of expected future cash flows
timing of expected future cash flows
opportunity cost of capital
all of the above factors are fundamental determinants of a firm’s value
Answer: d
Type: K
12. The difference between a firm’s opportunity cost of capital and the risk-free rate is
a.
b.
c.
d.
the firm’s risk premium
always greater (in magnitude) than the risk-free rate
always less (in magnitude) than the risk-free rate
diversifiable risk
Answer: a
Type: A
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13. Which of the following situations faces a potential underinvestment problem from
experiencing a loss due to fire?
a.
b.
c.
d.
debt financing, adequate insurance
debt financing, no insurance
no debt financing, adequate insurance
no debt financing, no insurance
Answer: b
Type: A
14. PatCo Incorporated has just purchased property and liability insurance. Which one of
the following will have a negative effect on expected cash flows?
a.
b.
c.
d.
payment of the expense loadings in the insurance premiums
bundling loss control services with the insurance purchase
the altering of contractual terms with lenders and suppliers
the change in expected bankruptcy costs
Answer: a
Type: K
15. Corporate insurance purchases will primarily affect the firm’s
a.
b.
c.
d.
cost of capital
risk premium
expected net cash flows
all of the above
Answer: c
Type: K
II. Fill-Ins
1.
Risk that can be eliminated by investors by holding diversified portfolios is called
risk.
diversifiable (or firm-specific or idiosyncratic or non-systematic )
2.
The
underinvestment
problem occurs when firms who have debt
financing but no insurance have incentive to opt not to reinvest after a loss because
the benefit of the reinvestment accrues to the lenders rather than to the shareholders.
3.
Services provided by insurers such as claims processing
and loss control
are benefits of insurance that can offset the additional cost due to premium loading.
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4.
The
risk premium
is the amount of return in excess of the risk free
rate which is demanded by providers of capital for bearing systematic or nondiversifiable risk.
5.
of an investment is the present value of the benefits
The
net present value
less the present value of the costs.
III. Problems and Short Answer Questions
1.
The Viable Company purchases commercial general liability insurance. What
impact is this likely to have on the firm’s cost of capital. Explain.
Answer: Liability risk is firm-specific and is therefore diversifiable by the firm’s
shareholders. If Viable’s shareholders are well-diversified, the purchase of this
insurance is unlikely to decrease the cost of capital.
Type: A
2.
In the question above, how might the purchase of insurance affect Viable’s cash
flows?
Answer: The loading on insurance policies generally means that the cost of insurance is
greater than the expected value of losses. However, there may be other benefits that
accrue to the firm such as reduced cost of claim processing and loss control services,
reduced likelihood of incurring the costs of raising funds to finance a loss, reduced
likelihood of financial distress, and reduced tax payments.
Type: A
3.
The Astute Insurance Company property insurance policy includes claims processing
and loss control services. Explain why bundling the insurance with the services
would be expected to result in lower claim costs.
Answer: An insurer that provides loss control services and pays losses has additional
incentive to identify and undertake cost-effective loss control measures. The claims
processing function provides the insurer with the incentive and the means to identify
and reduce the costs of fraudulent claims.
Type: A
4.
If the risk free rate is 5% and the risk premium for Bogie’s Stogies Inc. is 7%, what
is the opportunity cost of capital for Bogie’s Stogies Inc.?
Answer: The opportunity cost of capital = 5% + 7% = 13%.
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Type: A
5.
If Bogie’s Stogies Inc., in question #4 above, purchases insurance to cover its
product liability risk, what impact will this have on the cost of capital? Explain.
Answer: The purchase of insurance will not impact the cost of capital since product
liability risk is a diversifiable risk.
Type: A
6.
If Bogie’s Stogies Inc., in question #4 above, hedges their currency risk exposure,
what impact will this have on the cost of capital. Explain.
Answer: Currency risk is diversifiable, so the hedging activity will likely reduce the
firm’s cost of capital. However, the hedge will reduce corporate cash flows so that
the benefits and costs may offset each other.
Type: A
7.
Shaky Bakey is a restaurant supply company that is experiencing financial distress.
Without insurance, what impacts will the risk of bankruptcy have on Shaky’s
contracts with other claimholders?
Answer: Customers will be concerned about Shaky’s quality and reliability and may seek
other sources for their supplies. Employees will demand higher compensation for
the risk of losing their jobs. Shaky’s suppliers will demand higher prices to
compensate for the risk of not being paid. Lenders will demand higher interest rates.
Type: A
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Chapter 21
Tax, Regulatory, and Accounting Factors
Affecting Corporate Risk Management
I.
Multiple Choice
1.
A tax benefit:
a.
b.
c.
always accrues to the party who receives the tax deduction.
sometimes accrues to a party other than the one who receives the tax deduction.
will always increase the wealth of the shareholders of the firm receiving the tax
benefit.
all of the above
d.
Answer: b
Type: K
2.
The tax benefits of insurance, as compared to retention, arise from several factors
including:
a.
b.
c.
d.
regressive tax rates
hedging
tax treatment of unpaid losses
none of the above
Answer: c
Type: K
3.
Premium taxes and excise taxes:
a.
b.
c.
d.
increase the premium loading on insurance
decrease the present value of expected losses
cannot be passed on to insurance buyers in the form of higher premiums
do not affect the choice between insurance and retention
Answer: a
Type: K
4.
The tax treatment of uninsured losses:
a.
b.
is the same as the financial reporting of uninsured losses.
allows for a firm to choose when the loss will be deducted – either when the loss is
incurred or when it is paid
is the same for insurance companies and non-insurance companies.
requires that the loss be deducted in the year it is paid.
c.
d.
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Answer: d
Type: K
5.
The financial reporting requirements for uninsured losses require firms to recognize
losses:
a.
b.
c.
d.
when they occur
when they are paid
when they become probable and can be reasonably estimated.
none of the above.
Answer: a
Type: K
6.
A foreign insurer is:
a.
b.
c.
d.
domiciled in the state.
domiciled outside the U.S.
domiciled in another state in the U.S.
the same as an alien insurer.
Answer: c
Type: K
7.
An admitted insurer in a particular state:
a.
b.
c.
d.
can be domestic, foreign or alien.
is always a domestic insurer.
is not always licensed to sell insurance in the state.
faces stricter regulation than non-admitted insurers.
Answer: a
Type: K
8.
Which of the following statements is true regarding the relationship between a firm’s
risk management decisions and its capital structure decisions?
a.
The risk management decisions should be made independently from the capital
structure decisions.
Risk management has no affect on a firm’s capital structure.
Strategic decisions about a firm’s capital structure and risk management should not
be made independently.
None of the above.
b.
c.
d.
Answer: c
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Type: K
9.
Compulsory insurance rules:
a.
reduce the likelihood that firms will be unable to fulfill their legal obligations to
others.
are common for automobile liability risk.
may include a self-insurance option that allows qualifying firms to retain the risk.
all of the above.
b.
c.
d.
Answer: d
Type: K
10. A tax benefit should be defined (or stated) in terms of
a.
b.
c.
d.
actual tax payments
actual tax deductions
expected tax payments
expected loss financing
Answer: c
Type: K
11. A firm will receive an expected tax benefit by reducing the variability of its income
if
a.
b.
c.
d.
tax rates are progressive
tax rates are progressive and the probability of loss is low
tax rates are regressive
tax rates are regressive and the probability of loss is high
Answer: a
Type: K
12. Paying a fair premium that is equal to the firm’s expected loss has which of the
following effects? (Assume there is no premium loading.)
a.
b.
c.
d.
deducting the expected loss amount
reducing expected tax payments
increasing expected after-tax earnings
all of the above
Answer: d
Type: K
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13. US corporations can carry losses _____ years forward and _____ years backwards.
a.
b.
c.
d.
20 (forward), 3 (backwards)
25 (forward), 3 (backwards)
20 (forward), 2 (backwards)
22 (forward), 2 (backwards)
Answer: c
Type: K
14. This year’s deduction for incurred losses for CPT Insurance Company is equal to the
a.
b.
c.
d.
present value of losses that were incurred this year
value of losses that were paid this year
value of losses that were paid this year plus any change in the discounted value of
incurred losses that will be paid in the future
dollar value of losses that incurred this year, no matter when they are expected to be
paid, i.e. no discounting
Answer: c
Type: K
15. The principle advantage of using debt financing is/are
a.
b.
c.
d.
interest tax shields
cost of capital
lower probability of financial distress
a reduced variability of earnings
Answer: a
Type: K
II. Fill-ins
1.
When tax rates are
progressive
lower expected tax payments.
2.
The tax treatment of losses on depreciated property provides a tax benefit to
property
insurance.
3.
4.
Premium
and
, reducing the variability of cash flows will
excise taxes increase the premium loading on insurance.
Fronting
refers to the practice of purchasing primary insurance from one
insurer which immediately reinsures most of the exposure with another insurer.
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5.
The federal government excise tax on primary insurance transactions is
percent.
four
III. Problems and Short Answer Questions
1.
Explain why a tax benefit might not necessarily result in an increase in shareholder
wealth for the firm receiving the benefit.
Answer: If the product market is competitive, the firm that receives the tax break may be
forced to pass on the benefit to their customers in the form of lower output prices.
Type: K
2.
Ellis Manufacturing, Inc. is considering whether to buy property insurance for their
fully depreciated warehouse or to retain the risk. Explain how each of the following
factors might make the insurance option more attractive than retention.
a.
b.
progressive corporate income tax rates
tax treatment of depreciated property.
Answer:
a. Tax payments with insurance will be based on certain level of income whereas
without insurance, the firm will pay a higher tax rate when the loss does not
occur than when it does occur. As a result of progressive tax rates, the
reduction in after tax income in the years without a loss is less than the increase
in after tax income in the years with a loss;
b. Ellis be able to deduct the insurance premium whether or not a loss occurs. If a
loss occurs, Ellis will have to recognize a capital gain equal to the insurance
indemnity payment.. If the income tax rate exceeds the capital gains tax rate,
the income tax savings from deducting the premium will exceed the capital gains
tax payment.
Type: A
3.
Explain how less volatile financial accounting numbers due to the purchase of
insurance can influence the magnitude or variability of cash flows.
Answer: Purchase of insurance will cause less volatile earnings which will: a) allow
investors to predict earnings and cash flows more accurately which may reduce the
investor’s estimate of the riskiness of the firm (although this is non-systematic risk);
b) reduces the likelihood of default on debt contracts; c) make it less costly for
shareholders and other stakeholders to monitor management behavior.
Type: K
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4.
Explain the tax treatment and financial accounting treatment for each of the
following:
a.
b.
insurance premiums
uninsured losses
Answer:
a. premiums paid are a deductible expense in the year in which coverage is
provided (both for taxes and financial accounting)
b. uninsured losses are reported as an expense in the year in which they occur but
are deducted for tax purposes in the year in which they are paid.
Type: K
5.
Explain the reasons for “fronting”.
Answer: Fronting is used to comply with regulations that restrict the choice of insurers,
to reduce excise taxes, and to satisfy third party demands that insurance be provided
by a particular set of insurers.
Type: K
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Chapter 22
Risk Retention/Reduction Decisions
I.
Multiple Choice
1.
Which of the following is not a potential benefit to a firm from increasing retention?
a.
b.
c.
d.
savings on premium loadings
increased moral hazard
avoiding implicit taxes that arise from insurance price regulation
reduced exposure to insurance market volatility
Answer: b
Type: K
2.
Which one of the following firms is more likely to use retention?
a.
b.
c.
d.
closely held firm
publicly traded and widely held firm
a firm with a high level of financial leverage
a small firm
Answer: b
Type: K
3.
Bilbo Industries is a technology company that prides itself on the ability to react
quickly to new product developments. It maintains a significant research and
development budget. Regarding risk-reducing activities, Bilbo Industries is
a.
b.
c.
d.
more likely to retain risks thereby retaining use of more funds
more likely to retain risk because of their ability to react to changing developments
less likely to retain risks to concentrate on what they do best
less likely to retain risk to help ensure they have a steady supply of investment funds
Answer: d
Type: A
4.
A disaggregated risk management approach will generally result in
a.
b.
c.
d.
lower transactions costs
higher transactions cost
lower expected losses
higher expected losses
Answer: b
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Type: K
5.
Which one of the following is an example of an aggregated approach to risk
management?
a.
b.
c.
d.
hedging exchange rate risk
hedging interest rate risk
purchasing a high level of liability insurance
developing a (derivative) contract to stabilize fluctuations on total revenue
Answer: d
Type: A
Use these loss distributions to answer questions 6-8.
Liability Exposures
Amount
Probability
of Loss
of Loss
$8,000,000
.015
$0
.985
Property Exposures
Amount
Probability
of Loss
of Loss
$4,000,000
.035
$0
.965
6.
If the premium loading for the liability exposure is 35% of expected losses, what is
the fair insurance premium for the liability exposure? (Don’t be concerned with the
time value of money.)
a.
b.
c.
d.
$120,000
$135,000
$147,000
$162,000
Answer: d
Type: A
7.
If the premium loading for the property exposure is 25% of expected losses, what is
the fair insurance premium for the property exposure? (Don’t be concerned with the
time value of money.)
a.
b.
c.
d.
$140,000
$155,000
$175,000
$185,000
Answer: c
Type: A
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8.
If both the property & liability exposures are bundled together and covered under a
single contract that has a premium loading equal to 28% of the bundled expected
losses, how much savings in premium will be achieved? (Assume these exposures
are independent and as before, don’t be concerned with the time value of money.)
a.
b.
c.
d.
$4,200
$5,350
$8,100
$11,400
Answer: a
Type: A
9.
The underwriting cycle affects the retention/reduction decision because
a.
b.
the retention/reduction decision is often part of a long-term business plan
a firm usually wants to correctly alternate between retention and reduction as the
underwriting cycle dictates
purchasing insurance in soft market will stabilize cash flows
The underwriting cycle has little effect on the retention/reduction decision.
c.
d.
Answer: a
Type: A
10. Residual markets regulation can create an incentive to self-insure
a.
b.
c.
d.
when residual premiums are higher than those in the voluntary market
because firms who self-insure do not participate in residual market financing
because self-insured firms are subsidized by the residual markets
whenever residual markets provide coverage for compulsory coverages
Answer: b
Type: K
11. A large firm with a high degree of correlation across loss exposures will tend to rely
on
a.
b.
c.
d.
risk retention
risk reduction via an insurance contract
self-insurance
risk reduction via internal diversification
Answer: b
Type: A
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12. A basic guideline for the retain/insure decision is ‘Insure those exposures that…
a.
b.
c.
d.
have reasonably predictable losses.’ (This makes for stable premiums.)
can potentially result in large, disruptive losses
have high frequency and high severity
are measurable
Answer: b
Type: K
13. Firms concerned with their probability of insolvency will tend to
a.
b.
c.
d.
retain more risks so as to keep use of funds otherwise spent on premiums
retain more risks to avoid increasing their debt financing
insure more risks in order to decrease their reliance on debt financing
insure more risk to stabilize their cash flows
Answer: d
Type: A
14. A bundled insurance policy with a single overall retention limit can help a firm
a.
b.
c.
d.
avoid purchasing unnecessary coverage
avoid the problem of two contracts providing duplicate coverage
develop simpler contracts
understand the disaggregated loss distributions
Answer: a
Type: K
15. Newly designed bundled contracts will face the uncertainty of legal interpretation
and the settling of disputes thereof. This uncertainty, relative to established separate
contracts, is an example of
a.
b.
c.
d.
minimal risk transfer
‘bundled’ contract law
moral hazard
increased transactions costs (for a bundled policy)
Answer: d
Type: K
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II. Fill-Ins
1.
Optimal retention for many firms involves the retention of
predictable
losses and buying insurance against
large, potentially disruptive losses.
2.
Reducing exposure to insurance market volatility is a benefit
risk exposure.
3.
A firm who very actively seeks out new investment opportunities is most likely to
when evaluating the retention/reduction decision.
use risk retention
4.
The complexity of the contract is a disadvantage to the
approach to the risk retention/reduction decision.
5.
A firm with a high level of financial leverage is
retention.
of retaining a
aggregate
less
likely to use
III. Problems and Short Answer Questions
1.
The development and selection of alternative risk management methods involves a
fundamental tradeoff between the benefits of retention and the increased costs from
greater risk. What are the benefits of increased retention?
Answer: The potential savings from increased retention include: a) savings on premium
loadings; b)reduced exposure to insurance market volatility; c) reduced moral
hazard; d) avoiding high premiums that may accompany asymmetric information; e)
avoiding implicit taxes that arise from insurance price regulation; and f)
maintaining the use of funds until losses are paid.
Type: K
2.
Consider two firms: Firm A has 2,000 workers in twenty different states. Firm B has
500 workers at a single plant. All else equal, which firm would be more likely to
retain their workers compensation losses? Explain.
Answer: Firm A would be more likely to retain because the lower correlation among
workers reduces the variability of losses compared to Firm B where many workers
could be hurt in a single accident.
Type: A
3.
Killebrew Inc. has historically purchased separate policies for property insurance and
liability insurance. Each of the policies had $4 million retention. The company is
now considering the purchase of a bundled policy which covers both property and
liability exposures. The retention of the bundled policy is to be $8 million. Draw a
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graph illustrating the areas of unnecessary coverage that will exist if Killebrew
continues with separate policies.
Liability Loss
Answer:
8
4
Unnecessary
Coverage
4
8
Property Loss
Type: K
4.
Why does a firm which is very active in seeking out new investment opportunities,
e.g. a technology research firm, have less incentive to use retention?
Answer: A firm which is engaged in cutting-edge technology will desire a steady flow
source of investment funds. If such a firm suffers a loss on a retained risk exposure
some investment opportunities may have to be foregone as the funds will not be
available for the investment or the cost of raising funds externally may be too great.
Type: K
5.
Detail some of the difficulties in the aggregated approach to risk management.
Answer: The primary difficulty of the aggregate approach to risk management is the
complexity of the undertaking. Detailed knowledge of the individual risk exposures
and their correlations must be obtained. Given the breadth of some corporations this
might be quite difficult. The insurer (or whoever is assuming the risk under a
bundled policy) must understand how to price such an amalgamation of risks. All of
this complexity gives rise to higher transactions costs.
Additional issue that exists once a contract is established is how any disputes will be
resolved. These new types of contract will not have a established set of laws
governing interpretation of the contracts.
Type: A
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Chapter 24
Hedging with Derivative Contracts
I.
Multiple Choice
1.
Which of the following is not a factor that influences the price of a call option at a
given point in time t?
a.
b.
c.
d.
the price of the underlying asset at time t
the exercise price of the option
the date that the option was first created
the interest rate on government bonds (risk free rate)
Answer: c
Type: K
2.
A call option price will increase, all else equal, when:
a.
b.
c.
d.
the price of the underlying asset decreases
the volatility of the return on the underlying asset increases
the interest rate on government bonds decreases
time to maturity decreases
Answer: b
Type: A
3.
Call option A has an exercise price of $20. Call option B has an exercise price of
$15. If all other characteristics of these options are identical and they are on the same
underlying asset, which option will have a higher price?
a.
b.
c.
d.
Call option A will have a higher price.
Call option B will have a higher price.
Call option A and Call option B will have the same price.
It is impossible for two options on the same underlying asset to have different
exercise prices.
Answer: b
Type: A
4.
Option X and Option Y have the same underlying security and the same exercise
price. If Option X has 3 months to maturity and Option Y has 6 months to maturity,
which option will have a higher price?
a.
b.
Option X will have a higher price
Option Y will have a higher price
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c.
d.
Since Options X and Y are on the same underlying security, they will have the same
price.
Cannot be determined form the information given
Answer: b
Type: A
5.
Which of the following statements is true about a futures contract?
a.
The payoff is equal to the difference between the price of the underlying asset and
the futures price.
The payoff is the same as that of a call option.
Futures contracts always require delivery of the underlying asset to complete the
contract.
The futures price is paid by the buyer at the outset of the contract.
b.
c.
d.
Answer: a
Type: K
6.
The current spot price of oil is $12 per barrel, the interest rate is 8%, and the cost of
storing and insuring oil for one year is 1% of the value of the oil. What would be the
no arbitrage futures price today on a contract that expires one year from now?
a.
b.
c.
d.
$12
$12.96
$13.09
$13.20
Answer: c
Type: A
7.
Which of the following is not a true statement about the differences between overthe-counter (OTC) derivatives and exchange traded derivatives?
a.
The exchange markets have a clearinghouse that acts as an intermediary in every
transaction whereas the OTC contracts are between buyer and seller directly.
When trading OTC contracts, default risk of the counterparty is an important
consideration.
OTC contracts are each individually negotiated whereas exchange traded contracts
are standardized.
OTC contracts are more liquid than exchange traded contracts.
b.
c.
d.
Answer: d
Type: A
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8.
The type(s) of risk that is (are) very frequently hedged with derivatives are:
a.
b.
c.
d.
foreign exchange risk
interest rate risk
commodity price risk
all of the above
Answer: d
Type: K
9.
Factors that have contributed to the use of interest rate derivatives to hedge against
changes in value due to interest rate changes include:
a.
b.
c.
low interest rates in the 1990s
volatility of interest rates in the 1970s and 1980s
the Federal Reserve policy of trying to stabilize interest rates directly instead of
targeting monetary aggregates
all of the above
d.
Answer: b
Type: K
10. Which of the following is not a determinant of forward or futures prices?
a.
b.
c.
d.
the current price of the underlying asset
the time to expiration
the premium charged by the broker
the risk free rate of interest
Answer: c
Type: K
11. Basis risk exists when the hedging instrument
a.
b.
c.
d.
is likely to increase in value
is likely to decrease in value
differs in value from the item (or variable) being hedged
has a high level of volatility
Answer: c
Type: K
12. The notional principle for swap contracts is
a.
b.
an accurate measure of the amount of money at risk
usually double the amount of money at risk
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c.
d.
usually an inaccurate measure of the amount of money at risk
the expected value of the payout of the contract
Answer: c
Type: K
13. When compared to derivative contracts, insurance contracts
a.
b.
c.
d.
have greater basis risk
are used to hedge losses that are more specific to a firm
are more liquid
tend to have lower transactions (or contracting) costs
Answer: b
Type: K
14. Miker wants to protect his company from the increased costs it would face if the
price of corn exceeds $5 per bushel. Which of the following instruments will
generate value if the price per bushel of corn should exceed $5?
a.
b.
c.
d.
call option
put option
either a call option or a put option because both will suit his needs
swap option
Answer: a
Type: A
15. Which of the following is not true about call options contracts?
a.
b.
c.
d.
The potential payoff of a call options is asymmetrical.
The underlying asset is a market variable or some other aggregate economic variable.
Call option contracts are nonstandard.
Call option contract can be settled without physical delivery.
Answer: c
Type: K
II. Fill-Ins
1.
A contract whose payoff or value is derived from the value of an underlying asset is
contract.
known as a
derivative
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2.
A derivative contract in which the buyer of the contract receives a positive payoff
when the value of the underlying asset is above the exercise price is called a call
option
.
3.
A derivative contract in which the buyer of the contract receives a positive payoff
when the value of the underlying asset is below the exercise price is called a put
option
.
4.
The basis for a hedge is the difference between the value of what’s being hedged and
the value of the hedging instrument .
5.
An option that can be exercised at any time up to the expiration date is called a(n)
American
option.
6.
A measure commonly used to denote the value of outstanding swap contracts is
.
called the notional principal
7.
exists when the combination of the parts has greater value than the
Synergy
sum of the individual values.
8.
By purchasing a
put option
on an underlying asset which is positively
correlated with a firm’s revenue (and thus positively correlated with profits), a firm
can hedge against losses due to lower than expected revenue.
III. Problems and Short Answer Questions
1.
Explain how an insurance contract is similar to an option contract.
Answer: Both types of contracts can be used to generate cash when events occur that
otherwise would have caused a loss in firm value. Firms must pay a premium for
either type of contract. In both types of contracts, the firm will not make a claim or
exercise the contract rights if the negative event does not occur.
Type: K
2.
Anacott Steel uses oil in its production process and is therefore exposed to the risk of
changing oil prices. If it uses derivatives to hedge this risk, what are the types of
basis risk may it be exposed to?
Answer: There may be differences between the factors that affect the oil costs for Anacott
and the factors that affect the value of the derivative contract for Anacott These
differences create basis risk and could include;
 The derivative contract may be based on a different grade of oil than the one that
Anacott needs for production.
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

The maturity date of the contract may not correspond to Anacott’s purchasing
requirements (e.g. if they need to buy oil every day.
The delivery locations may differ.
Type: A
3.
Why do insurance contracts expose the firm to less basis risk than derivative
contracts? What are some of the additional costs of insurance contracts that may
outweigh the reduced basis risk?
Answer: Since derivative contracts are standardized and are based on market prices
rather than firm specific factors, it is impossible for a gain on a derivative contract
to exactly match the loss that the firm experiences. In contrast, insurance contracts
are based on firm-specific outcomes and can therefore be designed to perfectly
hedge the firm’s losses. Insurance contracts may be more expensive because insurers
must price policies to account for moral hazard, adverse selection, and higher
capital costs.
Type: K
4.
Draw an exposure diagram to illustrate a firm’s exposure to interest rate risk if the
firm needs to borrow $1 million one year from today. Assume the loan will be a one
year loan with all interest paid at the end of the year. Graph the relation between the
firm’s interest costs and interest rates. Also graph the relation between the firm’s
profit and interest rates assuming that higher interest costs cannot be passed on to
consumers.
Answer:
Exposure diagram
Profit Effects due to Interest Rates
Interest
Costs
Profit
Interest
Rates
Interest
Rates
Type: A
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5.
ZT company self-insures its workers’ compensation exposure. ZT is confident it can
reliable predict the expected number of worker injuries (874) and the expected
severity of each injury in today’s prices ($8,000). Since ZT is worried about health
care inflation it has formed a contract with Index R’ Us whereby Index R’ Us will
pay ZT, at year end, an amount equal to the magnitude of inflation greater than 3%
for each of the expected number of worker injuries. The contract is based on an
agreed to health care inflation index and ZT pays Index R’ Us a $120,000 premium.
a. Construct a table detailing the payoff of this contract for health care inflation
levels of 1% through 6%.
b. Comment on the basis risk of this contract
Answer:
(a)
Health
Care
Inflation
1%
2%
3%
4%
5%
6%
Average
Severity
$8,080
$8,160
$8,240
$8,320
$8,400
$8,480
Total cost of
expected number
of injuries
$7,061,920
$7,131,840
$7,201,760
$7,271,680
$7,341,600
$7,411,520
Payoff to ZT
from hedge
contract.*
-$120,000
-$120,000
-$120,000
-$50,080
$19,840
$209,760
*Note: ZT is paying for inflation costs up to 3%. These dollars are
outside the contract payoff.
(b) Two types of basis risk could arise from this contract, (1) the inflation of ZT’s health
care costs might deviate from the agreed upon index and (2) since the contact payoff
at the end of the year the timing of the payments is a source of risk.
Type: A
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Chapter 25
Alternative Risk Transfer
I.
Multiple Choice
1.
All of the following are examples of loss sensitive policies except:
a.
b.
c.
d.
retrospectively rated policies
experience rated policies
investment credit program
excess policies
Answer: d
Type: K
2.
Experience-rated policies are beneficial to the insurer because they help to reduce:
a.
b.
c.
d.
adverse selection
moral hazard
fraud
insurer insolvency
Answer: b
Type: K
3.
An insurance company that is set up as a subsidiary of a parent for the sole purpose
of providing insurance to the parent corporation is:
a.
b.
c.
d.
a subsidiary insurance company
an offshore insurance company
a pure captive insurance company
operating illegally
Answer: c
Type: K
4.
Captive insurance companies in the U.S. which only insure a single parent
corporation:
a.
will not necessarily result in reduced taxes for the parent since the tax laws tend to
treat them as self-insurance funds.
will always reduce the risk of the parent corporation.
will reduce loss costs to the parents as compared to buying insurance from a different
insurer.
all of the above.
b.
c.
d.
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Answer: a
Type: K
5.
Which one of the following is not a characteristic of retrospectively rated policies?
a.
b.
c.
retro premium is a function of the actual losses sustained during the policy period
retro premium is subject to a minimum and a maximum
retrospectively rated policies transfer more risk to the insurer than traditional
insurance policies
while the insurer fully settles all claims, it may subsequently require additional
premium from the insured
d.
Answer: c
Type: K
6.
Alternative risk transfer (ART) is difficult to define. ART transactions though, do
tend to have certain characteristics. Which one of the following is not a common
characteristic of ART?
a.
b.
c.
d.
low level of retention
involvement with capital market institutions and securities
contracts that span multiple years
contracts that cover multiple sources of risk
Answer: a
Type: K
7.
An oil refinery has recently suffered an explosion. The refinery has estimated its cost
from this explosion to be approximately $50 million dollars. Uncertainty still exists
though regarding the actual amount and timing of the loss payments. An insurer has
agreed, for a price, to assume all responsibility for the payment of this loss. This is
an example of a
a.
b.
c.
d.
retrospectively rated policy
loss portfolio transfer
premium financing arrangement
incurred loss retro
Answer: b
Type: A
8.
Which one of the following in not a characteristic of finite risk insurance?
a.
b.
transfers relatively little risk from insured to insurer
provides protection against the timing of insured’s loss payments
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c.
d.
the typical contract length is no more than two years
all of the above are characteristics of finite risk insurance
Answer: c
Type: K
9.
Regarding captives, ‘unrelated business’ refers to
a.
b.
c.
d.
insurance lines outside the captive’s scope
independent loss exposures
noninsurance activities
selling insurance coverage to entities not related to the parent corporation
Answer: d
Type: K
10. When a captive insurer writes coverage on a sister corporation the transaction is
a.
b.
c.
d.
considered ‘risk-reducing’
not treated as insurance for tax purposes
counted as related business
all of the above
Answer: a
Type: K
11. Multiline insurance policies
a.
b.
c.
d.
provide coverage for losses generated from different risk exposures
provide coverage against an aggregate measure of losses
can potentially allow the insured to save on transactions cost
all of the above
Answer: d
Type: K
12. A multitrigger insurance policy
a.
b.
c.
d.
provides coverage for losses generated from different risk exposures
is triggered by multiple conditions or contingencies
is triggered only when two losses of the same type occur
requires two insurers provide payment of large losses
Answer: b
Type: K
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13. A.J. Manufacturing has an agreement with the Bank of St. Croix whereby A.J. can
borrow up $3.5 million dollars should the manufacturing plant suffer a severe fire or
windstorm. The interest rate on the loan is guaranteed to not be greater than 7
percent. This is an example of
a.
b.
c.
d.
contingent debt
contingent equity
letter of credit
line of credit
Answer: a
Type: A
14. Structured debt instruments
a.
b.
c.
d.
are the same as contingency debt
link interest payments to some other variable, such as commodity prices
have made catastrophe bonds obsolete
all of the above
Answer: b
Type: K
15. An important economic factor that has contributed to the trend of increased use of
alternative risk transfer is
a.
b.
c.
d.
interest rate volatility of the 1990s
increased volatility of the underwriting cycle
slow growth of GDP in the U.S.
stock market drop of Oct. 1987
Answer: b
Type: K
II. Fill-Ins
1.
When the insurer pays losses and then bills the insured for the deductible amount, the
insurer will usually require that the insured provide a letter of credit . from a bank
that guarantees that the insured will pay losses as promised.
2.
When premiums depend on the losses that occur (or are paid) during the policy
period, the policy is said to be loss sensitive (or experience rated) .
3.
A captive insurer with multiple parent companies is know as a
captive.
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4.
The insurance transactions between a pure captive and its parent corporation are not
treated as insurance for tax purposes because these transaction are not regarded as
risk-reducing activities.
5.
In an effort to provide funding should an earthquake loss occur, MyCorporation has
issued a debt instrument whereby, in the event of an earthquake, principle and
interest payments do not have to be made. The debt instrument is called a
.
catastrophe bond
III. Problems and Short Answer Questions
1.
Discuss captive insurers and the issues of risk-reduction and pooling.
Answer: A major incentive for forming a captive insurer is to enable a parent
corporation to count insurance premiums as tax deductible and yet effectively retain
the risk. Since retention does not allow for the pooling of a firm’s risk exposures,
there is no perceived risk-reduction in the case of a pure captive. The parent of a
pure captive can thereby not count payments to its captive as deductible for tax
purposes.
Type: A
2.
Explain why a firm might want to finance its losses through a captive insurance
company.
Answer: The main reasons for using a captive are:
 to reduce tax payments (insurance premiums are tax deductible and many
captives are located offshore where there are more favorable tax laws)
 to be able to purchase reinsurance directly from reinsurers
 to reduce risk through diversification (if the captive also sells insurance to
other firms)
Type: K
3.
M. Knot has a finite risk insurance plan with R2 insurance company. The three-year
plan has the following terms;
 M. Knot will pay a $1,500,000 premium at the beginning of each year
 5% interest will be credited to each year’s beginning balance
 insurer will receive a fee of 12% of each premium
 an aggregate limit of $10 million
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Complete the following table.
Previous Year Balance
Premium
Insurer’s Fee
Beginning Balance
Claim Payments
Interest
End of Year Balance
Year 1
Year 2
Year 3
$1,500,000
$1,500,000
$1,500,000
-$850,000
-$2,400,000
-$1,200,000
Year 1
$0
$1,500,000
-180,000
1,320,000
Year 2
916,000
$1,500,000
-180,000
2,236,000
Year 3
-52,200
$1,500,000
-180,000
1,267,800
-$850,000
66,000
916,000
-$2,400,000
111,800
-52,200
-$1,200,000
63,390
131,190
Answer:
Previous Year Balance
Premium
Insurer’s Fee
Beginning Balance
Claim Payments
Interest
End of Year Balance
Type: A
4.
What are two reasons a firm may want use an incurred loss retro policy instead of an
excess policy with a high attachment point?
Answer:
a. The firm can gain a tax advantage with the incurred loss retro. Since additional
retro premium is paid when the losses are incurred, the firm is able to get an
earlier tax deduction. If the losses were retained via a high attachment point the
tax deduction could be taken until the losses were paid.
b. The incurred loss retro policy allows the firm to effectively retain the risk, yet
contract with the insurer to process claims.
Type: K
5.
What risks are transfer to the insurer with a loss portfolio transfer?
Answer: Since the actual loss event(s) has already occurred, the risk transferred with a
loss portfolio transfer is the uncertainty regarding the ultimate amount of the
loss(es) and the timing of when the loss payment(s) will ultimately be made.
Type: K
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Chapter 28
Corporate Liability to Customers,
Third Parties, and Shareholders
I.
Multiple Choice
1.
Product manufacturers are usually sued for product-related injuries based on:
a.
b.
c.
d.
strict liability
negligence
contributory negligence
all of the above
Answer: a
Type: K
2.
Which of the following is not one of the primary types of product defects?
a.
b.
c.
d.
manufacturing defect
design defect
hidden defect
warning defect
Answer: c
Type: K
3.
The court case, MacPherson v Buick (1916), established which one of the following
legal precedents?
a.
b.
Negligence needed to be proved in product liability cases
A contractual relationship between the injured party and the manufacturer is not
needed to recover damages.
The strict liability standard for products liability cases.
The ‘unreasonably dangerous’ standard for products liability.
c.
d.
Answer: b
Type: K
4.
A statute of repose is:
a.
a product liability reform proposal that would require product liability lawsuits be
brought within a certain number of years after the product was purchased.
a common law rule for product liability that is similar to a statute of limitations.
a statute that requires that the case be closed if there is no action on it within ten
years.
b.
c.
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d.
None of the above.
Answer: a
Type: K
5.
Strict liability for all consumer losses due to product-related injuries:
a.
b.
c.
d.
provides inadequate incentives for manufacturers to invest in safety
provides inadequate compensation for victims
provides appropriate incentives for consumers to take safety precautions
helps correct the problem of uninformed consumers who overconsume risky
products in the absence of such a liability rule.
Answer: d
Type: A
6.
Under the most recent commercial general liability policies, environmental damage
is
a.
b.
c.
d.
covered only if it was “sudden and intentional”.
excluded from coverage under the policy.
covered if the pollution was gradual.
covered if the policyholder was unaware that it was occurring.
Answer: b
Type: K
7.
Critics of the Superfund law argue that:
a.
the EPA has spent excessive resources on cleaning up sites that have little chance of
posing harm to area residents.
the law provides incentives for excessive investment in safety.
the clean-up efforts have increased the exposure to toxic substances in some cases
because these efforts have freed some of the substances into the environment.
All of the above.
b.
c.
d.
Answer: d
Type: K
8.
If the directors and officers of a corporation cause the shareholders to suffer a loss
they:
a.
b.
c.
d.
are personally liable for the losses.
are not liable if they can show that they acted with good business judgment.
can never be held personally liable because of the limited liability rule.
can only be liable up to the limit of their investment in the corporation.
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Answer: b
Type: K
9.
Which of the following statements is true about liability for environmental damage
under the common law?
a.
b.
c.
Liability has become easier to avoid.
Insurers are more willing to provide adequate coverage at reasonable prices.
Liability for environmental damage has been greatly expanded during the last several
decades.
None of the above.
d.
Answer: c
Type: K
10. Roaster Coaster Inc. manufactures rolling hotdog vending stands. Their usual
production is five vending stands per week. One of the hotdog vending stands comes
off the production line defective. The stand eventually starts on fire at an amusement
park. The fire causes a minor panic that results in a few children being injured as the
crowd rushes away from the fire. This defect is an example of a
a.
b.
c.
d.
manufacturing defect
hidden defect
design defect
warning defect
Answer: a
Type: A
11. If a group of shareholders file a lawsuit, on behalf of the corporation, against the
directors and officers of the corporation, it is called a
a.
b.
c.
d.
derivative lawsuit
direct action lawsuit
nuisance lawsuit
indemnity lawsuit
Answer: a
Type: K
12. ‘Do not use near fire or flame’ is written on a perfume bottle. This is an example of a
a.
b.
c.
warning defect
manufacturing defect
design defect
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d.
none of the above
Answer: d
Type: A
13. In event of a derivative lawsuit, a corporation can indemnify its directors and officers
for which of the following costs?
a.
b.
c.
d.
litigation expenses
fines levied
judgment and settlement amounts
all of the above
Answer: a
Type: K
14. Many analysts are of the opinion that a large proportion of securities class actions are
‘strike suits’. A strike suit is a securities class action that
a.
b.
c.
d.
has little or not merit, but is filed in order to coerce management into a settlement
is usually initiated by the corporation’s employees
is filed with the Securities Exchange Commission (SEC)
all of the above
Answer: a
Type: K
15. A manufacturer is subject to liability resulting from express warranties and implied
warranties. This is an example of
a.
b.
c.
d.
tort liability
contractual liability
strict liability
imputed liability
Answer: b
Type: K
II. Fill-Ins
1.
An important source of statutory liability for environmental contamination is
Comprehensive Environmental Response Compensation and Liability Act of 1980
(CERCLA) or Superfund law
.
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exclude
2.
The most recent CGL policies
liability.
coverage for environmental
3.
Insurance coverage for pollution liability is often offered in a separate
policy.
environmental impairment liability (EIL)
4.
If a director of a corporation makes a decision, using all available information and in
reasonable consideration of the pros and cons of that decision, he or she will not be
held personally liable in the event of a loss to shareholders because the
rule will be applied by the courts.
business judgment
5.
Directors and officers of a corporation owe a duty of
shareholders of the corporation.
6.
A suit that is brought by a shareholder on behalf of the corporation is called a
suit.
derivative
loyalty or care
to the
III. Problems and Short Answer Questions
1.
For each of the following examples of product liability cases, explain what type of
defect is being alleged.
a. liability of an off-road auto manufacturer for failing to install a rollbar to
minimize injuries if the vehicle overturns.
b. liability of a babyfood manufacturer for pieces of glass found inside some of the
jars.
c. liability of a pharmaceutical company for side-effects of a drug.
Answer: a) design defect, b) manufacturing defect, and c) warning defect
Type: A
2.
Kristopher is an avid bicycle enthusiast. He participates in Ride the Rockies, a
popular bike race in the Colorado mountains. During the race, he slips on some
gravel when going down a hill at 50 miles per hour and is thrown from his bike. His
bike helmet cracks and he has serious head injuries. If he survives, under what
theories can he sue the bike helmet manufacturer?
Answer: He can claim that the helmet is defective. It may be a design defect if he can
show that all the helmets have the same problem. If it can be shown to be peculiar to
his particular helmet, it might be a manufacturing defect, such as a bad batch of
plastic. It could also be a warning defect if the helmet was known by the
manufacturer to be able to resist impacts but not sufficient to protect him from this
type of road injury. An alternative possibility is to claim a breach of warranty since
the implied warranty is that the helmet is suitable for what it is intended.
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Type: A
3.
If the courts routinely hold manufacturers liable for injuries when the manufacturer
could not have foreseen the danger or when the danger is caused by the consumer’s
misuse of the product, what impact will this have on the incentives for product safety
and victim compensation?
Answer: This will likely result in too much investment in safety. Manufacturers will
provide excessive warnings and may withdraw products from the market that
actually might have a beneficial impact on risk. Two examples are drugs with rare
but dangerous side-effects and small airplanes. On the other hand, holding the
manufacturers liable in these cases makes it more likely that victims will be
compensated.
Type: A
4.
In what way is the current system of product liability regressive?
Answer: The current system is regressive because the cost of product liability is spread
among all consumers equally (since prices of products are unrelated to the wealth of
the purchaser), but the liability awards are generally higher for wealthy plaintiffs.
Type: K
5.
Name and briefly explain the types of product liability reforms that have been
adopted by individual states and proposed at the federal level.
Answer: These reforms include measures that would (1) reduce the potential liability of
producers (e.g. by curtailing joint and several liability, capping pain and suffering
damages, imposing limitations on punitive damages, and altering the collateral
source rule); (2) reduce incentives of plaintiff’s attorneys to file marginal cases (e.g.
by loser pays rule and reduced contingency fees for plaintiff’s attorneys); statute of
repose (requiring that suits be brought within a certain time after purchase of the
product).
Type: K
6.
Andy owns 100 shares of stock in XYZ Corporation. He believes that XYZ’s
management has been guilty of mismanagement. What possible remedies does he
have?
Answer: He can bring a derivative suit on behalf of the corporation, in which case any
damages would be awarded to the corporation. Alternatively, he could bring a
direct suit and win damages directly. A class action could be brought be a group of
shareholders. With only 100 shares, it is doubtful that this would be financially
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worthwhile to Andy and the management might be covered under the business
judgment rule.
Type: A
7.
The 500 residents of Teenytown USA have heard that a section of their town has
been declared a Superfund cleanup site. They are concerned that the costs of the
cleanup will outweigh the benefits. The cleanup of their town is estimated to cost
$5-10 million. The dump is 5 miles from town and the contaminants are not
currently affecting groundwater. What other information would be necessary for
them to conduct a cost benefit analysis? How would you suggest that Teenytown
residents present their argument?
Answer: Teenytown will need to estimate any other costs that may arise, including the
potential for the cleanup to release toxins into the ground, air and water. In the
absence of any other costs, the benefit to the community would have to be $10,000
per resident to make the cleanup worth the cost to taxpayers. Answers will vary.
Type: A
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Chapter 1 Risk in Our Society
1) Traditionally, risk has been defined as A) any situation in which the probability of loss is one.
B) any situation in which the probability of loss is zero. C) uncertainty concerning the occurrence of loss. D) the
probability of a loss occurring.
Answer: C
Question Status: Revised
2) Objective risk is defined as A) the probability of loss.
B) the relative variation of actual loss from expected loss. C) uncertainty based on a person!s mental condition or
state of mind. D) the cause of loss.
Answer: B
Question Status: Previous Edition
3) An insurance company estimates its objective risk for 10,000 exposures at 10 percent. Assuming the
probability of loss remains the same, what would happen to the objective risk if the number of exposures were to
increase to 1 million?
A) It would decrease to 1 percent. B) It would decrease to 5 percent.
C) It would remain the same. D) It would increase to 20 percent.
Answer: A
Question Status: Previous Edition
4) Uncertainty based on a person!s mental condition or state of mind is known as A) objective risk.
B) subjective risk. C) objective probability. D) subjective probability.
Answer: B
Question Status: Previous Edition
2
Rejda · Principles of Risk Management and Insurance, Tenth Edition
5) The long-run relative frequency of an event based on the assumption of an infinite number of observations
with no change in the underlying conditions is called
A) objective probability. B) objective risk.
C) subjective probability. D) subjective risk.
Answer: A
Question Status: Previous Edition
6) Which of the following statements about a priori probabilities is correct? A) They are subjective probabilities
based on ambiguity in the way probability is perceived.
B) They are subjective probabilities that may vary among individuals because of factors such as age, gender,
education, and the use of alcohol.
C) They are objective probabilities that can be determined by deductive reasoning. D) They are objective
probabilities that can be determined by subjective reasoning.
Answer: C
Question Status: Previous Edition
7) An individual!s personal estimate of the chance of loss is A) an objective probability.
B) an objective risk. C) a subjective probability. D) an a priori probability.
Answer: C
Question Status: Previous Edition
8) A peril is A) a moral hazard.
B) the cause of a loss. C) a condition which increases the chance of a loss. D) the probability that a loss will
occur.
Answer: B
Question Status: Previous Edition
9) An earthquake is an example of a A) moral hazard.
B) peril. C) physical hazard. D) objective risk.
Answer: B
Question Status: Previous Edition
10) Dense fog that increases the chance of an automobile accident is an example of a A) speculative risk.
B) peril. C) physical hazard. D) moral hazard.
Answer: C
Question Status: Previous Edition
11) Faking an accident to collect insurance proceeds is an example of a A) physical hazard.
B) objective risk. C) moral hazard. D) morale hazard.
Answer: C
Question Status: Previous Edition
12) Indifference to loss because of the existence of insurance is an example of a A) physical hazard.
B) objective probability. C) moral hazard. D) morale hazard.
Answer: D
Question Status: Previous Edition
Chapter 1
Risk in Our Society 3
4
Rejda · Principles of Risk Management and Insurance, Tenth Edition
13) Some characteristics of the judicial system and regulatory environment increase the frequency and severity of
loss. This hazard is called
A) moral hazard. B) physical hazard.
C) morale hazard. D) legal hazard.
Answer: D
Question Status: Previous Edition
14) Taylor Tobacco Company is concerned that the company may be held liable in a court of law and ordered to
pay a large damage award. The characteristics of the judicial system that increase the frequency and severity of
losses are known as
A) moral hazard. B) particular risk.
C) speculative risk. D) legal hazard.
Answer: D
Question Status: Revised
15) A phrase that encompasses all of the major risks faced by a business firm is A) financial risk.
B) speculative risk. C) enterprise risk. D) pure risk.
Answer: C
Question Status: Previous Edition
16) 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) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Revised
17) All of the following are considered financial risks EXCEPT A) the decline in the value of a bond portfolio
because of rising interest rates.
B) increased cost of production because of rising commodity prices. C) loss of money because of adverse
movements in currency exchange rates. D) loss of profits after a physical damage loss occurs.
Answer: D
Question Status: Previous Edition
18) Katelyn was just named Risk Manager of ABC Company. She has decided to create a risk management
program which considers all of the risks faced by ABC -pure, speculative, operational, and strategic-in a single
risk management program. Such a program is called a(n)
A) financial risk management program. B) enterprise risk management program.
C) fundamental risk management program. D) consequential risk management program.
Answer: B
Question Status: Previous Edition
19) 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.
Answer: A
Question Status: Previous Edition
20) The premature death of an individual is an example of a A) pure risk.
B) speculative risk. C) fundamental risk. D) physical hazard.
Answer: A
Question Status: Previous Edition
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21) Which of the following statements about speculative risks is true? A) They are almost always insurable by
private insurers.
B) They are more easily predictable than pure risks. C) Their occurrence may benefit society. D) They involve
only a chance of loss.
Answer: C
Question Status: Previous Edition
22) An automobile that is a total loss as a result of a collision is an example of which of the following types of
risk?
I.
Speculative risk II. Fundamental risk
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Revised
23) All of the following are programs to insure fundamental risks EXCEPT A) federally subsidized flood
insurance.
B) auto physical damage insurance. C) Social Security. D) unemployment insurance.
Answer: B
Question Status: Revised
24) All of the following are examples of personal risks EXCEPT A) poor health.
B) unemployment. C) premature death. D) flood.
Answer: D
Question Status: Previous Edition
25) Which of the following is a reason why premature death may result in economic insecurity? I.
Additional expenses associated with death may be incurred. II. The income of the deceased person!s
family may be inadequate to meet its basic needs.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
26) Which of the following are often consequences of long-term disability? I.
Loss or reduction of employee benefits
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Continuing medical expenses II.
Question Status: Previous Edition
27) All of the following are examples of direct property losses EXCEPT A) the theft of a person!s jewelry.
B) the destruction of a firm!s manufacturing plant by an earthquake. C) the cost of renting a substitute vehicle
while a collision-damaged car is being repaired. D) the vandalism of a person!s automobile.
Answer: C
Question Status: Revised
28) The extra expense incurred by a business to stay in operation following a fire is an example of a(n) A)
fundamental risk.
B) speculative risk. C) direct loss. D) indirect loss.
Answer: D
Question Status: Previous Edition
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29) Which of the following statements about liability risks is (are) true? I.
Future income and assets can be
attached to pay judgments if inadequate insurance is carried. II. There is an upper limit on the amount of loss.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
30) All of the following are burdens to society because of the presence of risk EXCEPT A) The size of an
emergency fund must be increased.
B) Individuals may profit from accepting a speculative risk. C) Society is deprived of certain goods and services.
D) Mental fear and worry are present.
Answer: B
Question Status: Previous Edition
31) Loss control includes which of the following? I.
Loss reduction II.
Loss prevention
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
32) Following good health habits can be categorized as A) loss prevention.
B) loss retention. C) noninsurance transfer. D) personal insurance.
Answer: A
Question Status: Previous Edition
33) From the insured!s perspective, the use of deductibles in insurance contracts is an example of A) risk transfer.
B) loss control. C) risk avoidance. D) risk retention.
Answer: D
Question Status: Previous Edition
34) The use of fire-resistive materials when constructing a building is an example of A) risk transfer.
B) loss control. C) risk avoidance. D) risk retention.
Answer: B
Question Status: Previous Edition
35) All of the following statements about risk retention are true EXCEPT A) It may be used intentionally if
commercial insurance is unavailable.
B) It may be used passively because of ignorance. C) Its use is most appropriate for low-frequency, high-severity
types of risks. D) Its use results in cost savings if losses are less than the cost of insurance.
Answer: C
Question Status: Revised
36) All of the following are methods of noninsurance transfer EXCEPT A) entering into a hold-harmless
agreement.
B) avoiding dangerous activities. C) hedging risk using futures contracts. D) incorporating a business.
Answer: B
Question Status: Revised
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37) Curt borrowed money from a bank to purchase a fishing boat. He purchased property insurance on the boat.
Curt had difficulty making loan payments because he did not catch many fish, and fish prices were low. Curt
intentionally sunk the boat, collected from his insurer, and paid off the loan balance. This scenario illustrates the
problem of
A) adverse selection. B) moral hazard.
C) fundamental risk. D) morale hazard.
Answer: B
Question Status: Previous Edition
38) 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 also 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) fundamental risk.
C) speculative risk. D) indirect loss.
Answer: D
Question Status: Revised
39) Brad started a pest control business. To protect his personal assets against liability arising out of the business,
Brad incorporated the business. Brad!s use of the corporate form of organization to shield against personal
liability claims illustrates
A) fundamental risk. B) noninsurance transfer.
C) risk retention. D) objective risk.
Answer: B
Question Status: Previous Edition
40) 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 does occur is called
A) objective probability. B) subjective probability.
C) objective risk. D) subjective risk.
Answer: C
Question Status: Previous Edition
41) Williams Company installed smoke detectors, a sprinkler system, and fire extinguishers in its new
manufacturing facility. These devices are all examples of
A) loss control. B) noninsurance transfer.
C) risk avoidance. D) risk retention.
Answer: A
Question Status: Previous Edition
42) Tyndal Products Company produces cereal. The company has entered into contracts to deliver 500,000 boxes
of cereal during the next 18 months. The company is concerned that the prices of two ingredients, corn and
wheat, may increase over the next 18 months. The company used grain futures contracts to hedge the price risk
associated with these commodities. Tyndal!s use of hedging illustrates which risk management technique?
A) noninsurance transfer B) risk avoidance
C) risk retention D) risk assumption
Answer: A
Question Status: Revised
43) Cathy!s car hit a patch of ice on the road. The car skidded off the road and hit a tree. The presence of ice on
the road is best described as a(n)
A) peril. B) subjective risk.
C) physical hazard. D) indirect loss.
Answer: C
Question Status: Previous Edition
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44) Jim and Paula Franklin started a dry cleaning business. The business may be successful or it may fail. The
type of risk that is present when either a profit or loss could occur is called
A) pure risk. B) subjective risk.
C) fundamental risk. D) speculative risk.
Answer: D
Question Status: Previous Edition
45) 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) speculative risk. B) liability risk.
C) fundamental risk. D) property risk.
Answer: B
Question Status: Previous Edition
46) MLX Drug Company would like to market a new hypertension drug. While the Food and Drug
Administration (FDA) was testing the drug, it discovered that the drug produced a harmful side effect. When
MLX learned of the FDA!s test result, MLX abandoned its plan to produce and distribute the drug. MLX!s
reaction illustrates
A) risk avoidance. B) hedging.
C) risk transfer. D) risk retention.
Answer: A
Question Status: Previous Edition
47) ABC Health Insurance Company sells health insurance in one state. Recently, that state!s legislature passed a
law forbidding health insurers from considering an individual!s health history when selecting applicants to
insure. This change in law will increase the possibility of unprofitable results for ABC. This type of hazard is an
example of
A) physical hazard. B) legal hazard.
C) moral hazard. D) morale hazard.
Answer: B
Question Status: Revised
48) All of the following are characteristics of the liability risk that most people face EXCEPT A) a lien may be
placed on your income and assets to satisfy a legal judgment.
B) substantial legal expenses may be incurred defending the claim. C) there is no upper limit on the amount of
the loss. D) owning liability insurance eliminates the possibility of being held legally liable.
Answer: D
Question Status: New
49) Which of the following statements about chance of loss and risk is (are) true? I.
If the chance of loss is
identical for two groups, the objective risk must be the same. II. Two individuals may perceive differently the
risk inherent in a given activity.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: New
Chapter 1
Risk in Our Society 13
Chapter 2 Insurance and Risk
1) All of the following are characteristics of insurance EXCEPT A) risk avoidance.
B) pooling of losses. C) payment of fortuitous losses. D) indemnification.
Answer: A
Question Status: Previous Edition
2) Which of the following is implied by the pooling of losses? A) sharing of losses by an entire group
B) inability to predict losses with any degree of accuracy C) substitution of actual loss for average loss D)
increase of objective risk
Answer: A
Question Status: Previous Edition
3) According to the law of large numbers, what happens as the number of exposure units increases? A) Actual
results will increasingly differ from probable results.
B) Actual results will more closely approach probable results. C) Fundamental risk will decrease. D) Objective
risk will increase.
Answer: B
Question Status: Previous Edition
4) According to the law of large numbers, what should happen as an insurer increases the number of units
insured?
A) The amount the insurer expects to pay in claims should decrease. B) Underwriting expenses should decrease.
C) Actual results will more closely approach expected results. D) The insurer!s profitability should become more
variable.
Answer: C
Question Status: Previous Edition
5) Characteristics of a fortuitous loss include which of the following? I. The loss is certain to occur. II. The loss
occurs as a result of chance.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
6) From the viewpoint of the insurer, all of the following are characteristics of an insurable risk EXCEPT
A) The loss must be accidental. B) The loss should be catastrophic.
C) The premium must be economically feasible. D) There must be a large number of exposure units.
Answer: B
Question Status: Previous Edition
7) From the standpoint of the insurer, all of the following are characteristics of an insurable risk EXCEPT
A) The loss must be unintentional. B) The chance of loss must be calculable.
C) The loss must be indeterminable. D) The loss must be measurable.
Answer: C
Question Status: Previous Edition
8) Why is a large number of exposure units generally required before a pure risk is insurable? A) It prevents the
insurer from losing money.
B) It eliminates intentional losses. C) It minimizes moral hazard. D) It enables the insurer to predict losses more
accurately.
Answer: D
Question Status: Revised
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9) 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) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
10) Which of the following is implied by the requirement that a loss should be determinable and measurable to
be insurable? I.
The loss must be definite as to place. II.
The loss must be definite as to amount.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
11) 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) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
12) Which of the following types of risks best meets the requirements for being insurable by private insurers?
A) market risks B) property risks C) financial risks
D) political risks Answer: B
Question Status: Previous Edition
13) Reasons why market, financial, and production risks are often uninsurable include which of the following?
I.
The potential to produce a catastrophic loss is great. II.
The chance of loss cannot be accurately
estimated.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
14) Which of the following types of risks is normally uninsurable by private insurers? A) personal risks
B) property risks C) liability risks D) market risks
Answer: D
Question Status: Previous Edition
15) Which of the following is a result of adverse selection? A) The insurer!s financial results will be substantially
improved.
B) Persons most likely to have losses are also most likely to seek insurance at standard rates. C) It is unnecessary
for the insurance company to use underwriting. D) Insurance can be written only by the federal government.
Answer: B
Question Status: Revised
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16) The tendency for unhealthy people to seek life or health insurance at standard rates is an example of
A) moral hazard. B) fundamental risk.
C) morale hazard. D) adverse selection.
Answer: D
Question Status: Previous Edition
17) 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) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
18) 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) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
19) Inland marine insurance provides coverage for A) goods being shipped on land.
B) premature death of members of the armed forces. C) goods being shipped on ocean-going vessels. D) liability
exposures of nonprofit organizations.
Answer: A
Question Status: Revised
20) All of the following are classified as casualty insurance EXCEPT A) life insurance.
B) general liability insurance. C) workers compensation insurance. D) burglary and theft insurance.
Answer: A
Question Status: Revised
21) Which of the following is a form of casualty insurance? A) fire insurance
B) general liability insurance C) inland marine insurance D) ocean marine insurance
Answer: B
Question Status: Previous Edition
22) The term "multiple-line insurance" is used to describe a type of insurance that combines which of the
following coverages into a single contract?
A) workers compensation and health insurance B) life and disability insurance
C) property and casualty insurance D) pensions and annuities
Answer: C
Question Status: Previous Edition
23) All of the following are benefits to society that result from insurance EXCEPT A) less worry and fear.
B) elimination of moral hazard. C) indemnification for loss. D) loss prevention.
Answer: B
Question Status: Previous Edition
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24) 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) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
25) All of the following are social costs associated with insurance EXCEPT A) insurance company operating
expenses.
B) fraudulent claims. C) inflated claims. D) increased cost of capital.
Answer: D
Question Status: Revised
26) A group of farmers agreed that if any farmer suffered a property loss, the loss would be spread over the entire
group. In this way, each farmer is responsible for the average loss of the group rather than the actual loss that the
farmer sustained. Which characteristic of insurance is embodied in this agreement?
A) pooling of losses B) fortuitous losses
C) risk avoidance D) indemnification
Answer: A
Question Status: Previous Edition
27) 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 insurable risk might be
violated if XYZ wrote flood insurance on property located in flood plains?
A) There must be a large number of similar exposure units. B) The loss should not be catastrophic.
C) The chance of loss must be calculable. D) The losses must be determinable and measurable.
Answer: B
Question Status: Previous Edition
28) ABC Appliance offers a warranty requiring an annual fee. The warranty may be purchased at the time of sale
or at any time within the first year after the appliance was purchased. The warranty fee after the date of purchase
is twice the time-of-purchase fee. When asked why the fee was higher after the date of purchase, ABC!s
president said, "Buying a warranty is voluntary. We!ve noted that those who buy the warranty after the purchase
date have a greater need for service." Charging the same rate or a lower rate after the date of purchase would
expose ABC to what problem that also impacts private insurers?
A) excessive premiums B) reduced claims
C) bad investments D) adverse selection
Answer: D
Question Status: Revised
29) Alpha Insurance Company insures a broad range of risks, including whatever is not covered by fire, marine,
and life insurers. Which term best describes the wide range of risks written by Alpha Insurance?
A) fidelity insurance B) casualty insurance
C) social insurance D) property insurance
Answer: B
Question Status: Previous Edition
30) LMN Insurance markets homeowners insurance. The LMN homeowners policy combines property and
casualty insurance in the same contract. Insurance policies combining property and casualty coverage in the same
contract are called
A) mono-line policies. B) multi-year policies.
C) multiple-line policies. D) manuscript policies.
Answer: C
Question Status: Previous Edition
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31) 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) social insurance programs.
C) casualty insurance programs. D) private insurance programs.
Answer: B
Question Status: Previous Edition
32) Gina would like to buy a house. She will pay 10 percent of the cost of the house as a down payment and
borrow the other 90 percent from a mortgage lender. The home will serve as collateral for the loan. The lender
requires Gina to purchase property insurance on the home so that the collateral supporting the loan will be
protected. This scenario illustrates which of the following benefits of insurance to society?
A) enhancement of credit B) reduction of fear and worry
C) source of investment funds D) incentives for loss prevention
Answer: A
Question Status: Previous Edition
33) ABC Insurance Company calculated the amount that it expected to pay in claims under 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) premium.
C) expense loading. D) rate credit.
Answer: C
Question Status: Previous Edition
34) JKL Insurance Company estimates that 14 out of every 100 homeowners it insures will file a claim each
year. Last year, JKL insured 200 homeowners. According to the law of large numbers, what should happen if
JKL insures 2,000 homeowners this year?
A) The total number of claims filed by JKL policyowners should decrease. B) The total dollar value of claims
will decrease.
C) The average size of loss will decline in value. D) The actual results will more closely approach the expected
results.
Answer: D
Question Status: Revised
35) 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) hedging. B) speculating. C) reinsurance.
D) loss avoidance. Answer: C
Question Status: Previous Edition
36) Bronson Company manufactures tools that it sells to wholesalers. Bronson is concerned that it may be unable
to collect money the company is owed by the wholesalers. To address this risk, Bronson Company could
purchase
A) a fidelity bond. B) general liability insurance.
C) allied lines insurance. D) credit insurance.
Answer: D
Question Status: Previous Edition
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37) Which of the following statements regarding insurance and hedging is (are) true? I. Insurance involves the
transfer of insurable risk while hedging handles risk that is typically uninsurable. II.
Both insurance and
hedging rely on the law of large numbers to reduce risk.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
38) Ashley opened an all-you-can-eat buffet restaurant. The cost per-person was based upon what Ashley
believed an average restaurant patron would consume. The restaurant began to lose money. Ashley concluded
that her patrons had "above average" appetites, and were attracted to her restaurant because they could eat as
much as they wanted while being charged an average price. A similar phenomenon exists in insurance markets.
This problem is called
A) moral hazard. B) adverse selection.
C) morale hazard. D) fundamental risk.
Answer: B
Question Status: New
39) Which of the following statements is (are) true concerning private insurance? I.
Social insurance
programs are private insurance programs. II.
Both individuals and businesses purchase private insurance.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: New
Chapter 3 Introduction to Risk Management
1) Risk management is concerned with A) the identification and treatment of loss exposures.
B) the management of speculative risks only. C) the management of pure risks that are uninsurable. D) the
purchase of insurance only.
Answer: A
Question Status: Previous Edition
2) A situation or circumstance in which a loss is possible, regardless or whether a loss occurs, is called a
A) deductible. B) loss exposure.
C) loss avoidance. D) peril.
Answer: B
Question Status: Previous Edition
3) All of the following are risk management objectives prior to the occurrence of loss EXCEPT A) analysis of
the cost of different techniques for handling losses.
B) continuing operations after a loss. C) reduction of anxiety. D) meeting externally imposed obligations.
Answer: B
Question Status: Previous Edition
4) Preloss objectives of risk management include which of the following? I.
the most economical way. II. Reduction of anxiety.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Preparing for potential losses in
Question Status: Previous Edition
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Rejda · Principles of Risk Management and Insurance, Tenth Edition
5) A risk manager is concerned with I.
Identifying potential losses. II.
Selecting the appropriate
techniques for treating losses.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
6) Sources of information that can be used by a risk manager to identify pure loss exposures include all of the
following EXCEPT
A) risk analysis questionnaires. B) currency exchange rates.
C) physical inspections. D) past losses.
Answer: B
Question Status: Revised
7) Loss severity is defined as the A) probable size of the losses which may occur during some period.
B) probable number of losses which may occur during some period. C) probability that any particular piece of
property may be totally destroyed. D) probability that a liability judgment may exceed a firm!s net worth.
Answer: A
Question Status: Previous Edition
8) Loss frequency is defined as the A) probable size of the losses that may occur during some period.
B) probable number of losses that may occur during some period. C) probability that any particular piece of
property may be totally destroyed. D) probability that a liability judgment may exceed a firm!s net worth.
Answer: B
Question Status: Previous Edition
9) The worst loss that could ever happen to a firm is referred to as the A) maximum possible loss.
B) maximum probable loss. C) frequency of loss. D) severity of loss.
Answer: A
Question Status: Previous Edition
10) The worst loss that is likely to happen is referred to as the A) maximum possible loss.
B) maximum probable loss. C) frequency of loss. D) severity of loss.
Answer: B
Question Status: Previous Edition
11) All of the following statements about avoidance are true EXCEPT A) Certain loss exposures are never
acquired.
B) Certain loss exposures may be abandoned. C) The chance of loss for certain loss exposures may be reduced to
zero. D) It can be used for any loss exposure facing a firm.
Answer: D
Question Status: Previous Edition
12) Abandoning an existing loss exposure is an example of A) avoidance.
B) retention. C) noninsurance transfer. D) insurance transfer.
Answer: A
Question Status: Revised
Chapter 3
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13) Which of the following conditions is (are) appropriate for using retention? I. Losses are difficult to predict.
II.
The worst possible loss is not serious.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
14) Which of the following statements about retention levels is (are) true? I.
A common rule of thumb is that
a firm!s maximum retention can be equal to 100 percent of its earnings before taxes. II. A financially strong firm
can have a higher retention level than a firm whose financial position is weak.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
15) All of the following statements about captive insurers are true EXCEPT A) They may act as a profit center
by insuring parties other than the parent company.
B) They provide a way to obtain types of insurance that may be unavailable from commercial insurers.
C) They increase the volatility of the parent company!s earnings. D) They make it easier for a firm to have access
to reinsurance.
Answer: C
Question Status: Revised
16) Which of the following statements about self-insurance is (are) true? I.
II.
State law usually prohibits its use for workers compensation.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
It is a form of planned retention.
Question Status: Previous Edition
17) All of the following are potential advantages of retention EXCEPT A) lower expenses.
B) increased cash flow. C) encouragement of loss prevention. D) protection from catastrophic losses.
Answer: D
Question Status: Previous Edition
18) A restaurant owner leased a meeting room at the restaurant to a second party. The lease specified that the
second party, not the restaurant owner, would be responsible for any liability arising out of the use of the meeting
room, and that the restaurant owner would be "held harmless" for any damages. The restaurant owner!s use of the
hold-harmless agreement is an example of
A) retention. B) self-insurance.
C) insurance. D) noninsurance transfer.
Answer: D
Question Status: Previous Edition
19) All of the following are disadvantages of noninsurance transfers EXCEPT A) The party to whom the
potential loss is transferred may be unable to pay.
B) The transfer may fail because the contract language is ambiguous. C) The only potential losses that can be
transferred are those that are not commercially insurable. D) The noninsurance transfer may be costly.
Answer: C
Question Status: Previous Edition
20) ABC Insurance retains the first $1 million of each property damage loss and purchases insurance for that part
of any property loss that exceeds $1 million. The insurance for property losses above $1 million is called
A) excess insurance. B) liability insurance.
C) coinsurance. D) primary insurance.
Answer: A
Question Status: Previous Edition
Chapter 3
Introduction to Risk Management 29
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21) Which of the following statements about the use of deductibles is (are) true? I.
They represent risk
retention by insurance purchasers. II.
They tend to increase the cost of adjusting small claims.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
22) Which of the following statements about an excess insurance plan is true?
A) The insurer does not participate in a loss until it exceeds the amount the firm has decided to retain.
B) The insurer pays first up to some specified level; the insured then pays all losses exceeding the insurer!s
retention level.
C) Losses in excess of a specified amount are not covered. D) The insured and insurer share equally in any loss
that occurs.
Answer: A
Question Status: Revised
23) Factors a risk manager must consider in selecting an insurer include which of the following? I.
availability of risk management services. II. The financial strength of the insurer.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
The
Question Status: Previous Edition
24) An insurance policy specifically written and designed to meet the needs of an insurance purchaser is called
a(n)
A) manuscript policy. B) bureau policy.
C) standard policy. D) excess policy.
Answer: A
Question Status: Previous Edition
25) All of the following are disadvantages of using insurance in a risk management program EXCEPT A) There
is an opportunity cost because premiums must be paid in advance.
B) Considerable time and effort must be spent selecting and negotiating coverages. C) It results in considerable
fluctuations in earnings after a loss occurs. D) Attitudes toward loss control may become lax when losses are
insured.
Answer: C
Question Status: Revised
26) Which of the following types of loss exposures may be appropriately handled through the purchase of
insurance? I. High-frequency, low-severity II.
Low-frequency, high-severity
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
27) Which of the following types of loss exposures are best handled by the use of avoidance? A) low-frequency,
low-severity
B) low-frequency, high-severity C) high-frequency, low-severity D) high-frequency, high-severity
Answer: D
Question Status: Revised
28) Low-frequency, low-severity loss exposures are best handled by A) avoidance.
B) retention. C) insurance. D) noninsurance transfer.
Answer: B
Question Status: Previous Edition
Chapter 3
Introduction to Risk Management 31
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Rejda · Principles of Risk Management and Insurance, Tenth Edition
29) All of the following statements about the administration of a risk management program are true EXCEPT
A) The risk manager is an important part of a firm!s management team.
B) A risk management policy statement can be used to educate top executives about the risk management
process.
C) If a risk management program is properly designed, periodic review of the program is unnecessary.
D) In order to properly identify loss exposures, the risk manager needs the cooperation of other departments.
Answer: C
Question Status: Previous Edition
30) 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) identify potential losses faced by XYZ Company. D) implement and administer a risk management plan for
XYZ Company.
Answer: C
Question Status: Previous Edition
31) Members of Mid-South Petroleum Distributors, a trade group, had trouble obtaining affordable pollution
liability insurance. The members formed a group captive that is exempt from many state laws that apply to other
insurers. This group captive is called a(n)
A) reinsurance pool. B) Lloyd!s association.
C) alien insurer. D) risk retention group.
Answer: D
Question Status: Revised
32) Acme Company has three identical manufacturing plants, one on the Texas Gulf Coast, one in southern
Alabama, and one in Florida. Each plant is valued at $50 million. Acme!s risk manager is concerned about the
damage which could be caused by a single hurricane. The risk manager believes there is an extremely low
probability that a single hurricane could destroy two or all three plants because they are located so far apart.
What is the maximum probable loss associated with a single hurricane?
A) $0 million B) $50 million
C) $100 million D) $150 million
Answer: B
Question Status: Revised
33) Acme Company has three identical manufacturing plants, one on the Texas Gulf Coast, one in southern
Alabama, and one in Florida. Each plant is valued at $50 million. Acme!s risk manager is concerned about the
damage which could be caused by a single hurricane. The risk manager believes there is an extremely low
probability that a single hurricane could destroy two or all three plants because they are located so far apart.
What is the maximum possible loss associated with a single hurricane?
A) $0 million B) $50 million
C) $100 million D) $150 million
Answer: D
Question Status: Revised
34) Laura Evans is risk manager of LMN Company. Laura decided to retain certain property losses. All of the
following are methods which Laura can use to fund retained property losses EXCEPT
A) private insurance. B) current net income.
C) funded reserve. D) borrowed funds.
Answer: A
Question Status: Previous Edition
Chapter 3
Introduction to Risk Management 33
34
Rejda · Principles of Risk Management and Insurance, Tenth Edition
35) 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) retention B) loss control and retention
C) transfer through insurance D) avoidance
Answer: B
Question Status: Previous Edition
36) Barb, who is self-employed, is the main breadwinner for her family. Barb does not have disability income
insurance because she has never stopped to consider the impact of a long-term disability upon her family. Barb!s
treatment of the risk of disability is best described as
A) risk transfer. B) passive retention.
C) risk avoidance. D) active retention.
Answer: B
Question Status: Previous Edition
37) Ryan decided to review his personal risk management program. His car is 10 years old, and he would receive
little money from his insurer if the car was damaged or destroyed. Ryan decided to drop the physical damage
insurance on the car. From a risk management perspective, dropping the physical damage insurance on the car is
best described as
A) increasing the use of avoidance in the risk management program. B) increasing the use of noninsurance
transfer in the risk management program.
C) increasing the use of retention in the risk management program. D) increasing the use of risk control in the
risk management program.
Answer: C
Question Status: Revised
38) To better understand her company!s operations, a risk manager asked a production manager to draw a
diagram tracing the steps in the production and distribution of the company!s products. Such a diagram, which is
useful in risk identification, is called a
A) financial statement. B) risk management matrix.
C) flowchart. D) risk management audit.
Answer: C
Question Status: Previous Edition
39) In reviewing his company!s operations, a risk manager noticed that all of the company!s finished goods were
stored in a single warehouse. The risk manager recommended that the finished goods be divided among three
warehouses to prevent all of the finished goods from being destroyed by the same peril. Dividing the finished
goods among three warehouses illustrates
A) risk avoidance. B) risk control.
C) insurance. D) noninsurance transfer.
Answer: B
Question Status: Previous Edition
40) Which of the following statements about a personal risk management program is (are) true? I.
Insurance and retention are the only techniques used to handle potential losses. II.
The steps in a
personal risk management process are the same steps used by businesses.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
Chapter 3
Introduction to Risk Management 35
36
Rejda · Principles of Risk Management and Insurance, Tenth Edition
41) Bev lives in the suburbs and works downtown. She drives to work, and her most direct route to work would
require her to pass through an area where carjackings and drive-by-shootings are common. Bev does not drive
through this area. Instead, she uses a route which adds 10 minutes to her commute. Which risk management
technique is Bev using with respect to the risk of injury while driving through the dangerous area?
A) noninsurance transfer B) avoidance
C) passive retention D) loss reduction
Answer: B
Question Status: Previous Edition
42) 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 insurance programming. B) personal estate planning.
C) personal financial planning. D) personal risk management.
Answer: D
Question Status: Revised
43) Which statement about a company!s cost of risk is (are) true? I.
Cost of risk includes insurance
premiums and retained losses. II.
Reducing the cost of risk increases profitability.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
44) A useful measure for an organization is the total of the organization!s expenditures for treating loss exposures
including retained losses, loss control expenses, insurance premiums, and other related expenses. This measure is
called the organization!s
A) cost of capital. B) cost of goods sold.
C) cost of risk. D) cost of equity.
Answer: C
Question Status: Revised
45) Mark owns a 1998 sedan. The last time Mark renewed his auto insurance, he decided to drop the physical
damage insurance on this vehicle. How is Mark dealing with the auto physical damage exposure in his personal
risk management program?
A) risk transfer B) passive retention
C) avoidance D) planned retention
Answer: D
Question Status: New
46) Purchasing health insurance illustrates the use of which personal risk management technique? A) avoidance
B) risk transfer C) loss control D) risk retention
Answer: B
Question Status: New
47) Which of the following statements about captive insurance companies is (are) true? I.
A captive
insurance company established by a U.S. company must be domiciled in the United States. II. A captive
insurance company may be owned by several parents.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: New
Chapter 3
Introduction to Risk Management
37
Chapter 4 Advanced Topics in Risk Management
1) All of the following are financial risks which may be faced by business organizations EXCEPT A) interest
rate risk.
B) commodity price risk. C) product liability risk. D) currency exchange rate risk.
Answer: C
Question Status: Previous Edition
2) Which of the following statements about the scope of risk management is (are) true? I.
Traditionally, risk
management was limited in scope to speculative loss exposures. II.
In the 1990s, some businesses began to
expand the scope of risk management to include financial risks.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
3) Mid-States Beef is a commercial feedlot business. Currently, the company has over 10,000 cattle in feedlots.
Mid-States is concerned that the price of corn, the grain fed to the cattle, will increase significantly. The risk that
the price of corn may increase and harm the profitability of Mid-States Beef!s operations is a(n)
A) currency exchange rate risk. B) property risk.
C) commodity price risk. D) interest rate risk.
Answer: C
Question Status: Previous Edition
Chapter 4
Advanced Topics in Risk Management
39
4) An integrated risk management program is a risk management program which combines A) pure and
speculative risks.
B) property and liability risks. C) interest rate risk and currency exchange rate risk. D) commodity price risk and
interest rate risk.
Answer: A
Question Status: Revised
5) Regional Airline (RA) spends millions of dollars each year on jet fuel. The company also has significant
liability exposures. RA can retain a large portion of its liability exposure if fuel costs are low. The company can
pay high fuel costs if retained liability losses are low. RA cannot, however, absorb both high fuel costs and high
retained liability claims. RA!s insurer designed an insurance program that pays only if both contingencies (high
fuel costs and high retained liability claims) occur. The contract the insurer designed is called a(n)
A) double indemnity rider. B) double trigger option.
C) multiple protection policy. D) other insurance provision.
Answer: B
Question Status: Revised
6) Which statement is (are) true with respect to enterprise risk management programs? I.
They address
traditional property, liability, and personnel loss exposures. II.
They do not address financial risks.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
7) A comprehensive risk management program that addresses an organization!s pure risks, speculative risks,
strategic risks, and operational risks is called a(n)
A) risk management information system. B) financial risk management plan.
C) speculative risk management plan. D) enterprise risk management plan.
Answer: D
Question Status: Revised
40
Rejda · Principles of Risk Management and Insurance, Tenth Edition
8) The property and liability insurance industry is characterized by a repetitive pattern of loose underwriting
standards with low premiums followed by tight underwriting standards with high premiums. This repetitive
pattern is called the
A) underwriting by exception method. B) business cycle.
C) underwriting cycle. D) account underwriting method.
Answer: C
Question Status: Revised
9) Which statement is (are) true regarding property and liability insurance market conditions? I.
Premiums are high when the insurance market is "hard." II.
Underwriting standards are tight when
the insurance market is "soft."
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
10) Which of the following statements is true regarding insurance market conditions and underwriting results?
A) A combined ratio greater than one (or 100 percent) indicates profitable underwriting. B) In a "soft" insurance
market, more retention is used than in a "hard" insurance market.
C) Insurance rates are high and underwriting standards are tight when the insurance market is "hard."
D) Property and liability insurance premiums and underwriting standards do not fluctuate over time.
Answer: C
Question Status: Previous Edition
11) The relative level of surplus in the insurance industry is called the industry!s A) capacity.
B) liabilities. C) reserves. D) admitted assets.
Answer: A
Question Status: Previous Edition
Chapter 4
Advanced Topics in Risk Management
41
12) Which of the following statements is (are) true regarding investment returns and the underwriting cycle?
I.
Investment returns have no impact upon the underwriting cycle. II.
Investment returns can lengthen
the duration of a soft market by offsetting underwriting losses.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
13) A large property and liability insurance company merged with a bank and then acquired a stock brokerage
company. This type of merger and acquisition activity is categorized as
A) insurance company consolidation. B) cross-industry consolidation.
C) financial risk management. D) insurance brokerage consolidation.
Answer: B
Question Status: Previous Edition
14) A risk manager has a fleet of 200 vehicles. On average, 50 vehicles per year experience property damage.
What is the probability that any vehicle will be damaged in any given year?
A) 10 percent B) 20 percent C) 25 percent D) 50 percent
Answer: C
Question Status: Previous Edition
15) RST Company has production facilities in Salt Lake City and Cleveland. The probability that in any given
year a fire will damage the production facility in Salt Lake City is 5 percent. The probability that in any given
year a fire will damage the Cleveland production facility is 4 percent. What is the probability that BOTH
production facilities will be damaged by fire in any given year?
A) 0.20 percent B) 2.00 percent C) 4.50 percent D) 9.00 percent
Answer: A
Question Status: Previous Edition
42
Rejda · Principles of Risk Management and Insurance, Tenth Edition
16) RST Company has production facilities in Salt Lake City and Cleveland. The probability that in any given
year a fire will damage the production facility in Salt Lake City is 5 percent. The probability that in any given
year a fire will damage the Cleveland production facility is 4 percent. What is the probability that AT LEAST
ONE of the production facilities will be damaged by fire in any given year?
A) 0.20 percent B) 2.00 percent C) 8.80 percent D) 9.00 percent
Answer: C
Question Status: Previous Edition
17) Some events cannot occur together because the occurrence of one event makes the occurrence of the second
event impossible. Such events are called
A) dependent events. B) independent events.
C) conditional events. D) mutually exclusive events.
Answer: D
Question Status: Previous Edition
18) Two buildings are located close together at a production facility. The probability that either of these
buildings will experience a fire loss is 4 percent. However, if one building has a fire, the probability that the
second building will have a fire is 60 percent. What is the probability that both buildings will have a fire?
A) 1.6 percent B) 2.4 percent C) 8.0 percent
D) 64.0 percent
Answer: B
Question Status: Previous Edition
Chapter 4
Advanced Topics in Risk Management
43
19) Which of the following statements is (are) true with regard to probability analysis? I.
If two events are
independent, the occurrence of one event does not affect the occurrence of the second event. II.
If two
events are dependent, the occurrence of one event affects the occurrence of the second event.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
20) Jane is risk manager of ABC Manufacturing Company. She is trying to decide whether to self-insure her
company!s workers compensation exposure or to purchase insurance. Jane would like to use regression analysis
to predict the number of workers compensation claims that will occur next year. The number of claims will be
the dependent variable in the regression. All of the following would be reasonable independent variables to use
EXCEPT
A) number of employees. B) number of hours worked.
C) total assets. D) payroll.
Answer: C
Question Status: Previous Edition
21) A method of characterizing the relationship between two or more variables and then using the
characterization to make a prediction is called
A) loss analysis. B) time value of money analysis.
C) regression analysis. D) capital budgeting analysis.
Answer: C
Question Status: Revised
44
Rejda · Principles of Risk Management and Insurance, Tenth Edition
22) A table showing losses that could occur and the corresponding chance that each loss could occur is called an
A) underwriting cycle. B) capital budget.
C) loss distribution. D) risk map.
Answer: C
Question Status: Revised
23) Which of the following statements is (are) true with respect to the time value of money? I. Money received
today is worth more than the same amount of money received in the future. II. The present value of a future
amount is greater than the future amount.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
24) Calculating the present value of a future amount is called A) interpolating.
B) discounting. C) compounding. D) regression analysis.
Answer: B
Question Status: Previous Edition
25) The process of determining which set of investments in plant and equipment to undertake is called A)
regression analysis.
B) loss forecasting. C) time value of money. D) capital budgeting.
Answer: D
Question Status: Previous Edition
Chapter 4
Advanced Topics in Risk Management
45
26) Which of the following statements is (are) true regarding the net present value of a capital investment?
I.
Net present value does not consider time value of money. II.
A positive net present value represents
an increase in value to the firm.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
27) Millie is risk manager of JKL Company. She is considering an investment in a loss control project. The
project will cost $40,000. Assuming a 10 percent discount rate, the present value of the future cash flows that this
project will generate is $60,000. What is the net present value (NPV) of this project?
A) $20,000 B) $26,000 C) $60,000
D) $100,000 Answer: A
Question Status: Previous Edition
28) A computerized data base that permits risk managers to store and analyze risk management data is called a
A) risk management information system. B) risk management Intranet.
C) risk management web site. D) risk map.
Answer: A
Question Status: Previous Edition
29) A grid charting the potential frequency and severity of losses is called a A) risk management information
system.
B) risk management Intranet. C) risk management web site. D) risk map.
Answer: D
Question Status: Previous Edition
46
Rejda · Principles of Risk Management and Insurance, Tenth Edition
30) Which of the following statements is (are) true with regard to the use of technology in risk management
programs? I. Risk management Intranets are web sites with search capabilities designed for an internal
audience. II. Risk management information systems can be used to store and track workers compensation
claims data.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
31) Terrorists attacked the World Trade Center on September 11, 2001. The attack simultaneously created large
losses for life insurers, property insurers, workers compensation insurers, health insurers, and liability insurers.
What name is given to an event that simultaneously creates large losses in several lines of insurance?
A) speculative loss B) clash loss
C) retroactive loss D) consequential loss
Answer: B
Question Status: Previous Edition
32) Which of the following was a consequence of passage of the Financial Modernization Act (Gramm-LeachBliley)?
A) Formation of insurers was made easier because capital requirements were reduced.
B) It became easier for insurers to conduct business as they were no longer required to be licensed in each state
where they operate, but only in the state where they are domiciled.
C) Insurers were required to prepare financial statements using generally accepted accounting principles (GAAP)
instead of using statutory accounting.
D) Depression-era barriers between underwriting risk, depository functions, and securities underwriting were
eliminated.
Answer: D
Question Status: Revised
Chapter 4
Advanced Topics in Risk Management
47
33) The transfer of insurable risk to the capital markets through the creation of a financial instrument is called
A) coefficient of risk. B) securitization of risk.
C) financial risk management. D) enterprise risk management.
Answer: B
Question Status: Previous Edition
34) LMN Insurance Company is concerned about its exposure to hurricane losses for property risks it insured on
the Gulf Coast. LMN borrowed money from investors by issuing financial securities. LMN promised to repay the
money it borrowed with interest if hurricane losses do not exceed a specified level. If hurricane losses exceed the
specified level, LMN will repay less than it borrowed and use the extra money to fund hurricane losses. The
securities that LMN issued are
A) call options. B) futures contracts.
C) weather options. D) catastrophe bonds.
Answer: D
Question Status: Revised
35) Hedge Fund Company offers a mutual fund to investors. Fund managers are concerned about fund volatility.
They analyzed the fund to determine the worst loss likely to occur in a calendar quarter, assuming a 90 percent
level of confidence. The worst probable loss is known as the fund!s
A) unrealized capital gain. B) value at risk.
C) beta coefficient. D) surrender value.
Answer: B
Question Status: Previous Edition
36) Reasons to adopt an enterprise risk management plan include all of the following EXCEPT A) to increase
earnings volatility.
B) to treat risks facing the business in a more holistic way. C) to increase net income. D) to gain an advantage
over competitors.
Answer: A
Question Status: Previous Edition
48
Rejda · Principles of Risk Management and Insurance, Tenth Edition
37) Which of the following statements concerning the securitization of risk is (are) true? I.
Securitization
increases the capacity of the insurance industry. II. Securitization can be used to protect against catastrophic loss.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
38) Big Brokerage Company uses a computer-based method of estimating the losses its clients will suffer if a
disastrous storm or earthquake occurs. This method of estimating losses is called
A) capital budgeting. B) securitization of risk.
C) risk mapping. D) catastrophe modeling.
Answer: D
Question Status: New
39) Which statement about capital budgeting is true? I.
All projects that have a positive internal rate of return
(IRR) are acceptable. II.
A project!s IRR is the average annual rate of return provided by investing in the
project.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: New
40) Uncertainty pertaining to the organization!s goals and objectives and the organization!s strengths,
weaknesses, opportunities, and threats is called
A) operational risk. B) strategic risk.
C) subjective risk. D) pure risk.
Answer: B
Question Status: New
Chapter 4
Advanced Topics in Risk Management
49
41) Consolidation in the insurance industry is a continuing trend. One area where mergers and acquisitions
frequently occur is between marketing intermediaries who represent insurance purchasers. These intermediaries
are called
A) insurance adjusters. B) insurance agents.
C) insurance underwriters. D) insurance brokers.
Answer: D
Question Status: New
42) Two Below Zero is a new ski resort in Colorado. Two Below Zero is concerned that an abnormally warm
winter will prevent the accumulation of snow needed to have a profitable ski season. Two Below Zero purchased
a contract that will pay the company a lump sum payment if the daily high temperature exceeds 30 degrees for
more than 12 days between January 1st and March 31st. The contract Two Below Zero purchased is called a(n)
A) catastrophe bond. B) weather derivative.
C) interest rate swap. D) convertible bond.
Answer: B
Question Status: New
43) Which statement is (are) true concerning catastrophe models? I.
Businesses other than insurance
companies use catastrophe models. II.
Catastrophe models are able to precisely predict disaster occurrences
and loss values.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: New
Chapter 5 Types of Insurers and Marketing Systems
1) Which of the following statements about stock insurers is true? A) They issue assessable policies.
B) They are not permitted to write property and liability insurance. C) Stockholders bear any losses and share in
any profits. D) They are owned by their policyowners.
Answer: C
Question Status: Revised
2) Which of the following statements about mutual insurers is true? A) They are legally organized as
partnerships.
B) They have a board of directors which is selected by state insurance departments. C) They are owned by their
stockholders. D) They may pay dividends to their policyowners.
Answer: D
Question Status: Revised
3) Why are some mutual insurers referred to as "assessment mutuals"?
A) They charge low premiums because the loss exposures of their insureds are thoroughly assessed before a
policy is written.
B) They are noted for being very thorough in their assessment of investment opportunities. C) They are assessed
for state premium taxes only if they make a profit. D) They can assess policyowners if premiums are insufficient
to pay losses and expenses.
Answer: D
Question Status: Previous Edition
4) The corporate structure of mutual insurers is changing rapidly. All of the following are current trends
EXCEPT
A) Demutualization of some insurers. B) Sharp increase in the number of mutual insurance companies.
C) Increase in company mergers. D) Formation of mutual holding companies.
Answer: B
Question Status: New
Chapter 5
Types of Insurers and Marketing Systems 51
5) All of the following statements about fraternal insurers are true EXCEPT A) They are a form of mutual
insurer.
B) They specialize in writing property and liability insurance. C) They enjoy tax advantages because of their
nonprofit or charitable status. D) They market their coverage to members of a social organization or religious
group.
Answer: B
Question Status: Previous Edition
6) Which of the following statements about a reciprocal exchange is (are) true? I.
health insurance. II. It is an unincorporated mutual insurance company.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
It usually specializes in
Question Status: Revised
7) Which of the following statements about Lloyd!s of London is true? A) Coverage is actually written by
syndicates who belong to Lloyd!s of London.
B) Its underwriters specialize in writing life and health insurance. C) It operates as an admitted insurer
throughout the United States. D) It allows underwriters to write coverage without meeting stringent financial
requirements.
Answer: A
Question Status: Previous Edition
8) Temporary evidence of insurance until a policy is actually issued is provided by a(n) A) binder.
B) brokerage agreement. C) pre-approval form. D) endorsement.
Answer: A
Question Status: Previous Edition
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Rejda · Principles of Risk Management and Insurance, Tenth Edition
9) Which of the following statements about brokers is (are) true? I.
They legally represent the insured
rather than the insurance company. II.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
They are prohibited from being licensed as agents.
Question Status: Previous Edition
10) Neil needs insurance that is unavailable in the state where he lives. To obtain insurance from a nonadmitted
insurer, Neil should contact a
A) surplus lines broker. B) nonadmitted agent.
C) general agency broker. D) direct writer.
Answer: A
Question Status: Previous Edition
11) All of the following statements about the general agency system used for selling life insurance are true
EXCEPT
A) A general agent is responsible for hiring, training, and motivating new agents.
B) A general agent is a salaried employee whose responsibilities are limited to selling life insurance.
C) A general agent may receive an allowance for the expenses of maintaining an agency office. D) A general
agent receives a commission based on the amount of business produced.
Answer: B
Question Status: Previous Edition
12) Which of the following statements about the managerial system of marketing life insurance is (are) true?
I.
It uses branch offices run by independent agents who represent several companies. II. The branch
manager is an employee of the insurer who has the responsibility for hiring and training new agents.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
Chapter 5
Types of Insurers and Marketing Systems 53
13) Advantages of the direct response system for marketing life insurance include which of the following?
I.
Advertising can be specifically directed to selected markets. II. Complex products can be easily sold.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
14) Which of the following statements about the exclusive agency system for marketing property and liability
insurance is true?
A) Exclusive agents typically have complete ownership of policy expirations.
B) A higher commission rate is usually paid on exclusive agents! renewal business than on new business.
C) Exclusive agents represent several different insurance companies.
D) New exclusive agents usually start as employees and after a training period become independent contractors.
Answer: D
Question Status: Previous Edition
15) All of the following statements about the independent agency system are true EXCEPT A) Agents are often
authorized to adjust small claims.
B) Agents are compensated on the basis of commissions. C) The insurer rather than the agent owns the renewal
rights to the business. D) The agent is an independent business person who represents several insurers.
Answer: C
Question Status: Previous Edition
16) The salespersons of a direct writer are considered to be A) independent agents.
B) independent contractors. C) employees. D) brokers.
Answer: C
Question Status: Previous Edition
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17) Which of the following statements about the sale of property and liability insurance through the direct
response system is (are) true? I.
Selling expenses are higher because market segmentation tends to be less
precise than with other marketing methods.
II.
It is the most appropriate system for selling complex products. A) I only
B) II only C) both I and II D) neither I nor II
Answer: D
Question Status: Revised
18) Under one life insurance marketing system, an insurer sells its products through established agents who are
already engaged in life insurance sales. Under this system, an insurer enters into contracts with successful agents
who agree to sell the insurer!s products. This life insurance marketing system is called the
A) direct response system. B) nonbuilding agency system. C) independent agency system.
D) agency building system. Answer: B
Question Status: Previous Edition
19) Which of the following is characteristic of a typical mass merchandising plan? A) higher commission scales
for agents and higher administrative expenses
B) premiums may be paid through payroll deduction C) group rather than individual underwriting D) employer
contributions to the cost of coverage
Answer: B
Question Status: Previous Edition
Chapter 5
Types of Insurers and Marketing Systems 55
20) David has always been successful in sales. Recently, he was approached by a life insurer interested in hiring
him. Initially, David was not interested in the job because he feared it would require a lot of administrative work.
"You!re a super salesperson, David," he was told, "We!re hiring you to do one thing and one thing onlyÁSELL!"
David accepted the position. David is a(n)
A) exclusive independent agent. B) personal-producing general agent.
C) branch office agent/manager. D) direct writing exclusive agent.
Answer: B
Question Status: Revised
21) Sarah owns a property and liability insurance agency. She is authorized to represent several insurance
companies and is compensated by commissions. Sarah!s agency owns the expiration rights to the business she
sells. Sarah is a(n)
A) independent agent. B) exclusive agent.
C) direct writer. D) insurance broker.
Answer: A
Question Status: Previous Edition
22) The leaders of a religious group decided to start a life insurance organization to insure members of the
religious group. The insurer will operate as a nonprofit organization, thus receiving favorable tax treatment. The
insurer formed will be a
A) health maintenance organization. B) stock insurer.
C) fraternal insurer. D) reciprocal exchange.
Answer: C
Question Status: Revised
23) Scott works in property and liability insurance marketing. He legally represents insurance purchasers, rather
than insurance companies. Scott is paid a commission on the insurance placed with insurers. Scott is a(n)
A) exclusive agent. B) direct writer.
C) branch manager. D) insurance broker.
Answer: D
Question Status: Previous Edition
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Rejda · Principles of Risk Management and Insurance, Tenth Edition
24) ABC Insurance has always used the exclusive agency system to market coverages. ABC, however, cannot
afford full-time agents in sparsely-populated areas. To reach customers in these areas, ABC enters into
agreements with local independent agents. Using more than one marketing system is called employing a
A) direct response system. B) general agency system.
C) multiple distribution system. D) branch office system.
Answer: C
Question Status: Previous Edition
25) Cathy just started a job with XYZ Manufacturing Company. She attended an orientation and was given a
packet providing information about the various employee benefits XYZ offers. One item in the packet was a
booklet and application form from an auto insurer. The insurer offers lower premiums to XYZ employees. The
insurer!s plan for selling individually-underwritten auto insurance to employees of XYZ Manufacturing
Company is called
A) direct response. B) mass merchandising.
C) personal selling. D) multiple marketing.
Answer: B
Question Status: Revised
26) Brian is a life insurance agent. He is licensed to represent one company and has been assigned a territory. In
addition to marketing life insurance products in the territory, Brian is also responsible for recruiting, training, and
motivating new agents for the company in his territory. Brian is a(n)
A) exclusive agent. B) general agent.
C) insurance broker. D) personal-producing general agent.
Answer: B
Question Status: Previous Edition
Chapter 5
Types of Insurers and Marketing Systems 57
27) Big Mutual Insurance Company would like to take advantage of financial services deregulation by acquiring
a bank and a stock brokerage firm. Big Mutual, however, would have trouble raising the funds needed to make
these acquisitions under the mutual form of organization. Big Mutual is planning to switch from the mutual form
of organization to the stock form, and to issue shares of common stock to raise capital. This change in
organizational structure is called
A) mutualization. B) retrocession. C) reinsurance.
D) demutualization. Answer: D
Question Status: Previous Edition
28) Jim would like to start a business raising thoroughbred racehorses. The business would be the first of its kind
in the state where he lives. Obtaining insurance on the horses is a key concern, and he was dismayed to learn that
none of the insurers authorized to operate in his state offer this specialty insurance. What is the name of the
intermediary which Jack can use to place this coverage with an insurer not admitted to his state?
A) alien insurer B) general agent
C) surplus lines broker D) direct writer
Answer: C
Question Status: Previous Edition
29) Some investors decided to start an insurance company. Each investor contributed $50,000 to raise the capital
required to charter a new company. Each investor received an ownership interest in the company. The company
will raise additional capital by selling ownership rights to other investors. Under this type of organization, the
customer and owner functions are separate. This type of insurer is called a
A) stock company. B) reciprocal exchange.
C) fraternal company. D) mutual company.
Answer: A
Question Status: Previous Edition
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Rejda · Principles of Risk Management and Insurance, Tenth Edition
30) RST Insurance is an interesting company. It doesn!t have any agents. Instead, the company sells insurance
through radio ads, telemarketers, and newspaper and magazine inserts. This distribution method is called
A) reciprocal exchange. B) direct response system.
C) mass merchandising. D) multiple distribution system.
Answer: B
Question Status: Revised
31) One type of insurer is a community-oriented health insurer. In most states, this insurer is set-up as a nonprofit organization that provides coverage for hospital services, physicians! and surgeons! fees, and other medical
services. This type of insurer is called a
A) stock insurer. B) captive insurer.
C) health maintenance organization (HMO). D) Blue Cross/Blue Shield Plan.
Answer: D
Question Status: Revised
32) Which of the following statements is (are) true with respect to the financial services industry? I.
The
number of firms operating in the industry continues to increase at a high rate. II. The Financial Modernization
Act of 1999 permits financial institutions to compete in other financial markets outside their core business area.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Revised
33) The financial services field is currently experiencing consolidation and convergence. If both of these trends
continue, in the future we should observe
A) fewer financial institutions offering a narrower range of financial services products. B) fewer financial
institutions offering a wider range of financial services products.
C) more financial institutions offering a narrower range of financial services products. D) more financial
institutions offering a wider range of financial services products.
Answer: B
Question Status: Revised
Chapter 5
Types of Insurers and Marketing Systems 59
34) All of the following are reasons why mutual insurance companies convert to stock insurance companies
EXCEPT
A) Stock companies can offer stock options to attract and retain key personnel. B) Stock companies can raise
new capital more easily.
C) Stock companies are exempt from state insurance regulation. D) Stock companies offer greater flexibility to
expand through acquisitions.
Answer: C
Question Status: Previous Edition
35) The demutualization process is expensive and time consuming. As an alternative to demutualization, many
states have enacted legislation allowing a mutual company to reorganize as a company that directly or indirectly
controls another insurer. The other insurer is a stock company that can issue additional shares of stock to raise
capital. The reorganized company is called a
A) captive insurance company. B) conglomerate.
C) mutual holding company. D) stock holding company.
Answer: C
Question Status: New
36) R.I.P. Company manufactures herbicide and pesticide. The company had difficulty finding affordable
liability insurance. R.I.P. established its own insurance company based in Bermuda for the purpose of insuring
R.I.P.!s loss exposures. The company that R.I.P. formed is called a
A) captive insurer. B) reciprocal insurer.
C) fraternal insurer. D) holding company.
Answer: A
Question Status: New
37) Which of the following statements is (are) true about savings bank life insurance (SBLI)? I.
SBLI is
available in every state in the United States. II.
The goal of SBLI is to provide low-cost life insurance to
consumers.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: New
Chapter 6 Insurance Company Operations
1) The function of an actuary is to A) adjust claims.
B) determine premium rates. C) negotiate reinsurance treaties. D) invest insurance company assets.
Answer: B
Question Status: Previous Edition
2) Insurers obtain data which can be used to determine rates from A) pricing pools.
B) insurance advisory organizations. C) banks. D) reciprocal exchanges.
Answer: B
Question Status: Previous Edition
3) Which of the following statements about underwriting policy is (are) true? I. A company must establish an
underwriting policy consistent with company objectives. II.
Underwriting policy is usually subjective and
allows the underwriter considerable flexibility with respect to lines written and forms used.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
4) All of the following statements about underwriting standards are true EXCEPT A) The purpose of
underwriting standards is to reduce adverse selection against the insurer.
B) The underwriter should select only those insureds who are expected to have no losses.
C) The underwriter should select a book of business so that there is a proper balance within each rate
classification.
D) Equitable rates should be charged so that each group of policyowners pays its own way in terms of losses and
expenses.
Answer: B
Question Status: Previous Edition
5) The underwriting process begins with the A) agent.
B) desk underwriter. C) inspection report. D) acceptance of the application.
Answer: A
Question Status: Previous Edition
6) Common sources of underwriting information for life and health insurance include all of the following
EXCEPT
A) the application. B) a physical examination.
C) the Medical Information Bureau. D) the applicant!s income tax return.
Answer: D
Question Status: Revised
7) If an underwriter suspects moral hazard, the underwriter may ask an outside firm to investigate the applicant
and make a detailed report to the insurer. This report is called a(n)
A) inspection report. B) application.
C) M.I.B. report. D) agent!s report.
Answer: A
Question Status: Revised
8) One source of life and health insurance underwriting information is an organization that life and health
insurance companies can join. As a member, life and health insurance companies report health impairments of
applicants, and this information is shared with member companies. Although the information is shared, the
underwriting decision of the member company is not disclosed. What is this organization called?
A) Fair Isaac Corporation (FICO) B) Medical Information Bureau (MIB)
C) National Association of Insurance Commissioners (NAIC) D) National Association of Mutual Insurance
Companies (NAMIC)
Answer: B
Question Status: Revised
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9) Factors that may result in more restrictive underwriting decisions include which of the following? I.
Inadequate rates. II. The unavailability of reinsurance at favorable terms.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
10) All of the following are functions of the marketing department of an insurance company EXCEPT A) to
advertise the insurer!s products.
B) to develop new products. C) to identify production goals. D) to make final underwriting decisions.
Answer: D
Question Status: Previous Edition
11) Which of the following statements about claim settlement is (are) true? I.
The fair payment of claims
requires an insurer to adopt a very liberal claims policy. II. To prevent lawsuits, an insurer should provide no
personal assistance to a claimant other than that which is required by contractual obligations.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
12) All of the following statements about claims settlement are true EXCEPT A) Agents may have the authority
to settle claims.
B) Independent adjustors may be used in a geographic area where the volume of business is too low for an
insurer to have its own adjustors.
C) Company adjustors are salaried employees who work for one insurer. D) A public adjustor is usually paid a
flat fee that is independent of the size of a claim.
Answer: D
Question Status: Previous Edition
13) Which of the following statements about adjustment bureaus is (are) true? I. They are frequently used to
settle claims when a large number of losses occur in a given geographic location as a result of a catastrophic
event. II.
Their major advantage is low cost because of the use of part-time adjustors.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
14) All of the following statements about the settlement of a claim are true EXCEPT
A) The insurance policy usually has a provision specifying how a notice of loss is to be made to the insurance
company.
B) One step in the investigation of a claim is to determine whether the policy was in force when the loss
occurred.
C) The adjustor must file the proof of loss, which is a sworn statement supporting his or her decision regarding a
claim.
D) A policy provision may determine how disputes over claim settlements are resolved. Answer: C
Question Status: Previous Edition
15) All of the following statements about reinsurance are true EXCEPT A) A reinsurer may also purchase
reinsurance.
B) Reinsurance is an arrangement by which the primary insurer that initially writes the insurance transfers to
another insurer part or all of the potential losses associated with such insurance.
C) The insurer transferring business to a reinsurer is called the ceding insurer. D) The amount of insurance
transferred to a reinsurer is called the net retention.
Answer: D
Question Status: Previous Edition
16) All of the following are reasons for a primary insurer to use reinsurance EXCEPT A) to increase the
unearned premium reserve.
B) to increase underwriting capacity. C) to protect against catastrophic losses. D) to stabilize profits.
Answer: A
Question Status: Previous Edition
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Insurance Company Operations
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17) The unearned premium reserve of an insurer is A) an asset representing the investments made with premium
income.
B) a liability representing the unearned portion of gross premiums on outstanding policies. C) a liability
representing claims that have been filed, but not yet paid. D) the portion of the insurer!s net worth belonging to
policyowners.
Answer: B
Question Status: Previous Edition
18) A reinsurance contract that is entered into on a case-by-case basis after an application for insurance is
received by a primary insurer is called
A) a reinsurance pool. B) automatic treaty reinsurance.
C) retrocession. D) facultative reinsurance.
Answer: D
Question Status: Revised
19) Which of the following statements about treaty reinsurance is true? A) The reinsurer is required to underwrite
each individual applicant that is reinsured.
B) The reinsurer must accept all business that falls within the scope of the treaty.
C) The ceding insurer can choose which business falling within the scope of the treaty it wishes to reinsure.
D) It protects the reinsurer by requiring the ceding insurer to charge adequate premiums. Answer: B
Question Status: Previous Edition
20) Which of the following statements about treaty reinsurance is true?
A) Under a surplus-share treaty, 100 percent of the ceding insurer!s liability must be transferred to the reinsurer.
B) Using a quota-share treaty increases the ceding insurer!s unearned premium reserve. C) Under an excess-ofloss treaty, the reinsurer pays losses in full only if they are less than the
ceding insurer!s retention limit. D) Using a reinsurance pool provides financial capacity to write large amounts of
insurance.
Answer: D
Question Status: Previous Edition
21) Delta Insurance Company has a surplus-share treaty with Eversafe Reinsurance. Delta has a retention limit of
$200,000, and nine lines of insurance are ceded to Eversafe. How much will Eversafe pay if a $1,600,000
building insured with Delta suffers an $800,000 loss?
A) $600,000 B) $700,000 C) $720,000 D) $800,000
Answer: B
Question Status: Previous Edition
22) Huge Insurance Company is a property insurer that is interested in protecting itself against cumulative losses
that exceed $200 million during the year. This protection can best be obtained using
A) a quota-share reinsurance treaty. B) a surplus-share reinsurance treaty.
C) an excess-of-loss reinsurance treaty. D) a reinsuance pool.
Answer: C
Question Status: Previous Edition
23) All of the following statements about life insurance company investments are true EXCEPT
A) Funds for these investments are derived primarily from premium income, investment earnings, and maturing
investments that must be reinvested.
B) Income from these investments reduces the cost of insurance. C) A primary objective in making these
investments is safety of principal. D) The majority of these investments are short-term investments.
Answer: D
Question Status: Previous Edition
24) Which of the following statements about the investments of property and liability insurers is (are) true?
I.
Income from investments is important in offsetting any unfavorable underwriting experience. II. Because
premium income is continually being received, the investment objective of liquidity is of little importance.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
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25) Functions of an insurance company!s legal department include which of the following? I. Lobbying for
legislation favorable to the insurance industry. II. Drafting policy provisions.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
26) Jan is employed by an insurance company. She reviews applications to determine whether her company
should insure the applicant. If insurable, Jan assigns the applicant to a rating category based on the applicant!s
degree of risk. Jan is a(n)
A) underwriter. B) actuary.
C) loss control engineer. D) claims adjustor.
Answer: A
Question Status: Previous Edition
27) Mark has been an underwriter for 20 years. An application he recently reviewed looked odd to him. The
building value in the application seemed far too high, and Mark suspected the applicant might be planning to
destroy the property after it is insured. Mark contacted an outside firm and hired someone to investigate the
applicant and to prepare a report about the applicant. This report is called a(n)
A) agent!s report. B) binder.
C) physical inspection. D) inspection report.
Answer: D
Question Status: Previous Edition
28) Antonio is a claims adjustor for LMN Insurance Company. After the insurer is notified that there has been a
loss, Antonio meets with the insured. The first step in the claims process that Antonio should follow is to
A) determine the amount of the loss. B) attempt to deny the claim regardless of whether he believes the claim is
covered.
C) verify that a covered loss has occurred. D) delay paying the claim if the claim is covered.
Answer: C
Question Status: Previous Edition
29) Beverly lives in a sparsely populated area in northern Idaho. Some insurance companies marketing coverage
in northern Idaho cannot afford to have full-time adjustors there. Several insurers hire Beverly to adjust claims
for their insureds. Beverly charges the insurers a fee for each claim that she settles. Beverly is a(n)
A) public adjustor. B) adjustment bureau.
C) independent adjustor. D) company adjustor.
Answer: C
Question Status: Previous Edition
30) New Liability Insurance Company began operations last year and has been very successful. The company!s
ability to grow is being restricted by an accounting rule that requires insurers to realize acquisition expenses
immediately, while not realizing premium income until some time has passed. Reinsurance is often used in such
cases for which of the following purposes?
A) to stabilize profitability B) to reduce the unearned premium reserve
C) to provide protection against catastrophic losses D) to withdraw from a line of business or territory
Answer: B
Question Status: Previous Edition
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Insurance Company Operations
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31) Liability Insurance Company (LIC) was approached by a regional airline to see if LIC would write the
airline!s liability coverage. LIC agreed to write the coverage and entered into an agreement with a reinsurer.
Under the agreement, LIC retains 25 percent of the premium and pays 25 percent of the losses, and the reinsurer
receives 75 percent of the premium and pays 75 percent of the losses. This reinsurance arrangement is best
described as
A) excess-of-loss reinsurance. B) surplus-share reinsurance.
C) quota-share reinsurance. D) pool reinsurance.
Answer: C
Question Status: Previous Edition
32) Ross studied engineering in college. After graduation, he went to work for an insurance company. Ross visits
properties insured by his company. He conducts inspections and makes recommendations about alarm systems,
sprinkler systems, and building construction. In what functional area does Ross work?
A) underwriting B) loss control
C) electronic data processing D) claims adjusting
Answer: B
Question Status: Revised
33) Amy heads the legal staff of a large property and liability insurance company. Amy!s staff is likely involved
in all of the following activities EXCEPT
A) reviewing policy wording before policies are adopted and marketed.
B) recouping subrogation recoveries from third parties who injured individuals insured by Amy!s company.
C) providing legal advice about marketing, taxation, and insurance law. D) reviewing applications to determine if
the company should insure the risk.
Answer: D
Question Status: Revised
34) Sue double-majored in mathematics and statistics in college. She also enrolled in a number of finance
courses. After graduation, she was hired by Econodeath Insurance Company. Her job is to calculate premium
rates for life insurance coverages. Sue is a(n)
A) actuary. B) underwriter.
C) claims adjustor. D) producer.
Answer: A
Question Status: Previous Edition
35) Easy Pay Insurance Company may require insureds who suffer a loss to submit a sworn statement to
substantiate that a loss occurred and to describe the conditions under which the loss occurred. This sworn
statement is called a
A) binder. B) proof of loss.
C) inspection report. D) notice of loss.
Answer: B
Question Status: Previous Edition
36) All of the following are methods that a property and liability insurance company can use to protect against
catastrophic losses EXCEPT
A) sale of catastrophe bonds. B) purchase of common stock.
C) purchase of excess-of-loss reinsurance. D) quota share reinsurance with a low retention percentage.
Answer: B
Question Status: Revised
37) Which of the following statements is (are) true with respect to catastrophe bonds? I. The bonds are issued by
the U.S. Government. II.
The bonds pay relatively high interest rates.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Revised
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38) Underwriters try to have a proper balance within each risk classification. Much of personal lines
underwriting today involves all exposures units with similar loss-producing characteristics being placed in the
same category and charged the same rate. This type of underwriting is known as
A) class underwriting. B) merit underwriting.
C) line underwriting. D) field underwriting.
Answer: A
Question Status: Previous Edition
39) Pac-Coast Insurance (PCI) concentrates its underwriting activities in California. The company is concerned
that if a catastrophic earthquake occurs, it might threaten the solvency of the company. To address this risk, PCI
issued some debt securities. If a catastrophic earthquake occurs, PCI does not have to repay the borrowed funds
or pay interest. The securities PCI issued are called
A) catastrophe futures contracts. B) interest rate swaps.
C) catastrophe bonds. D) contingent options contracts.
Answer: C
Question Status: Revised
40) The process of transferring risk to the capital markets through the use of financial instruments such as bonds,
futures contracts, and options is knows as
A) consolidation of risk. B) avoidance of risk.
C) securitization of risk. D) compartmentalization of risk.
Answer: C
Question Status: Previous Edition
41) Which of the following statements is (are) true about life insurance company investments? I.
The
majority of life insurance company general account assets are invested in bonds. II.
The majority of life
insurance company separate account assets are invested in stocks.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: New
42) One method through which reinsurance is provided is through an organization of insurers that underwrites
insurance on a joint basis. Through the organization, financial capacity is available for large commercial risks.
This reinsurance arrangement is a(n)
A) quota-share treaty. B) surplus-share treaty. C) excess-of-loss treaty.
D) reinsurance pool. Answer: D
Question Status: New
43) Most insurance companies require their marketing representatives to submit an evaluation of the prospective
insured. This important source of underwriting information is called the
A) application. B) agent!s report.
C) inspection report. D) physical inspection.
Answer: B
Question Status: New
Chapter 6
Insurance Company Operations
71
Chapter 7 Financial Operations of Insurers
1) LMN Mutual Insurance Company has total liabilities of $300 million. The company has total assets of $380
million. What is LMN!s policyholders! surplus?
A) $680 million B) $340 million
C) $80 million D) -$80 million
Answer: C
Question Status: New
2) All of the following would appear in the asset section of an insurance company!s balance sheet EXCEPT
A) loss reserves. B) bonds.
C) common stock. D) real estate.
Answer: A
Question Status: New
3) Under one method of estimating a loss reserve, the reserve is based on life expectancy, duration of disability,
remarriage of the beneficiary, and similar factors. This method of estimating loss reserves is called the
A) judgment method. B) tabular value method.
C) loss ratio method. D) average value method.
Answer: B
Question Status: New
4) Reasons for the unearned premium reserve include which of the following? I. To pay losses that occur during
the policy period. II. To pay premium refunds to policyholders in the event of cancellation.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
5) A property and casualty insurer!s loss reserve includes estimates for all of the following EXCEPT A) claims
anticipated but not yet incurred.
B) claims reported and adjusted but not yet paid. C) claims reported and filed but not yet adjusted. D) claims
incurred but not yet reported to the company.
Answer: A
Question Status: Previous Edition
6) Which of the following statements about methods for estimating loss reserves for property and casualty
insurers is (are) true? I.
The judgment method involves the use of a statutory formula to estimate the loss
reserve. II.
The average value method is used when the number of claims is large and the claims are settled
quickly.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
7) One item that appears on an insurance company!s financial statements is a liability that represents an estimate
of the claims reported and adjusted but not yet paid, claims reported and filed but not yet adjusted, and claims
incurred but not yet reported to the company. This liability is called the insurer!s
A) net income. B) loss reserve.
C) admitted assets. D) unearned premium reserve.
Answer: B
Question Status: Previous Edition
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Financial Operations of Insurers
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8) A loss reserve established for each individual claim when it is reported to a property and casualty insurance
company is call a(n)
A) admitted asset. B) incurrred-but-not-reported (IBNR) reserve.
C) unearned premium reserve. D) case reserve.
Answer: D
Question Status: New
9) All of the following items would appear in the income section of an insurance company!s income and expense
statement EXCEPT
A) gain on sale of securities. B) common stock dividends.
C) commissions. D) premiums.
Answer: C
Question Status: New
10) JKL Insurance Company reported the following information on its accounting statements last year:
Premiums Written Loss Adjustment Expenses Underwriting Expenses Premiums Earned Incurred Losses
What was JKL!s loss ratio last year? A) 70.0 percent
B) 75.0 percent C) 83.3 percent D) 90.0 percent
Answer: B
Question Status: New
$90,000,000 $5,000,000 $30,000,000 $100,000,000 $70,000,000
11) JKL Insurance Company reported the following information on its accounting statements last year:
Premiums Written Loss Adjustment Expenses Underwriting Expenses Premiums Earned Incurred Losses
What was JKL!s expense ratio last year? A) 5.0 percent
B) 30.0 percent C) 33.3 percent D) 50.0 percent
Answer: C
Question Status: New
$90,000,000 $5,000,000 $30,000,000 $100,000,000 $70,000,000
12) JKL Insurance Company reported the following information on its accounting statements last year:
Premiums Written $90,000,000
Loss Adjustment Expenses $5,000,000 Underwriting Expenses $30,000,000 Premiums Earned
$100,000,000 Incurred Losses
$70,000,000
What was JKL!s combined ratio last year? A) 100.0
B) 103.3 C) 105.0 D) 108.3
Answer: D
Question Status: New
13) Which of the following statements about property and casualty insurance company operating results is (are)
true? I. An insurance company can have a combined ratio greater than 1 (or 100 percent) and still be required to
pay income taxes. II. By all measures, the property and casualty insurance industry is highly profitable when
compared to other industries.
A) I only B) II only
C) both I and II D) neither I not II
Answer: A
Question Status: New
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14) Life insurance policyowners may borrow the cash value from their life insurance policies. Where are life
insurance policy loans shown on a life insurance company!s financial statements?
A) as an asset B) as a liability
C) as income D) as an expense
Answer: A
Question Status: New
15) MedProf Insurance markets medical malpractice insurance. The company!s combined ratio in 2006 was 95.4.
Its expense ratio was 25.4. What was the company!s loss ratio?
A) 60.4 B) 70.0 C) 88.2
D) 120.8 Answer: B
Question Status: New
16) To protect policyholders, state laws place limitations on a life insurance company!s investments. The assets
backing interest-sensitive products, such as variable life insurance and variable annuities, are not subject to these
restrictions. Assets backing interest-sensitive products are placed in a special account called the life insurer!s
A) policy reserve account. B) asset valuation reserve account.
C) separate account. D) policyholders surplus.
Answer: C
Question Status: New
17) Which of the following statements is (are) true concerning investments of property and casualty insurers and
life insurers? I.
Property and casualty insurance companies place greater emphasis on liquidity than do life
insurers.
II.
Life insurance company investments are, on average, of longer duration than property and casualty
insurance company investments.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: New
18) All of the following are expenses of life insurance companies EXCEPT A) matured endowments.
B) surrender benefits. C) disability income payments. D) realized capital gains.
Answer: D
Question Status: New
19) All of the following statements about business objectives in designing a rating system are true EXCEPT
A) The rating system should encourage loss control activities. B) The rating system should be independent of
long-run changes in economic conditions.
C) The rating system should be simple to understand.
D) The rating system should be stable over short periods so that consumer satisfaction can be maintained.
Answer: B
Question Status: Previous Edition
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20) All of the following statements about regulatory objectives of insurance rate making are true EXCEPT
A) One purpose of rate adequacy is to maintain the solvency of insurers.
B) Rates unfairly discriminate if loss exposures that are similar with respect to losses and expenses are charged
substantially different rates.
C) Insurers know in advance if the coverages marketed will be profitable, so rate regulation is not needed.
D) Rates are excessive if policyholders are paying substantially more than the actual value of their protection.
Answer: C
Question Status: Previous Edition
21) The unit of measurement used in property and casualty insurance pricing is called the A) unit rate.
B) premium. C) exposure unit. D) experience unit.
Answer: C
Question Status: Previous Edition
22) The portion of an insurance premium allocated to expenses, profit, and a margin for contingencies is called
the
A) loading. B) pure premium.
C) gross premium. D) experience rate.
Answer: A
Question Status: Previous Edition
23) Which of the following statements about judgment rating is true? A) It involves the manual rating of
exposures.
B) It is used when the loss exposures are so diverse that a class rate cannot be calculated. C) It is a form of
experience rating. D) It is only used when credible loss statistics are available.
Answer: B
Question Status: Previous Edition
24) Under one type of merit rating, the class or manual rate is adjusted upward or downward based on past loss
history. This type of merit rating is called
A) schedule rating. B) judgment rating.
C) experience rating. D) retrospective rating.
Answer: C
Question Status: Previous Edition
25) All of the following statements about class rating are true EXCEPT A) Exposures with similar characteristics
are placed in the same underwriting class.
B) The rate charged for each class reflects the average loss experience for that class.
C) The complexity of class rating makes it inappropriate for personal lines coverages.
D) It is based on the assumption that future losses to insureds will be determined by the same classification
factors currently in use.
Answer: C
Question Status: Previous Edition
26) Under the pure premium method of determining class rates, the gross rate is determined by which of the
following formulas?
A) pure premium/(1 + expense ratio) B) pure premium/(1 - expense ratio) C) (1 + pure premium)/expense ratio
D) expense ratio/(1 - pure premium)
Answer: B
Question Status: Previous Edition
27) The expected loss ratio for a class of business is 60 percent. What change would be indicated in the level of
rates under the loss ratio method if the actual loss ratio turned out to be 68 percent?
A) 6.67 percent B) 13.33 percent C) 25.00 percent D) 33.33 percent
Answer: B
Question Status: Previous Edition
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28) Which of the following statements about schedule rating is (are) true? I.
It involves the determination of
a basis rate for each exposure, which is then modified by credits or debits. II.
It is based on the assumption
that certain physical characteristics of the insured!s operations will influence the insured!s future loss experience.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
29) Which of the following statements about experience rating is (are) true? I.
experience is used to determine the premium for the next policy period. II.
small firms whose actual experience lacks credibility.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
The insured!s past loss
Its use is generally limited to
Question Status: Previous Edition
30) Which of the following statements about retrospective rating is true? A) The premium for the current period
is determined by the loss experience for prior periods.
B) The premium for the current period is determined by the loss experience during the current period.
C) The premium for future periods is determined by the average loss experience for the current and previous
periods.
D) The premium for future periods is determined by the loss experience for the current period.
Answer: B
Question Status: Previous Edition
31) Monopoly Insurance is the only company marketing a certain line of insurance in a state. After complaints
from several consumers, the State Insurance Department investigated Monopoly!s rates. The regulators
determined that Monopoly was taking advantage of being the only insurer offering the line by charging more
than double the actuarial cost of the coverage. Which regulatory rating objective was Monopoly violating?
A) Rates must be adequate. B) Rates should encourage loss control.
C) Rates must not be excessive. D) Rates must not unfairly discriminate.
Answer: C
Question Status: Previous Edition
32) Small Town used to be just thatÁa small town 6 miles from Large City. Over the years, the area between
Small Town and Large City was developed, and now Small Town is part of the suburbs surrounding Large City.
An auto insurer that operated in the area had a large increase in auto claims from Small Town insureds. The
insurer did not adjust its rates, and this year will lose money because of claims attributable to higher population
density. Which business rating objective did this insurer fail to meet?
A) simplicity B) stability
C) responsiveness D) encouragement of loss control
Answer: C
Question Status: Previous Edition
33) Nathan was hired as an actuary with ABC Insurance. Nathan was asked to calculate the annual premium for a
new product and to explain his calculations to ABC!s director of ratemaking. Nathan calculated the pure
premium and presented this value as the final premium. After Nathan!s presentation, the director of ratemaking
said, "You left out something very important. If we sell coverage at the pure premium rate, we!ll be out of
business soon." What did Nathan overlook in his calculations?
A) loadings B) the underwriting cycle
C) seasonality of claims D) investment income
Answer: A
Question Status: Previous Edition
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34) XYZ Insurance Company expects $500,000 in claims and loss adjustment expenses for each 1,000 properties
that it insures in a certain category of business insurance. What pure premium should XYZ charge for each
property insured?
A) $69.99 B) $166.67 C) $350.00 D) $500.00
Answer: D
Question Status: Previous Edition
35) XYZ Insurance Company uses class rating to determine the rate to charge for insurance. For one type of
insurance, the pure premium XYZ actuaries calculated is $75 per unit. If XYZ!s expense ratio is 25 percent, what
is the gross rate for this coverage?
A) $37.50 B) $55.25 C) $75.00
D) $100.00 Answer: D
Question Status: Revised
36) RST is a manufacturer. The company does not have a good safety record and pays high workers
compensation premiums. RST just hired a new risk manager, and she has instituted several employee safety
programs. She has also persuaded the insurer writing RST!s workers compensation insurance to base the
premium on RST!s actual loss experience during the current period rather than on the company!s historical
performance. This type of plan is called a(n)
A) retrospectively rated plan. B) class rated plan.
C) experience rated plan. D) judgment rated plan.
Answer: A
Question Status: Previous Edition
37) An Econodeath Insurance Company actuary calculated the present value of the expected death claim the
company will pay if it sells whole life insurance to a 30-year-old woman. This value is called the
A) net level premium. B) gross premium.
C) net single premium. D) life insurance policy reserve.
Answer: C
Question Status: Previous Edition
38) Metro City has six different zip codes. XYZ Insurance Company markets coverages in Metro City. Any
applicant who lists one particular zip code is automatically quoted a premium that is three times the average
premium for applicants from the other five zip codes. Which regulatory objective is not being met given XYZ!s
premium structure?
A) Rates must be adequate. B) Rates must not unfairly discriminate.
C) Rates must be responsive. D) Rate must not be excessive.
Answer: B
Question Status: Previous Edition
39) All of the following statements about the combined ratio are true EXCEPT A) It is equal to the loss ratio plus
the expense ratio.
B) A combined ratio greater than 1 (or 100 percent) means an underwriting loss has occurred. C) The combined
ratio does not consider investment income. D) A combined ratio less than 1 (or 100 percent) indicates that an
underwriting loss has occurred.
Answer: D
Question Status: Previous Edition
40) In schedule rating, each building is individually evaluated based on several rating factors. One factor refers to
the possibility that the building will be damaged or destroyed by a fire that starts at an adjacent property and
spreads to the building. This rating factor is known as
A) occupancy. B) protection.
C) maintenance. D) exposure.
Answer: D
Question Status: Previous Edition
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41) A strip-mall includes eight identical-sized retail units. All of the units were built at the same time and each
has an identical sprinkler system. Unit number two is a dry cleaning business. Unit number three is a bar and
grill. Unit number four is a dress shop. The owners of these three units are all insured by the same insurance
company, but the property insurance premiums vary significantly. Which of the following rating factors best
explains the difference in premiums?
A) exposure B) protection
C) construction D) occupancy
Answer: D
Question Status: Revised
Chapter 8 Government Regulation of Insurance
1) Reasons for regulation of insurance include which of the following? I. Maintaining insurer solvency. II.
Ensuring reasonable rates.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
2) The right of the states to regulate the business of insurance was first established by A) the South-Eastern
Underwriters Association case.
B) Paul v. Virginia. C) the Financial Modernization Act. D) the Sherman Act.
Answer: B
Question Status: Revised
3) The basis for current state regulation of insurance is A) the McCarran-Ferguson Act.
B) Paul v. Virginia. C) the South-Eastern Underwriters Association case. D) the National Association of
Insurance Commissioners.
Answer: A
Question Status: Previous Edition
4) All of the following statements about the methods of regulating insurance are true EXCEPT A) All states have
insurance laws that regulate the operations of insurers.
B) Insurers are totally exempt from regulation by federal agencies and laws.
C) The courts regulate insurance in many ways, including the interpretation of policy clauses and provisions.
D) State insurance commissioners, through administrative rulings, have considerable power over insurers doing
business in their states.
Answer: B
Question Status: Previous Edition
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5) Which of the following statements about the licensing of insurance companies is (are) true? I.
A new
capital stock insurer must meet minimum capital and surplus requirements, which vary by state and line of
insurance. II. The licensing requirements for insurance companies are less stringent than those imposed on most
other types of firms.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
6) An insurance company incorporated in another state has been licensed to operate in your state. In your state,
the insurer would be considered a(n)
A) nonadmitted insurer. B) foreign insurer.
C) alien insurer. D) reciprocal insurer.
Answer: B
Question Status: Previous Edition
7) An insurance company chartered in another country has been licensed to operate in your state. In your state,
the insurer would be considered a(n)
A) nonadmitted insurer. B) foreign insurer.
C) alien insurer. D) reciprocal insurer.
Answer: C
Question Status: Previous Edition
8) Which of the following is considered a nonadmitted asset for an insurer? A) cash
B) preferred stocks C) real estate D) office furniture
Answer: D
Question Status: Previous Edition
9) The policyholders! surplus of an insurer is defined as the difference between its A) assets and its liabilities.
B) premium income and its expenses. C) reserves and its liabilities. D) assets and its nonadmitted assets.
Answer: A
Question Status: Previous Edition
10) Which of the following statements about the use of risk-based capital requirements is (are) true? I. Insurers
must have a certain amount of capital depending on the riskiness of their investments and insurance operations.
II.
Insurers may be required to take certain actions depending on how much capital they have relative to their
risk-based capital requirements.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
11) Which of the following statements about the regulation of insurance company investments is (are) true?
I.
The purpose of regulating insurance company investments is to prevent insurers from making unsound
investments which could threaten their solvency. II.
Life insurers can invest an unlimited amount of their
assets in common stocks.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
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12) Which of the following statements about the regulation of life insurance companies is (are) true? I. The
amount a life insurance company may invest in a specific type of asset (e.g., stocks or bonds) is generally limited
by law. II.
The purpose of limiting the accumulation of surplus is to prevent an insurer from increasing its
surplus at the expense of policyowner dividends.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
13) Which of the following statements about state insurance guaranty funds is (are) true? I. They limit the
amount that policyowners can collect if an insurer becomes insolvent. II. They are usually funded by general
revenues of the states.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
14) Under one type of rating law, insurers are not required to file their rates with the state insurance department.
However, insurers may be required to furnish rate schedules and supporting data to state officials. A fundamental
assumption underlying this type of rating law is that market forces will determine the price and availability of
insurance, rather than discretionary acts of regulators. This type of rating law is called a(n)
A) flex-rating law. B) prior-approval law.
C) file-and-use law. D) open competition law.
Answer: D
Question Status: Revised
15) Under what type of rate regulation are insurers required to obtain approval of rates before using them if the
rate change exceeds a specified predetermined range?
A) flex-rating law B) prior-approval law
C) file-and-use law D) open competition law
Answer: A
Question Status: Revised
16) By misrepresenting the true facts, Gretchen was able to convince a client to drop a life insurance policy with
another company and to purchase a policy from the company that Gretchen represents. Gretchen has engaged in
an illegal sales practice called
A) bait and switch. B) rebating.
C) retaliating. D) twisting.
Answer: D
Question Status: Revised
17) Which of the following statements about premium taxes is (are) true? I.
They are levied by the federal
government as a result of the McCarran-Ferguson Act. II. Their primary purpose is to provide funds for
insurance regulation.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
18) Advantages cited by proponents of federal regulation of insurance include all of the following EXCEPT
A) greater efficiency. B) greater opportunity for innovation.
C) uniformity of laws. D) more competent regulators.
Answer: B
Question Status: Previous Edition
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19) Advantages cited by proponents of state regulation of insurance include all of the following EXCEPT
A) uniformity of laws by the NAIC. B) greater opportunity for innovation.
C) greater responsiveness to local needs. D) centralization of political power.
Answer: D
Question Status: Previous Edition
20) Shortcomings of state regulation of insurance found by Congressional committees and the General
Accounting Office include all of the following EXCEPT
A) inadequate protection against insolvency. B) inadequate market conduct examinations. C) inability to respond
to unique local needs.
D) regulator!s over-responsiveness to the insurance industry. Answer: C
Question Status: Previous Edition
21) The major reasons for insurer insolvency include which of the following? I. Inadequate pricing and loss
reserves. II. Rapid growth and inadequate surplus.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
22) The principal methods of ensuring insurer solvency include all of the following EXCEPT A) Security and
Exchange Commission oversight of investments.
B) risk-based capital standards. C) field examinations. D) review of required annual financial statements.
Answer: A
Question Status: Previous Edition
23) Which of the following is an argument for repealing the McCarran-Ferguson Act? A) It would make it easier
for small insurers to compete.
B) It would encourage sharing of information. C) It would make it easier to develop common coverage forms. D)
It would eliminate defects in state regulation.
Answer: D
Question Status: Previous Edition
24) The number of title insurance companies operating in State Z is relatively low. Recently, the largest of these
companies (50 percent market share) acquired the second largest company (30 percent market share).
Immediately after the acquisition, the insurer raised premiums by 75 percent. This scenario demonstrates which
of the following rationales for the regulation of insurance?
A) maintain insurer solvency B) compensate for inadequate consumer knowledge
C) ensure reasonable rates D) make insurance available
Answer: C
Question Status: Previous Edition
25) 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) Paul v. Virginia B) South-Eastern Underwriters Association case
C) McCarran-Ferguson Act D) Financial Modernization Act
Answer: B
Question Status: Revised
26) A life insurance company based in Canada was licensed to operate in Massachusetts. When operating in
Massachusetts, the Canadian insurer would be considered a(n)
A) domestic insurer. B) captive insurer. C) foreign insurer.
D) alien insurer.
Answer: D
Question Status: Previous Edition
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27) XYZ Mutual Insurance Company has total assets of $10 million. The policyholders! surplus is $2 million.
What are XYZ Mutual!s total liabilities?
A) $4.0 million B) $8.0 million C) $10.0 million
D) $12.0 million Answer: B
Question Status: Previous Edition
28) Mutual Property Insurance Company has a surplus of $2 million. According to a conservative rule of thumb,
how much new net premiums can Mutual Property Insurance Company safely write?
A) $4 million B) $8 million C) $10 million
D) $20 million Answer: A
Question Status: Previous Edition
29) Fly-By-Night Insurance Company had much larger losses than forecast. The company did not charge
adequate premiums nor did the company purchase reinsurance. If Fly-By-Night becomes insolvent, which of the
following will help pay the unpaid claims of the insurer?
A) guaranty fund B) premium taxes
C) risk-based capital D) admitted assets
Answer: A
Question Status: Revised
30) Grace is a life insurance agent. She is attempting to sell a large life insurance policy, but the prospective
purchaser is having second thoughts. To persuade the prospective purchaser, Grace said, "I will earn a $1,000
commission if you buy this policy. I!ll give you $500 of my commission if you buy the policy." In most states,
what illegal sales practice will Grace be guilty of if she splits her commission with the purchaser?
A) rebating B) churning
C) twisting D) backdating
Answer: A
Question Status: Previous Edition
31) State X!s premium tax rate is 2 percent. State Y!s premium tax rate is 3 percent. State X insurers are required
to pay the 3 percent rate on business written in State Y. State X requires insurers from State Y to pay a 3 percent
premium tax on business written in State X, even though the premium tax rate is only 2 percent in State X. This
practice is known as a
A) tax tariff. B) guaranty fund assessment.
C) risk-based capital requirement. D) retaliatory tax law.
Answer: D
Question Status: Revised
32) ABC Insurance Company would like to purchase a bank. For many years, ABC was not permitted under
federal law to enter into banking operations. Which of the following legislative acts eliminated the prohibition
that prevented banks, insurers, and investment firms from entering into one another!s markets?
A) The McCarran-Ferguson Act B) The Tax Reform Act
C) The Consolidated Omnibus Budget Reconciliation Act D) The Financial Modernization Act (Gramm-LeachBliley Act)
Answer: D
Question Status: Previous Edition
33) Under one type of rating law, insurers are free to change rates and to use modified rates immediately.
However, the new rate must be filed with regulators within a specified period, such as 60 days after the modified
rate is employed. This type of rating law is called
A) prior approval. B) file-and-use. C) use-and-file.
D) flex rating. Answer: C
Question Status: New
34) The regulation of insurers in areas that affect consumers, which include claims handling, underwriting,
complaints, advertising, sales practices, and other trade practices is called
A) solvency surveillance. B) market conduct regulation.
C) combined ratio analysis. D) market share regulation.
Answer: B
Question Status: Previous Edition
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35) The National Association of Insurance Commissioners (NAIC) administers an "early warning system" to
help ensure insurance company solvency. This system uses data provided in the annual statement to identify
companies that may pose a solvency risk. This early warning system is called
A) the risk-based capital requirements. B) an insurance guaranty fund.
C) the Insurance Regulatory Information System (IRIS) D) the assessment method.
Answer: C
Question Status: Previous Edition
36) Which of the following statements is (are) true regarding the quality of insurance regulation? I.
The
quality of insurance regulation is uniform from state to state. II. All evidence suggests federal regulation of
insurance would improve the quality of regulation.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
37) Which of the following statements concerning the proposed optional federal charter for life insurers is (are)
true?
I.
Large insurers operating in many states would more likely prefer a state charter while smaller, regional,
insurers would more likely choose a federal charter. II.
Proponents of the federal charter argue that it would
speed the development and approval of new products.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
38) All of the following are methods helping to insure the solvency of insurers EXCEPT A) open competition
rating laws.
B) risk-based capital standards. C) the NAIC!s early warning system. D) the NAIC!s FAST screening system.
Answer: A
Question Status: Previous Edition
39) A score derived from an individual!s credit history and other factors that is used by many auto and
homeowners insurers for underwriting and rating purposes is called a(n)
A) CLUE score. B) insurance score.
C) expense ratio score. D) combined ratio score.
Answer: B
Question Status: Previous Edition
40) All of the following are arguments in favor of using an applicant!s credit record in personal lines
underwriting EXCEPT
A) Most consumers have good credit records and benefit when credit history is used as a rating factor.
B) Use of credit data in underwriting or rating discriminates against certain groups. C) Underwriting and rating
may be more consistent if applicants! credit histories are considered. D) There is high correlation between an
applicant!s credit record and future claims experience.
Answer: B
Question Status: Revised
41) All of the following statements about insurance regulation are true EXCEPT A) Insurance commissioners are
appointed in some states and elected in some states.
B) Insurers are subject to regulation by certain federal agencies and laws.
C) The National Association of Insurance Commissioners (NAIC) can force states to adopt legislative acts.
D) An insurance commissioner can revoke or suspend an insurer!s license to do business in his or her state.
Answer: C
Question Status: Previous Edition
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42) Jasper Company suffered a large, uninsured, liability loss. The company was ordered to pay $25 million in
damages. After filing an appeal, Jasper Company purchased a multiple-year, high premium, insurance policy to
cover this potential loss. The net effect of the insurance purchase is that it will allow Jasper to pay premiums for
five years, which will smooth the company!s reported earnings instead of the company recording a large loss in
one year. The type of insurance that Jasper purchased in called
A) excess-of-loss reinsurance. B) gap insurance.
C) paid-loss retrospectively rated insurance. D) finite risk insurance.
Answer: D
Question Status: New
43) Some insurance companies offer higher compensation to insurance brokers based on the premium volume the
broker generates with the insurer. Thus a broker may have an incentive to place business with an insurer offering
this form of compensation even though placing the insurance with another insurer may be in a client!s best
interest. This type of compensation is known as
A) profit-sharing commission. B) cost-plus pricing.
C) contingent commission. D) no pay, no play pricing.
Answer: C
Question Status: New
44) Which of the following statements is (are) true about finite reinsurance (also known as finite risk insurance)?
I.
The loss that is insured may already have occurred. II.
Premiums are low because coverage is for a
short period of time.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: New
45) Which of the following statements is (are) true concerning the State Modernization and Regulatory
Transparency (SMART) Act? I.
It would simplify the licensing of insurers that operate in multiple states. II.
It would create greater uniformity in insurance regulation.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: New
46) All of the following are current problems and issues in insurance regulation EXCEPT: A) unauthorized
entities selling health insurance.
B) bid-rigging by insurance brokerage firms. C) life insurance availability problems because of insurer
consolidation. D) insurers using credit-based insurance scores in the underwriting process.
Answer: C
Question Status: New
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Chapter 9 Fundamental Legal Principles
1) Fundamental purposes of the principle of indemnity include which of the following? I.
physical hazards. II. To prevent the insured from profiting from insurance.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
To reduce
Question Status: Previous Edition
2) Which of the following is a fundamental purpose of the principle of indemnity? A) to reduce moral hazard
B) to minimize physical hazards C) to settle property insurance losses on a replacement cost basis D) to require
deductibles in all property insurance policies
Answer: A
Question Status: Previous Edition
3) Sam!s stereo was destroyed by a fire. The stereo cost $1200 when it was purchased, but a similar new stereo
now costs $1800. Assuming the stereo was 50 percent depreciated, what is the actual cash value of Sam!s loss?
A) $600 B) $900 C) $1200
D) $1800 Answer: B
Question Status: Previous Edition
4) All of the following are exceptions to the principle of indemnity EXCEPT A) life insurance.
B) valued policies. C) replacement cost property insurance. D) actual cash value property insurance.
Answer: D
Question Status: Previous Edition
5) Under which of the following rules is actual cash value determined by taking into consideration all relevant
factors an expert would use to determine the value of the property?
A) the circumstantial evidence rule B) the broad evidence rule
C) the property indemnity rule D) the objective value rule
Answer: B
Question Status: Previous Edition
6) A total loss under a valued policy is settled on the basis of the A) market value of the loss.
B) actual cash value of the loss. C) replacement value of the loss. D) amount of insurance covering the loss.
Answer: D
Question Status: Previous Edition
7) Which of the following statements describes how losses will be settled if a property insurance policy is written
on a replacement cost basis?
A) Losses are settled without the applicable deductible. B) Losses are settled without a deduction for
depreciation.
C) The insurer must replace the damaged or destroyed property in lieu of a cash settlement. D) The policy is
converted to a valued policy.
Answer: B
Question Status: Previous Edition
8) Which of the following statements about the principle of insurable interest is (are) true? I. It makes it
difficult to measure the amount of an insured!s loss. II.
It reduces moral hazard.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
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9) All of the following will support an insurable interest for purposes of purchasing property and liability
insurance EXCEPT
A) ties of blood and marriage. B) potential legal liability.
C) secured creditors. D) a contract right.
Answer: A
Question Status: Previous Edition
10) Which of the following statements about an insurable interest in life insurance is (are) true? I.
It is
required of any person named as beneficiary. II. It may result from a pecuniary (financial) interest, even if
there is no relationship by marriage or blood.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
11) When must an insurable interest legally exist in life insurance? A) only at the time of the insured!s death
B) only at the inception of the policy C) only at the time the beneficiary is paid D) both at the time of the
insured!s death and at the inception of the policy
Answer: B
Question Status: Previous Edition
12) When must an insurable interest legally exist in property insurance? A) only at the time of the loss
B) only at the inception of the policy C) only at the time the loss settlement process takes place D) both at the
time of the loss and at the inception of the policy
Answer: A
Question Status: Revised
13) Sue!s office building was damaged by a fire caused by a careless tenant. After paying Sue for her loss, the
insurance company sued the tenant to recover its loss. This suit is based on the principle of
A) warranty. B) insurable interest.
C) utmost good faith. D) subrogation.
Answer: D
Question Status: Previous Edition
14) All of the following are basic purposes of subrogation EXCEPT A) to eliminate adverse selection.
B) to hold down the cost of insurance. C) to prevent an insured from collecting twice for the same loss. D) to
hold the negligent person responsible for a loss.
Answer: A
Question Status: Previous Edition
15) Which of the following statements about subrogation is true? A) It is used primarily for losses paid under life
insurance policies.
B) It allows the insurer to sue its own insured who is negligent.
C) The insured!s right to collect benefits may be forfeited if the insured interferes with the insurer!s rights after a
loss.
D) The insurer is required to exercise its subrogation rights. Answer: C
Question Status: Previous Edition
16) The principle of utmost good faith is supported by all of the following legal doctrines EXCEPT A)
representations.
B) warranty. C) subrogation. D) concealment.
Answer: C
Question Status: Previous Edition
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17) What is the legal significance of a material concealment by an insurance applicant? A) The contract is
automatically voided from its inception.
B) The contract is voidable at the insurer!s option. C) Loss payments are reduced by the degree of the
concealment. D) The insurer is immediately entitled to a higher premium.
Answer: B
Question Status: Previous Edition
18) What is the legal significance of a material misrepresentation in an insurance application? A) The contract is
automatically voided from its inception.
B) The contract is voidable at the insurer!s option. C) Loss payments are reduced by the degree of the
misrepresentation. D) The insurer is immediately entitled to a higher premium.
Answer: B
Question Status: Previous Edition
19) A false statement made by an applicant for insurance is an example of a A) concealment.
B) breach of warranty. C) lack of offer and acceptance. D) misrepresentation.
Answer: D
Question Status: Previous Edition
20) Which of the following statements about an insurance warranty is (are) true? I.
It is part of the insurance
contract. II. Statements made by an insurance applicant are considered warranties rather than representations.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
21) David lives in an apartment in a high-crime area. In order to obtain physical damage insurance on his car,
David promised to park the car in a garage with 24-hour security. This agreement, which was incorporated into
the insurance contract, is an example of a
A) representation. B) unilateral contract.
C) contract of adhesion. D) warranty.
Answer: D
Question Status: Previous Edition
22) Which of the following statements about offer and acceptance for insurance contracts is true?
A) In property and liability insurance, agents typically do not have the authority to bind coverage.
B) In life insurance, the agent can usually accept an offer by immediately binding coverage. C) In property
insurance, the offer and acceptance are usually in writing but may be oral. D) In life insurance, the offer is
merely the promise to pay the first premium.
Answer: C
Question Status: Previous Edition
23) Chris applied for life insurance and paid the first premium on Monday. She was given an insurability
premium receipt which specified that coverage was effective on the date of the application or the date of the
medical exam, whichever is later. She took the medical exam the following Thursday. She was found to be in
perfect health. On which day was her coverage effective?
A) on Monday, when she completed the application and paid the first premium B) on Wednesday, two days after
completing the application and paying the first premium
C) on Thursday when she passed the medical exam D) on Saturday, two days after passing the medical exam
Answer: C
Question Status: Previous Edition
24) Which of the following statements about consideration in an insurance contract is (are) true? I.
The
insured!s total consideration is submission of a completed application. II. The insurer!s consideration is the
promise to do those things specified in the policy.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
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25) A contract in which the values exchanged are not equal because chance is involved is called a(n) A) contract
of adhesion.
B) unilateral contract. C) conditional contract. D) aleatory contract.
Answer: D
Question Status: Previous Edition
26) Why are insurance contracts said to be contracts of adhesion? A) The values exchanged are not equal.
B) One party writes the contract, and the other party must accept the contract as written. C) Only one party
makes a legally enforceable promise. D) Conditions are placed on the insurer!s promise to perform.
Answer: B
Question Status: Previous Edition
27) Why does the insured get the benefit of the doubt if an insurance policy contains any ambiguities or
uncertainties?
A) because insurance contracts are aleatory B) because insurance contracts are unilateral
C) because insurance contracts are conditional D) because insurance contracts are contracts of adhesion
Answer: D
Question Status: Previous Edition
28) Why can an insurer refuse to pay a claim if an insured fails to abide by the policy provisions? A) because
insurance contracts are aleatory
B) because insurance contracts are unilateral C) because insurance contracts are conditional D) because
insurance contracts are contracts of adhesion
Answer: C
Question Status: Previous Edition
29) Which of the following types of insurance policies can usually be assigned without the insurer!s consent?
I.
Life insurance II.
Property insurance
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
30) What is the practical effect of an insurance policy being a conditional contract?
A) The insurer can refuse to pay claims unless the insured has complied with all policy conditions.
B) The insured can assign the policy only with the insurer!s consent. C) The insurer can sue the insured for
failure to pay any premiums. D) The insured gets the benefit of the doubt if a policy contains any ambiguities or
uncertainties.
Answer: A
Question Status: Previous Edition
31) What is the practical effect of an insurance policy being a contract of adhesion?
A) The insurer can refuse to pay claims unless the insured has complied with all policy provisions.
B) The insured can assign the policy only with the insurer!s consent.
C) The insurer can sue the insured for failure to pay any premiums.
D) The policy is interpreted in the insured!s favor if the policy contains any ambiguities or uncertainties.
Answer: D
Question Status: Previous Edition
32) All of the following statements about the rules governing agency relationships are true EXCEPT A) An agent
must be authorized to act on behalf of a principal.
B) An agency agreement may grant certain powers to the agent as well as denying the agent other powers.
C) The principal is responsible for the acts of agents only if the acts are criminal.
D) Knowledge of the agent is presumed to be knowledge of the principal with respect to matters within the scope
of the agency relationship.
Answer: C
Question Status: Previous Edition
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33) The voluntary relinquishment of a legal right is called A) subrogation.
B) adhesion. C) estoppel. D) waiver.
Answer: D
Question Status: Previous Edition
34) Frank would like to change jobs. He asked his company!s employee benefits director if his group health
coverage could be converted to individual coverage if he quit his job. The benefits director said, "Yes, you can
convert to an individual policy, and the coverage is identical to your group coverage." Frank quit his job and
converted to an individual policy. Six months later he filed a medical claim. He was dismayed to learn that the
conversion policy was very limited compared to the coverage he had as an employee. What legal doctrine will
allow Frank to bring a successful legal action against his former employer because he was financially harmed
due to his reasonable reliance upon a representation of fact?
A) adhesion B) concealment
C) estoppel D) subrogation
Answer: C
Question Status: Revised
35) Janice purchased a living room set for $1,000 and insured this furniture on an actual cash value basis. Two
years later the living room set was destroyed by a covered peril. At the time of loss, the property had depreciated
in value by 25 percent. The replacement cost of the furniture at the time of loss was $1,200. Assuming no
deductible, how much will Janice receive from her insurer?
A) $900 B) $950
C) $1,000 D) $1,200
Answer: A
Question Status: Previous Edition
36) Jacob sold his house to Shelia for $140,000 in cash. Jacob "threw in" insurance on the house as part of the
deal and did not bother telling the insurer that there was a new owner. Four months after Shelia purchased the
home, a windstorm damaged the roof. Which of the following legal characteristics of insurance contracts could
the insurer use to legally deny payment for the damage to the roof?
A) Insurance contracts are unilateral contracts. B) Insurance contacts are contracts of adhesion.
C) Insurance contracts are aleatory contracts. D) Insurance contracts are personal contracts.
Answer: D
Question Status: Previous Edition
37) Melody!s car was damaged when another driver ran a stop sign and hit her car. Melody decided to collect
from her own insurer and to let her insurer recoup the loss payment from the driver who hit her. What
fundamental legal principle is illustrated in this scenario?
A) the principle of utmost good faith B) the principle of insurable interest
C) the principle of subrogation D) the principle of reasonable expectations
Answer: C
Question Status: Previous Edition
38) When Ben applied for life insurance, he was asked on the application if he smoked or used tobacco products.
Ben answered "No." In reality, Ben smokes two packs of cigarettes a day. The policy was issued at the
"preferred, nonsmoker rate." If Ben dies 6 months after the policy is issued, upon what grounds will the insurer
be able to legally deny the claim?
A) warranty B) misrepresentation
C) waiver D) concealment
Answer: B
Question Status: Previous Edition
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39) Robin plans to open a bar in a high-crime area. She had difficulty obtaining insurance for the business. She
found an insurer willing to write the coverage, but only if Robin agreed to have a security alarm system in
operation at all times when the business is closed. Robin!s promise to have a security alarm system operational as
a condition of having the insurance coverage in force is a
A) binder. B) warranty.
C) waiver. D) deductible.
Answer: B
Question Status: Revised
40) Dave is an agent for Easy Pay Insurance. Easy Pay insures only the highest-quality applicants. Dave wanted
to earn more commissions, so he sold some policies to applicants he knew were below-average risks. When these
policyowners started filing claims, Easy Pay tried to deny the claims stating that Dave had not acted
appropriately. Which general rule of agency makes Easy Pay responsible for the claims of the higher-thanaverage risk policyowners?
A) There is no presumption of an agency relationship. B) Agents should be compensated based on the quality of
the business they generate.
C) A principal is responsible for the acts of its agents who are acting within the scope of their authority.
D) An agent must have authority to represent the principal. Answer: C
Question Status: Previous Edition
41) Ted!s insurance claim was denied by XYZ Insurance Company. When Ted inquired why the claim was
denied, he was told to, "Read the exclusion on page 5 of the policy." Ted read the exclusion. In his opinion, the
exclusion was poorly worded and vague. If a court of law agrees with Ted!s assessment of the exclusion, Ted
may still be able to have his claim paid by the insurer because insurance contracts are
A) personal contracts. B) unilateral contracts.
C) aleatory contracts. D) contracts of adhesion.
Answer: D
Question Status: Previous Edition
42) Mark owns a bar. The bar has a back room where Mark has some slot machines. Mark lets some of his
patrons play the machines, and Mark keeps any profits. This type of gambling is illegal where Mark lives. Mark
wanted to purchase insurance in case his slot machines were confiscated by the police. Such an insurance
contract would not be enforceable. Which requirement needed to form a valid insurance contract is missing?
A) consideration B) offer and acceptance
C) legal purpose D) competent parties
Answer: C
Question Status: Previous Edition
43) Which distinct legal characteristic of insurance contracts states that only the insurer!s promise to perform is
legally enforceable?
A) contracts of adhesion B) unilateral contracts
C) aleatory contracts D) personal contracts
Answer: B
Question Status: Previous Edition
44) Some courts have ruled that an alternative to "replacement cost less depreciation" should be used to
determine the actual cash value of a property loss. Under this alternative, the value of property lost is determined
by the price a willing buyer would pay a willing seller for the property in a free market. This method of
determining actual cash value is called the
A) broad evidence rule method. B) valued policy method.
C) fair market value method. D) reconstruction cost method.
Answer: C
Question Status: Previous Edition
45) Some states have a law that requires payment of the face amount of insurance to the insured if a total loss to
real property occurs from a peril specified in the law. These laws are called
A) agreed amount laws. B) replacement cost laws.
C) homestead laws. D) valued policy laws.
Answer: D
Question Status: New
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46) The general rule that ambiguity in insurance contracts is construed against the insurer is reinforced by an
important legal principle. This principle states the insured is entitled to coverage under a policy that he or she
would assume the policy would provide, and exclusions must be conspicuous, plain, and clear. This principle is
known as
A) the principle of utmost good faith. B) the principle of reasonable expectations .
C) the principle of subrogation. D) the principle of indemnity.
Answer: B
Question Status: New
Chapter 10 Analysis of Insurance Contracts
1) The portion of a property and liability insurance contract that contains information about the property or
activity to be insured is called the
A) declarations. B) insuring agreement.
C) exclusions. D) conditions.
Answer: A
Question Status: Previous Edition
2) What information is contained in the insuring agreement of an insurance policy? A) a description of the
property or life to be insured
B) a summary of the major promises of the insurer C) a summary of the obligations of the insured D) a list of the
property, losses, and perils that are excluded
Answer: B
Question Status: Previous Edition
3) Which of the following statements about "all-risks" coverage is (are) true? I. All losses are covered except
those losses specifically excluded. II.
The burden of proof is on the insured to prove that a loss is covered.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
4) The exclusion of flood in a homeowners policy is an example of an A) excluded activity.
B) excluded condition. C) excluded property. D) excluded peril.
Answer: D
Question Status: Previous Edition
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5) Exclusions are used in insurance policies for all of the following reasons EXCEPT A) to reduce moral hazard.
B) to waive policy conditions. C) to eliminate coverage for uninsurable perils. D) to eliminate coverage not
needed by typical insureds.
Answer: B
Question Status: Previous Edition
6) Reasons why a peril may be considered uninsurable and therefore excluded from insurance contracts include
which of the following? I. The losses from the occurrence of the peril may be due to a predictable decline in
value. II.
The losses from the occurrence of the peril may be incalculable and catastrophic.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
7) The policy provision requiring the filing of proof of loss with the insurer is an example of a(n) A) declaration.
B) condition. C) insuring agreement. D) miscellaneous provision.
Answer: B
Question Status: Previous Edition
8) Which of the following statements about the definition of the insured is (are) true? I. In some cases, a person
who is not specifically named may be classified as an insured. II. Under no circumstances can more than one
person be named as an insured.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
9) All of the following statements about endorsements and riders are true EXCEPT A) They are usually written.
B) They can be used to add or delete policy provisions.
C) They normally take precedence over other conflicting policy provisions.
D) They are primarily used to circumvent the purpose of legislation requiring specific policy provisions.
Answer: D
Question Status: Previous Edition
10) Deductibles are used in all of the following types of insurance EXCEPT A) life insurance.
B) health insurance. C) property insurance. D) automobile insurance.
Answer: A
Question Status: Previous Edition
11) All of the following are purposes of deductibles EXCEPT A) to eliminate small claims.
B) to reduce premiums. C) to reduce morale hazard. D) to exclude uninsurable perils.
Answer: D
Question Status: Previous Edition
12) The deductible for automobile collision losses is an example of a(n) A) corridor deductible.
B) elimination period. C) straight deductible. D) aggregate deductible.
Answer: C
Question Status: Previous Edition
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13) Which of the following statements about a calendar-year deductible is (are) true? I. It requires the insured to
pay a specified amount of each claim regardless of when the claim occurs during the year and regardless of any
previous claims during the year. II. It is used only in policies which cover direct property losses.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
14) A provision in a disability income insurance policy that requires a person to be disabled for 60 days before
receiving benefits is an example of a(n)
A) corridor deductible. B) exclusion period.
C) elimination period. D) probationary period.
Answer: C
Question Status: Revised
15) At what point in time must an insured meet the coinsurance requirement in a property insurance policy in
order to avoid having to pay a portion of the loss?
A) only at the time of loss B) only at the time of policy inception
C) only at the time of policy application D) both at the time of policy inception and at the time of loss
Answer: A
Question Status: Revised
16) David owns a commercial building with a replacement cost of $4 million. The building is insured on a
replacement cost basis for $3 million under a fire insurance policy that has an 80 percent coinsurance clause.
How much will David collect if the building sustains a covered fire loss with a replacement cost of $320,000?
A) $266,667 B) $275,000 C) $300,000 D) $320,000
Answer: C
Question Status: Previous Edition
17) The primary purpose of coinsurance in property insurance is to A) reduce moral hazard.
B) achieve equity in rating. C) minimize problems in settling claims. D) eliminate small losses.
Answer: B
Question Status: Previous Edition
18) Which of the following statements about problems arising from the use of a coinsurance clause is (are) true?
I.
The amount of insurance should be periodically evaluated to avoid a coinsurance penalty because of
inflation. II. An agreed value coverage option is one method used to solve the problem of values that fluctuate
throughout the policy term.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
19) Connie has a major medical policy with a $200 deductible and a 75 -25 coinsurance (percentage
participation) clause. If she has eligible medical expenses of $10,000, how much will be paid by her insurer?
A) $7,300 B) $7,350 C) $7,500 D) $9,800
Answer: B
Question Status: Previous Edition
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20) Purposes of the coinsurance (percentage participation) clause in health insurance contracts include which of
the following? I.
To reduce premiums. II.
To exclude coverage for certain medical procedures.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
21) The purpose of other-insurance provisions is to A) eliminate the need for deductibles.
B) penalize those insureds who carry inadequate amounts of insurance. C) specify who will pay losses if the
insurer is bankrupt. D) preserve the principle of indemnity.
Answer: D
Question Status: Previous Edition
22) Lisa has three fire insurance policies on her office building. The policy from company A is for $400,000, and
the policies from companies B and C are for $100,000 each. If Lisa has a $360,000 loss, how much of the loss
will be covered by each policy if the loss is settled on a pro rata basis by the insurers?
A) each policy: $120,000 B) policy A: $160,000; policies B and C: $100,000 each
C) policy A: $240,000; policies B and C: $60,000 each D) policy A: $360,000; policies B and C: nothing
Answer: C
Question Status: Previous Edition
23) Kevin has three liability policies which provide for contribution by equal shares in case other insurance
applies to a loss. How much will each policy pay for a $3,000,000 liability judgment if policy A provides
$500,000 of coverage, policy B provides $1,000,000 of coverage, and policy C provides $3,000,000 of coverage?
A) Each policy will pay $500,000, and Kevin must pay the remaining $1,500,000.
B) Policy A will pay $500,000, policies B and C will each pay $1,000,000, and Kevin must pay the remaining
$500,000.
C) Policy A will pay nothing, policy B will pay $1,000,000, and policy C will pay $2,000,000. D) Policy A will
pay $500,000, policy B will pay $1,000,000, and policy C will pay $1,500,000.
Answer: D
Question Status: Revised
24) Helen and John both own automobiles on which they carry liability insurance. If Helen is negligent and has
an accident while driving John!s car, how will each insurer respond to any liability judgment against Helen?
A) The insurers will pay the judgment on a pro rata basis.
B) John!s insurer will pay on an excess basis if Helen!s insurance is insufficient to cover the judgment.
C) Helen!s insurance will pay on an excess basis if John!s insurance is insufficient to cover the judgment.
D) The policies will pay the judgment on the basis of contribution by equal shares. Answer: C
Question Status: Previous Edition
25) Kate is covered under her employer!s group health plan. She is also covered as a dependent under her
husband!s group health plan. Under the usual coordination-of-benefits provision, how will each company
respond to a claim filed by Kate?
A) Kate!s plan is primary, and her husband!s plan is excess. B) Her husband!s plan is primary, and Kate!s plan is
excess.
C) The plan of the person with the birthday earliest in the year pays first, and the other plan is excess.
D) Each plan will pay 50 percent of the claim.
Answer: A
Question Status: Previous Edition
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26) Eric!s property was damaged in an accident. He phoned his agent to see if the loss was covered under his
property insurance policy. The agent said, "As long as the cause of loss is not specifically excluded in the policy,
the loss is covered." Based on the agent!s answer, what type of insuring agreement appears in the policy?
A) unconditional coverage B) named-perils coverage
C) extended-perils coverage D) "all-risks" coverage
Answer: D
Question Status: Revised
27) Janet hit a wall causing a large dent in the fender of her car. She was busy at work and delayed reporting the
damage to her insurer for 9 months. The insurer denied the claim, stating, "Although such a loss is usually
covered, you are required under the terms of the contract to provide prompt notification in case of loss." The
prompt notification requirement is an example of a(n)
A) declaration. B) definition.
C) insuring agreement. D) condition.
Answer: D
Question Status: Previous Edition
28) Mark reviewed his homeowners policy. He learned that his personal property was insured on an actual cash
value basis. He would like replacement cost coverage on the property. He contacted his agent who said, "I!ll
simply add an amendment to your contract that changes the basis of recovery to replacement cost." The written
provision the agent was referring to is called a(n)
A) endorsement. B) coinsurance clause.
C) binder. D) deductible.
Answer: A
Question Status: Previous Edition
29) Under the terms of Jenny!s auto insurance policy, she must pay the first $500 of any physical damage loss to
her vehicle before her insurer will pay anything. What type of deductible is included in Jenny!s auto insurance
policy?
A) calendar-year deductible B) corridor deductible
C) straight deductible D) aggregate deductible
Answer: C
Question Status: Previous Edition
30) Shauna hurt her back and was unable to work. She filed a claim under her disability income insurance policy.
Under terms of the policy, 60 days must pass between the date of the injury and when the insurer begins to
replace lost earnings. This 60-day period is called a(n)
A) grace period. B) enrollment period.
C) probationary period. D) elimination (waiting) period.
Answer: D
Question Status: Previous Edition
31) ABC Company insured its building on a replacement cost basis for $700,000 under a property insurance
policy that included an 80 percent coinsurance clause. The building had a replacement cost of $1 million when it
sustained a $40,000 loss. How much will ABC Company receive from its insurer, assuming no deductible
applies?
A) $33,333 B) $35,000 C) $36,000 D) $40,000
Answer: B
Question Status: Previous Edition
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32) XYZ Company insured its building on a replacement cost basis for $450,000 under a property insurance
policy that included an 80 percent coinsurance clause. The building had a replacement cost of $500,000 when it
sustained a $50,000 loss. How much will XYZ Company receive from its insurer, assuming no deductible
applies?
A) $42,500 B) $45,000 C) $50,000 D) $56,250
Answer: C
Question Status: Previous Edition
33) Laura!s major medical insurance policy includes a $500 deductible and an 80 -20 coinsurance clause. Laura
was hospitalized and her covered medical expenses were $10,500. How much of the $10,500 will be paid by the
insurer under Laura!s major medical policy?
A) $7,500 B) $7,900 C) $8,000
D) $10,000 Answer: C
Question Status: Previous Edition
34) James purchased liability insurance with a $100,000 limit from Insurer A. When Insurer A denied a claim
that James thought should be covered, he bought a second liability insurance policy with a $150,000 limit from
Insurer B. Before he cancelled the policy with Insurer A, a $60,000 loss occurred. If this loss is settled on a pro
rata basis, how much must each insurer pay?
A) Insurer A will pay $10,000 and Insurer B will pay $50,000. B) Insurer A will pay $20,000 and Insurer B will
pay $40,000. C) Insurer A will pay $24,000 and Insurer B will pay $36,000. D) Insurer A will pay $40,000 and
Insurer B will pay $20,000.
Answer: C
Question Status: Previous Edition
35) Jane purchased a $50,000 liability insurance policy from Insurer A. Fearing that she did not have enough
liability insurance, she purchased an additional $100,000 of liability coverage from Insurer B. As a result of her
negligence, Jane was ordered to pay $75,000 in damages. Assuming the coverage from Insurer A is primary and
the coverage from Insurer B is excess, how will this claim be settled?
A) Insurer A will pay $50,000 and Insurer B will pay $25,000. B) Insurer A will pay $37,500 and Insurer B will
pay $37,500 . C) Insurer A will pay $25,000 and Insurer B will pay $50,000. D) Insurer A will pay nothing and
Insurer B will pay $75,000.
Answer: A
Question Status: Previous Edition
36) One method of providing group health insurance is a basic medical expense plan supplemented with major
medical insurance. The insured is required to pay a deductible between where the basic coverage ends and where
the major medical coverage begins. This deductible is called a(n)
A) corridor deductible. B) waiting period.
C) aggregate deductible. D) straight deductible.
Answer: A
Question Status: New
37) The purpose of a coordination-of-benefits provision in group health insurance plans is to A) determine which
plan pays first if more than one plan covers a loss.
B) determine which health care provider an insured may use for his or her care. C) determine if the calendar-year
deductible has been satisfied by the insured. D) determine if the employee is eligible for coverage under the
group health plan.
Answer: A
Question Status: New
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Chapter 11 Life Insurance
1) Which of the following types of families is likely to have the least need for a large amount of life insurance?
A) a blended family B) a traditional family
C) a single person family D) a sandwiched family
Answer: C
Question Status: Revised
2) The human life value is defined as the A) present value of a deceased breadwinner!s future gross income.
B) future value of a deceased breadwinner!s past earnings. C) present value of the family!s share of a deceased
breadwinner!s future earnings. D) future value of the family!s share of a deceased breadwinner!s future earnings.
Answer: C
Question Status: Previous Edition
3) All of the following information is needed to calculate a person!s human life value EXCEPT A) the person!s
average annual earnings over his or her productive lifetime.
B) the person!s estimated annual Social Security benefits after retirement. C) the person!s cost of selfmaintenance. D) the number of years from the person!s present age to the expected retirement age.
Answer: B
Question Status: Previous Edition
4) To calculate a human life value, it is necessary to deduct certain costs from a person!s average annual
earnings. These costs include
A) funeral costs. B) income taxes.
C) investment income. D) pension benefits after retirement.
Answer: B
Question Status: Previous Edition
5) All of the following are defects which limit the usefulness of the human life value approach in determining the
correct amount of life insurance to purchase EXCEPT
A) The effects of inflation are ignored. B) Other sources of income for survivors are ignored.
C) Earnings are assumed to remain constant. D) Earnings during the individual!s productive lifetime are ignored.
Answer: D
Question Status: Revised
6) Which of the following statements about the needs approach for estimating the amount of life insurance to
purchase is (are) true? I.
It involves an analysis of various family needs which must be met if a family
breadwinner dies. II. Its use is appropriate only if a person currently has no life insurance protection.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
7) The purpose of an estate clearance fund is to pay all of the following EXCEPT A) burial expenses.
B) estate administration expenses. C) education costs. D) installment debts.
Answer: C
Question Status: Previous Edition
8) What is the length of the readjustment period which is considered when the needs approach is used to
determine the amount of life insurance to own?
A) 3 to 6 months B) 1 to 2 years
C) until the youngest child reaches age 18 D) until the surviving spouse reaches age 65
Answer: B
Question Status: Revised
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9) Under the needs approach, when is the dependency period of a surviving spouse assumed to end? A) 1 or 2
years after the breadwinner!s death
B) when the youngest child reaches age 18 C) when the surviving spouse reaches age 65 D) when the surviving
spouse dies
Answer: B
Question Status: Previous Edition
10) The period during which a surviving spouse is ineligible for Social Security benefits is referred to as the
A) emergency period. B) readjustment period.
C) dependency period. D) blackout period.
Answer: D
Question Status: Previous Edition
11) Which of the following statements about the capital retention approach for determining life insurance needs
is (are) true? I.It assumes that life insurance proceeds will be liquidated to provide income to survivors. II.
It requires the preparation of a personal balance sheet.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
12) When the capital retention approach is used to determine how much life insurance to purchase, all of the
following are subtracted from total assets to calculate capital available to produce income EXCEPT
A) Social Security benefits. B) the amount of any educational funds.
C) final expenses. D) the value of household property.
Answer: A
Question Status: Revised
13) Disadvantages of the capital retention approach include which of the following? I. Assets are often
liquidated too quickly. II.
It underestimates the amount of life insurance needed.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
14) Tom and Nancy Boyle provide financial support for their two children. In addition, they provide financial
support for Tom!s aged father and Nancy!s aged mother. The Boyle family can be described as a
A) blended family. B) single-parent family.
C) two-income earner family. D) sandwiched family.
Answer: D
Question Status: Previous Edition
15) Julian, age 45, would like to determine how much life insurance to purchase using the human life value
approach. He assumes his average annual earnings over the next 20 years will be $40,000. Of this amount,
$20,000 is available annually for the support of his family. Julian will generate this income for 20 more years and
he believes that 5 percent is the appropriate interest (discount) rate. The present value of one dollar payable for
20 years at a discount rate of 5 percent is $12.46. What is Julian!s human life value?
A) $184,600 B) $249,200 C) $360,800 D) $400,000
Answer: B
Question Status: Previous Edition
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16) Jessica is an agent for LMN Life Insurance Company. She met with Brad, who was interested in purchasing
life insurance. Jessica explained the various uses of life insurance, including income for Brad!s wife during the 1or 2-year period following Brad!s death. This period is known as the
A) dependency period. B) estate clearance period.
C) blackout period. D) readjustment period.
Answer: D
Question Status: Previous Edition
17) Sarah is using the needs approach to determine how much life insurance to buy. Her cash needs are $30,000;
her income needs are $140,000; and special needs are $100,000. Sarah has the following assets: $20,000 in bank
accounts, $30,000 in retirement plans, and $40,000 in investment accounts. Sarah owns no individual life
insurance. She is covered by a $50,000 group life insurance policy through her employer. Based on this
information, how much additional life insurance should Sarah purchase?
A) $80,000 B) $130,000 C) $150,000 D) $160,000
Answer: B
Question Status: Previous Edition
18) Richard is using the capital retention approach to determine how much life insurance to purchase. Richard
would like to provide $35,000 per year to his family, forever, if he dies. The assets that he has today will provide
$25,000 in annual income without the liquidation of these assets. If life insurance proceeds can be invested to
earn a 5 percent annual return, how much life insurance should Richard purchase to fund the additional income
needed to meet the $35,000 annual income goal?
A) $10,000 B) $100,000 C) $150,000 D) $200,000
Answer: D
Question Status: Previous Edition
19) Bill is attempting to determine how much life insurance to purchase. He has two dependent children and his
wife does not work outside of the home. An advisor suggested that Bill should consider Social Security benefits
when doing his life insurance planning. One concern in this regard is the period after Social Security benefits to a
widow terminate until they resume again. This period is called the
A) blackout period. B) dependency period.
C) emergency period. D) readjustment period.
Answer: A
Question Status: Revised
20) When using the needs approach, several "special needs" should be considered. One special need is money to
cover unexpected events, such as major car repairs, dental bills, or home repairs. Money set aside for this
purpose is called a(n)
A) estate clearance fund. B) emergency fund.
C) readjustment period fund. D) mortgage redemption fund.
Answer: B
Question Status: Previous Edition
21) Most family heads need substantial amounts of life insurance. However, with limited income, money spent
on life insurance reduces the amount of discretionary income available for other high-priority needs. What an
insured person gives up when he or she purchases life insurance instead of using the premium dollars for other
purposes is called the
A) true cost of life insurance. B) net cost of life insurance.
C) real (inflation-adjusted) cost of life insurance. D) opportunity cost of buying life insurance.
Answer: D
Question Status: Previous Edition
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22) Which of the following statements about yearly renewable term insurance is (are) true? I. It requires
evidence of insurability for renewal. II.
It is most appropriate when an insured needs lifetime protection.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
23) What happens to the premiums for yearly renewable term insurance as an insured gets older? A) They
increase at an increasing rate.
B) They increase at a decreasing rate. C) They decrease at a constant rate. D) They remain level.
Answer: A
Question Status: Revised
24) All of the following statements about term insurance are true EXCEPT A) The insurance provides protection
for a specified period of time.
B) Most policies can be renewed for additional periods without evidence of insurability. C) Most policies can be
converted to a permanent life insurance policy. D) Most policies have a cash value that is refunded when
coverage ceases.
Answer: D
Question Status: Previous Edition
25) All of the following statements about the conversion of a term policy are true EXCEPT
A) Under an attained age conversion, the premium is based on the insured!s attained age at the time of
conversion.
B) Under an original age conversion, the policyowner must pay a financial adjustment in addition to the premium
for the new policy.
C) Most insurers require original age conversion to take place within a specified period (5 years, for example) of
the issue of the term policy.
D) Evidence of insurability is required before a conversion is permitted.
Answer: D
Question Status: Previous Edition
26) Which of the following statements about a decreasing term insurance policy is true? A) The face amount of
the policy decreases during the policy period, and the premium increases.
B) The face amount of the policy decreases during the policy period, but the premium remains level.
C) The premium decreases during the policy period, but the face amount remains constant.
D) Both the premium and the face amount of the policy decrease gradually over the policy period.
Answer: B
Question Status: Previous Edition
27) The purchase of term insurance is justified by which of the following circumstances? I. The insured wants
to save money through the policy for a specific need. II. The insured has a temporary need for life insurance
protection.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Revised
28) A legal reserve in life insurance is a result of
A) premium taxes payable by life insurance companies being postponed during the early policy years.
B) dividends being paid to policyowners. C) inadequate premiums in the early policy years being subsidized by
investment earnings. D) excess premiums in the early policy years being invested at compound interest.
Answer: D
Question Status: Previous Edition
29) The net amount at risk for a life insurance policy is the difference between the A) present value of future
benefits and the present value of future premiums.
B) face amount of the policy and the total premiums that have been paid. C) face amount of the policy and the
legal reserve. D) annual premium and the annual policyholder dividend.
Answer: C
Question Status: Previous Edition
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30) Which of the following statements about life insurance cash values is (are) true? I. Cash values are a result
of the level premium method of purchasing life insurance. II.
The cash value of a policy must always exceed
the policy!s legal reserve.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
31) All of the following statements about ordinary life insurance are true EXCEPT A) Premiums are level
throughout the policy period.
B) The face amount of the policy is paid if the insured lives to age 65. C) There is a build-up of cash value that
can be borrowed by the policyholder. D) It offers the policyholder the flexibility to meet a wide variety of
financial objectives.
Answer: B
Question Status: Previous Edition
32) Which of the following statements about limited-payment life insurance is true? A) It is a form of term
insurance.
B) It matures at the end of the premium-payment period. C) The premium decreases each year during the
premium-payment period. D) Its use may be appropriate if a person wants paid-up life insurance during
retirement.
Answer: D
Question Status: Previous Edition
33) Which of the following statements about endowment insurance policies is (are) true? I.
The face amount
is paid if the insured dies during the policy period or at the end of the policy period if the insured is still alive. II.
The use of endowment insurance has increased in recent years because of its favorable tax treatment.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
34) All of the following statements about variable life insurance are true EXCEPT A) The premium is level and
guaranteed not to increase.
B) The death benefit varies according to investment experience. C) The policyowner has the option of investing
the cash value in several investment accounts. D) Cash surrender values are subject to minimum guarantees.
Answer: D
Question Status: Previous Edition
35) All of the following statements about universal life insurance are true EXCEPT A) Interest is credited to the
policy!s cash value each month.
B) Any withdrawal of a policy!s cash value reduces the amount of the death benefit. C) Interest credited to a
policy!s cash value is taxable for the policyowner in the year credited. D) The policyowner can add to a policy!s
cash value at any time subject to policy guidelines.
Answer: C
Question Status: Previous Edition
36) Which of the following statements about universal life insurance is (are) true? I.
The interest rate credited
to the cash value at the time the policy is issued remains fixed for the life of the policy. II.
A monthly
deduction is made from the policy!s cash value for the cost of insurance protection.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
37) All of the following statements describe the flexibility available to the owner of a universal life insurance
policy EXCEPT
A) Policy loans are permitted on an interest-free basis. B) The frequency of premium payments can be varied.
C) The death benefit can be increased with evidence of insurability.
D) Premium payments can be any amount provided there is sufficient cash value to keep the policy in force.
Answer: A
Question Status: Previous Edition
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38) Which of the following statements about a variable universal life insurance policy is (are) true? I. There is
a minimum guaranteed interest rate for the cash value. II. The policyowner has a variety of investment options
for the cash value.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
39) All of the following statements about current assumption whole life insurance are true EXCEPT A) It is a
form of participating whole life insurance that pays annual dividends.
B) An accumulation account is credited with an interest rate based on market conditions and company
experience.
C) Under the low-premium version, the premium is subject to change after an initial guaranteed period.
D) Under the high-premium version, the premium may vanish after a period of time. Answer: A
Question Status: Previous Edition
40) Which of the following statements about an indeterminate-premium whole life insurance policy is (are) true?
I.
It permits the insurer to adjust premiums based on anticipated future experience. II.
It allows
policyholder dividends to be used to lower premiums.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
41) A whole life insurance policy in which premiums are reduced for an initial period (e.g. 3 years) and are
higher thereafter is an example of a
A) level-term policy. B) modified life policy.
C) limited-payment whole life policy. D) variable life policy.
Answer: B
Question Status: Previous Edition
42) Which of the following statements about policies sold to preferred risks is (are) true? I.
Preferred risks are
people whose mortality experience (deaths per thousand at a given age) is expected to be lower than average. II.
Insurers require preferred risks to purchase at least a minimum amount of life insurance, such as
$100,000.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
43) Which of the following statements about second-to-die life insurance is (are) true? I.
The insurance is a
form of endowment coverage. II.
The premium is lower than the combined cost of purchasing a life insurance
policy on each insured.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
44) Which of the following statements about savings bank life insurance is true? A) The maximum amount that a
depositor can purchase is $50,000.
B) The maximum amount of insurance that a depositor can purchase is limited to the amount of money on
deposit in his or her savings account with the savings bank.
C) The objective of savings bank life insurance is to provide protection to the bank in case a borrower dies before
a loan is repaid.
D) The objective of savings bank life insurance is to provide low-cost insurance to consumers by holding down
expenses.
Answer: D
Question Status: Previous Edition
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45) Which of the following statements about industrial life insurance (also called home service life insurance)
policies is true?
A) Most policies have a face value exceeding $100,000. B) Most industrial life insurance policies are cash value
coverage.
C) Industrial life insurance is group term insurance coverage marketed to employers. D) This popular product
accounts for over 40 percent of the life insurance sold today.
Answer: B
Question Status: Previous Edition
46) Michael wants to make sure that life insurance proceeds are available to pay his outstanding mortgage
balance if he dies. He purchased a type of life insurance in which the amount of coverage gradually declines, just
as his outstanding mortgage balance gradually declines. This type of life insurance is called
A) modified life insurance. B) decreasing term insurance.
C) re-entry term insurance. D) current assumption whole life.
Answer: B
Question Status: Previous Edition
47) Carl would like to purchase life insurance. He would also like to invest in a mutual fund. An agent told Carl
about a form of life insurance in which Carl could select where the saving component is invested. This form of
life insurance has fixed premiums and the cash value is not guaranteed. This type of life insurance is called
A) universal life insurance. B) current assumption whole life.
C) variable life insurance. D) indeterminate-premium whole life.
Answer: C
Question Status: Previous Edition
48) Tamara purchased a term insurance policy when she had high life insurance needs and limited income. Now
Tamara can afford whole life insurance. What term life insurance provision will permit Tamara to switch her
term insurance to whole life insurance without having to show that she is still insurable?
A) renewal provision B) tax-free exchange provision
C) conversion provision D) free look provision
Answer: C
Question Status: Previous Edition
49) Alex, age 26, purchased a 20-payment whole life insurance policy. After Alex has made 20 premium
payments, his life insurance policy is considered
A) matured. B) reduced. C) expired. D) paid-up.
Answer: D
Question Status: Previous Edition
50) Ann is considering the purchase of a life insurance policy with these characteristics: flexible premium
payments, the insurance and savings components are separate, the interest rate credited to the savings is tied to a
market interest rate but a minimum rate is guaranteed, and a monthly administrative fee is charged. Ann is
considering buying
A) whole life insurance. B) variable life insurance.
C) universal life insurance. D) current assumption whole life.
Answer: C
Question Status: Previous Edition
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51) Dave purchased a life insurance policy. The policy is nonparticipating and the cash values are based on the
insurer!s present mortality, investment, and expense experience. After 2 years, the insurer will recalculate the
premium based on the mortality, investment, and expense experience at that time. Dave purchased
A) current assumption whole life. B) variable life insurance.
C) universal life insurance. D) variable universal life insurance.
Answer: A
Question Status: Previous Edition
52) Which of the following $100,000 whole life insurance policies, issued by the same company to a man age 32,
would require the highest first-year premium?
A) continuous premium (ordinary) life B) whole life paid-up at 65
C) 10-payment whole life D) 20-payment whole life
Answer: C
Question Status: Previous Edition
53) Which of the following statements about variable universal life insurance is (are) true? I Variable universal
life insurance has fixed premium payments. II.
Variable universal life insurance allows the policyowner to
decide where the cash value is invested.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
Chapter 12 Life Insurance Contractual Provisions
1) Which of the following statements about the ownership of a life insurance policy is (are) true? I.
Under
the ownership clause, the policyowner and beneficiary equally share all contractual rights in the policy while the
insured is living. II. The policyowner can designate a new owner by filing an appropriate form with the
insurance company.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
2) Which of the following statements about the entire contract clause is true?
A) It allows the insurer to void a policy if the insured made misrepresentations to the agent when the policy was
purchased.
B) It specifies that all statements in the application are considered warranties.
C) It specifies that the life insurance policy and the attached application constitute the complete agreement
between the parties.
D) It prevents the insurance company from contesting a policy after it has been in force for two years during the
lifetime of the insured.
Answer: C
Question Status: Previous Edition
3) All of the following are reasons an insurer can contest a policy after the contestable period has ended
EXCEPT
A) The beneficiary purchased a policy with the intent of murdering the insured. B) An insurable interest did not
exist at the inception of the policy.
C) The applicant had someone else take the medical examination required for policy approval for her.
D) The policyowner concealed a material fact at the time of application.
Answer: D
Question Status: Revised
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4) Amy purchased a life insurance policy with the intent of committing suicide to pay all the debts that were
burdening her family. If she commits suicide 9 months after the policy is purchased, and the insurer is able to
prove that her death was a suicide, how much will be paid by the insurance company?
A) nothing, because the policy is void B) the premiums paid for the policy
C) the policy!s cash value D) the face value of the policy
Answer: B
Question Status: Previous Edition
5) Which of the following statements about the grace period in a life insurance contract is (are) true? I. It is
usually between 90 and 180 days in duration. II. If the insured dies during the grace period, the death benefit is
reduced by 50 percent.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
6) All of the following statements about the requirements to reinstate a lapsed life insurance policy are true
EXCEPT
A) Evidence of insurability is required.
B) The lapse must have resulted from something other than the surrender of the policy for its cash value.
C) All overdue premiums must be paid along with interest from the premium due dates. D) The policy must be
reinstated within 1 year.
Answer: D
Question Status: Previous Edition
7) Bert purchased a life insurance policy 4 years ago. He inadvertently stated that he was 3 years younger than
his actual age. If Bert dies today, how much will the insurance company pay?
A) nothing B) less than the policy face value
C) the policy face value D) more than the policy face value
Answer: B
Question Status: Previous Edition
Chapter 12 Life Insurance Contractual Provisions
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8) Which of the following statements about beneficiary designations is true?
A) A primary beneficiary is entitled to the death proceeds of a life insurance policy only if the contingent
beneficiary dies before the insured.
B) If a revocable beneficiary designation is used, the insured must obtain the beneficiary!s permission to exercise
most policy rights.
C) The effect of a class beneficiary is to divide death proceeds equally among the members of a particular group.
D) Naming the insured!s estate as primary beneficiary is the best way to avoid probate expenses, inheritance
taxes, and claims of creditors.
Answer: C
Question Status: Previous Edition
9) A contingent beneficiary in a life insurance policy has the right to A) receive the policy proceeds if the
primary beneficiary dies before the insured.
B) share the policy proceeds with the primary beneficiary. C) change the beneficiary designation under specified
circumstances. D) exercise policy rights if the insured is incapacitated.
Answer: A
Question Status: Previous Edition
10) Which of the following statements about the change of plan provision in a life insurance contract is (are)
true?
I.
A change to a lower premium policy results in a refund of the difference in the cash values of the two
policies. II. A change to a higher premium policy requires evidence of insurability.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
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11) Which of the following statements about the assignment of a life insurance policy is true?
A) The insurer must be notified of any assignment or the death proceeds will be paid to the named beneficiary.
B) Under an absolute assignment, the only right transferred to a new owner is the right to change the beneficiary
designation.
C) As long as a collateral assignment exists, a creditor will receive the entire death benefit even if the loan has
been paid off.
D) Assignment may be made only with the permission of the insurer and the beneficiary. Answer: A
Question Status: Previous Edition
12) Which of the following statements about assignments of life insurance policies is (are) true? I.
collateral assignment, the policyowner assigns a life insurance policy as collateral for a loan. II.
absolute assignment, only limited ownership rights in a policy are transferred.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Under a
Under an
Question Status: Previous Edition
13) The transfer of all ownership rights in a life insurance policy can be accomplished through a(n) A) absolute
assignment.
B) irrevocable beneficiary designation. C) incontestable clause. D) participating-policy provision.
Answer: A
Question Status: Previous Edition
14) Which of the following statements about life insurance policy loans is true? A) They are interest-free since
the policyowner is borrowing his or her own money.
B) They are forgiven if the insured dies before the loans are repaid. C) Newer policies carry higher fixed interest
loan rates than older policies. D) They must be repaid on the basis of a schedule determined at the time of the
loan.
Answer: C
Question Status: Previous Edition
Chapter 12 Life Insurance Contractual Provisions
141
15) All of the following statements about the automatic premium loan provision in a life insurance policy are true
EXCEPT
A) Its purpose is to prevent a policy from lapsing because of nonpayment of premium. B) The premium loan
requires interest to be paid at a stated contractual rate.
C) If the provision is used, the insured must show evidence of insurability to resume regular premium payments.
D) The policy proceeds will be reduced if the premium loans are not repaid by the time of death. Answer: C
Question Status: Revised
16) What major feature distinguishes a participating policy from a nonparticipating policy? A) the availability of
a waiver-of-premium provision
B) the existence of settlement options C) the payment of dividends D) the method by which beneficiaries can be
named
Answer: C
Question Status: Previous Edition
17) Sources of life insurance dividends include which of the following? I.
Excess interest earned on the
assets necessary to maintain legal reserves II.
Favorable mortality experience
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
18) All of the following are common dividend options found in participating whole life insurance policies
EXCEPT
A) reduction of premiums. B) dividend accumulations.
C) purchase of paid-up insurance. D) purchase of insurance company stock.
Answer: D
Question Status: Previous Edition
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19) Which of the following statements about dividend options is (are) true? I. The interest on dividends left to
accumulate with the insurer is not considered to be taxable income. II. Paid-up additions are a form of whole
life insurance.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
20) Advantages of selecting the paid-up additions dividend option in a life insurance policy include which of the
following? I. Evidence of insurability is not required to purchase additional insurance. II.
The additions are
purchased at net rates without loading for expenses.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
21) A dividend option that allows the policyowner to purchase 1-year term insurance is referred to as the
A) fifth dividend option. B) policy loan dividend option.
C) face value dividend option. D) family protection dividend option.
Answer: A
Question Status: Previous Edition
22) All of the following are nonforfeiture options found in cash value life insurance policies EXCEPT A) cash
value.
B) reduction of premiums. C) reduced paid-up insurance. D) extended term insurance.
Answer: B
Question Status: Revised
Chapter 12 Life Insurance Contractual Provisions
143
23) Which of the following statements about nonforfeiture options found in life insurance policies is true?
A) Under the reduced paid-up option, the paid-up policy is term insurance. B) Under the extended term option,
the amount of term insurance is less than the face value of
the surrendered cash value policy.
C) Under the reduced paid-up option, no additional premiums must be paid.
D) Unless the policyowner has selected another nonforfeiture option, the cash value option goes into effect
automatically.
Answer: C
Question Status: Revised
24) All of the following statements about the interest settlement option are true EXCEPT A) The minimum
guaranteed interest rate is usually equal to the prime rate.
B) The interest can be paid monthly, quarterly, semiannually, or annually. C) The beneficiary may be allowed to
withdraw part or all of the proceeds. D) The beneficiary may be allowed to change to another settlement option.
Answer: A
Question Status: Revised
25) Which of the following statements about life insurance settlement options is true?
A) Under the fixed period option, the beneficiary normally has the right to make partial withdrawals in case of
emergency.
B) Under the fixed period option, any remaining proceeds revert to the insurer if the beneficiary dies before the
end of the fixed period.
C) Under the fixed amount option, the beneficiary can be given the right to increase or decrease the fixed
amount.
D) Under the fixed amount option, any interest credited in excess of the guaranteed rate increases the amount of
each periodic payment.
Answer: C
Question Status: Previous Edition
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26) Which of the following statements about life income settlement options is (are) true? I.
Under a joint-andsurvivor life income option, payments cease at the death of the first annuitant. II. Under a life income with period
certain, a contingent beneficiary is guaranteed a minimum number of payments regardless of when the primary
beneficiary dies.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
27) Disadvantages of life insurance settlement options include which of the following? I.
Higher yields can
often be obtained elsewhere. II.
Life income options have limited usefulness at younger ages.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
28) Which of the following statements about the waiver-of-premium provision is true? A) Because the
probability of becoming disabled exceeds the probability of premature death, the
cost to include this provision is usually prohibitive at younger ages. B) Premiums are usually waived if the
insured becomes partially disabled.
C) Life insurance protection continues in force during a period of disability, but dividends cease and cash values
are reduced.
D) The disability must occur before a stated age, such as 65, for premiums to be waived. Answer: D
Question Status: Previous Edition
29) All of the following are requirements that must be satisfied before premiums are waived under a waiver-ofpremium provision EXCEPT
A) The insured must furnish proof of disability to the insurer. B) The insured must be disabled before some
specified age, such as age 60 or 65.
C) The insured must satisfy the definition of disability. D) The insured must satisfy a 2-year waiting period.
Answer: D
Question Status: Previous Edition
Chapter 12 Life Insurance Contractual Provisions
145
30) Which of the following statements about the guaranteed purchase option is true? A) An insured usually has
24 months to exercise an option.
B) The option cannot be exercised until the insured reaches age 40.
C) The amount of life insurance that can be purchased at each option is limited to 10 percent of the face amount
of the basic policy.
D) The additional coverage can be purchased without demonstrating insurability. Answer: D
Question Status: Revised
31) Which of the following statements about the guaranteed purchase option is true? A) It is usually available
with term insurance policies.
B) The premium when an option is exercised is based on the insured!s age at the time the basic policy was issued.
C) The option permits the insured to purchase specified amounts of life insurance in the future even if the insured
is in substandard health or has become uninsurable.
D) If a guaranteed purchase option expires without being used, it can simply be exercised at a later date.
Answer: C
Question Status: Revised
32) Which of the following statements about a typical accidental death benefit rider is (are) true? I.
Death
must occur within 14 days of the covered accident. II.
The accidental death must occur prior to some
specified age.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
33) Reasons for NOT purchasing an accidental death benefit rider include which of the following? I. Most
people die as a result of a disease rather than from an accident. II. The economic value of a human life is not
increased if death occurs because of an accident.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
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34) The cost-of-living rider typically bases increases in the policy face value on changes in the A) gross national
product.
B) interest rate for short-term U.S. government securities. C) consumer price index. D) national wage level.
Answer: C
Question Status: Previous Edition
35) Which of the following statements about accelerated death benefits riders is (are) true? I. Under a terminal
illness rider, after a partial payment is made to the insured, there is a reduction in the face amount of insurance,
cash value, and premiums. II.
Benefits under a long-term care rider are for home health care only.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
36) The practice of buying the life insurance policy of a terminally ill insured at a discount is referred to as a
A) collateral assignment. B) viatical settlement.
C) catastrophic illness conversion. D) grace period transaction.
Answer: B
Question Status: Previous Edition
37) Al was named the beneficiary in his mother!s life insurance policy. His mother died during the contestable
period. The insurer denied payment, citing a material misrepresentation on the application. Al believes the
insurer should pay the claim because the misrepresentation occurred on the application, and the application is not
part of the formal agreement between the insurer and the policyholder. Which provision protects the insurer by
making the application part of the formal agreement between the parties to the contract?
A) incontestable clause B) entire contract clause
C) ownership clause D) reinstatement clause
Answer: B
Question Status: Previous Edition
Chapter 12 Life Insurance Contractual Provisions
147
38) Cal purchased a whole life policy 6 years ago. The policy requires annual premium payments. Cal forgot to
pay the premium that was due 2 weeks ago. He wonders if his life insurance is still in force. Which life insurance
policy provision is designed to keep the policy in force for a short time even if the premium payment is late?
A) waiting period B) grace period
C) guaranteed purchase option D) reinstatement clause
Answer: B
Question Status: Revised
39) Bruce lied about his health history when he purchased a life insurance policy. He died 3 years after the policy
was issued. Which life insurance policy provision will require the life insurer to pay the beneficiary even though
Bruce lied on the application?
A) incontestable clause B) entire contract clause
C) ownership clause D) change-of-plan provision
Answer: A
Question Status: Previous Edition
40) Which life insurance policy provision specifies that it is the policyowner, and not the insured or beneficiary,
who possesses all contractual rights while the policy is in force?
A) nonforfeiture options B) entire contract clause
C) incontestable clause D) ownership clause
Answer: D
Question Status: Previous Edition
41) Becky is considering the purchase of a whole life policy on her own life. She is concerned that if she
becomes disabled, paying premiums will become a burden. Which provision can Becky attach to her life
insurance policy to address this concern?
A) guaranteed purchase option B) waiver-of-premium provision
C) accidental death benefit rider D) accelerated death benefits rider
Answer: B
Question Status: Revised
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42) Tim purchased a 10-payment whole life insurance policy 15 years ago. Tim would like to donate this paid-up
policy to a charity. Under which policy provision can Tim transfer all ownership rights in the policy to the
charity?
A) absolute assignment B) extended term nonforfeiture option
C) reinstatement D) collateral assignment
Answer: A
Question Status: Previous Edition
43) Beth purchased a participating life insurance policy 6 years ago. Her life insurance needs have increased, but
she has developed a medical condition that makes it impossible for her to purchase more life insurance at
affordable premiums. Which dividend option makes sense for Beth to use given her medical condition?
A) cash B) apply to premium
C) dividend accumulations D) paid-up additions
Answer: D
Question Status: Previous Edition
44) Lionel purchased a $200,000 ordinary life insurance policy when he was 25 years old and had significant life
insurance needs. Now Lionel is 50. His mortgage is almost paid-off and his children have left home and are
financially independent. Lionel no longer wants to pay premiums, but he would like to have some permanent life
insurance in force. Which nonforfeiture option could Lionel employ to meet these objectives?
A) cash value B) reduced paid-up insurance
C) paid-up additions D) extended term insurance
Answer: B
Question Status: Previous Edition
Chapter 12 Life Insurance Contractual Provisions
149
45) Jane purchased a life insurance policy on her own life and named her daughter, Cheryl, the beneficiary.
Cheryl has a history of not managing money well. Jane wants the death benefit paid to Cheryl in monthly
installments over 20 years. Which settlement option should Jane pre-select for Cheryl?
A) lump sum B) fixed amount
C) fixed period D) interest option
Answer: C
Question Status: Previous Edition
46) Malcolm would like to purchase life insurance. He is concerned that he might need additional life insurance
in the future and that he might be uninsurable at that time. What provision can Malcolm add to his life insurance
policy that will permit him to purchase additional life insurance at specified times in the future without providing
evidence of insurability?
A) double indemnity rider B) guaranteed purchase option
C) waiver-of-premium provision D) accelerated death benefits rider
Answer: B
Question Status: Previous Edition
47) Which of the following statements is (are) true concerning settlement options? I.
A straight life annuity
provides the lowest periodic income of all the life income options. II.
Fixed-period and fixed-amount are life
income options.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: New
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48) Which of the following statements is (are) true concerning the automatic premium loan provision? I.
Unlike other policy loans, interest is not charged on automatic premium loans. II.
of an automatic premium loan is to prevent a life insurance policy from lapsing.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
The basic purpose
Question Status: New
Chapter 13 Buying Life Insurance
1) Major factors that must be considered in determining the cost of life insurance include all of the following
EXCEPT
A) time value of money. B) premiums paid.
C) settlement options. D) dividends.
Answer: C
Question Status: Previous Edition
2) Under the traditional net cost method, the net cost of life insurance for a given period (e.g., 20 years) is
determined by which of the following formulas?
A) the total premiums for the period less the policy reserve at the end of the period.
B) the total premiums for the period less the sum of the total dividends received during the period and the cash
value at the end of the period.
C) the sum of the total premiums and dividends for the period less the cash value at the end of the period.
D) the sum of the total dividends received during the period and the cash value at the end of the period less the
total premiums paid for the period.
Answer: B
Question Status: Previous Edition
3) Which of the following statements about the traditional net cost method of measuring the cost of life insurance
is (are) true? I.The traditional net cost method does not consider the time value of money. II. The traditional net
cost method can show that life insurance has a negative cost.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
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4) All of the following statements about the surrender cost index for measuring the cost of life insurance are true
EXCEPT
A) It is based on a specific time period, such as 10 or 20 years. B) It takes into account the settlement options
available in the policy.
C) It requires that annual premiums be accumulated at a specified interest rate. D) It takes the amount and timing
of each dividend into consideration.
Answer: B
Question Status: Previous Edition
5) Which of the following statements describes how the net payment cost index differs from the surrender cost
index?
A) Dividends are ignored. B) The cash value is ignored.
C) Premiums are not accumulated at a specified interest rate. D) Dividends are not accumulated at a specified
interest rate.
Answer: B
Question Status: Previous Edition
6) David purchased a $100,000 participating whole life policy. The annual premium is $2,280. Projected
dividends for the first 20 years are $15,624. The cash value after 20 years will be $35,260. If the premiums were
invested at 5 percent for 20 years, the premiums would grow to $79,156. If the dividends were accumulated at 5
percent for 20 years, they would grow to be $24,400. The amount to which $1 deposited annually will
accumulate in 20 years at 5 percent is $34.719. Based on this information, what is the traditional net cost per
thousand per year of David!s policy over the 20-year period?
A) -$1.52 B) -$2.64
C) $5.17 D) $9.75
Answer: B
Question Status: Previous Edition
7) David purchased a $100,000 participating whole life policy. The annual premium is $2,280. Projected
dividends for the first 20 years are $15,624. The cash value after 20 years will be $35,260. If the premiums were
invested at 5 percent for 20 years, the premiums would grow to $79,156. If the dividends were accumulated at 5
percent for 20 years, they would grow to be $24,400. The amount to which $1 deposited annually will
accumulate in 20 years at 5 percent is $34.719. Based on this information, what is the surrender cost per
thousand per year of David!s policy over the 20-year period?
A) $5.62 B) $13.75 C) $15.77 D) $27.38
Answer: A
Question Status: Previous Edition
8) David purchased a $100,000 participating whole life policy. The annual premium is $2,280. Projected
dividends for the first 20 years are $15,624. The cash value after 20 years will be $35,260. If the premiums were
invested at 5 percent for 20 years, the premiums would grow to $79,156. If the dividends were accumulated at 5
percent for 20 years, they would grow to be $24,400. The amount to which $1 deposited annually will
accumulate in 20 years at 5 percent is $34.719. Based on this information, what is the net payment cost per
thousand per year of David!s policy over the 20-year period?
A) $5.62 B) $13.75 C) $15.77 D) $27.38
Answer: C
Question Status: Previous Edition
9) Which of the following statements about the use of interest-adjusted cost data for comparing life insurance
policies is (are) true? I.
Using interest-adjusted cost data provides a more accurate measure of the cost of
life insurance than is provided if the time value of money is ignored. II. Its use is most appropriate in deciding
between policies when the cost variation is very small.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
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10) Which of the following statements about the Linton yield is (are) true? I.
It is based on the assumption
that a cash-value policy can be viewed as a combination of insurance protection and a savings fund. II. It is the
average compound annual rate of return required to make the savings deposits in a life insurance policy equal to
the policy!s guaranteed cash value at the end of a specified period.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
11) Which of the following statements about the yearly-rate-of-return method (also known as the Belth method)
of calculating the yearly rate of return for a life insurance policy is (are) true? I. The formula requires the use of
benchmark prices per $1,000 of protection. II.
The main drawback of the formula is its complexity,
necessitating the use of a computer to calculate the rate of return.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
12) Consumer experts typically recommend all of the following rules when buying life insurance EXCEPT
A) Consider the financial strength of the insurer. B) Deal with a competent agent.
C) Ignore all factors other than cost. D) Shop around for a low-cost policy.
Answer: C
Question Status: Previous Edition
13) Consumer experts typically recommend which of the following rules for purchasing life insurance? I.
Avoid policies which pay dividends. II.
Purchase life insurance equal to ten times your annual salary.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
14) Why might the use of "grades" assigned by a life insurance company rating organization not be a reliable
guide for consumers? I.
There are wide variations in grades given by the different rating organizations. II.
They ignore factors such as profitability and quality of investments.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
15) Marshall is interested in determining the cost per thousand of his life insurance policy. Which of the
following will provide Marshall the most meaningful measure of the cost per thousand dollars per year of his life
insurance?
A) the needs approach B) the traditional net cost method
C) the human life value approach D) the surrender cost index
Answer: D
Question Status: Previous Edition
Chapter 13 Buying Life Insurance
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16) Lynn calculated the future value of the first twenty premiums she will pay under her nonparticipating whole
life insurance policy. Then she subtracted the cash value after 20 years. Next, she divided this value by the future
value annuity due factor for 20 years to arrive at an annual cost of insurance. Finally, she divided the annual cost
by the number of thousands of dollars of life insurance purchased to arrive at the cost per thousand per year.
Lynn calculated the
A) traditional net cost per thousand per year. B) the Linton Yield.
C) the surrender cost per thousand per year. D) the net payment cost per thousand per year.
Answer: C
Question Status: Previous Edition
17) Which method of analyzing the cost of life insurance does not consider the cash value of the policy in the
analysis?
A) traditional net cost method B) net payment cost index
C) the Linton Yield D) the surrender cost index
Answer: B
Question Status: Previous Edition
18) Mary is interested in comparing life insurance policies. Rather than looking at the cost per thousand, she
would like to compare the rate of return earned on the savings portion of the policy. Which of the following
would be of the most interest to Mary?
A) the policy!s Linton Yield B) the policy!s surrender cost
C) the policy!s traditional net cost D) the policy!s net payment cost
Answer: A
Question Status: Previous Edition
19) Which of the following statements is (are) true regarding taxation of life insurance? I.
Life insurance
proceeds paid in a lump-sum are received free of federal income taxes. II.
The policyowner must pay taxes
annually on the amount by which the cash value of his or her life insurance policy has increased.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
20) The first step in "shopping for life insurance" is to A) estimate the amount of life insurance to purchase.
B) decide whether you want a policy which pays dividends. C) determine if you need life insurance. D) decide on
the best type of life insurance for you.
Answer: C
Question Status: Previous Edition
21) Lisa does not want her life insurance policy included in her gross estate when she dies. Lisa can remove the
life insurance policy from her estate if she does which of the following more than 3 years before she dies?
A) borrow on the cash value of the policy B) make an absolute assignment of the policy to someone else
C) change the beneficiary to someone who does not have insurable interest D) select a lump sum settlement
option and name her estate the beneficiary
Answer: B
Question Status: Previous Edition
22) Brad owns a cash value life insurance policy. Last year, the cash value increased by $300. Brad received
$100 in policyowner dividends on the policy last year. Brad was the beneficiary named in his grandmother!s
$50,000 life insurance policy. When she died this past year, Brad received $50,000. How much taxable income
relating to life insurance must Brad report for federal income tax purposes?
A) $0 B) $100
C) $400 D) $50,400
Answer: A
Question Status: Previous Edition
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23) Carl and Carol Williams, a married couple, are doing some estate planning. Upon his death, Carl plans to
leave $1,000,000 in property to his wife. This amount will reduce the value of Carl!s gross estate and will be
taxed later when Carol dies. This reduction of the gross estate is called the
A) unified tax credit. B) taxable estate.
C) capital gains deduction. D) marital deduction.
Answer: D
Question Status: Previous Edition
24) Paul is shopping for a life insurance policy. An agent asked Paul if he would like to purchase a participating
policy. What is a "participating" policy?
A) a policy which has a cash value B) a policy which pays dividends
C) a policy which invests in common stock D) a policy which provides for an increasing death benefit
Answer: B
Question Status: Previous Edition
25) Each of the following helps to reduce federal estate taxes EXCEPT A) the marital deduction.
B) the applicable unified tax credit amount. C) life insurance policies in which the deceased had an incident of
ownership. D) expenses such as the cost of the funeral, estate settlement costs, and probate costs.
Answer: C
Question Status: Previous Edition
26) Which of the following statements is (are) true with regard to using interest-adjusted cost data when
shopping for life insurance? I.
Cost indexes apply to new policies and should not be used to determine
whether to replace a policy. II.
Cost indexes should only be used to compare similar plans of insurance.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
27) All of the following statements about the tax treatment of individually-purchased life insurance are true
EXCEPT
A) policyowner dividends are received tax-free. B) the annual increase in cash value is not taxable while the
policy remains in force.
C) premiums paid for individual life insurance are a tax deductible expense. D) life insurance proceeds paid to a
beneficiary in a lump-sum are received tax-free.
Answer: C
Question Status: Previous Edition
28) Which of the following statements is (are) true about the federal estate tax? I.
The gross estate can be
reduced by a number of deductions. II.
If the person who died had any ownership interest in a life insurance
policy at the time of death, the proceeds are included in the gross estate for federal estate tax purposes.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
29) Life insurance policy reserves A) are another name for the policy!s cash value.
B) are a major asset of life insurance companies. C) are paid to the beneficiary when the insured dies. D) are a
major liability of life insurance companies.
Answer: D
Question Status: New
30) Purposes of life insurance policy reserves include which of the following? I. Generation of investment
income. II.
Formal recognition of the obligation to pay future claims.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: New
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31) The difference between the present value of future benefits payable under a life insurance policy and the
present value of net premiums for the policy is the policy!s
A) retrospective reserve. B) policyholders surplus.
C) prospective reserve. D) admitted assets.
Answer: C
Question Status: New
32) The policy reserve at the end of any given policy year is called the A) terminal reserve.
B) unearned premium reserve. C) mean reserve. D) initial reserve.
Answer: A
Question Status: New
33) To level a net single premium (NSP), the NSP is divided by A) the maximum number of years the premium
could be paid.
B) the ordinary life annuity factor for the premium payment period. C) the life annuity due due factor for the
premium payment period. D) the deferred life annuity factor for the premium payment period.
Answer: C
Question Status: New
34) The gross premium is defined as A) the net premium plus the loading allowance.
B) the terminal reserve plus the commission. C) the net premium minus expenses. D) the sum of all acquisition
expenses.
Answer: A
Question Status: New
Chapter 14 Annuities and Individual Retirement
Accounts
1) Which of the following statements is (are) true with respect to annuities? I. Annuities are the opposite of
life insurance. II.
The fundamental purpose of annuities is to replace lost income in case of premature death.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
2) In offering life annuities, what risk is the insurer pooling? A) bad investment performance
B) premature death C) bad expense experience D) excessive longevity
Answer: D
Question Status: Previous Edition
3) Annuity payments are made up of all of the following EXCEPT A) return of premiums.
B) interest earnings. C) unliquidated principal of annuitants who live too long. D) unliquidated principal of
annuitants who die early.
Answer: C
Question Status: Previous Edition
4) Margaret paid an insurance company $50,000 when she was 50 years old. At age 62, Margaret plans to begin
to receive payments from the insurer. Based on the description provided, this annuity can be described as a(n)
A) deferred annuity. B) life annuity with guaranteed payments.
C) immediate annuity. D) variable annuity.
Answer: A
Question Status: Previous Edition
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5) Cassie, age 62, paid a life insurer $100,000 in exchange for a life annuity. If Cassie dies before receiving 120
monthly payments from the insurer, the remaining payments will be made to a beneficiary. If Cassie dies after
receiving 120 payments, no additional payments are made by the insurer. Cassie purchased a
A) variable annuity. B) life annuity with guaranteed payments.
C) installment refund annuity. D) cash refund annuity.
Answer: B
Question Status: Previous Edition
6) Which of the following statements is (are) true with respect to a joint-and-survivor annuity? I.
Some
joint-and-survivor annuities reduce the income payment after the first annuitant dies. II. No payments are made
until after the first annuitant has died.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
7) During the funding period, the premiums paid for a variable annuity are used to purchase A) annuity units.
B) immediate participation shares. C) mutual fund shares. D) accumulation units.
Answer: D
Question Status: Revised
8) Brad funded a life annuity through installment payments. At age 60, he decided to elect an annuity settlement
option and to begin to receive payments. Which of the following life income options will provide Brad with the
highest monthly income?
A) life annuity (no refund) B) life income with payments guaranteed for 5 years
C) life income with payments guaranteed for 10 years D) installment refund annuity
Answer: A
Question Status: Previous Edition
Chapter 14 Annuities and Individual Retirement Accounts
163
9) Which of the following statements is (are) true with respect to the cash (lump sum) annuity settlement option?
I.
The taxable portion of the distribution is subject to federal and state income taxes. II. The option results
in adverse selection against the insurer as those in poor health are more likely to take cash than to annuitize the
funds.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
10) Which of the following statements is (are) true with respect to variable annuities? I. The price at which
accumulation units can be purchased fluctuates during the funding period. II.
The value of annuity units
fluctuates over time.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
11) Bridget started to fund a variable annuity. Three years later, she experienced financial difficulty. She called
her agent and cancelled the contract. The insurer returned all but 4 percent of the account balance. The 4 percent
kept by the insurer is a(n)
A) account administration fee. B) investment management fee.
C) front-end load. D) surrender charge.
Answer: D
Question Status: Revised
12) Insurers offering variable annuities charge a number of expenses. One category of expenses is to pay the fund
manager and to pay brokerage fees. This expense is the
A) investment management charge. B) administrative charge.
C) surrender charge. D) front-end load.
Answer: A
Question Status: Previous Edition
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13) Insurers offering variable annuities charge a number of fees and expenses. One category of fees and expenses
is to cover the cost of record keeping, paperwork, and periodic reports to annuity owners. This expense is the
A) investment management charge. B) surrender charge.
C) administrative charge. D) front-end load.
Answer: C
Question Status: Previous Edition
14) All of the following statements about variable annuities are true EXCEPT A) The periodic payments
received by the annuitant fluctuate.
B) Variable annuities typically provide a guaranteed death benefit payable to a beneficiary if the annuitant dies
prior to retirement.
C) Insurers offering variable annuities charge a variety of fees and expenses. D) Although the value of annuity
units fluctuates, accumulation units have a fixed value.
Answer: D
Question Status: Previous Edition
15) Which of the following statements is (are) true with respect to an equity-indexed annuity? I.
The
maximum percentage gain is usually capped. II. There is no downside protection against loss of principal if
the annuity is held to term.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
16) With an equity-indexed annuity, what name is given to the method of crediting excess interest to the annuity?
A) the capitation method B) the indexing method
C) the distribution method D) the earnings method
Answer: B
Question Status: Previous Edition
Chapter 14 Annuities and Individual Retirement Accounts
165
17) Under an equity-indexed annuity, what name is given to the percentage increase in the stock index that is
credited to the contract?
A) the expense rate B) the exclusion ratio
C) the indexing rate D) the participation rate
Answer: D
Question Status: Revised
18) Which of the following statements regarding the taxation of individual annuities is (are) true? I.
The
exclusion ratio is the percentage of the annuity income that is taxable. II. After the net cost of the annuity has
been paid to the annuitant, the total annuity payment is taxable.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
19) Juanita paid a life insurer $45,000 in exchange for an immediate life annuity. Juanita will receive $500 per
month from the insurer, and her life expectancy is 15 years (180 months). What is the exclusion ratio in this
case?
A) 33.33 percent B) 40.00 percent C) 50.00 percent D) 66.67 percent
Answer: C
Question Status: Previous Edition
20) Juanita paid a life insurer $45,000 in exchange for an immediate life annuity. Juanita will receive $500 per
month from the insurer, and her life expectancy is 15 years (180 months). Assume that Juanita receives 12
monthly payments of $500 the first year. How much taxable income must she report?
A) $3,000 B) $4,000 C) $4,500 D) $6,000
Answer: A
Question Status: Previous Edition
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21) Juanita paid a life insurer $45,000 in exchange for an immediate life annuity. Juanita will receive $500 per
month from the insurer, and her life expectancy is 15 years (180 months). If Juanita is alive 20 years later, how
much of the $6,000 received during the year is taxable?
A) nothing B) $3,000 C) $4,500 D) $6,000
Answer: D
Question Status: Previous Edition
22) Which of the following statements is (are) true regarding the taxation of distributions from individual
annuities? I. Individual annuity distributions are never taxable. II.
Once the annuitant has recovered the
premiums he or she paid for the annuity, the entire annuity distribution is taxable.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
23) All of the following are permissible IRA investments EXCEPT A) mutual funds.
B) life insurance. C) individual stocks. D) bonds.
Answer: B
Question Status: Revised
24) Which of the following statements is (are) true regarding the Roth IRA? I.
deductible. II. Roth IRA investment income accumulates income-tax free.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Roth IRA contributions are tax
Question Status: Previous Edition
Chapter 14 Annuities and Individual Retirement Accounts
167
25) Rita is 66 years old. She earned $20,000 this year working part-time at a store and her modified adjusted
gross income was $28,000. Rita is considering making a $3,000 contribution to her traditional IRA. Which of the
following statements is true regarding this contribution?
A) Rita cannot contribute to her traditional IRA because she is over age 65. B) Rita can make a $3,000
contribution to her traditional IRA, but it is not tax deductible.
C) Rita can make a $3,000 contribution to her traditional IRA, but it is only partially tax deductible.
D) Rita can make a $3,000 contribution to her traditional IRA, and it is fully tax deductible. Answer: D
Question Status: Revised
26) Cheryl, age 42, quit her job. Her employer offered a defined contribution pension plan, and the balance in the
account was $30,000 when Cheryl quit. She can avoid immediate taxation of these funds by
A) taking a lump-sum distribution. B) using an IRA rollover account.
C) receiving the money through four equal installments. D) using the funds to purchase common stock issued by
the former employer.
Answer: B
Question Status: Previous Edition
27) Which of the following statements is (are) true with regard to Roth IRAs? I. The portion of a Roth IRA
distribution that is attributable to investment income is taxable. II. There is a maximum income level above
which Roth IRA contributions are not allowed.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
28) All of the following statements about traditional and Roth IRAs are true EXCEPT A) Traditional IRA
contributions may be fully, partially, or not income tax deductible.
B) Qualified distributions from Roth IRAs are received income tax free. C) Contributions to Roth IRAs are made
with after-tax dollars. D) Traditional IRAs are exempt from the penalty tax on premature distributions.
Answer: D
Question Status: Previous Edition
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29) Which of the following persons can establish a traditional IRA? I.
Persons whose only income received is
from investments. II. Employed persons under age 70.5 who are not active participants in an employer sponsored retirement plan.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
30) Donna is single and earns $30,000 annually. She is covered under her employer!s retirement plan. Donna
would like to start a traditional IRA and contribute $3,000 this year. Which of the following describes her ability
to establish a traditional IRA and the tax treatment of her contribution?
A) Her contribution is fully tax deductible. B) Her contribution is partially tax deductible.
C) No portion of the contribution is tax deductible. D) Donna is not eligible to establish a traditional IRA, so no
contribution can be made.
Answer: A
Question Status: Revised
31) Which of the following statements about the withdrawal of funds from a traditional IRA is true?
A) Withdrawals of deductible contributions between the ages of 59.5 and 65 are subject to a tax penalty unless
they are withdrawn because of specified circumstances such as death or long-term disability.
B) Amounts attributable to nondeductible contributions are fully taxable as ordinary income when received.
C) Withdrawals must begin no later than April 1 of the year following the calendar year in which an individual
attains age 70.5.
D) Withdrawals must be taken in the form of an annuity.
Answer: C
Question Status: Revised
Chapter 14 Annuities and Individual Retirement Accounts
169
32) All of the following are circumstances under which withdrawals from a traditional IRA may be made prior to
age 59.5 without incurring a substantial penalty EXCEPT
A) The withdrawal is in substantially equal installments paid over the individual!s life expectancy.
B) The withdrawal is used to pay living expenses after unemployment insurance benefits cease.
C) The withdrawal is used to pay unreimbursed medical expenses that exceed 7.5 percent of adjusted gross
income.
D) The withdrawal is because of income needed due to the individual!s disability. Answer: B
Question Status: Previous Edition
33) Which of the following statements regarding individual retirement account s (IRAs) is (are) true? I. If an
individual!s only income during the year is from investments, he or she cannot make an IRA contribution. II.
The funds in the IRA can be used to purchase life insurance on the owner.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
34) Which of the following statements is (are) true with regard to IRAs? I.
Contribution limits are higher
for workers aged 50 and older. II. A spouse who does not work outside of the home may make a fully
deductible contribution to a traditional IRA even if his or her spouse is covered by a retirement plan at work.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
35) The fundamental purpose of a variable annuity is A) to provide funding flexibility to the purchaser.
B) to provide a hedge against inflation. C) to fund the purchase of cash value life insurance. D) to guarantee a
fixed-dollar benefit throughout retirement.
Answer: B
Question Status: New
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36) An immediate life annuity offers all of the following benefits EXCEPT A) Interest income can be earned
during the long deferral period until annuity payments begin.
B) Simplicity for the purchaser as he or she does not have to manage investment funds. C) Security for the
purchaser as stable lifetime income that cannot be outlived is provided. D) The principal is safe as the funds are
guaranteed by the assets of the insurer.
Answer: A
Question Status: New
37) Which of the following statements is (are) true with regard to the inflation-indexed annuity option? I.
The initial monthly payment is lower than the initial payment a fixed annuity would have provided if
purchased at the same age. II.
Periodic payments to the annuitant are adjusted for inflation.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: New
38) Which of the following statements about converting a traditional IRA to a Roth IRA is (are) true? I. Such
conversions can be done with no income tax consequences. II.
Qualified distributions from a Roth IRA after a
conversion are received tax-free.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: New
Chapter 15 Individual Health Insurance Coverages
1) Problems with the current health care system in the United States include which of the following? I. A large
number of people are without health care coverage. II.
high.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
The administrative costs of delivering health care are
Question Status: Previous Edition
2) The basic benefits provided by individual hospital expense insurance coverage include which of the
following? I. Daily hospital benefits II.
Miscellaneous hospital expenses, such as X-rays and lab tests
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
3) Which of the following statements about hospital-surgical insurance plans is true? A) Most insurers use a
schedule approach to determine reimbursement for surgical procedures.
B) Most insurers pay a flat dollar amount per day spent in the hospital. C) Hospital insurance also covers X-rays,
inpatient drugs, and lab tests. D) Outpatient care is excluded from coverage.
Answer: C
Question Status: Revised
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4) Which of the following statements about a schedule of surgical operations found in a surgical expense
insurance policy is true?
A) Covered surgical procedures are listed, and the surgeon can charge the usual, reasonable, or customary fee for
performing the covered procedures.
B) It specifies the number of times that surgical procedures must be performed in order to be covered in full.
C) It lists the maximum dollar amount that will be paid for each surgical procedure. D) It is a list of the surgical
procedures that are excluded.
Answer: C
Question Status: Previous Edition
5) Which of the following statements about surgical expense policies that reimburse physicians on the basis of
reasonable and customary charges is (are) true? I. To determine if a fee for a medical procedure is reasonable
and customary, it is compared to what other physicians in the same area charge for the procedure.
II.
A schedule of surgical procedures and dollar amounts payable is included in the policy and all surgeons
are paid the scheduled amount for the same procedure.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
6) Which of the following would be covered by the physicians! visits benefit portion of a hospital-surgical
insurance plan?
A) cost of a minor surgical procedure performed in a doctor!s office B) cost of a surgical procedure performed at
a hospital
C) outpatient lab tests and X-rays D) nonsurgical treatment provided by a doctor at a hospital
Answer: D
Question Status: Revised
7) Major medical insurance is characterized by which of the following? A) internal limits for all categories of
expenses
B) high maximum limits C) no exclusions D) no coinsurance
Answer: B
Question Status: Previous Edition
Chapter 15 Individual Health Insurance Coverages
173
8) The length of time major medical benefits will be paid after a deductible is satisfied is called a A) benefit
period.
B) deductible runoff. C) coinsurance period. D) stop limit.
Answer: A
Question Status: Previous Edition
9) Which of the following statements about a common accident provision in a major medical insurance policy is
true?
A) It specifies the types of accidents that are covered without deductibles or coinsurance.
B) It specifies the method for apportioning insurance coverage among two or more policies covering an accident.
C) It specifies that only one deductible has to be satisfied if two or more family members are injured in the same
accident.
D) It provides disability income benefits if an insured is disabled from an accident that also results in medical
expenses.
Answer: C
Question Status: Revised
10) Purposes of the coinsurance provision in major medical insurance policies include which of the following?
I.
To reduce premiums. II.
To prevent overutilization of policy benefits.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
11) The effect of a stop-loss limit in a major medical insurance policy is to A) limit the lifetime benefits payable
under the policy.
B) put a cap on annual benefits that will be paid.
C) prevent the insured from receiving duplicate benefits if medical expenses are also covered under workers
compensation insurance.
D) cover 100 percent of eligible medical expenses after an insured has incurred a specified amount of out-ofpocket expenses.
Answer: D
Question Status: Revised
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12) All the following are common exclusions in a major medical insurance policy EXCEPT A) routine dental
care.
B) surgeons! fees. C) expenses covered by workers compensation laws. D) cost of eyeglasses.
Answer: B
Question Status: Previous Edition
13) Which of the following statements about long-term care insurance is (are) true? I. It is no longer needed
once a person is eligible for Medicare. II. Purchasers have a choice of daily benefits and benefit periods.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
14) Which of the following statements is (are) true concerning benefit payments under long-term care insurance?
I.
Reimbursement policies pay for actual charges up to a specified daily limit. II. Per diem policies pay a
specified daily benefit regardless of the charges incurred.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: New
15) All of the following statements about long-term care insurance are true EXCEPT A) Premiums can be
reduced by electing shorter elimination periods.
B) A common benefits trigger is the inability to perform a certain number of activities of daily living.
C) Protection against inflation is usually made available as an optional benefit. D) Policies currently sold are
guaranteed renewable.
Answer: A
Question Status: Previous Edition
Chapter 15 Individual Health Insurance Coverages
175
16) Which of the following statements about disability is (are) true? I. The economic loss to a family from the
breadwinner!s long-term total and permanent disability is less than the economic loss from the bread-winner!s
premature death. II. The probability of a working individual, age 25, being disabled at least 3 months before
age 65 is less than one percent.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
17) Which of the following statements about individual disability income policies is true? A) Benefits are
typically paid only for disabilities resulting from sickness.
B) Benefits paid for partial disabilities are usually greater than benefits paid by the same policy for total
disabilities.
C) Most policies pay a benefit equal to 100 percent of the disabled person!s lost income.
D) Newer policies often provide a residual disability benefit for persons who are able to work but at a reduced
income.
Answer: D
Question Status: Previous Edition
18) All of the following statements about individual disability income policies are true EXCEPT
A) Premiums are often waived while a person is disabled but must be resumed if the insured recovers.
B) At the time of purchase, the insured can choose the length of the benefit period from among several available
options.
C) In order to encourage rehabilitation, benefits may be continued during periods of vocational training.
D) Most long-term disability policies contain an elimination period of 15 or fewer days.
Answer: D
Question Status: Previous Edition
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Rejda · Principles of Risk Management and Insurance, Tenth Edition
19) Which of the following statements about the dual definition of total disability typically found in many
individual disability income policies is (are) true? I.
During the initial period of disability, the insured must
be unable to perform the duties of any gainful occupation. II.
After the initial period of disability, the insured
must be unable to perform the duties of any occupation for which he or she is reasonably fitted by education and
training.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
20) Which of the following statements is (are) true regarding the calendar-year deductible used in most major
medical policies? I. Once the deductible is satisfied, no additional deductible is payable during the calendar
year. II.
A carryover provision helps to avoid paying two deductibles in a short period of time.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
21) All of the following statements about optional disability income benefits are true EXCEPT
A) Under a cost-of-living rider, benefits may be subject to limitations on the size of the annual or aggregate
increases.
B) A Social Security rider pays additional benefits if the insured is turned down for Social Security disability
benefits.
C) The election of a return of premium rider results in a lower premium.
D) Under an option to purchase additional insurance, the premium for the additional coverage is based on the
insured!s age at the time the additional coverage is purchased.
Answer: C
Question Status: Previous Edition
Chapter 15 Individual Health Insurance Coverages
177
22) Kevin has an individual major medical policy that his insurer agrees to keep in force until age 65. However,
the company has the right to increase the premium each year for the underwriting class in which Kevin has been
placed. Which renewal provision is found in Kevin!s policy?
A) noncancellable B) guaranteed renewable
C) conditionally renewable D) nonrenewable for stated reasons only
Answer: B
Question Status: Previous Edition
23) Which of the following statements about provisions in individual health insurance policies is true?
A) If a policy is issued with a "guaranteed renewable" renewal provision, under no circumstances can the insurer
raise the premium when the policy is renewed.
B) After a policy is in force for 3 months, the time limit on certain defenses provision prohibits the insurance
company from denying a claim based on a fraudulent misstatement in the application.
C) The usual length of the grace period is 90 days.
D) Under a preexisting conditions provision, a preexisting medical condition is either excluded or not covered
until a policy has been in force for a specified period of time.
Answer: D
Question Status: Previous Edition
24) Consumer experts generally recommend all of the following when shopping for individual health insurance
EXCEPT
A) Insure for the large loss. B) Avoid limited policies.
C) Consider individual insurance before group insurance. D) Use deductibles and elimination periods to reduce
premiums.
Answer: C
Question Status: Previous Edition
25) Which of the following statements about shopping for health insurance is (are) true? I.
policy with the lowest premium. II. Consider group health insurance first.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Always select the
Question Status: Revised
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Rejda · Principles of Risk Management and Insurance, Tenth Edition
26) Greta purchased a long-term care policy. Greta!s eligibility for benefits under the policy will most likely be
determined by
A) how long premiums have been paid. B) inability to perform activities of daily living.
C) continuous hospitalization for at least 60 days. D) eligibility for Medicare benefits.
Answer: B
Question Status: Revised
27) The inability of the insured to perform one or more important duties of his or her occupation is called
A) sporadic disability. B) total disability.
C) recurrent disability. D) partial disability.
Answer: D
Question Status: Previous Edition
28) Ellen purchased an individual hospital-surgical policy. Under the renewal provision in the policy, the insurer
has the right to terminate coverage on the policy anniversary date. This renewal provision is
A) cancellable. B) optionally renewable.
C) guaranteed renewable. D) noncancellable.
Answer: B
Question Status: Previous Edition
29) Marcus does not have any health insurance. All of the following are guidelines that Marcus should follow
when shopping for individual health insurance EXCEPT
A) Insure for the large (catastrophic) loss. B) Consider first-dollar coverage.
C) Consider group health insurance first. D) Watch out for restrictive provisions and exclusions.
Answer: B
Question Status: Previous Edition
Chapter 15 Individual Health Insurance Coverages
179
30) Brad purchased a major medical insurance policy. All of the following are typical characteristics of major
medical insurance EXCEPT
A) first-dollar coverage. B) broad coverage.
C) high maximum limits. D) coinsurance.
Answer: A
Question Status: Previous Edition
31) Barb was injured in an auto accident. She was totally disabled and collected disability income benefits for 8
months. She would like to return to work on a part-time basis to see if her recovery is complete. During this
period, her insurer will pay reduced disability income benefits. This type of disability is called
A) recurrent disability. B) residual disability.
C) permanent disability. D) partial disability.
Answer: D
Question Status: Previous Edition
32) An individual health insurance policy provision excluding coverage for impairments that were present or
were treated during some specified period prior to the effective date of the policy is called a(n)
A) time limit on certain defenses. B) preexisting-conditions clause.
C) benefit period provision. D) elimination (waiting) period.
Answer: B
Question Status: Revised
33) One long-term care insurance benefit trigger considers whether the insured needs supervision to protect
against threats to health or safety due to memory loss or disorientation. This benefit trigger is referred to as a(n)
A) activities of daily living trigger. B) medical necessity trigger.
C) needs test trigger. D) severe cognitive impairment trigger.
Answer: D
Question Status: New
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Rejda · Principles of Risk Management and Insurance, Tenth Edition
34) Beth!s disability income insurance policy provides benefits for accidental death, dismemberment, and loss of
sight. The maximum amount payable under this benefit is known as the
A) face value. B) cash value.
C) principal sum. D) monthly benefit.
Answer: C
Question Status: Previous Edition
35) Jan needed health insurance. She met with an agent who described the provisions of a health insurance
policy. Jan purchased the policy. When she got home, she reviewed the policy and noted several provisions were
different from what the agent described. She was not satisfied with the policy and immediately sent it back to the
agent with a note stating her reasons for returning the policy. Jan is guaranteed a premium refund because of
which policy provision?
A) waiting period B) time limit on certain defenses
C) ten-day right to examine the policy D) waiver-of-premium provision
Answer: C
Question Status: Previous Edition
36) One guideline when purchasing individual health insurance is to avoid limited policies. All of the following
are examples of limited policies EXCEPT
A) hospital indemnity policy. B) surgical policy using reasonable and customary charges.
C) cancer policy. D) accident-only disability policy.
Answer: B
Question Status: Previous Edition
37) Some physicians, hospitals, and other health care providers agree to make medical services available to
insureds at discounted prices. Insureds are not required to use these entities, but if they do, care costs are less
than if these entities are not used. Such health care entities are called
A) preferred providers. B) high deductible health plans.
C) Blue Cross/Blue Shield Plans. D) health savings accounts (HSAs).
Answer: A
Question Status: Previous Edition
Chapter 15 Individual Health Insurance Coverages
181
38) Which of the following statements about eligibility requirements for qualified Health Savings Accounts
(HSAs) is (are) true? I.
Only individuals who are eligible for Medicare benefits can establish a qualified
HSA. II.
You must be covered by a high deductible health plan and not be covered by any other
comprehensive health plan to establish a qualified HSA.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: New
39) All of the following statements about the tax treatment of Health Savings Accounts (HSAs) are true
EXCEPT
A) Contributions to a qualified HSA are tax deductible. B) Distributions from a qualified HSA used to fund
medical expenses are taxable.
C) Investment income in a qualified HSA accumulates income tax free.
D) Distributions from a qualified HSA prior to age 65 for nonmedical purposes are subject to a 10 percent
penalty tax.
Answer: B
Question Status: New
40) Which of the following statements about high deductible health insurance plans is (are) true? I.
Coverage under a high deductible health plan is necessary to establish a qualified health savings account
(HSA). II.
High deductible health plans provide a maximum limit on annual out-of-pocket expenses.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: New
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Rejda · Principles of Risk Management and Insurance, Tenth Edition
41) Which of the following statements about health savings accounts (HSAs) is true? A) There are no limits to
annual contributions that an individual may make to his or her HSA.
B) Once an individual has reached age 65 or is covered by Medicare, no additional contributions to the HSA may
be made.
C) The health insurance plan covering the HSA account beneficiary is not permitted to use a deductible.
D) HSAs offer no tax benefits for the account beneficiary.
Answer: B
Question Status: New
Chapter 16 Employee Benefits: Group Life and Health
Insurance
1) All of the following statements about the characteristics of group insurance are true EXCEPT A) Many people
are covered under a single contract.
B) The cost of group insurance may be lower than the cost of individual insurance. C) The actual experience of a
group may be a factor in determining the premium that is charged. D) Individual evidence of insurability is
usually required.
Answer: D
Question Status: Previous Edition
2) Which of the following statements about group insurance underwriting principles is (are) true? I.
If a plan
is contributory, 100 percent of the eligible employees must be covered. II.
Employees should be allowed to
determine their own level of benefits.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
3) Which of the following statements about group insurance underwriting principles is true? A) Employees
should be required to remit premiums directly to the insurance company.
B) The average age of the group should ideally increase over time. C) A group should be formed for the specific
purpose of obtaining insurance. D) The employer should ideally share in the cost of a group insurance plan.
Answer: D
Question Status: Previous Edition
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Rejda · Principles of Risk Management and Insurance, Tenth Edition
4) Reasons for having a minimum participation requirement before a group is eligible for insurance include
which of the following? I. To lower the expense rate per unit of insurance. II. To minimize the possibility of
insuring a group which consists largely of unhealthy individuals.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
5) All of the following statements about the eligibility requirements for group insurance are true EXCEPT
A) Most plans cover both full-time and part-time employees. B) An employee must be actively at work on the
day the employee!s group life insurance and
group health insurance becomes effective.
C) An employee can sign-up for insurance during an eligibility period without furnishing evidence of
insurability.
D) One purpose of a probationary period is to lower administrative costs by eliminating coverage on transient
workers.
Answer: A
Question Status: Revised
6) The period of time during which an employee can sign up for group insurance coverage without furnishing
evidence of insurability is called a(n)
A) probationary period. B) noninsurability window.
C) waiting period. D) eligibility period.
Answer: D
Question Status: Previous Edition
Chapter 16 Employee Benefits: Group Life and Health Insurance
185
7) Which of the following statements about group term life insurance is true? A) It usually is written in the form
of 5-year level term insurance.
B) An employee who leaves the group can usually convert the coverage to an individual term life insurance
policy.
C) Many employers provide a reduced amount of coverage on retired employees. D) It represents only about 5
percent of the group life insurance in force.
Answer: C
Question Status: Previous Edition
8) High deductible group health insurance plans have all of the following characteristics EXCEPT A) health
savings accounts
B) high dollar deductibles C) low coverage limits D) major medical insurance
Answer: C
Question Status: Revised
9) Which of the following statements about group accidental death and dismemberment (AD&D) insurance is
(are) true? I. The principal sum is paid if the employee dies in an accident. II. The employer usually pays at
least 50 percent of the cost of voluntary AD&D coverage.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
10) All of the following statements about group universal life insurance are true EXCEPT A) Interest rates
credited to a policy vary over time but are subject to a minimum guarantee.
B) Premiums can be varied as long as the cash value is sufficient to pay current mortality and expense charges.
C) Coverage is issued on a guaranteed basis up to certain limits with no evidence of insurability.
D) At retirement, an employee must begin liquidating his or her cash value in the form of an annuity.
Answer: D
Question Status: Previous Edition
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Rejda · Principles of Risk Management and Insurance, Tenth Edition
11) Which of the following statements about Blue Cross Plans is (are) true? I. They typically provide service
benefits rather than cash benefits to members. II. They usually provide very limited benefits for hospital
charges.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
12) What is the purpose of stop-loss insurance that is used with self-insured group medical expense plans?
A) to require employees to buy insurance for losses in excess of some specified amount B) to have a commercial
insurer pay claims that exceed a specified limit
C) to obtain administrative services from a commercial insurer D) to exempt self-insured plans from state
insurance laws that require mandated benefits
Answer: B
Question Status: Previous Edition
13) All of the following are reasons why employers self-insure medical expense plans EXCEPT A) to reduce
certain costs, such as premium taxes and commissions.
B) to provide mandated state benefits. C) to retain funds until needed to pay claims. D) to eliminate the need to
comply with separate state laws.
Answer: B
Question Status: Previous Edition
14) All of the following statements about group basic medical expense insurance are true EXCEPT
A) Benefits under surgical expense insurance may be based on the reasonable and customary charge for the
medical procedure.
B) Benefits are usually provided for diagnostic X-ray and laboratory benefits. C) Benefits are designed to cover
the cost of catastrophic medical expenses. D) Benefits are provided for nonsurgical care provided by a physician.
Answer: C
Question Status: Previous Edition
Chapter 16 Employee Benefits: Group Life and Health Insurance
187
15) Which of the following statements about supplemental group major medical insurance is (are) true?
I.
Most plans have a lifetime limit of $50,000 to $100,000. II.
Most plans contain a stop-loss limit that
places a dollar limit on the maximum amount an individual must pay out of his or her own pocket.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
16) A deductible that must be satisfied after the benefits of a basic medical expense plan are exhausted and
before supplemental major medical benefits are payable is called a(n)
A) initial deductible. B) prospective deductible.
C) back door deductible. D) corridor deductible.
Answer: D
Question Status: Revised
17) Which of the following is (are) characteristics of HMO managed care plans? I.
physicians and hospitals II. Emphasis on controlling the cost of covered services
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Unlimited choice of
Question Status: Revised
18) Which of the following statements about HMO managed care plans is (are) true? I. There is an emphasis on
controlling costs. II. They usually have high deductibles.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
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19) An HMO physician who determines if medical care from a specialist is necessary is called a(n) A) capitator.
B) internist. C) network facilitator. D) gatekeeper.
Answer: D
Question Status: Previous Edition
20) An HMO that contracts with two or more independent group practices to provide medical services to covered
members is called a(n)
A) group model HMO. B) network model HMO.
C) multilevel HMO. D) independent practice association HMO.
Answer: B
Question Status: Revised
21) Which of the following statements about preferred provider organization (PPO) plans is (are) true? I.
A PPO plan contracts with health care providers to provide medical services to members at reduced fees.
II.
Plan members are given a financial incentive to use PPO providers rather than other providers of health
care.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
22) A managed care plan under which members can receive medical care from non-network providers at higher
out-of-pocket costs is an example of a(n)
A) group practice plan. B) individual practice plan.
C) exclusive provider organization. D) point-of-service plan.
Answer: D
Question Status: Previous Edition
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189
23) All of the following statements about HMOs are true EXCEPT A) They organize and deliver health care
services.
B) Most medical services are covered in full or with nominal charges.
C) Comprehensive coverage is provided even when a subscriber is outside the geographic region served by the
HMO.
D) The selection of physicians is usually limited to physicians affiliated with the HMO. Answer: C
Question Status: Previous Edition
24) All of the following are criticisms of managed care plans EXCEPT A) Care is being reduced because of the
emphasis on cost control.
B) Preventive care is unlikely to be provided.
C) Restrictions may be placed on physicians! abilities to treat patients.
D) Network physicians may have a financial conflict of interest between providing high-quality medical care and
holding down costs.
Answer: B
Question Status: Previous Edition
25) Which of the following statements regarding the Health Insurance Portability and Accountability Act is true?
A) It guarantees the availability of group health insurance to small employers.
B) It requires employers to provide at least a minimum level of health benefits prescribed by law.
C) It requires giving credit for previous coverage with respect to any preexisting condition exclusion found in a
new health plan.
D) It limits preexisting condition exclusions to 90 days. Answer: C
Question Status: Previous Edition
26) Under the Health Insurance Portability and Accountability Act, what is the maximum length of a preexisting
condition exclusion if an employee enrolls when initially eligible?
A) 60 days B) 6 months
C) 1 year D) 2 years
Answer: C
Question Status: Previous Edition
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27) Some employers offer employees a choice of health care plans which are designed to make employees more
sensitive to health care costs, to provide an incentive to avoid unneeded care, and to seek low-cost health care
providers. Such plans are called
A) employee assistance plans. B) consumer-driven health plans.
C) cafeteria plans. D) preferred provider organization (PPO) plans.
Answer: B
Question Status: New
28) Maria is covered under a group medical expense plan as an employee. She is also covered under her
husband!s plan as a dependent. If Maria is hospitalized, how will each plan respond to her medical bills if both
plans have the typical coordination-of-benefits provision?
A) Maria!s plan is primary, and her husband!s plan is excess. B) Her husband!s plan is primary, and Maria!s plan
is excess.
C) Her husband!s plan will pay its benefits, and Maria!s plan will deny coverage. D) Both plans will pay benefits
on a pro rata basis.
Answer: A
Question Status: Previous Edition
29) Under one type of HMO, the physicians are employees of the HMO and are paid a salary and sometimes an
incentive bonus to hold down costs. This type of HMO is called a(n)
A) individual practice association (IPA). B) staff model.
C) group model. D) network model.
Answer: B
Question Status: Previous Edition
30) Which of the following statements about the continuation of group health insurance under COBRA is true?
A) A continuation of coverage must be made available even if an employee voluntarily terminates employment.
B) The length of the continuation of coverage is 90 days. C) The option to continue coverage applies to minor
children only, not to adults. D) The employer must pay the entire cost of coverage during the continuation period.
Answer: A
Question Status: Previous Edition
Chapter 16 Employee Benefits: Group Life and Health Insurance
191
31) HBM Company offers three health plans to its employees. The "Gold Plan" costs $300 per month and
provides generous benefits. The "Silver Plan" costs $250 per month and provides more limited benefits. The
"Bronze Plan" is quite limited and costs $200 per month. HBM contributes $200 per month for each employee!s
health care benefits. Employees who desire broader coverage are free to contribute the additional $100 or $50
needed to fund the coverage. Based on the description, HBM!s health plan is a
A) preferred provider health plan. B) Blue Cross/Blue Shield health plan.
C) defined contribution health plan. D) high-deductible health plan.
Answer: C
Question Status: New
32) All of the following statements about cost controls in dental insurance plans are true EXCEPT A) The
coinsurance percentage used may vary by type of dental service.
B) Cosmetic dental work is usually excluded.
C) The limit on benefits may be expressed as an annual limit or as a lifetime limit for certain types of dental
services.
D) To eliminate small claims, there is no coverage for routine oral examinations, X-rays, or cleaning teeth.
Answer: D
Question Status: Previous Edition
33) Which of the following statements about group short-term disability income plans is true? A) Most plans pay
benefits for a period of 3 to 5 years.
B) Most plans cover occupational disabilities only. C) Most plans provide benefits for total disabilities only. D)
Most plans have a 90-day elimination (waiting) period.
Answer: C
Question Status: Revised
34) All of the following statements about group short-term disability income plans are true EXCEPT A) Most
plans have a short elimination period for accidents but cover sickness from the first day
of disability. B) Disability is usually defined in terms of the employee!s own occupation.
C) The amount of disability income benefits typically is equal to some percentage of a worker!s normal earnings.
D) Except for small groups, preexisting conditions are usually covered immediately.
Answer: A
Question Status: Previous Edition
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35) All of the following statements about group long-term disability income plans are true EXCEPT A) The
definition of disability becomes less restrictive after a worker has been disabled for 2
years. B) Coverage is provided for both occupational and nonoccupational disabilities.
C) Benefits are reduced if a worker is eligible for Social Security or workers compensation benefits.
D) Maximum monthly benefits under long-term disability income plans are higher than the benefits paid under
short-term disability income plans.
Answer: A
Question Status: Previous Edition
36) Which of the following statements about cafeteria plans is (are) true? I.
Unspent flexible spending
account balances are refunded to the employee, tax -free, at year-end. II. Cafeteria plans enable employees to
select benefits that meet their specific needs.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Revised
37) Advantages of cafeteria plans include all of the following EXCEPT A) simplicity of benefit administration.
B) employees can select benefits that best match their needs. C) reduced taxes for employees. D) greater
employer control over increasing benefit costs.
Answer: A
Question Status: Revised
38) Which of the following statements is (are) true concerning high deductible health plans? I. An employee can
withdraw money tax-free from a health savings account to pay medical costs. II. There is a cap on an employee!s
out-of-pocket expenses under the plan.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
Chapter 16 Employee Benefits: Group Life and Health Insurance
193
39) Tracy had continuous group health insurance coverage at her previous employer for 6 years. Tracy decided to
change jobs. Under federal law, if Tracy changes jobs, the new employer or group health plan must give her
credit for previous and continuous health insurance coverage. This characteristic is called
A) renewability. B) vesting.
C) portability. D) convertibility.
Answer: C
Question Status: Previous Edition
40) John and Jane Smith were just divorced. Jane was awarded custody of the couple!s child, Maggie. John was
born on March 18, 1979. Jane was born on January 24, 1980. John and Jane are each covered under generous
employee benefit plans at work. The plans also cover the spouse and children of the worker for no extra fee.
Assuming there is no court decree specifying responsibility for Maggie!s health care expenses, which of the
following is true regarding coverage of Maggie!s health care expenses?
A) Coverage under John!s plan is primary, and coverage under Jane!s plan is excess. B) Each plan will pay onehalf of the expenses.
C) Coverage under Jane!s plan is primary, and coverage under John!s plan is excess. D) Each plan will pay its
pro rata share of any claims.
Answer: C
Question Status: Revised
41) Turner Company self-insures its group life and group health insurance plans. Turner entered into an
agreement with ABC Insurance through which ABC handles the plan design, claims processing, and record
keeping for Turner. The agreement between Turner and ABC is called a(n)
A) preferred provider agreement. B) administrative services only contract.
C) exclusive provider agreement. D) point-of-service contract.
Answer: B
Question Status: Previous Edition
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42) Med Profs is a group of 18 doctors. These doctors work out of their own offices and treat patients on a feefor-service basis. In addition, Med Profs doctors also agree to treat HMO members at reduced fees. The type of
HMO that uses organizations like Med Profs is called a(n)
A) group model plan. B) closed panel plan.
C) individual practice association plan. D) network model plan.
Answer: C
Question Status: Previous Edition
43) Nancy!s employer provides an interesting employee benefit plan. Each employee is given 250 employee
benefit credits to spend. A wide array of benefits are available, and the employee uses benefit credits to select the
benefits that he or she wants. This type of employee benefit plan is called a(n)
A) defined benefit plan. B) cafeteria plan.
C) employee selection plan. D) contributory plan.
Answer: B
Question Status: Revised
44) Marv is covered by a group health insurance plan at work. His employer funds the entire cost of the group
health insurance. Because of this characteristic, the group health insurance plan can be described as
A) defined benefit. B) contributory.
C) defined contribution. D) noncontributory.
Answer: D
Question Status: Previous Edition
Chapter 16 Employee Benefits: Group Life and Health Insurance
195
45) Karen started a business 2 years ago. The business has been successful, and Karen is thinking about starting
to offer some employee benefits for her workers. She plans to offer a group term life insurance benefit. All of the
following are usual eligibility requirements for participation in a group life insurance plan EXCEPT
A) full-time employment. B) be actively at work when insurance becomes effective.
C) apply for desired coverages during the eligibility period. D) satisfy a 2-year probationary period.
Answer: D
Question Status: Revised
46) ABC Company provides a group health insurance plan for its employees. The plan is a basic medical expense
plan with supplemental major medical. While the basic plan provides first -dollar coverage, employees must pay
a deductible once the basic insurance limit is met and before the supplemental major medical plan begins to
provide benefits. This deductible is called a(n)
A) franchise deductible. B) corridor deductible. C) straight deductible.
D) calendar-year deductible. Answer: B
Question Status: Previous Edition
47) Which of the following statements is (are) true with regard to group life insurance? I.
Most group life
insurance is whole life coverage. II. Most group life insurance plans allow a modest amount of life insurance on
the employee!s spouse and dependent children.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
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48) HMOs typically pay network physicians or medical groups a fixed annual payment for each member,
regardless of the frequency or type of service provided. This payment is called a(n)
A) pro-rata charge. B) persistency bonus.
C) capitation fee. D) corridor payment.
Answer: C
Question Status: Previous Edition
49) One recent trend in managed care plans is a three-tier pricing system for prescription drugs. Which of the
following statements is (are) true with respect to the three-tier pricing system? I. Employees must pay a higher
copayment if a brand-name drug is used rather than an available generic drug.
II.
The copayment for a brand-name drug is higher if the drug does not appear on an approved list of drugs
called a formulary.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
50) The "Patients Bill of Rights" proposal is to designed to A) protect the rights of patients in managed care
plans from denial of care and other problems.
B) protect the rights of patients who have been harmed by surgeons by making it easier to file malpractice
claims.
C) shield patients from the rising cost of medical care. D) prevent physicians from practicing defensive medicine
and billing patients for the cost of
additional X-rays, scans, and lab fees.
Answer: A
Question Status: New
Chapter 16 Employee Benefits: Group Life and Health Insurance
197
51) Which of the following statements about managed care plans is (are) true? I. Even though managed care
plans emphasize cost control, total health benefit costs continue to increase. II. Many physicians are critical of
managed care plans because of restrictions placed upon their freedom to treat patients.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: New
Chapter 17 Employee Benefits: Retirement Plans
1) All of the following statements about tax implications of qualified pension plans are correct EXCEPT
A) Investment earnings on plan assets accumulate on a tax-deferred basis.
B) Employer contributions are deductible up to certain limits as an ordinary business expense.
C) Employer contributions are considered taxable income to employees but are taxed at capital gains rates.
D) Pension benefits attributable to the employer!s contributions are not taxed until the employee retires or
receives the funds.
Answer: C
Question Status: Previous Edition
2) Beta Corporation has 1,000 employees eligible to participate in the firm!s pension plan, and 100 of these
employees are considered highly compensated. All of the highly compensated employees are covered by the
plan. What is the minimum number of the 900 non-highly compensated employees who must be covered by the
plan in order for the plan to satisfy the ratio test?
A) 500 B) 630 C) 667 D) 900
Answer: B
Question Status: Revised
3) What are the minimum age and service requirements that can be imposed on employees eligible to participate
in a retirement plan?
A) age 18 and 6 months of service B) age 21 and 1 year of service
C) age 21 and 3 years of service D) age 25 and 4 years of service
Answer: B
Question Status: Previous Edition
Chapter 17 Employee Benefits: Retirement Plans
199
4) Which of the following statements about retirement ages in pension plans is (are) true? I. The normal
retirement age in most plans is 65. II.
The early retirement age is the earliest age at which an employee can
retire without receiving actuarially reduced benefits.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
5) Which of the following statements describes a defined-benefit pension plan? A) The contribution rate is fixed,
but the retirement benefit is not known in advance.
B) The contribution rate is fixed, and the retirement benefit is known in advance. C) The contribution rate is
variable, and the retirement benefit is not known in advance. D) The contribution rate is variable, but the
retirement benefit is known in advance.
Answer: D
Question Status: Previous Edition
6) Which of the following statements describes a defined-contribution pension plan? A) The contribution rate is
fixed, but the retirement benefit is not known in advance.
B) The contribution rate is fixed, and the retirement benefit is known in advance. C) The contribution rate is
variable, and the retirement benefit is not known in advance. D) The contribution rate is variable, but the
retirement benefit is known in advance.
Answer: A
Question Status: Previous Edition
7) All of the following are potential disadvantages to employees covered by a defined -contribution pension plan
EXCEPT
A) The contribution rate by the employer is uncertain. B) The retirement benefit can only be estimated in
advance of retirement.
C) The benefit formula may produce an inadequate benefit if an employee enters the plan at an older age.
D) The investment losses are borne by the employees.
Answer: A
Question Status: Previous Edition
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8) Which of the following statements about retirement benefits under pension plans is true?
A) Under a flat percentage of annual earnings defined benefit formula, each employee receives the same dollar
benefit.
B) A benefit using final pay is usually based on an employee!s earnings during the last month of plan
participation.
C) A unit-benefit formula considers both earnings and years of service. D) Past service benefits are the result of
bonuses and overtime pay during the period an
employee participated in the plan. Answer: C
Question Status: Previous Edition
9) Under a unit-benefit formula, benefits are a function of both A) earnings and years of service.
B) age and earnings. C) age and gender. D) years of service and position within a firm.
Answer: A
Question Status: Revised
10) Vesting refers to A) the employer!s right to terminate contributions if a pension plan is adequately funded.
B) the employer!s right to recapture employee contributions to a pension plan if employment terminates prior to
retirement.
C) the employee!s right to the employer!s contributions or benefits attributable to the contributions if
employment terminates prior to retirement.
D) the employer!s right to discriminate against non-highly compensated employees when determining pension
benefit levels.
Answer: C
Question Status: Previous Edition
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11) Which of the following statements about the minimum vesting standards for a qualified defined benefit plan
is (are) true? I.Under cliff vesting, an employee must be at least 50 percent vested after 5 years of service. II.
Under graded vesting, an employee must be at least 20 percent vested after 3 years of service and 100
percent vested after 7 years.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
12) Which of the following statements about the protection provided by the Pension Benefit Guaranty
Corporation is (are) true? I. Only defined benefit plans are insured. II. Only benefits that are not yet vested are
guaranteed.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
13) Which of the following distributions from a retirement plan would result in a 10 percent penalty tax?
I.
A distribution at age 50 because of an employee!s total and permanent disability. II. A lump sum
distribution upon early retirement to an employee at age 54.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
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14) Taylor is director of employee benefits at ABC Company. He noted that additional benefits could be
provided to highly compensated employees through an adjustment. As Social Security slants benefits in favor of
lower-paid workers, the Internal Revenue Code permits employers to adjust pension benefits so that the overall
benefit (private pension plus Social Security) is nondiscriminatory. Adjusting benefits and contributions to
consider Social Security contributions is called
A) prorating. B) indexing.
C) offset. D) integration.
Answer: D
Question Status: Revised
15) Which of the following requirements must be met by a top-heavy pension plan to retain its qualified status? I.
A special rapid vesting schedule must be used for non-key employees. II. Certain minimum benefits or
contributions must be provided for non-key employees.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
16) A financial institution or individual that provides for the accumulation or administration of funds that will be
used to pay pension benefits is called a
A) trust fund. B) pension agency.
C) funding instrument. D) funding agency.
Answer: D
Question Status: Previous Edition
Chapter 17 Employee Benefits: Retirement Plans
203
17) All of the following statements about the various types of pension plans are true EXCEPT
A) Under a trust fund plan, an individual annuity is purchased for each participant, and additional annuity credits
are purchased annually.
B) A separate investment account is a group pension account with a life insurance company.
C) Under an investment guarantee contract, the insurer receives funds over a number of years and if actual
interest rates are higher than the guaranteed projected rate for the later years, the higher rate is paid.
D) Under a guaranteed investment contract, the insurer guarantees the principal of a lump sum deposit as well as
an interest rate for a number of years on the deposit.
Answer: C
Question Status: Revised
18) Which of the following statements about trust fund plans is (are) true? I.
The trustee typically purchases
annuities for retiring employees. II. The trustee guarantees the adequacy of the fund to pay the promised
benefits.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
19) All of the following statements about Section 401(k) plans are correct EXCEPT
A) Elective salary deferrals to these plans are free of federal income taxation until the funds are actually
withdrawn.
B) These plans are subject to rules that prevent discrimination in favor of highly compensated employees.
C) There is no limit on the actual percentage of salary that can be deferred by highly compensated employees
under a qualified plan.
D) Most plans allow employees to determine how funds are invested.
Answer: C
Question Status: Previous Edition
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20) Which of the following statements about withdrawals from Section 401(k) plans is (are) true? I.
Withdrawals may be made without penalty because of the death or disability of the employee. II.
Withdrawals may be made without penalty at age 59.5 or older.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
21) Which of the following statements about Keogh plans is correct? A) They can be used by owners of
incorporated businesses only.
B) Investment income accumulates on a tax-deferred basis. C) The maximum annual contribution for any one
participant is limited to $2,000. D) Plan distributions must start prior to age 59.5.
Answer: B
Question Status: Revised
22) All the following statements about SIMPLE retirement plans are true EXCEPT
A) They are limited to employers with 100 or fewer eligible employees and who do not maintain another
qualified plan.
B) They encourage small employers to establish pension plans for their employees.
C) They are subject to more stringent discrimination rules than those that apply to most qualified plans.
D) They can be structured either as an IRA or as a 401(k) plan. Answer: C
Question Status: Previous Edition
23) Which of the following statements is (are) true with respect to SIMPLE retirement plans? I.
Employers of any size can start a SIMPLE plan, provided the employer does not maintain another
qualified plan. II.
SIMPLE plans are exempt from most nondiscrimination and administrative rules that apply
to qualified plans.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
Chapter 17 Employee Benefits: Retirement Plans
205
24) Rita went to work for a manufacturing company. The company offers a defined-benefit pension plan. The
benefit at retirement is equal to 1.5 percent multiplied by years of service with the company, with the result
multiplied by average salary in the three highest consecutive years of paid employment with the company. The
benefit formula used at Rita!s company is a
A) flat dollar amount for all employees. B) flat percentage of annual earnings.
C) flat dollar amount for each year of service. D) unit-benefit formula.
Answer: D
Question Status: Previous Edition
25) Which of the following statements is (are) true with respect to vesting under a qualified retirement plan?
I.
Vesting helps to reduce labor turnover. II. An employee who terminates employment after four years of
service has no vested retirement benefit under graded vesting.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
26) Early distributions from qualified retirement plans are assessed a 10 percent penalty tax. However, there are
some exceptions to this rule. All of the following distributions would be exempt from the penalty tax EXCEPT
A) distributions made after age 59.5. B) distributions made when an employee of any age changes employers.
C) distributions made after the death or permanent disability of the employee.
D) distributions that are part of a series of substantially equal payments over the worker!s life expectancy.
Answer: B
Question Status: Previous Edition
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27) ACME Company is considering starting a retirement plan for its employees. One option ACME is
considering is a profit-sharing plan. All of the following are advantages of this type of retirement plan EXCEPT
A) The employer!s cost is not affected by the age and the number of employees. B) Profit sharing plans provide
an incentive for employees to work harder and more efficiently.
C) The 10 percent penalty tax does not apply to distributions prior to age 59.5. D) ACME enjoys greater
flexibility in employer contributions.
Answer: C
Question Status: Revised
28) ABC Company offers a qualified retirement plan. ABC selected a funding instrument with an insurer in
which the insurer guarantees a relatively high interest rate for a number of years on a lump sum deposit. This
funding instrument is called a(n)
A) trust-fund plan. B) group deferred annuity.
C) separate investment account. D) guaranteed investment contract.
Answer: D
Question Status: Revised
29) RST Company offers a qualified retirement plan. Each employee contributes 4 percent of his or her pretax
income to the plan, and RST matches each employee!s contribution. An employee!s benefit at retirement is
determined by his or her account balance at the time of retirement. What type of retirement plan does RST offer?
A) defined benefit, flat percentage of annual earnings B) defined benefit, flat dollar amount for all employees
C) defined benefit, unit-credit formula D) defined contribution plan
Answer: D
Question Status: Previous Edition
Chapter 17 Employee Benefits: Retirement Plans
207
30) Harrison Company just received notice from the Internal Revenue Service that there is a problem with its
retirement plan. Because over 60 percent of the benefits are designated for highly compensated employees, a
special set of rules apply. These rules require rapid vesting for non-highly compensated employees and minimum
benefit promises for non-highly compensated employees. What name is given to such plans?
A) top-heavy plans B) top-hat plans
C) golden handshake plans D) defined-benefit plans
Answer: A
Question Status: Revised
31) JKL Company just converted its traditional defined-benefit plan to another type of plan. Under the plan,
benefits are defined in terms of a hypothetical account balance, with retirement benefits dependent upon the
value of the participant!s account at retirement. Each year, employees receive an interest rate credit and a pay
credit which is a specified percentage of compensation. This type of plan is called a(n)
A) section 401(k) plan. B) deposit-administration plan.
C) cash-balance plan. D) trust fund plan.
Answer: C
Question Status: Revised
32) All the following statements concerning a Roth 401(k) plan are true EXCEPT A) After-tax dollars are used
to fund the plan.
B) Investment earnings accumulate on a tax-free basis. C) Employees at all income levels may contribute to the
plan, but annual contributions are
limited. D) Qualified distributions at retirement are fully taxable.
Answer: D
Question Status: New
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33) Special vesting rules apply to qualified defined contribution plans with voluntary employee contributions and
matching employer contributions. Which of the following statements is (are) true with respect to these vesting
rules? I.
Employer contributions must vest immediately. II. Graded vesting is permitted, and employer
contributions must be 20 percent vested after 2 years, with an additional 20 percent vested in each of the next 4
years.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Revised
34) Small business owners have a number of retirement savings options. One type of plan is limited to selfemployed individuals and business owners who have no employees other than a spouse. The plan permits both
deferral of income earned by the business as well as salary deferral. Such plans are called
A) self-employed 401(k) plans. B) Roth 401(k) plans.
C) cash balance plans. D) simplified employee pension (SEP) IRAs.
Answer: A
Question Status: New
35) Which of the following statements is (are) true with respect to profit-sharing plans? I.
There is no limit
on the amount that an employer can contribute annually to an employee!s account under a profit sharing plan. II.
Profit sharing plans offer greater funding flexibility for employers than under other qualified plans.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
Chapter 17 Employee Benefits: Retirement Plans
209
36) Lynn works for a state university. In addition to her regular pension plan, Lynn established another
retirement savings plan. She elected to have $5,000 of her salary withheld and contributed to a tax-sheltered
annuity with an insurer. The type of plan that Lynn established is called a
A) SIMPLE plan. B) 403(b) plan.
C) defined benefit plan. D) Keogh plan.
Answer: B
Question Status: Previous Edition
37) All of the following statements about 403(b) plans are correct EXCEPT A) Contributions to a 403(b) reduce
an employee!s taxable income.
B) 403(b) plans are designed for employees of public school systems and tax-exempt organizations.
C) The law limits the amount of income that an employee can elect to defer under a 403(b) plan. D) Matching
employer contributions are not permitted under a 403(b) plan.
Answer: D
Question Status: Previous Edition
38) Which of the following statements is (are) true regarding cash-balance pension plans? I. Cash balance
plans are defined contribution plans. II.
Under a cash balance plan, the employer creates an actual account
for each employee into which the employer makes contributions and allocates investment gains and losses.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: New
39) Which of the following statements concerning defined benefit and defined contribution pension plans is (are)
true? I. The employer bears the investment risk with a defined contribution plan. II.
Defined benefit plans
favor workers who enter the plan at older ages.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: New
Chapter 18 Social Insurance
1) All of the following are reasons for social insurance programs EXCEPT A) to solve complex social programs.
B) to provide a base of economic security. C) to provide competition to the private insurance industry. D) to
provide coverage for perils which are difficult to insure privately.
Answer: C
Question Status: Previous Edition
2) Which of the following statements about the characteristics of social insurance programs is true? A) Benefits
are loosely related to a worker!s earnings.
B) Benefits are paid primarily on the basis of individual equity. C) Participation in social insurance programs is
voluntary. D) Social insurance programs must be fully funded at all times to pay required benefits.
Answer: A
Question Status: Revised
3) All of the following statements about the characteristics of social insurance programs are true EXCEPT
A) They are designed to provide a floor of income with respect to the risks which are covered. B) The method of
determining benefits is prescribed by law.
C) Participants are required to satisfy a means test to receive benefits. D) With few exceptions, social insurance
programs are compulsory.
Answer: C
Question Status: Revised
4) Which of the following statements about covered occupations under the Social Security program is true?
A) Employees of private firms are exempt from coverage if they are covered by private pension plans.
B) Ministers are automatically covered unless they elect out of coverage because of conscience or religious
principles.
C) Self-employed persons are covered only if their net annual earnings are $5,000 or less. D) Federal civilian
employees hired after 1983 are covered for Medicare only.
Answer: B
Question Status: Previous Edition
5) Which of the following statements about credits (quarters of coverage) under the Social Security program is
(are) true? I. Up to 10 credits can be earned in a single year. II. A worker receives one credit for each $10,000
of covered wages in a calendar year, regardless of the worker!s wagers.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
6) As of this year, Brad, age 50, has 40 credits under the Social Security program. These credits were all earned
in the last 10 years. What is Brad!s insured status under the program?
A) He is currently and fully insured. B) He is currently insured, but not fully insured.
C) He is fully insured, but not currently insured. D) He is neither currently insured nor fully insured.
Answer: A
Question Status: Previous Edition
7) Which of the following statements about the full retirement age under the Social Security program is true?
A) The current retirement age for full benefits is age 62. B) Beginning in the year 2022, the retirement age will
be gradually increased to age 80.
C) Early retirement with reduced benefits is allowed as early as age 55.
D) Delayed retirement beyond the age for full benefits increases the amount of the monthly benefit.
Answer: D
Question Status: Previous Edition
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8) All of the following persons are eligible for a benefit under the retirement portion of the Social Security
program EXCEPT
A) a divorced spouse, age 55, who was married to the retired worker for 6 years. B) a retired worker!s 63 yearold spouse who is no longer caring for children.
C) a retired worker!s 52 year-old spouse who is caring for a 12 year-old daughter of the retired worker.
D) a retired worker!s unmarried 20 year-old son who has been severely disabled since an automobile accident
while he was in elementary school.
Answer: A
Question Status: Revised
9) Which of the following statements about a worker!s primary insurance amount is (are) true? I.
It is the
monthly amount paid to a worker who elects early retirement at age 62. II.
It is equal to 50 percent of the
worker!s final average pay that was subject to Social Security taxes.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
10) Which of the following statements about the Social Security cost-of-living adjustment is (are) true? I.
The amount of the adjustment is limited to a maximum of 2.5 percent annually. II.
Increases are
based on changes in the consumer price index.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
11) Which of the following statements is (are) true with respect to the Social Security earnings test? I. The
earnings test does not apply to dividends, interest, and rental income. II. The earnings test does not apply to
work earnings for those individuals who have reached the full retirement age under Social Security.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
12) All of the following persons are eligible for survivor benefits under Social Security EXCEPT A) dependent
parents age 62 or older.
B) unmarried children between the ages of 18 and 22 if attending college. C) a surviving spouse age 60 or older.
D) a surviving spouse with eligible children younger than age 16.
Answer: B
Question Status: Revised
13) Which of the following statements about disability benefits under Social Security is true? A) There is a oneyear waiting period before benefits are payable.
B) Benefits are payable as long as the disabled worker is unable to perform his or her regular occupation.
C) Benefits are payable only if the condition causing the disability is expected to result in death prior to age 65.
D) In addition to the disabled worker receiving the benefits, benefits can also be paid to eligible dependents.
Answer: D
Question Status: Previous Edition
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14) In addition to most persons over age 65, which of the following persons is (are) eligible for Medicare
benefits? I. Persons under age 65 who have been entitled to Social Security disability benefits for at least 24
months. II.
Persons under 65 who need long-term kidney dialysis treatment or a kidney transplant.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
15) Which of the following statements about the coverage of home health care services under Part A of Medicare
is (are) true? I.Services in the patient!s home are covered if the patient requires skilled care and meets certain
conditions.
II.
Hospitals are reimbursed for inpatient services under a prospective payment system. A) I only
B) II only C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
16) Which of the following statements about hospice benefits under the hospital insurance (Part A) portion of
Medicare is (are) true? I.
Hospice benefits are only payable while the beneficiary is hospitalized. II. Hospice
benefits are provided to persons who are terminally ill.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
17) Charges for all of the following medical expenses are covered under the medical insurance (Part B) portion
of Medicare EXCEPT
A) physicians! services in doctors! offices. B) hospital equipment and other durable medical equipment used at
home.
C) clinical laboratory services. D) prescription drugs outside of the hospital.
Answer: D
Question Status: Revised
18) Which of the following statements about the medical insurance (Part B) portion of Medicare is (are) true?
I.
Participation in Part B of Medicare is voluntary. II. It is provided at no cost to anyone who is fully insured
under Medicare.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
19) Which of the following statements about the role of physicians with respect to Medicare claims is (are) true?
I.
Physicians who do not accept an assignment of Medicare claims can charge as much as 200 percent of the
Medicare-approved fee. II. Physicians who accept assignment agree to accept the Medicare-approved amount
as payment in full.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Revised
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20) Which of the following statements about Medigap policies is (are) true? I. Insurers are required to have an
open enrollment period of 6 months from the date an applicant first enrolls in Medicare Part B and is age 65 or
older. II.
Most policies are of limited value because they largely duplicate benefits already provided by
Medicare.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
21) Which of the following statements about the financing of the Social Security programs is (are) true? I.
Although the self-employed pay an OASDI tax rate that is twice the employee rate, they are allowed
certain deductions that reduce the effective tax rate. II.
The earnings base on which OASDI taxes are paid
increases annually based on changes in average wages in the national economy.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
22) Objectives of unemployment insurance include which of the following? I.
find jobs. II. To encourage employers to stabilize employment.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
To help unemployed workers
Question Status: Previous Edition
23) In order to receive unemployment insurance benefits, an unemployed worker must meet all of the following
eligibility requirements EXCEPT
A) have qualifying wages and employment. B) be able to work.
C) be actively seeking work. D) satisfy a 6-month waiting period.
Answer: D
Question Status: Previous Edition
24) Which of the following statements about unemployment insurance benefits is true? A) Benefits are a flat
amount regardless of a worker!s previous wages.
B) Because of federal legislation, the maximum benefit is the same in all states.
C) Most states pay regular benefits for a maximum duration of 26 weeks.
D) Under the extended benefits program, the federal government continues benefit payments for up to 2 years for
workers who have exhausted their regular benefits.
Answer: C
Question Status: Previous Edition
25) All of the following statements about the financing of unemployment insurance benefits are true EXCEPT
A) All contributions from a state are deposited in the state!s account in a federal trust fund from which benefits
are paid.
B) The tax rate for a given employer may be reduced if the employer has a favorable employment record.
C) The costs of extended benefits are shared equally by the federal government and the states. D) Most state
programs are financed primarily by payroll taxes paid by employees.
Answer: D
Question Status: Previous Edition
26) Which of the following statements about the problems and issues of unemployment insurance programs is
(are) true? I. Many state programs are inadequately financed. II. Only a small portion of the total unemployed
receive benefits at any time.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
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27) Prior to the establishment of workers compensation laws, an employer could use all of the following defenses
to block an injured worker!s claim for benefits EXCEPT
A) the contributory negligence doctrine. B) the fellow-servant doctrine.
C) the employer liability doctrine. D) the assumption-of-risk doctrine.
Answer: C
Question Status: Previous Edition
28) All of the following statements about workers compensation programs are true EXCEPT A) They are based
on the principle of liability without fault.
B) Disabled workers are paid for their injuries based on a schedule of benefits established by law.
C) Options available for complying with the law may include one or more of the following: self-insurance,
private insurance, or insurance through a state insurance fund.
D) Most states have elective laws whereby the employer can choose whether or not to provide workers
compensation coverage to employees.
Answer: D
Question Status: Revised
29) All of the following statements about benefits under workers compensation programs are true EXCEPT
A) Disability income benefits are usually paid retroactively to the date of injury if the worker is still disabled
after satisfying a waiting period.
B) Death benefits and benefits to eligible survivors are payable if a worker is killed on the job. C) Medical
benefits are usually subject to deductibles and coinsurance. D) Rehabilitation benefits are available to restore
disabled workers to productive employment.
Answer: C
Question Status: Revised
30) Current problems and issues with workers compensation include all of the following EXCEPT A)
involvement of lawyers in workers compensation claims
B) treatment of terrorism-related risks C) reduced coverage of occupational illness D) rising medical costs
Answer: C
Question Status: New
31) Which of the following statements about problems and issues in workers compensation insurance is (are)
true?
I.
The cost of medical care under workers compensation continues to rise. II.
Enactment of workers
compensation statutes has eliminated litigation with respect to work-related illnesses and injuries.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
32) Marion owns substantial financial assets. She was surprised that she qualified for Social Security old-age
benefits when she retired because of her high investment income. What characteristic of social insurance
programs is Marion overlooking with respect to her Social Security old-age benefits?
A) Social insurance programs are financially self-supporting. B) Social insurance program benefits are loosely
related to earnings.
C) Social insurance benefits are not means tested. D) Full funding of social insurance programs is unnecessary.
Answer: C
Question Status: Previous Edition
33) Tony is 48 years old. He earned the maximum taxable wage base under Social Security annually between the
time when he was 26 and when he was 40. At age 40, he dropped out of the workforce to care for children as his
wife had a high-paying job. Which statement is true regarding Tony!s insured status under Social Security?
A) Tony is fully insured and currently insured. B) Tony is fully insured, but not currently insured. C) Tony is
currently insured, but not fully insured.
D) Tony is neither fully insured nor is he currently insured.
Answer: B
Question Status: Previous Edition
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34) Frank is doing some life insurance planning. A financial advisor said, "be sure to consider Social Security
when examining sources of funds available for family support if you die." The financial advisor was referring to
which Social Security benefit?
A) retirement benefits B) survivor benefits
C) disability benefits D) health insurance benefits
Answer: B
Question Status: Previous Edition
35) All of the following statements about Medicare are true EXCEPT
A) While Social Security old-age benefits are available at age 62, Medicare Part A benefits are not available, in
most cases, until age 65.
B) Medicare covers disabled persons younger than age 65 who have been entitled to Social Security disability
benefits for at least 24 months.
C) An individual who does begin to receive Social Security old-age benefits until age 67 is not eligible for
Medicare benefits until age 67.
D) Beneficiaries must pay a monthly premium for Medicare Part B coverage. Answer: C
Question Status: Previous Edition
36) Which of the following statements is (are) true with respect to the Medicare Advantage Plans? I.
These
plans replace the original program, Parts A and B, which are no longer available to new retirees. II.
These
plans provide an opportunity for retirees to receive Medicare coverage through private health care plans.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Revised
37) Dale, age 65, was dismayed to learn about all of the deductibles, co -pays, limits, and exclusions in the
Medicare program. Dale bought a type of health insurance specifically designed to supplement Medicare, and
selected his coverage from among 12 standard policies that private insurers offer. What type of health insurance
did Dale purchase?
A) long-term care insurance B) Medigap insurance
C) major medical insurance D) viatical insurance
Answer: B
Question Status: Revised
38) EFG Company suffered reduced demand for its products during a recession. EFG managers were ready to lay
off some workers when the personnel director stated, "Let!s not lay off these workers. If we do, our
unemployment insurance premiums will increase. The state considers employment stability when determining
our premium." Considering the firm!s employment record when determining the rate to charge for unemployment
insurance is called
A) experience rating. B) class rating.
C) schedule rating. D) retrospective rating.
Answer: A
Question Status: Revised
39) Beth was injured at work and is eligible to receive workers compensation benefits. All of the following
benefits are provided under workers compensation EXCEPT
A) disability income. B) retirement benefits.
C) rehabilitation. D) medical care.
Answer: B
Question Status: Previous Edition
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40) Marco, a risk manager in California, is interviewing for a new position in the state of Washington. When
Marco asked about methods of providing workers compensation, the answer surprised him. In Washington,
employers can self-insure the risk or obtain coverage through a state fund. Private insurers do not market workers
compensation insurance in Washington. Washington uses a
A) competitive state fund. B) guaranty fund.
C) reinsurance facility. D) monopoly state fund.
Answer: D
Question Status: Previous Edition
41) Which of the following statements about the financing of OASDI and Medicare is (are) true? I.
There is
a maximum taxable wage base for OASDI. II.
There is a maximum taxable wage base for Part A of
Medicare.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
42) Which of the following statements about the taxation of Social Security retirement benefits is (are) true?
I.
Social Security retirement benefits are never considered taxable income. II.
Up to 85 percent of
Social Security retirement benefits may be considered taxable income, depending on the amount of other income
received by the beneficiary.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
43) All of the following are options for reducing the long-range OASDI actuarial deficit EXCEPT A) increasing
the payroll tax.
B) reducing benefits. C) reducing the taxable wage base. D) using general revenues to fund benefits.
Answer: C
Question Status: Previous Edition
44) Which of the following statements about the Medicare prescription drug benefit is (are) true? I.
Beneficiaries select a prescription drug plan and pay a monthly premium, with the premium waived for
low-income beneficiaries. II. The benefit provides first-dollar coverage of prescription drugs up to a maximum of
$10,000 per year, but no coverage after $10,000.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
45) All of the following statements about the Medicare Prescription Drug Plan are true EXCEPT A) Medicare
prescription drug coverage is available to all Medicare beneficiaries.
B) The Federal government negotiates discounts on the most-prescribed prescription drugs.
C) Private firms administer the program on a regional basis.
D) In addition to the initial deductible, there is a coverage gap where the beneficiary must pay the entire cost of
prescription drugs.
Answer: B
Question Status: New
46) All of the following statements about the Medicare prescription drug benefit are true EXCEPT A)
Beneficiaries are required to pay a monthly premium for the benefit.
B) The plan provides protection against catastrophic prescription drug expenditures. C) The plan requires a $20
deductible for each prescription which is filled. D) The plan has a coverage gap before a beneficiary has
coverage for catastrophic costs.
Answer: C
Question Status: Previous Edition
47) Under one type of Medicare Advantage Plan, members of the plan can see any doctor or health services
provider that accepts Medicare patients. If members receive care outside the network of member physicians and
care facilities, they must pay higher out-of-pocket costs. This type of Medicare Advantage Plan is a
A) Medicare HMO. B) Medicare PPO.
C) Medicare Special Needs Plan. D) Medicare Private Fee-for-Service Plan.
Answer: B
Question Status: New
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48) Which of the following statements concerning Medicare Prescription Drug Plans is (are) true? I.
The
monthly premium is based on the health status of the beneficiary and the number of prescriptions the beneficiary
needs. II.
After the beneficiary has paid an initial deductible, Medicare pays the entire cost of all
prescription drugs the beneficiary needs.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: New
Chapter 19 The Liability Risk
1) A tort is defined as a A) breach of contract which is punishable by a fine.
B) legal wrong for which the law allows a remedy in the form of money damages. C) legal wrong against society
which is punishable by fines. D) legal wrong against society which is punishable by imprisonment or death.
Answer: B
Question Status: Previous Edition
2) All of the following are examples of intentional torts EXCEPT A) negligence.
B) trespass. C) slander. D) assault.
Answer: A
Question Status: Previous Edition
3) A situation in which a person is held legally liable even though fault or negligence cannot be proven is an
example of
A) general damages. B) comparative negligence.
C) an intentional tort. D) strict liability.
Answer: D
Question Status: Revised
4) Failure to exercise the degree of care required by law to protect others from harm is A) premeditated liability.
B) vicarious liability. C) punitive damages. D) negligence.
Answer: D
Question Status: Previous Edition
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5) All of the following are elements of negligence EXCEPT A) the ability to pay damages.
B) the failure to perform a legal duty to use reasonable care. C) damages or injuries to a claimant. D) proximate
cause between the negligent act and the infliction of injury.
Answer: A
Question Status: Previous Edition
6) Which of the following statements about the elements of negligence is (are) true? I. The negligence of the
tortfeasor may arise from a failure to act. II. The damage that results must be in the form of property damage.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
7) Damages awarded for losses that can be determined or measured are A) special damages.
B) general damages. C) punitive damages. D) comparative damages.
Answer: A
Question Status: Previous Edition
8) Which of the following statements about monetary damages awarded by a court is (are) true? I.
The
purpose of general damages is to provide benefits for medical expenses or loss of earnings. II. The purpose of
punitive damages is to punish the tortfeasor so that others are deterred from committing the same wrongful act.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
9) Heather sued Robert for injuries suffered in an automobile accident. Based upon the facts presented, the jury
concluded that Heather was 40 percent at fault in the accident and Robert was 60 percent at fault. Under the
common law doctrine of contributory negligence, the jury should award Heather
A) nothing. B) 40 percent of her actual damages.
C) 60 percent of her actual damages. D) 100 percent of her actual damages.
Answer: A
Question Status: Previous Edition
10) Which of the following statements about comparative negligence laws is (are) true? I.
Under the pure
rule, any negligence by the plaintiff automatically bars recovery for damages. II. Under the 50 percent rule,
parties who are equally at fault are each allowed to recover damages.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
11) Nancy was injured when she drove her car through a stop sign and was struck by Philip!s car. Philip saw
Nancy and could have stopped. However, he failed to do so since he had the right-of-way. Nancy can recover
damages from Philip under which of the following legal doctrines?
A) vicarious liability B) the last clear chance rule
C) contributory negligence D) the assumption of risk doctrine
Answer: B
Question Status: Previous Edition
12) Common situations involving strict liability include all of the following EXCEPT A) blasting operations.
B) operating a motor vehicle. C) work-related injuries under workers compensation. D) crop dusting.
Answer: B
Question Status: Revised
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13) All of the following may give rise to imputed negligence EXCEPT A) employer-employee relationships.
B) joint business ventures. C) vicarious liability laws. D) attractive nuisance situations.
Answer: D
Question Status: Previous Edition
14) Laws under which businesses that sell liquor may be held liable for the negligence of those who consume the
liquor are referred to as
A) proprietary function laws. B) attractive nuisance laws.
C) apothecary laws. D) dram-shop laws.
Answer: D
Question Status: Revised
15) All of the following requirements must be met to satisfy the doctrine of res ipsa loquitur EXCEPT A) The
injured party has not contributed to the accident in any way.
B) The injured party must prove negligence on the part of the defendant. C) The event is one that normally does
not occur in the absence of negligence. D) The defendant has exclusive control over the instrumentality causing
the accident.
Answer: B
Question Status: Previous Edition
16) Which of the following statements about the legal obligations of a property owner is (are) true? I. A
property owner must inspect the premises for the benefit of an invitee and correct any unsafe conditions. II.
A property owner has the right to set a trap designed to injure a trespasser.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
17) Under common law, which of the following persons is most likely to be classified as an invitee? A) a mail
carrier
B) a social guest C) a door-to-door salesperson D) a solicitor for a charitable organization
Answer: A
Question Status: Revised
18) Which of the following are legal obligations of a property owner with respect to an invitee? I.
The
property owner must warn an invitee of any unsafe conditions. II. The property owner must inspect the premises
and eliminate any dangerous conditions revealed by the inspection.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
19) What is the effect of the family purpose doctrine? A) to impose liability on children for the care of elderly
parents
B) to impose liability on the owner of an automobile for the negligence of immediate family members operating
the automobile
C) to impose liability on a parent for any negligence caused by a child D) to impose strict liability on the owner
of a wild animal for any injuries caused by the animal
Answer: B
Question Status: Previous Edition
20) Which of the following statements about the immunity of governmental entities is (are) true? I.
Governmental entities are more likely to be immune from liability when performing proprietary functions
than when performing governmental functions. II. Many courts have eliminated the immunity of government
entities.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
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21) The doctrine of respondeat superior applies to a(n) A) parent!s liability for a negligent child.
B) pet owner!s liability for the pet. C) employer!s liability for a negligent employee. D) manufacturer!s liability
for a faulty product.
Answer: C
Question Status: Previous Edition
22) Situations under which parents can be held liable for the actions of a child include which of the following?
I.
The child uses a parent!s gun to injure someone. II. The child is acting as an agent of the parent.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
23) Under one doctrine, a person who understands the danger inherent in an activity cannot recover damages in
the event of injury from the activity. This doctrine is the
A) contributory negligence doctrine. B) assumption of risk doctrine.
C) comparative negligence doctrine. D) fellow servant doctrine.
Answer: B
Question Status: Previous Edition
24) One tort reform permits manufacturers to assert that as long as the product conformed to the prevailing
technology and production methods at the time it was produced, it cannot be considered a defective product
today. This defense is called the
A) collateral sources rule. B) state of the art defense.
C) strict liability defense. D) privity of contract rule.
Answer: B
Question Status: Previous Edition
25) Many medical malpractice insurers have experienced large underwriting losses in recent years. One measure
of underwriting profitability is the ratio of claims plus underwriting expenses to premiums. This ratio is called
the
A) loss ratio. B) surplus ratio.
C) expense ratio. D) combined ratio.
Answer: D
Question Status: Previous Edition
26) Shareholders and employees harmed by the negligent acts and deceptive statements of company leaders may
file lawsuits against the company leaders. Such claims are covered under which type of insurance?
A) employment practices liability insurance B) employee benefit liability insurance
C) directors and officers liability insurance D) general liability insurance
Answer: C
Question Status: Previous Edition
27) All of the following are proposed solutions to the medical malpractice problem EXCEPT A) shortening the
statute of limitations for filing lawsuits.
B) eliminating arbitration panels to resolve disputes. C) placing limitations on contingent fees charged by
attorneys. D) placing limitations on damage awards.
Answer: B
Question Status: Previous Edition
28) The Sarbanes-Oxley Act requires which of the following? I. Accounting firms auditing a company!s books
must provide other major services to the firm besides auditing services. II.
The company!s Chief Executive
Officer (CEO) must swear to the accuracy of quarterly and annual financial reports.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Revised
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29) Arguments in favor of reforming the civil justice system include which of the following? I.
There is
often a long delay in settling lawsuits. II. Compensation awards have decreased significantly over the past two
decades.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
30) All of the following are examples of tort reform proposals EXCEPT A) modifying the collateral source rule.
B) eliminating caps on noneconomic damages. C) regulation of attorney fees. D) imposing penalties to deter
frivolous lawsuits.
Answer: B
Question Status: Previous Edition
31) A defendant who is only slightly liable may be required to pay the full amount of damages under which of
the following?
A) the joint and several liability rule B) the collateral source rule
C) arbitration D) res ipsa loquitor
Answer: A
Question Status: Previous Edition
32) Alternative techniques for resolving legal disputes without litigation include which of the following?
I.
Arbitration II. Mediation
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
33) All of the following are categories of torts EXCEPT A) intentional torts.
B) breach of contract. C) strict liability. D) negligence.
Answer: B
Question Status: Revised
34) James was injured in an auto accident caused by another motorist!s negligence. To reimburse him for his
hospital bills and lost earnings, items which can be specifically itemized, James will receive
A) punitive damages. B) special damages.
C) imputed damages. D) general damages.
Answer: B
Question Status: Revised
35) James was injured in an auto accident caused by another motorist!s negligence. He received severe facial
lacerations and injured his back in the accident. In payment for his pain, suffering, and disfigurement, losses
which cannot be specifically itemized, James will receive
A) punitive damages. B) special damages.
C) imputed damages. D) general damages.
Answer: D
Question Status: Previous Edition
36) Michelle had major abdominal surgery. Months after the surgery, she still did not feel well. When she was
operated on again, the surgeon discovered two sponges that were not removed at the conclusion of the first
operation. Michelle should be able to collect damages without having to prove negligence under the doctrine of
A) joint and several liability. B) res ipsa loquitor.
C) contributory negligence. D) uberrimae fidei.
Answer: B
Question Status: Previous Edition
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The Liability Risk
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37) Francis opened a store. She knows that customers who come to the store may be injured on the premises and
hold her responsible for their injuries. Under common law, business customers in the store Francis opened are
considered
A) aliens. B) licensees.
C) trespassers. D) invitees.
Answer: D
Question Status: Previous Edition
38) Malcolm was involved in an auto accident. He was judged to be 20 percent at fault in the accident, and the
other party was judged to be 80 percent at fault. Malcolm!s actual damages were $40,000. Under a pure
comparative negligence rule, how much will Malcolm receive for his injuries?
A) $8,000 B) $24,000 C) $32,000 D) $40,000
Answer: C
Question Status: Previous Edition
39) Louise was in a hurry and tried to cross the street in the middle of the block rather than at a street corner. A
car struck her. Even though Louise placed herself in danger, she may still be able to collect for her injuries if the
driver had an opportunity to avoid hitting her but failed to do so. This rule is called the
A) last clear chance rule. B) collateral sources rule.
C) alternative dispute resolution rule. D) joint and several liability rule.
Answer: A
Question Status: Previous Edition
40) Bruce believes a local manufacturer is responsible for contaminating some land he owns. He filed suit
against the company. Rather than have the case go to court, the manufacturing company!s legal team suggested
mediation or arbitration to settle the case. Methods that are employed to resolve legal disputes without litigation,
such as mediation, are called
A) collateral source rules. B) alternative dispute resolution techniques.
C) joint and several liability techniques. D) comparative negligence rules.
Answer: B
Question Status: Revised
41) Jan was injured in a work-related auto accident. She sued the other driver, and the case went to court. While
questioning Jan, the defendant!s lawyer asked if her injuries and lost earnings were covered under workers
compensation. Jan!s lawyer objected to the question. The judge ruled the question was improper and instructed
the jury to disregard the question. Based on the judge!s reaction to the question, we can conclude that which of
the following rules is in force where this trial took place?
A) the joint and several liability rule B) the last clear chance rule
C) the comparative negligence rule D) the collateral source rule
Answer: D
Question Status: Previous Edition
42) Trisha was injured by the delivery driver for a local furniture store. The delivery driver claimed that the
brakes of the delivery truck failed, causing the accident. Trisha filed suit, and in her lawsuit named the delivery
driver, the furniture store, the service station responsible for vehicle maintenance, and the manufacturer of the
vehicle. Even though the manufacturer of the vehicle may be only 1 percent responsible for the accident, it may
be required to pay a large percentage of the damages under the
A) collateral sources rule. B) assumption of risk rule.
C) joint and several liability rule. D) last clear chance rule.
Answer: C
Question Status: Previous Edition
Chapter 19 The Liability Risk
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43) One difficulty in asbestos liability cases is that a long period of time may pass between exposure to asbestos
and the lung/respiratory problem develops. This period of time between exposure and manifestation of the
problem is know as the
A) probationary period. B) elimination period.
C) waiting period. D) latency period.
Answer: D
Question Status: Previous Edition
44) Compensatory damages include A) general damages and special damages.
B) special damages and punitive damages. C) punitive damages and general damages. D) general damages,
special damages, and punitive damages.
Answer: A
Question Status: New
45) Congress passed the Sarbanes-Oxley Act to address which of the following problems? A) deficiencies in the
tort liability system
B) corporate fraud and lax corporate governance C) inefficiencies in state regulation of the insurance industry D)
inadequate availability of certain insurance coverages
Answer: B
Question Status: New
Chapter 20 Homeowners Insurance, Section I
1) Which of the following statements is (are) true regarding renters insurance? I. Renters insurance is needed if
you rent a house, but is not needed if you rent an apartment. II. The ISO renter!s policy provides "all-risks"
coverage on the insured!s personal property.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
2) Which of the following statements about eligibility requirements for homeowners insurance is (are) true?
I.
A contract can be written on a six-unit apartment complex as long as the tenants are families. II. Separate
forms are available for renters and condominium owners.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
3) All of the following statements about the Homeowners 6 (unit-owners form) policy are true EXCEPT
A) It includes personal liability coverage. B) It covers personal property on an "all-risks" basis.
C) It provides limited coverage for improvements and alterations. D) It provides limited coverage for loss
assessments.
Answer: B
Question Status: Previous Edition
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4) Which homeowners policy is designed for the tenants of rented premises? A) Homeowners 2
B) Homeowners 4 C) Homeowners 6 D) Homeowners 8
Answer: B
Question Status: Previous Edition
5) Which of the following statements about the Homeowners 8 policy is (are) true? I.
Losses to the dwelling
are settled on a replacement cost basis if the dwelling is insured for its full market value. II.
primarily for expensive, newer, dwellings.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
It is designed
Question Status: Revised
6) Which of the following statements about the Homeowners 3 policy is (are) true? I. Losses to the dwelling
are always settled on an actual cash value basis. II. Coverage on personal property is limited to $5,000.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
7) The major difference between the Homeowners 2 policy and the Homeowners 3 policy is the A) insured perils
for the dwelling.
B) insured perils for personal property. C) type of liability coverage provided. D) amount of coverage for other
structures.
Answer: A
Question Status: Revised
8) Persons insureds under Section I of the Homeowners 3 policy include which of the following? I.
A spouse
of the named insured if living in the same household II. The named insured!s children who are under age 24
and who are full-time college students
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
9) Section I of the Homeowners 3 policy provides coverage for all of the following EXCEPT A) loss of use.
B) personal property. C) other structures. D) medical payments.
Answer: D
Question Status: Previous Edition
10) All of the following are covered under the dwelling coverage (Coverage A) of the Homeowners 3 policy
EXCEPT
A) any structure attached to the dwelling. B) the land on which the insured dwelling is located.
C) materials and supplies intended for alteration or repair of the dwelling. D) materials and supplies intended for
construction of a detached garage.
Answer: B
Question Status: Previous Edition
11) Which of the following statements about the coverage for other structures (Coverage B) under the
Homeowners 3 policy is true?
A) The amount of insurance on other structures is equal to a percentage of the coverage on the dwelling.
B) Structures attached to the dwelling by a fence or utility line are considered to be part of the dwelling rather
than other structures.
C) Coverage applies even if the other structure is used for business purposes. D) There is coverage for a private
garage only if it is rented to a tenant of the dwelling.
Answer: A
Question Status: Revised
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12) All of the following losses are subject to special limits of liability under the Homeowners 3 policy EXCEPT
the
A) theft of firearms. B) destruction by fire of property used for business purposes.
C) storm damage to a boat at a marina. D) destruction of jewelry by fire.
Answer: D
Question Status: Revised
13) Which of the following statements about the personal property coverage (Coverage C) of the Homeowners 3
policy is (are) true? I. The coverage applies only in the United States and Canada. II.
The full amount of
coverage applies only if the property is permanently located at any residence of the insured.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
14) The Homeowners 3 policy limits the amount of coverage provided on certain personal property (e.g. coin
collections and silverware). This personal property can be adequately insured by
A) lowering the deductible which applies to personal property losses. B) storing the property away from the
home at another location.
C) adding a schedule to the policy listing the property with specific amounts of insurance. D) adding an appraisal
clause to the policy.
Answer: C
Question Status: Previous Edition
15) Which of the following property is covered under the personal property coverage (Coverage C) of the
Homeowners 3 policy?
A) a pet iguana owned by the named insured!s spouse B) a bicycle owned by a foster child living with the named
insured
C) music CDs located in the named insured!s automobile D) a stamp collection insured under a separate policy
Answer: B
Question Status: Previous Edition
16) All of the following statements about the coverage for loss of use (Coverage D) under the Homeowners 3
policy are true EXCEPT
A) If a covered loss makes the home unfit for living, the insurer pays additional living expenses the insured may
incur as a result of the loss.
B) The duration of payments for additional living expenses is limited to a maximum of 15 days.
C) There is coverage for the fair rental value of any part of the premises rented to others.
D) There is coverage if civil authorities prohibit the insured from using the premises because of a loss to a
neighboring premises from an insured peril.
Answer: B
Question Status: Previous Edition
17) Which of the following statements about the additional coverages under Section I of the Homeowners 3
policy is true?
A) There is coverage for the reasonable cost incurred to protect property from further damage after a covered
loss occurs.
B) There is unlimited coverage for furnishings of the landlord in an apartment on the premises that is rented to
others.
C) Property removed from the premises because it is endangered by an insured peril is covered on a named-perils
basis while it is outside the insured premises.
D) Damage caused by the settling of the insured structure is covered as a collapse. Answer: A
Question Status: Previous Edition
18) All of the following are additional coverages under Section I of the Homeowners 3 policy EXCEPT A) the
reasonable expenses of removing debris of covered property after an insured loss.
B) fire department service charges for which the insured is liable by contract or agreement. C) damage to trees
and shrubs caused by a windstorm. D) losses incurred from the unauthorized use of a stolen credit card.
Answer: C
Question Status: Previous Edition
19) All of the following are covered perils under the personal property coverage (Coverage C) of an unendorsed
Homeowners 3 policy EXCEPT
A) earthquake. B) theft.
C) windstorm. D) explosion.
Answer: A
Question Status: Previous Edition
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20) Which of the following losses to a dwelling would be covered under an unendorsed Homeowners 3 policy?
A) smoke damage resulting from agricultural operations of a neighboring farmer B) damage to the structure
caused by a flash flood
C) damage to the structure caused by the weight of heavy snow D) damage to a floor caused by water backing up
through a sewer pipe
Answer: C
Question Status: Revised
21) Which of the following statements about covered perils under the personal property coverage (Coverage C)
of the Homeowners 3 policy is true?
A) Theft losses to boats and watercraft are covered only if they occur at the insured!s residence. B) Damage from
an explosion is covered only if the explosion is the result of fire or lightning.
C) Property damage from vehicles is covered only if it is caused by the insured. D) Smoke damage is covered
only if it arises from agricultural or industrial operations.
Answer: A
Question Status: Previous Edition
22) Which of the following types of water damage is covered under an unendorsed Homeowners 3 policy?
A) damage from flood B) damage from water backing up through a drain
C) damage from water below the surface of the ground that seeps into a basement D) damage from water that
overflows from a malfunctioning washing machine
Answer: D
Question Status: Previous Edition
23) All of the following are general exclusions under Section I of the Homeowners 3 policy EXCEPT A) losses
due to earthquake.
B) losses due to the failure of the insured to use all reasonable means to save and preserve property after the time
of a loss.
C) losses resulting from a power failure caused by an insured peril on the residence premises. D) losses due to
radiation from a nuclear power plant.
Answer: C
Question Status: Previous Edition
24) Which of the following is (are) included among the duties of an insured following a loss covered under the
Homeowners 3 policy? I.
To file a proof of loss within a specified time period after the insurer!s request. II.
To prepare an inventory of damaged personal property.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
25) Which of the following statements about the replacement cost provision of the Homeowners 3 policy is true?
A) It applies to personal property losses only.
B) Except for small losses, the insured must repair or replace the damaged property in order to receive full
replacement cost.
C) The insured is required to carry an amount of insurance equal to 100 percent of the replacement value of the
insured property.
D) Loss settlements are equal to 50 percent of the value of the loss if the insured is carrying less than the required
amount of insurance.
Answer: B
Question Status: Previous Edition
26) David has a Homeowners 3 policy that provides $280,000 of insurance on his dwelling, which has a current
replacement value of $400,000. Ignoring any deductible, how much will David collect if a kitchen with a
replacement value of $24,000 but an actual cash value of $18,000 is destroyed in a fire?
A) $18,000 B) $20,000 C) $21,000 D) $24,000
Answer: C
Question Status: Previous Edition
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27) Which of the following statements about the appraisal clause in the Homeowners 3 policy is true? A) The
appraiser for each party is selected by a judge.
B) A binding settlement can be reached only if the umpire agrees with both appraisers. C) Both the insured and
the insurer must agree that the appraisal process be used. D) Appraisal expenses are shared by the insured and the
insurer.
Answer: D
Question Status: Previous Edition
28) Under the Homeowners 3 policy, all of the following are options of the insurer for settling claims EXCEPT
A) paying the claim in cash. B) replacing the property. C) repairing the property.
D) paying the claim with insurance company stock. Answer: D
Question Status: Previous Edition
29) All of the following are duties of the mortgagee under the standard mortgage clause EXCEPT A) to
reimburse the insurer for any loss payments.
B) to notify the insurer of any change in ownership of the property of which the mortgagee is aware.
C) to provide a proof of loss form if the insured fails to do so. D) to pay the premium if the insured fails to do so.
Answer: A
Question Status: Previous Edition
30) All of the following statements about the cancellation of a Homeowners 3 policy are true EXCEPT
A) The insurer may cancel a new policy for any reason if it has been in force for less than 60 days and is not a
renewal policy.
B) At least 100 days notice of cancellation must be given if an insurer cancels a policy for nonpayment of
premium.
C) A policy written for longer than 1 year can be cancelled for any reason on the anniversary date by giving the
insured at least 30 days notice of cancellation.
D) After a policy has been in force for at least 60 days, it can be cancelled by the insurer if the risk has increased
substantially since the policy was issued.
Answer: B
Question Status: Previous Edition
31) All of the following statements about conditions under a homeowners policy are true EXCEPT
A) If an insurer broadens coverage without an additional premium during the policy period, the broadened
coverage applies immediately to the present policy.
B) A waiver or change in any policy provision must be approved in writing by the insurer to be valid.
C) The insurer must give written consent for an assignment of the policy to be valid.
D) If the named insured dies, coverage automatically ceases with respect to any property of the deceased.
Answer: D
Question Status: Previous Edition
32) Cal is renting an apartment. Which homeowners policy is specially designed to insure renters? A) HO-2
B) HO-3 C) HO-4 D) HO-6
Answer: C
Question Status: Previous Edition
33) Shauna purchased a condominium unit. Which homeowners policy is specially designed for condominium
unit owners?
A) HO-2 B) HO-3 C) HO-4 D) HO-6
Answer: D
Question Status: Previous Edition
34) Michelle had four matching end tables in her home. A fire damaged the home, destroying two of the end
tables. Michelle!s home was covered by an unendorsed Homeowners 3 policy. Which of the following is true
with regard to the settlement for the end tables in this case?
A) Loss to a pair or set is excluded under the policy. B) The insurer will pay the actual cash value of the loss. C)
The insurer will pay the replacement cost of the loss.
D) If a partial loss to a pair or set occurs, the insurer is liable for replacement of the entire pair or set.
Answer: B
Question Status: Revised
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35) Betty!s personal property is insured for $100,000 under her Homeowners 3 policy. If she usually keeps some
personal property at a mountain cabin that she owns, how much coverage for this property is available under her
homeowners policy?
A) $10,000 B) $20,000 C) $40,000 D) $50,000
Answer: A
Question Status: Previous Edition
36) Linda wants to purchase a homeowners policy, but she has some valuable personal property to which internal
policy limits apply. Her agent said that she could obtain coverage under her homeowners policy by attaching a
list of this valuable property with specific amounts of insurance. Such a listing is called a(n)
A) binder. B) schedule.
C) application. D) warranty.
Answer: B
Question Status: Previous Edition
37) All of the following are additional coverages provided under Section I of the Homeowners 3 policy EXCEPT
A) reasonable repairs. B) debris removal.
C) personal liability. D) property removal.
Answer: C
Question Status: Previous Edition
38) Darla purchased an unendorsed Homeowners 3 policy. While the policy was in force, a fire occurred that
destroyed a living room set. The living room set cost $4,000 new, but was 25 percent depreciated when the loss
occurred. Replacement furniture will cost $4,400. Assuming no deductible, how much will Darla receive from
her insurer?
A) $3,000 B) $3,300 C) $3,400 D) $4,400
Answer: B
Question Status: Previous Edition
39) A dwelling with a replacement cost of $150,000 was insured under a Homeowners 3 policy for $100,000 at
the time the roof was destroyed by a windstorm. The actual cash value of the loss was $9,000, but it will cost
$12,000 to replace the roof. Assuming no deductible, what will the insurer pay to settle this loss?
A) $8,000 B) $9,000 C) $10,000
D) $12,000 Answer: C
Question Status: Previous Edition
40) Ellen believes the value of the loss to her home is $30,000. The insurer has offered $18,000 to settle the loss.
If Ellen and the insurer cannot agree on the value of the loss, which homeowners policy provision specifies how
this dispute will be settled?
A) insurer!s option B) appraisal clause
C) loss payment clause D) mortgage clause
Answer: B
Question Status: Previous Edition
41) Ted purchased a home. To fund the purchase, he borrowed $140,000 from ABC Bank, pledging the home as
collateral. Shortly after purchasing the home, Ted lost his job. He could not find another job and could not pay
the mortgage each month. Ted set fire to the home. The claims adjuster suspected arson, and an investigation
proved that Ted intentionally caused the loss. Under the mortgage clause of the Homeowners 3 policy, how will
this loss be settled?
A) The insurer has no liability because the loss was intentional. B) The insurer will pay Ted the actual cash value
of the loss as intentional loss is not excluded.
C) The insurer will pay ABC the value of its insurable interest and pay Ted the value of his insurable interest.
D) The insurer will pay ABC the value of its insurable interest and then attempt to recoup the loss payment from
Ted.
Answer: D
Question Status: Revised
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42) Mike and Michelle built their "dream home." They agreed to insure the home for its full value. Their insurer
offered a special homeowners policy. Under the policy, if a total loss occurs, the insurer agrees to replace the
home exactly as it was before the loss even if the replacement cost exceeds the amount of insurance stated in the
policy. What is this type of homeowners policy called?
A) waiver of inventory policy B) fair market value policy
C) guaranteed replacement cost policy D) actual cash value policy
Answer: C
Question Status: Previous Edition
43) Jose and Maria would like "all-risks" coverage on their home and their personal property. Which unendorsed
homeowners form provides this coverage?
A) Homeowners 2 B) Homeowners 3 C) Homeowners 4 D) Homeowners 5
Answer: D
Question Status: Previous Edition
44) All of the following statements about covered perils and loss settlements under an unendorsed Homeowners
3 policy are true EXCEPT
A) The dwelling is covered on an all-risk basis. B) Personal property losses are settled on a replacement cost
basis.
C) Losses to the dwelling may be settled on an actual cash value basis. D) Personal property is covered on a
named-perils basis.
Answer: B
Question Status: New
45) Which of the following statements is (are) true regarding how the Homeowners 3 policy handles the peril of
collapse? I. Collapse is specifically excluded, and there are no exceptions to the exclusion. II.
Collapse
that is caused by a Coverage C peril is covered.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: New
46) Following catastrophic hurricane losses, South Coast Insurance Company changed its deductible provision.
Rather than using a specified dollar value, $250 for example; the dollar value of the deductible increases with the
size of the loss. The type of deductible that South Coast changed to is called a(n)
A) aggregate deductible. B) franchise deductible.
C) straight deductible. D) percentage deductible.
Answer: D
Question Status: New
Chapter 20
Homeowners Insurance, Section I
249
Chapter 21 Homeowners Insurance, Section II
1) All of the following persons are insured for personal liability under the homeowners policy EXCEPT
A) children of the named insured under age 24 who are attending college full time and temporarily residing
elsewhere.
B) foster children under the age of 21 who reside with the named insured. C) nonresident employees of the
named insured. D) the spouse of the named insured if a resident of the same household.
Answer: C
Question Status: Revised
2) Persons insured for personal liability under the homeowners policy include which of the following? I.
Relatives while visiting the named insured. II.
Overnight guests who are not relatives of the named
insured.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Revised
3) All of the following statements about the personal liability coverage (Coverage E) of the homeowners policy
are true EXCEPT
A) Coverage is written on an occurrence basis. B) Coverage is provided for bodily injury liability.
C) Coverage is provided for property damage liability. D) Coverage is provided for personal injury liability.
Answer: D
Question Status: Previous Edition
4) Which of the following statements about the insurer!s obligation to provide a legal defense under the personal
liability coverage (Coverage E) of the homeowners policy is (are) true? I. The insurer agrees to defend the
insured only if the suit is not groundless, false, or fraudulent. II. The insurer!s obligation to defend the insured
ceases after the amount paid for damages from an occurrence equals the policy limit.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
5) Which of the following statements about the coverage for medical payments to others (Coverage F) under the
homeowners policy is true?
A) Medical payments may be made for any resident of the named insured!s household. B) Medical expenses
incurred within 3 years of an accident are covered.
C) Medical payments are made only if the insured is not legally liable. D) Covered medical expenses are limited
to emergency room charges.
Answer: B
Question Status: Previous Edition
6) Which of the following persons is (are) eligible for benefits under medical payments to others (Coverage F) of
the homeowners policy? I. A friend who slips and falls on a wet patio while visiting the named insured. II.
A neighborhood child who is severely scratched by a cat in the care of the named insured.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
7) All of the following are considered insured locations for medical payments to others (Coverage F) under a
homeowners policy EXCEPT
A) a new vacation home purchased by an insured during the policy period. B) a motel room where an insured is
temporarily residing.
C) a hall rented by the insured for her daughter!s graduation party. D) farmland owned by the insured.
Answer: D
Question Status: Previous Edition
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8) Section II of the homeowners policy has exclusions applying to all of the following EXCEPT A) activities of
the named insured!s minor children.
B) business activities. C) transmission of a communicable disease. D) intentional injuries.
Answer: A
Question Status: Revised
9) All of the following situations are excluded from coverage under Section II of the homeowners policy
EXCEPT
A) the rental of a spare bedroom which is used by the tenant as an office. B) the use of a rented airplane to take a
vacation.
C) the ownership of a four-unit apartment house as an investment. D) the performance of professional services
by the insured at the residence premises.
Answer: A
Question Status: Previous Edition
10) Which of the following situations is covered under Section II of an unendorsed homeowners policy?
A) injuries which occur at a park resulting from a motorcycle owned by the insured B) injuries resulting from an
auto not subject to registration because it is in dead storage
C) injuries resulting from an auto rented by the insured while on a vacation D) injuries resulting from a trailer
being pulled by the insured!s auto
Answer: B
Question Status: Previous Edition
11) Which of the following statements regarding watercraft liability under Section II of an unendorsed HO-3
policy is (are) true? I. No coverage is available for watercraft liability. II. Liability arising out of the use of
watercraft that are under certain length and horsepower limits is covered.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
12) Which of the following situations would be covered under Section II of a homeowners policy? I. The
insured is sued by his girlfriend because he infected her with the AIDS virus. II. The insured!s son is sued after a
friend suffered serious injury as a result of using illegal drugs sold to him by the son.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
13) For which of the following situations would there be personal liability coverage under the homeowners
policy? I.
The named insured accidentally injures her husband with a chain saw. II. The named insured
breaks his wife!s valuable vase while practicing his golf swing.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
14) All of the following are exclusions in the homeowners policy that apply to medical payments to others
(Coverage F) EXCEPT
A) bodily injury resulting from nuclear radiation. B) bodily injury to persons who are social guests at the insured
location.
C) bodily injury to persons eligible to receive workers compensation benefits. D) bodily injury to residents of the
household who are in the care of an insured.
Answer: B
Question Status: Previous Edition
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15) Which of the following statements about the additional coverages included in Section II of the homeowners
policy is true?
A) Damage to property of others is covered only if the insured is legally liable. B) Damage to property owned by
the insured is an additional coverage.
C) Interest that accrues on a judgment after the judgment is awarded but before payment is made is covered
under claims expenses.
D) First aid expenses incurred by the insured for bodily injury covered under the policy are not covered.
Answer: C
Question Status: Previous Edition
16) Which of the following statements about the additional coverage for damage to property of others in Section
II of the homeowners policy is true?
A) The maximum amount of coverage is $25,000 per occurrence. B) Payments are made on the basis of the
replacement cost of the damaged property.
C) There is coverage for property damage arising out of a business engaged in on a full-time basis by an insured.
D) There is coverage for intentional acts by any insured who is a teenager. Answer: B
Question Status: Previous Edition
17) Liability arising out of all of the following are covered under the personal injury endorsement to the
homeowners policy EXCEPT
A) bodily injury. B) malicious prosecution.
C) slander. D) invasion of privacy.
Answer: A
Question Status: Previous Edition
18) Liability arising out of all of the following are covered under the personal injury endorsement to the
homeowners policy EXCEPT
A) property damage. B) false arrest.
C) libel. D) slander.
Answer: A
Question Status: Revised
19) Factors that affect the cost of homeowners insurance include which of the following? I.
material II. Deductible amount
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Construction
Question Status: Revised
20) Which of the following statements about endorsements to the homeowners policy is (are) true? I. The
purpose of the inflation guard endorsement is to help prevent home-owners from being under-insured. II.
The purpose of the watercraft endorsement is to provide coverage for watercraft when they are used
outside the United States.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
21) Which of the following statements about buying homeowners insurance is true?
A) There is no reason to carry insurance equal to more than 80 percent of a dwelling!s replacement cost.
B) The deduction for depreciation will be increased if a personal property replacement cost endorsement is
purchased.
C) Premiums often can be reduced substantially by selecting a higher deductible.
D) There is little reason to compare cost since the lack of competition results in little price variation among
companies.
Answer: C
Question Status: Previous Edition
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22) Which of the following statements about an earthquake endorsement for a homeowners policy is (are) true?
I.
The endorsement also covers landslides and volcanic eruptions. II.
The coverage for earthquakes is
written without a deductible.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
23) Which of the following statements about the personal property replacement cost endorsement used with the
homeowners policy is (are) true? I. The damaged or destroyed property must be repaired or replaced, no matter
the size of the loss.
II.
It is designed primarily for antiques and fine art. A) I only
B) II only C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
24) Which of the following statements about the scheduled personal property endorsement to the homeowners
policy is (are) true? I. It provides named-perils coverage on scheduled items. II. It can be used to insure valuable
items such as jewelry, silverware, and coin collections.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Revised
25) All of the following losses are covered under Section II of an unendorsed Homeowners 3 policy EXCEPT
A) The homeowner accidentally dropped a bowling ball, injuring another bowler!s foot.
B) A baby sitter slipped and fell at the insured!s home, breaking her ankle and incurring medical expenses.
C) The insured slandered a city council member at a city council meeting. D) The insured!s dog bit a veterinarian
while the dog was at the veterinary clinic.
Answer: C
Question Status: Previous Edition
26) Tom is planning to build a home. He is weighing many factors, including construction materials, location,
and other considerations. Which of the following statements is true with regard to homeowners insurance and
Tom!s new home?
A) The higher the construction costs are in the area, the lower Tom!s homeowners insurance premiums will be.
B) The lower the homeowners deductible selected, the lower the premium will be. C) Older homes cost more to
insure than newer homes. D) A wood frame home costs less to insure than a brick home.
Answer: C
Question Status: Previous Edition
27) Robert purchased an unendorsed Homeowners 3 policy. He is concerned that if his personal property is
destroyed, the insurer will take depreciation into consideration when determining the loss settlement and will pay
him less than the amount needed to purchase new assets. Which endorsement can Robert add to his Homeowners
3 policy to address this concern?
A) inflation guard endorsement B) personal injury endorsement
C) personal property replacement cost endorsement D) earthquake endorsement
Answer: C
Question Status: Revised
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28) Gail lives in southern Illinois, near the New Madrid Fault Line. She added an earthquake endorsement to her
Homeowners 3 policy. All of the following statements about the endorsement are true EXCEPT
A) The deductible is expressed as a percentage of the coverage limit rather than as a dollar amount.
B) The endorsement also covers landslides and volcanic eruptions.
C) Aftershocks occurring within 72 hours of an earthquake are considered part of the same occurrence.
D) The endorsement also covers flood losses. Answer: D
Question Status: Revised
29) Lu would like to save money on her homeowners premium. All of the following steps will help her to reduce
her homeowners premium EXCEPT
A) raising the deductible in the homeowners policy to a higher amount. B) shopping around a homeowners
policy.
C) installing burglar alarms, smoke detectors, and dead-bolt locks. D) insuring the value of the land beneath the
house.
Answer: D
Question Status: Previous Edition
30) Reggie just purchased a home. A friend told him to consider insurance coverage for natural disasters when
insuring the home. Losses from all of the following perils are covered under an unendorsed Homeowners 3
policy EXCEPT
A) tornadoes. B) floods.
C) hurricanes. D) forest fires.
Answer: B
Question Status: Previous Edition
31) All of the following losses are excluded from coverage under Section II of an unendorsed Homeowners 3
policy EXCEPT
A) Phyllis, a medical technician, misread a lab test and the patient is suing her. B) A canoe Bert was piloting hit
another canoe. The other canoe sank. He is being sued.
C) Violet runs a for-profit daycare service in her home. The parents of a child injured while in Violet!s care are
suing Violet.
D) The homeowner!s son was injured when he fell off a swing in the homeowners!s yard.
Answer: B
Question Status: Revised
32) Which of the following losses would be covered under the medical payments coverage of the Homeowners 3
policy?
A) injuries to another person arising out of the insured!s negligent operation of a vehicle B) medical payments
resulting from the transmission of a communicable disease
C) injury to a resident employee at the insured!s home D) workers compensation medical payments
Answer: C
Question Status: Previous Edition
33) Which of the following losses would be covered under the personal liability coverage (Coverage E) of the
Homeowners 3 policy?
A) liability arising out of the manufacture and sale of illegal narcotics B) liability arising out of damage to a
neighbor!s property that occurred over time
C) liability arising out of damage to non-owned property in the care of the insured D) liability arising out of
bodily injury to an insured
Answer: B
Question Status: Previous Edition
34) Tom and Tammy Evans were ready to purchase a home. The home was to serve as collateral for their
mortgage loan. Two insurers declined to insure the home, citing "an adverse CLUE report." Why would an
insurer reject a homeowners insurance application because of an adverse CLUE report?
A) because the previous owner had defaulted on the mortgage loan B) because the home is located in an area
where the zoning law had been changed
C) because there had been previous property insurance claims filed on the home D) because the home is located
in an area that does not have a certified fire department
Answer: C
Question Status: Revised
35) Which of the following statements is (are) true concerning the use of an individual!s credit history as an
insurance rating factor? I.
Individuals with poor credit histories generally file more homeowners claims than
do individuals with good credit histories.
II.
The use of credit history as an insurance rating factor is controversial. A) I only
B) II only C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
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36) A credit-based score that is highly predictive of future claims cost is an individual!s A) CLUE score.
B) insurance score. C) loss ratio score. D) underwriting score.
Answer: B
Question Status: Previous Edition
37) Which of the following statements is (are) true concerning the home business insurance coverage
endorsement?
I.
It increases the coverage on business personal property at the insured residence from $2,500 to the
Coverage C limit. II. It excludes coverage for liability arising out of the home business.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: New
38) One of the "Tips for Buying a Homeowners Policy" is to consider purchasing a personal umbrella policy.
What coverage is provided by a personal umbrella policy?
A) blanket property coverage for any damage caused by water
B) excess liability coverage and coverage for some liability claims excluded by underlying policies
C) all-risk, replacement cost, property coverage D) coverage for business and professional liability
Answer: B
Question Status: New
Chapter 22 Auto Insurance
1) Which of the following statements about the liability limits of the PAP is (are) true? I.
The policy is
written with split limits of liability. II.
Prejudgment interest is considered part of the damage award and is
subject to the policy limit of liability.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
2) Which of the following statements about the payment of defense costs by the PAP is (are) true? I.
They are
paid in addition to the policy limits. II.
They are payable even after the limit of liability is exhausted.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
3) All of the following are covered autos under the liability section of the PAP EXCEPT A) a nonowned van
which is driven by the insured on a regular basis.
B) a trailer owned by the named insured. C) a borrowed auto used by the insured as a substitute for a stolen
covered auto. D) a newly acquired auto which replaces a vehicle previously described in the policy.
Answer: A
Question Status: Previous Edition
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4) All of the following are insured persons under the liability coverage of the PAP EXCEPT A) a friend to whom
the named insured loans a covered auto.
B) the employer of the named insured for actions resulting from the named insured!s use of a covered auto.
C) the former spouse of the named insured who moved out of the home 2 years ago when the divorce was
finalized.
D) a relative of the named insured if a member of the same household. Answer: C
Question Status: Previous Edition
5) Which of the following persons is (are) covered for liability insurance under the PAP? I. A family member
who drives a covered auto. II.
A family member who occasionally drives a friend!s auto.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
6) All of the following are covered as supplementary payments under the liability section of the PAP EXCEPT
A) the cost of an appeal bond in a lawsuit. B) the cost of a bail bond for a traffic violation when no accident is
involved.
C) interest which accrues on a liability judgment covered by the policy.
D) reasonable expenses incurred by the insured to testify at a trial involving a lawsuit covered by the policy.
Answer: B
Question Status: Previous Edition
7) Which of the following situations would be covered by the liability section of an unendorsed PAP if the
insured is legally liable?
A) The insured injures a pedestrian while operating a friend!s new motorcycle. B) The insured backs into and
damages the garage door of his rented house.
C) A friend!s suitcase and laptop computer were damaged in an auto accident while the insured and the friend
were vacationing together.
D) The insured damages a parked car while driving a dump truck for his or her employer.
Answer: B
Question Status: Previous Edition
8) What is the purpose of the extended nonowned liability coverage endorsement to the PAP?
A) to provide liability coverage for an insured!s employer when an insured uses his or her auto for business
purposes
B) to provide liability coverage for an insured who occasionally operates a nonowned auto C) to provide liability
coverage for anyone who loans a covered auto to another driver D) to provide liability coverage for an insured
who operates a nonowned auto on a regular basis
Answer: D
Question Status: Previous Edition
9) Which of the following situations would be covered under the liability section of the PAP? I.
A
mechanic is sued by a pedestrian who is injured when the mechanic has an accident while road testing the
insured!s auto. II.
The daughter of the named insured is sued after she has an accident when a new friend she
just met at a campus hangout lets her drive his car.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
10) Larry has $25,000 of bodily injury liability coverage under his PAP. This limit is the minimum amount
required by his state to be considered financially responsible. While on a vacation, Larry visited a neighboring
state which has a minimum financial responsibility limit of $50,000 for bodily injury. Which of the following
statements describes the situation for Larry while he was in the neighboring state?
A) Larry!s policy was suspended while he was in the neighboring state. B) Larry had only $25,000 of liability
coverage.
C) Larry!s policy automatically provided $50,000 of liability coverage. D) Larry!s policy automatically provided
$100,000 of liability coverage.
Answer: C
Question Status: Previous Edition
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11) John occasionally borrows the car of his friend, Sophie. Sophie has a PAP with liability limits of 100/300/50.
John also has a PAP, and his liability limits 250/500/50. John had an accident while using Sophie!s car and was
found to be legally liable for $300,000 in bodily injury liability. How much will be paid by each policy?
A) Sophie!s policy will pay $150,000, John!s policy will pay $150,000. B) Sophie!s policy will pay $50,000,
John!s policy will pay $250,000. C) Sophie!s policy will pay $100,000, John!s policy will pay $200,000.
D) John!s policy will pay the entire amount. Answer: C
Question Status: Revised
12) Which of the following statements about the medical payments coverage of the PAP is true? A) The amount
of the benefit typically is $100,000.
B) Covered expenses must be incurred within 6 months of the accident. C) Covered expenses include the cost of
funeral services. D) The benefit limit applies on a per-accident basis rather than on a per-person basis.
Answer: C
Question Status: Previous Edition
13) All of the following are covered persons under the medical payments coverage of the PAP EXCEPT A) a
family member of the named insured if struck by an auto while crossing the street.
B) a pedestrian struck by the named insured!s auto. C) the named insured who is injured while occupying a
friend!s auto. D) a friend who is injured while occupying the named insured!s auto.
Answer: B
Question Status: Previous Edition
14) Tony has a PAP which provides medical payments coverage. Under which of the following circumstances
would the injured person be eligible for benefits under Tony!s policy? I. A friend is injured while Tony is
driving a nonowned auto. II. A hitchhiker riding with Tony!s son is injured when the son wrecks Tony!s auto.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
15) All of the following are exclusions under the medical payments coverage of the PAP EXCEPT A) injuries
incurred while riding a motorcycle.
B) injuries incurred while an auto is being used without the presumption that permission would have been
granted to use the auto.
C) injuries incurred in an auto while it is used in a share-the-expense car pool. D) injuries incurred during the
course of employment if workers compensation benefits are
available. Answer: C
Question Status: Previous Edition
16) Which of the following statements about the uninsured motorists coverage of the PAP is true? A) The
coverage usually applies only to property damage.
B) The coverage applies only if the uninsured motorist is legally liable.
C) Unless higher amounts are purchased, the maximum benefit is normally limited to $1,000.
D) A covered person!s only recourse is to sue the insurer if there is a disagreement over the amount of damages.
Answer: B
Question Status: Previous Edition
17) Which of the following persons is (are) insured under the uninsured motorists coverage of the PAP?
I.
A pedestrian struck by a covered auto if he or she has no insurance to pay medical expenses II. The
spouse of a named insured who is killed by an uninsured motorist
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
18) All of the following are considered to be uninsured vehicles for purposes of the uninsured motorists coverage
of the PAP EXCEPT
A) a vehicle owned by an individual who is insured, but for less than the amount required by the state!s financial
responsibility law.
B) a hit-and-run vehicle, the ownership of which cannot be determined. C) a vehicle upon which just enough
liability insurance has been purchased to satisfy the state!s
financial responsibility law. D) a vehicle insured by a company which becomes insolvent before a claim can be
paid.
Answer: C
Question Status: Revised
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19) Joyce was injured by an uninsured drunk driver while she was riding in a friend!s car. Joyce and her friend
each have a PAP with an uninsured motorists limit of $50,000. How much will be paid by each policy if it is
determined that Joyce has $70,000 of bodily injuries?
A) Each policy will pay $35,000. B) Joyce!s policy will pay $50,000, and the friend!s policy will pay nothing.
C) Joyce!s policy will pay $50,000, and the friend!s policy will pay $20,000. D) The friend!s policy will pay
$50,000, and Joyce!s policy will pay $20,000.
Answer: D
Question Status: Previous Edition
20) All of the following statements about Part D (coverage for damage to your auto) of the PAP are true
EXCEPT
A) Coverage may be purchased with or without collision insurance. B) Losses are paid regardless of fault.
C) Coverage applies to a nonowned auto occasionally driven by an insured.
D) A newly acquired auto is covered only if the named insured asks the company to insure it within 24 hours of
acquisition.
Answer: D
Question Status: Revised
21) Which of the following is considered to be a collision loss under Part D (coverage for damage to your auto)
of the PAP?
A) The covered auto hits a deer. B) The covered auto is vandalized by a thief after it is stolen.
C) The covered auto is damaged when it slid off an icy road and hit a fence. D) The covered auto is damaged
when struck by a rock thrown by a child.
Answer: C
Question Status: Revised
22) John has an auto which is covered for collision losses subject to a $250 deductible. Kate!s auto also has
collision coverage but her deductible is $500. Which of the following statements describes how a $2,000
collision loss will be paid if it occurs when John borrows Kate!s car because his car is in the shop for repairs?
A) John!s policy will pay $1,500, and Kate!s policy will pay nothing. B) John!s policy will pay $1,750, and
Kate!s policy will pay nothing. C) Kate!s policy will pay $1,750, and John!s policy will pay nothing.
D) Kate!s policy will pay $1,500, and John!s policy will pay $250.
Answer: D
Question Status: Previous Edition
23) All of the following losses are excluded under Part D (coverage for damage to your auto) of an unendorsed
PAP EXCEPT
A) vandals damages a portable cell phone kept in the car. B) theft of a compact disc player which was
permanently installed in the auto.
C) damage caused to a car!s engine because the named insured never changed the oil. D) destruction of a radar
detector which overheated and caught on fire.
Answer: B
Question Status: Revised
24) The insurance company!s options for settling a collision loss to a covered auto under the PAP include which
of the following? I. Pay the loss in money. II.
Repair or replace the damaged auto.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
25) Duties of an insured after a collision loss covered under the PAP include which of the following? I. Take
reasonable steps to protect the vehicle from further damage. II. Admit fault if the insured believes he or she
caused the collision.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
26) In addition to providing coverage in the United States, its territories and possessions, and Puerto Rico, where
else does the PAP provide coverage?
A) in Mexico B) in Canada
C) in both Mexico and Canada D) anywhere in the world
Answer: B
Question Status: Previous Edition
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27) All of the following statements about the termination provisions of the PAP are true EXCEPT A) The
insured can cancel the policy for any reason.
B) The insurer can cancel a newly-written policy if it has been in force for fewer than 60 days. C) The insurer
can cancel the policy after it has been in force for 60 days only if the insured has
three or more traffic violations.
D) The insurer can refuse to renew the policy at its annual anniversary date as long as proper notice is given prior
to the end of the policy period.
Answer: C
Question Status: Revised
28) The Miscellaneous-Type Vehicle Endorsement to the PAP can be used to insure all of the following vehicles
EXCEPT
A) motor homes. B) golf carts.
C) snowmobiles. D) motorcycles.
Answer: C
Question Status: Revised
29) Which of the following statements about the Miscellaneous-Type Vehicle Endorsement to the PAP is (are)
true?
I.
It provides bodily injury liability coverage for any vehicle rented by the insured. II.
To lower
premiums when a motorcycle is insured, bodily injury to passengers can be excluded.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
30) Ken fell asleep while driving late at night. He crossed the center line and hit a car approaching from the other
direction. The following losses occurred: ÁThe driver of the other car suffered $30,000 in bodily injuries. ÁKen!s
car sustained $5,000 in damages.
ÁKen incurred $5,000 in medical expenses. ÁThe car that Ken hit was a total loss. Which of Ken!s Personal Auto
Policy (PAP) coverages will cover the other driver!s medical expenses?
A) bodily injury liability B) collision coverage
C) medical payments coverage D) property damage liability
Answer: A
Question Status: Previous Edition
31) Ken fell asleep while driving late at night. He crossed the center line and hit a car approaching from the other
direction. The following losses occurred. ÁThe driver of the other car suffered $30,000 in bodily injuries. ÁKen!s
car sustained $5,000 in damages.
ÁKen incurred $5,000 in medical expenses. ÁThe car that Ken hit was a total loss. Which of Ken!s Personal Auto
Policy (PAP) coverages will cover the damage to Ken!s car?
A) bodily injury liability B) collision coverage
C) medical payments coverage D) property damage liability
Answer: B
Question Status: Previous Edition
32) Ken fell asleep while driving late at night. He crossed the center line and hit a car approaching from the other
direction. The following losses occurred. ÁThe driver of the other car suffered $30,000 in bodily injuries. ÁKen!s
car sustained $5,000 in damages.
ÁKen incurred $5,000 in medical expenses. ÁThe car that Ken hit was a total loss. Which of Ken!s Personal Auto
Policy (PAP) coverages will cover Ken!s medical expenses?
A) bodily injury liability B) collision coverage
C) medical payments coverage D) property damage liability
Answer: C
Question Status: Previous Edition
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33) Ken fell asleep while driving late at night. He crossed the center line and hit a car approaching from the other
direction. The following losses occurred. ÁThe driver of the other car suffered $30,000 in bodily injuries. ÁKen!s
car sustained $5,000 in damages.
ÁKen incurred $5,000 in medical expenses. ÁThe car that Ken hit was a total loss. Which of Ken!s Personal Auto
Policy (PAP) coverages will cover the damage to the car that Ken hit?
A) bodily injury liability B) collision coverage
C) medical payments coverage D) property damage liability
Answer: D
Question Status: Previous Edition
34) Sarah purchased a Personal Auto Policy with liability limits of 50/100/25. Sarah ran a stop sign and hit a van.
The van sustained $15,000 in damages. The following bodily injuries were suffered by passengers in the van:
Passenger #1, $15,000; Passenger #2, $60,000; and Passenger #3, $10,000. Sarah sustained $5,000 in medical
expenses, and Sarah!s car sustained $10,000 in damages. How much will Sarah!s insurer pay under Part A:
Liability Coverage?
A) $90,000 B) $100,000 C) $115,000 D) $125,000
Answer: A
Question Status: Previous Edition
35) Patricia purchased a Personal Auto Policy (PAP). Her car was rear-ended by a driver who fled the scene.
Patricia suffered whiplash, migraine headaches, and she was unable to work. Which of the following coverages
will cover her lost work earnings?
A) medical payments B) uninsured motorists
C) underinsured motorists D) bodily injury liability
Answer: B
Question Status: Previous Edition
36) Rob purchased a Personal Auto Policy (PAP) with collision and other-than-collision coverage. All of the
following losses are excluded under this physical damage coverage EXCEPT
A) Rob wrecked his car while using it as a taxi cab. B) Thieves took Rob!s radar detector from his car.
C) A flash flood washed Rob!s car off the road and damaged it. D) The new tires Rob had on the car were
defective and wore out after 2 months.
Answer: C
Question Status: Previous Edition
37) Angie was injured when her car was struck by a driver who ran a red light. The other driver carried the
minimum liability coverage necessary to be considered financially responsible. Angie!s injuries were $15,000
above the minimum bodily injury limit. There is a coverage that can be added to the PAP that applies when a
negligent driver carries the minimum liability insurance required by the state, but less than the insured!s actual
damages for bodily injury. This coverage is called
A) medical payments coverage. B) underinsured motorists coverage.
C) bodily injury liability coverage. D) uninsured motorists coverage.
Answer: B
Question Status: Previous Edition
38) Dennis was involved in an accident. He believes the damage to his auto is $6,000. His insurer believes the
damage is only $3,500. Which PAP provision is designed to handle disputes between the insurer and the insured
over the amount of the loss?
A) other insurance provision B) agreed amount endorsement
C) coinsurance provision D) appraisal provision
Answer: D
Question Status: Previous Edition
39) The purpose of the collision damage waiver when renting an auto is to A) relieve the renter of financial
responsibility if the rented car is damaged or stolen.
B) relieve the renter of legal liability to third parties arising out of operation of the rented car.
C) relieve the renter!s insurer of legal liability to third parties arising out of operation of the rented car.
D) waive the insured!s deductible if the rented car is damaged or stolen.
Answer: A
Question Status: Revised
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40) Which of the following statements is (are) true with respect to the collision damage waiver on rented cars?
I.
It is inexpensive and is provided at no charge by most rental car companies. II. It waives renter!s
liability for bodily injury liability arising out of the use of the rented auto.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
41) The purpose of gap insurance is to
A) pay the difference between the bodily injury liability limit purchased and the actual amount of bodily injury
liability if it exceeds the limit.
B) pay the difference between the amount the insurer pays if a car is a total loss and the amount owed on a lease
or car loan.
C) pay the difference between the medical payments coverage limit and the actual medical expenses of injured
family members or passengers in the insured auto.
D) pay the difference between the uninsured motorists coverage limit and the actual amount of the medical
expenses incurred by the insured.
Answer: B
Question Status: Previous Edition
42) A car damaged in an auto accident may have reduced market or resale value after it is repaired. Some
insureds sought to recover this reduction in market or resale value. This loss in value is called:
A) gap coverage. B) betterment. C) diminution.
D) subrogation.
Answer: C
Question Status: Revised
43) If the value of a vehicle is increased after repairs, such as repainting an entire auto when only one fender or
door is damaged, the insurer will not pay for the increase in value. Another name for the increase in value is
A) diminution. B) betterment.
C) appraisal. D) subrogation.
Answer: B
Question Status: Previous Edition
44) The 2005 PAP states that the insurer has no duty to provide coverage if the insured fails to comply with
certain listed duties. In practice, however, the insurer is only relieved of its duty to provide coverage if
A) the insured was unaware of the listed duties. B) failure to comply with the duties is prejudicial to the insurer.
C) the claim involves bodily injuries of more than $50,000. D) the claim occurred in another state.
Answer: B
Question Status: New
45) Which statement concerning towing and labor coverage under the PAP is (are) true? I.
If the insured
purchases collision coverage, towing and labor coverage is provided automatically. II. Towing and labor
coverage pays for repairs at a service station or garage.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Revised
Chapter 22
Auto Insurance
273
Chapter 23 Automobile Insurance and Society
1) Under financial responsibility laws, proof of financial responsibility is generally required under all of the
following circumstances EXCEPT
A) the use of an auto by any driver with fewer than 3 years of driving experience. B) an auto accident involving
property damage over a specified amount.
C) failure to pay a final judgment resulting from an auto accident. D) conviction for certain serious traffic
offenses, such as driving while intoxicated.
Answer: A
Question Status: Revised
2) Defects of financial responsibility laws include which of the following? I.
Accident victims may not be
fully compensated for their injuries. II.
They apply only to property damage losses, not to bodily injury
claims.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
3) Criticisms of compulsory insurance laws include which of the following? I. They provide less than complete
protection since they require only a minimum amount of liability insurance. II. Even with compulsory
insurance laws, a substantial number of motorists continue to operate vehicles without insurance.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
4) Which of the following statements about unsatisfied judgment funds is (are) true? I. An accident victim must
obtain a judgment against the motorist who caused an accident and must show the judgment cannot be collected.
II.
The major disadvantage is that the negligent uninsured motorist is relieved of legal liability.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
5) Which of the following statements about uninsured motorists coverage is true? A) An innocent motorist must
establish that the uninsured motorist is legally liable.
B) The amount of coverage in most states must be at least $300,000. C) Property damage is covered in all states
but bodily injury is not covered in all states. D) The coverage is very expensive and beyond the means of all but
wealthy insureds.
Answer: A
Question Status: Previous Edition
6) Which of the following statements is true with respect to a pure no-fault auto insurance plan? A) Under such a
plan, you would collect from your own insurer and retain the right to sue the
other party if your injuries surpass a dollar or verbal threshold. B) Most no-fault plans that have been adopted by
states are pure no-fault plans.
C) Under such a plan, you would collect from your own insurer and retain the right to sue the other party without
having to satisfy a threshold.
D) Under such a plan, an accident victim cannot sue the other party, and no payments are made for pain and
suffering.
Answer: D
Question Status: Previous Edition
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7) Which of the following statements about modified no-fault laws is (are) true? I.
Claims less than a
certain dollar threshold must be assumed by the injured accident victim, but the injured person has the right to
sue a negligent driver. II.
Claims above a certain dollar threshold are paid in full by an injured accident
victim!s insurer, and the right to sue a negligent driver is eliminated.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
8) A no-fault law under which benefits are paid to an accident victim without regard to fault and the accident
victim can still sue the negligent driver who caused the accident is referred to as a(n)
A) pure no-fault law. B) add-on no-fault law.
C) modified no-fault law. D) comparative no-fault law.
Answer: B
Question Status: Revised
9) All of the following are arguments for no-fault automobile insurance laws EXCEPT A) It is often difficult to
determine fault under the tort liability system.
B) A large portion of each premium dollar is used for purposes other than compensating accident victims for
their losses.
C) There are delays in compensating accident victims under the tort system.
D) Seriously injured accident victims tend to be overcompensated, while those with small economic losses are
inadequately indemnified.
Answer: D
Question Status: Revised
10) Arguments often used against no-fault automobile insurance laws include all of the following EXCEPT
A) It is often difficult to determine which driver was negligent when a multiple-vehicle accident occurs.
B) Many injured persons will not be compensated for their full losses because payments for pain and suffering
will be eliminated.
C) The defects of the negligence system are exaggerated, and the system needs only to be reformed.
D) Claims of efficiency and premium saving are exaggerated, and automobile insurance premiums might actually
increase.
Answer: A
Question Status: Previous Edition
11) Which of the following statements about the characteristics of current no-fault laws is true? A) Most laws in
force today are pure no-fault laws.
B) Most laws apply to both bodily injury and property damage. C) Most laws permit payment of survivor
benefits to a surviving spouse and children. D) States with add-on plans restrict the right of accident victims to
sue negligent drivers.
Answer: C
Question Status: Previous Edition
12) The term used to describe plans in which automobile insurers participate to make insurance available to
drivers unable to obtain coverage in the standard market is the
A) foreign market. B) fair market.
C) residual (shared) market. D) high-premium market.
Answer: C
Question Status: Previous Edition
13) Under which type of automobile insurance arrangement are all automobile insurers in a state assigned their
proportionate share of high-risk drivers based on the total volume of automobile business written in the state?
A) automobile insurance plan B) unsatisfied judgment fund
C) reinsurance facility D) specialty automobile plan
Answer: A
Question Status: Previous Edition
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14) Disadvantages of automobile insurance plans include which of the following? I.
High premiums may
cause many high-risk drivers to go uninsured. II. Large underwriting profits have resulted in high-risk drivers
subsidizing the cost of insurance for good drivers in the voluntary markets.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
15) Which of the following statements about joint underwriting associations for insuring high-risk drivers is (are)
true? I. Underwriting losses are proportionately shared by all auto insurers based on premiums written in the
state.
II.
Each company participating in a joint underwriting association sets it own rates. A) I only
B) II only C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
16) Which of the following statements about reinsurance facilities for insuring high-risk drivers is (are) true?
I.
Underwriting losses in the reinsurance facility are shared by all auto insurers in the state. II.
An
insurer must accept all applicants for insurance, but the insurer has the option of placing high-risk drivers in the
reinsurance pool.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
17) Which of the following statements about automobile insurers that specialize in insuring motorists with poor
driving records is (are) true? I.
The actual premium paid by an applicant is set by the federal government
and is independent of an applicant!s driving record.
II.
The coverages available may be more limited than those written by insurers in the standard market.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Revised
18) Which of the following statements about the factors affecting automobile insurance rates is true? A) The cost
of collision coverage increases as a car gets older.
B) Because of high speeds in rural areas, rural drivers tend to pay more for auto insurance than city drivers pay
for auto insurance.
C) Young unmarried male drivers tend to have fewer accidents than young married male drivers in the same age
category.
D) People who drive a car to and from work tend to be charged higher rates than those who use a car for pleasure
purposes.
Answer: D
Question Status: Revised
19) All of the following are major rating factors for determining private passenger automobile insurance
premiums EXCEPT
A) gender. B) age.
C) race. D) marital status.
Answer: C
Question Status: Previous Edition
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20) All of the following statements about shopping for auto insurance are true EXCEPT A) Adequate liability
insurance is the most important consideration.
B) Consideration should be given to dropping physical damage insurance on an older car with a low market
value.
C) To obtain the lowest premium, an applicant should review his or her eligibility for all discounts offered.
D) Price comparisons are of little value since auto insurers tend to charge the same premiums. Answer: D
Question Status: Revised
21) A state just passed a law requiring individuals who have been involved in an auto accident or who have been
convicted for certain vehicle-related offenses to demonstrate the ability to pay liability claims up to a specified
dollar amount. Such a provision is called a(n)
A) financial responsibility law. B) compulsory insurance law.
C) unsatisfied judgment fund law. D) "no pay, no play" law.
Answer: A
Question Status: Revised
22) Bill was severely injured by an uninsured driver. Bill did not purchase uninsured motorists coverage, and the
other driver, although held liable, could not pay the damages awarded. After exhausting all sources of recovery,
Bill obtained some relief from a state fund designed to compensate individuals like Bill. These state funds are
called
A) guaranty funds. B) unsatisfied judgment funds.
C) rainy-day funds. D) second injury funds.
Answer: B
Question Status: Previous Edition
23) Sharon lives in a state that has a no-fault automobile insurance law. Under the law, an injured person has the
right to sue the negligent driver only if the bodily injury claim exceeds a dollar or verbal threshold. The no-fault
law in Sharon!s state is a(n)
A) pure no-fault plan. B) modified no-fault plan.
C) add-on plan. D) choice no-fault plan.
Answer: B
Question Status: Previous Edition
24) A few states have dual automobile insurance systems. A motorist can pay a higher premium and retain the
right to sue under the tort system, or pay a lower premium and be covered under the state!s no-fault law. This
dual system is called a(n)
A) pure no-fault plan. B) modified no-fault plan.
C) "no pay, no play" law. D) choice no-fault plan.
Answer: D
Question Status: Previous Edition
25) A number of benefits are payable under no-fault plans. Under one provision, benefits are paid for tasks
normally performed by the insured, including such things as lawn care, housework, and home repairs. These
tasks are called
A) home health care services. B) hospice services.
C) activities of daily living. D) essential services expenses.
Answer: D
Question Status: Previous Edition
26) Alan has been involved in three accidents and has a number of moving violations. He tried to purchase auto
insurance, but three insurers refused to sell him coverage. The generic name for state plans designed to insure
drivers like Alan is the
A) exchange market. B) residual market.
C) voluntary market. D) excess market.
Answer: B
Question Status: Previous Edition
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27) Janet was unable to obtain auto insurance in the voluntary insurance market. She was contacted by the state
insurance department and notified that XYZ Insurance would be her insurer. Eric was also unable to obtain auto
insurance, and he received a similar notice. ABC Insurance would be his insurer. The mechanism used in Janet!s
and Eric!s state to provide auto insurance to high-risk drivers is a(n)
A) automobile insurance plan. B) joint underwriting association.
C) specialty automobile insurer. D) reinsurance facility.
Answer: A
Question Status: Revised
28) In the state where Susan lives, drivers whom private insurance companies do not want to insure are placed in
a common pool, and each insurer pays its pro rata share of pool losses and expenses. A common policy is used
for all high-risk drivers. Susan!s state handles high-risk drivers through a(n)
A) auto insurance plan. B) joint underwriting association.
C) pure no-fault plan. D) specialty auto insurer.
Answer: B
Question Status: Revised
29) Scott had trouble obtaining auto insurance. After three companies refused to insure him, he called the state
insurance department. A representative suggested he obtain coverage through Last Chance Insurance Company
because "that!s all they insureÁhigh-risk drivers." Scott contacted Last Chance. He was not refused coverage;
however, the premium Scott was required to pay was three times greater than the average premium in the market.
Last Chance Insurance Company is a(n)
A) reinsurance facility. B) auto insurance plan.
C) specialty auto insurer. D) joint underwriting association.
Answer: C
Question Status: Previous Edition
30) Amber believes that her auto insurance premium is too high. All of the following will reduce Amber!s auto
insurance premium EXCEPT
A) Amber could raise her physical damage deductible. B) Amber could move from the city where she lives to a
rural area outside the city.
C) Amber could increase the amount of liability insurance that she carries. D) Amber could improve her driving
record.
Answer: C
Question Status: Previous Edition
31) Which of the following statements is (are) true with respect to the use of credit scores as an auto insurance
rating factor? I.
Insurers claim that drivers who have poor credit scores are expected to have relatively
more accidents.
II.
The use of credit scores in personal lines underwriting is controversial. A) I only
B) II only C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
32) Some states have enacted laws which prohibit uninsured drivers from suing a negligent driver for
noneconomic damages, such as pain and suffering. These laws are called
A) pure no-fault laws. B) "no pay, no play" laws.
C) financial responsibility laws. D) unsatisfied judgment laws.
Answer: B
Question Status: Previous Edition
33) A credit-based score that insurers claim is highly predictive of future claims costs is an individual!s A)
combined ratio.
B) loss ratio. C) insurance score. D) underwriting score.
Answer: C
Question Status: Previous Edition
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34) A few states have enacted laws to make minimum amounts of liability insurance available at reduced rates to
individuals who cannot afford regular insurance or who have limited financial assets to protect. The coverage
made available through such a plan is called
A) probationary insurance. B) uninsured motorists insurance.
C) no-fault auto insurance. D) low-cost auto insurance.
Answer: D
Question Status: Previous Edition
35) New Jersey!s dollar-a-day auto insurance coverage is designed for A) elderly individuals.
B) Medicaid recipients. C) drivers under age 25. D) high-risk drivers.
Answer: B
Question Status: New
36) In Maryland, drivers who are unable to obtain auto insurance in the voluntary market are insured through
a(n)
A) state fund. B) reinsurance facility.
C) joint underwriting association D) auto insurance plan.
Answer: A
Question Status: New
37) The multi-car discount is based on the assumption that A) two cars owned by the same person will not be
driven as frequently as one car.
B) multiple vehicle owners are safer drivers. C) owners of more than one vehicle are more likely to be financially
responsible. D) lower liability limits are needed if there are multiple autos insured.
Answer: A
Question Status: New
Chapter 24 Other Property and Liability Insurance
Coverages
1) Which of the following statements about Dwelling Property 1 (basic form) is true? A) Coverage on the
dwelling is written on a replacement cost basis.
B) The full amount of personal property coverage applies to property away from the insured premises.
C) Coverage for fair rental value of the dwelling is subject to both an overall maximum and a monthly
maximum.
D) "All-risk" coverage is automatically provided for both the dwelling and personal property. Answer: C
Question Status: Revised
2) Perils insured under Dwelling Property 1 (basic form) include which of the following? I.
Smoke
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Earthquake II.
Question Status: Previous Edition
3) All of the following are perils covered under Dwelling Property 2 (broad form) EXCEPT A) weight of ice,
snow, or sleet.
B) flood. C) sudden and accidental damage from an artificially generated electrical current. D) freezing of a
plumbing or heating system.
Answer: B
Question Status: Previous Edition
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4) Which of the following statements about Dwelling Property 3 (special form) is (are) true? I. Personal property
is covered on an "open perils" (all risks) basis. II. The dwelling and other structures are covered only for those
perils specifically named in the policy.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
5) Which of the following coverages are provided by an unendorsed ISO Dwelling Program form? I.
personal property II. Personal liability insurance
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Theft of
Question Status: Previous Edition
6) Which of the following statements about the eligibility requirements for insuring mobile homes by endorsing a
homeowners policy is (are) true? I. The mobile home must be designed for year-round living. II.
The
mobile home must be located in a fenced area with security guards.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
Chapter 24 Other Property and Liability Insurance Coverages 287
7) Which of the following statements about mobile home insurance is (are) true? I.
Coverage for the mobile
home may be written on either a replacement cost basis or an actual cash value basis, depending on how much
the mobile home has depreciated. II. An additional coverage pays, up to a specified dollar limit, for the cost of
transporting the mobile home to a safe place when it is endangered by a covered peril.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
8) All of the following are characteristics of most inland marine floater policies EXCEPT A) The insurance can
be tailored to the specific type of personal property insured.
B) The insured can select higher limits of coverage than are available under an unendorsed homeowners policy.
C) Coverage is normally written on a named-perils basis. D) Covered property is insured anywhere in the world.
Answer: C
Question Status: Previous Edition
9) Which of the following statements about the Personal Articles Floater is (are) true? I. It is designed to cover
several classes of personal property. II.
Coverage is written on an "open perils" (all-risks) basis.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
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10) Which of the following statements about various coverages under a Personal Articles Floater is (are) true?
I.
Each item of jewelry is described and is insured for a specified amount. II.
Stamp and coin
collections can be insured on a blanket basis.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
11) Which of the following statements about types of property covered under the Personal Articles Floater is
true?
A) Golfer!s equipment is covered only in the United States and Canada. B) Furs are covered on a blanket basis
without the necessity to schedule individual items.
C) A higher premium must be paid to insure musical instruments if they are played for pay. D) Coverage for
silverware and goldware is not available under the Personal Articles Floater.
Answer: C
Question Status: Revised
12) Reasons why an insured might add a scheduled personal property endorsement to a homeowners policy
include which of the following? I. To lower the premium by limiting the perils covered II. To obtain higher
limits for certain personal property
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
13) All of the following statements about the boatowners package policy are true EXCEPT
A) Physical damage coverage for the boat is usually written to cover all losses except those losses specifically
excluded.
B) Liability coverage is provided for bodily injury only. C) Some policies provide optional uninsured boaters
coverage. D) Medical payments coverage for water-skiers is available under the policy.
Answer: B
Question Status: Revised
Chapter 24 Other Property and Liability Insurance Coverages 289
14) All of the following statements about yacht insurance are true EXCEPT A) Property damage coverage
includes damage from insects, weathering, and wear and tear.
B) Liability coverage includes the cost of raising, removing, or destroying a sunken or wrecked yacht.
C) Coverage can be added for maritime workers covered by the United States Longshoremen and Harbor
Workers Compensation Act.
D) Medical payments coverage pays for medical expenses because of accidental bodily injury. Answer: A
Question Status: Revised
15) All of the following statements about the federal flood insurance program are true EXCEPT A) Under the
write-your-own program, each insurer services the policies it writes.
B) The regular portion of the program allows the purchase of higher amounts of coverage than are available
under the emergency portion of the program.
C) The program is designed to be financially self-supporting for the average historical loss year. D) The
maximum amount of coverage that can be written on any single dwelling is $25,000.
Answer: D
Question Status: Previous Edition
16) Which of the following statements about coverage under the federal flood insurance program is (are) true?
I.
Subsidized coverage is available for contents, but not for dwellings. II. A $10,000 deductible applies to
each loss.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Revised
17) All of the following are considered floods under the federal flood insurance program EXCEPT A) the
overflow of tidal waters.
B) the accumulation of surface water after a heavy rain. C) a mudslide caused by an accumulation of water after
a heavy rain. D) wind-driven rain which enters a dwelling through storm-damaged doors or windows.
Answer: D
Question Status: Revised
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18) Which of the following statements about federal flood insurance is true? A) It is available even if property
has been previously flooded.
B) It is unavailable in high-risk flood areas. C) It is available only for residences, not for businesses. D) Waiting
periods are not used in the federal flood insurance program.
Answer: A
Question Status: Previous Edition
19) The basic purpose of FAIR plans is to provide A) property insurance to persons who cannot obtain it in
normal markets.
B) automobile insurance to persons who cannot obtain it in normal markets. C) health insurance to persons who
cannot afford it in normal markets. D) workers compensation insurance to employers who do business in several
states.
Answer: A
Question Status: Previous Edition
20) Which of the following statements concerning FAIR plans is (are) true? I. All property is eligible for
coverage regardless of physical condition. II.
Losses and expenses are shared by insurers who participate in
a plan.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
21) Jan purchased a boat owners package policy. While using his boat, he negligently hit a pier. A person
standing on the pier fell and was severely injured. Which of the boat owners package policy coverages will
respond to a lawsuit filed as a result of this negligent act?
A) physical damage coverage B) liability coverage
C) medical expense coverage D) uninsured boaters coverage
Answer: B
Question Status: Previous Edition
Chapter 24 Other Property and Liability Insurance Coverages 291
22) Which of the following statements about title insurance is true? A) A premium must be paid annually to keep
the policy in force.
B) The policy term runs for 20 years or the length of the insured!s mortgage loan, whichever is shorter.
C) The policy guarantees that the owner will keep possession of the property if a defect in the title is discovered.
D) The policy provides protection against title defects which have occurred prior to the effective date of the
policy.
Answer: D
Question Status: Previous Edition
23) Which of the following statements about a typical personal umbrella policy is (are) true? I.Losses covered
under the basic underlying policies are paid on a pro rata basis by the umbrella policy. II.
Losses not
covered by the basic underlying contracts are subject to a self-insured retention which typically is at least
$25,000.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
24) The personal umbrella policy covers personal injury. All of the following are considered personal injury
EXCEPT
A) invasion of privacy. B) property damage.
C) defamation of character. D) slander.
Answer: B
Question Status: Previous Edition
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25) George has a personal auto policy with a per-person liability limit of $300,000. He also has a personal
umbrella policy with a limit of $2,000,000 and a self-insured retention of $1,000. How much will be paid by each
policy if a person wins a judgment of $500,000 against George as a result of bodily injury arising from the auto
accident?
A) The auto policy will pay nothing, and the umbrella policy will pay $449,000. B) The auto policy will pay
nothing, and the umbrella policy will pay $500,000. C) The auto policy will pay $300,000, and the umbrella
policy will pay $199,000. D) The auto policy will pay $300,000, and the umbrella policy will pay $200,000.
Answer: D
Question Status: Previous Edition
26) All of the following are commonly excluded by personal umbrella policies EXCEPT A) acts committed with
the intent to cause bodily injury or property damage.
B) professional liability. C) aircraft liability. D) libel, slander, and other types of personal injury.
Answer: D
Question Status: Previous Edition
27) William would like to insure his home. He does not want theft or personal liability coverage; however, he
would like "open perils" (all-risks) coverage on the dwelling. William should purchase a
A) Homeowners 3 Policy. B) Dwelling Property 1 Form. C) Dwelling Property 2 Form. D) Dwelling Property 3
Form.
Answer: D
Question Status: Previous Edition
28) Steve and Mary are art collectors. They own lithographs, etchings, and vintage photographs valued at over
$100,000. Steve and Mary display their art collection at their home. They can insure this valuable personal
property through a
A) title insurance policy. B) dwelling property form.
C) personal articles floater form. D) personal umbrella policy.
Answer: C
Question Status: Revised
Chapter 24 Other Property and Liability Insurance Coverages 293
29) Martin would like to insure valuable personal property limited in coverage by his homeowners policy. Martin
has two options. He can purchase the coverage through a separate personal articles floater policy or he can add
an endorsement to his homeowners policy. The endorsement is called the
A) extended coverage endorsement. B) scheduled personal property endorsement.
C) personal injury endorsement. D) replacement cost endorsement.
Answer: B
Question Status: Revised
30) Carolyn is considering the purchase of a large (60-foot) boat. She called her insurance agent to see if she
needs a separate policy for the boat. The agent said that a special category of insurance policies was designed to
insure large watercrafts. These policies are called
A) yacht insurance policies. B) inland marine policies.
C) floater policies. D) Dwelling Property 3 (special form) policies.
Answer: A
Question Status: Revised
31) Jerry built a home in a flood plain. He did not purchase flood insurance. Recently, a noted meteorologist
predicted torrential rains for the area for the next 7 days. Jerry attempted to purchase flood insurance through the
National Flood Insurance Program. Which flood insurance provision is likely to block Jerry!s efforts to obtain
coverage for protection against the predicted torrential rain?
A) waiting period B) definition of covered flood
C) deductible D) insurance limit
Answer: A
Question Status: Previous Edition
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32) Which of the following statements is (are) true about the National Flood Insurance Program? I.
You
can!t purchase flood insurance through this program if your property is located in a high-flood-risk area. II.
Coverage is not available for any property which has been flooded previously.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Previous Edition
33) Frank purchased a building in a run-down area of a city. When Frank was unable to obtain property
insurance in the voluntary insurance market, an agent suggested that he contact a state pool created in the 1960s
that makes property insurance available in riot-prone areas. The state pool the agent referred to is called a(n)
A) unsatisfied judgment fund. B) FAIR plan.
C) guaranty fund plan. D) assigned risk plan.
Answer: B
Question Status: Revised
34) Len is considering the purchase of a home. As a home is a large investment, Len wants to make sure that
there are no liens, easements, or other encumbrances preventing him from an unchallenged right to possess and
enjoy his property. Len can protect this right through the purchase of
A) extended coverage insurance. B) replacement cost insurance.
C) personal umbrella insurance. D) title insurance.
Answer: D
Question Status: Revised
Chapter 24 Other Property and Liability Insurance Coverages 295
35) Tina purchased a personal umbrella policy with a $1 million limit. Her insurer required her to carry liability
limits of 250/500/50 under her auto insurance policy. The personal umbrella policy was written with a $1,000
self-insured retention. Tina was responsible for an auto accident in which the other driver was severely injured.
The other driver!s bodily injuries were $400,000 and the property damage was $20,000. How much will the
insurer pay under Tina!s umbrella policy?
A) nothing B) $149,000 C) $150,000 D) $170,000
Answer: C
Question Status: Revised
36) Tina purchased a personal umbrella policy with a $1 million limit and a $1,000 self-insured retention. Her
insurer required her to carry a $300,000 liability limit under her homeowners policy. Tina was held responsible
for slandering a public official. The public official won a $100,000 judgment against Tina. The insurer that wrote
Tina!s homeowners policy denied coverage. How much will the insurer pay under Tina!s personal umbrella
policy?
A) nothing B) $49,000 C) $99,000
D) $100,000 Answer: C
Question Status: Previous Edition
37) All of the following are ISO personal umbrella liability policy exclusions EXCEPT A) liability arising out of
uncompensated board service for a nonprofit organization.
B) liability arising out of expected or intentional injury. C) liability arising out of business operations. D) liability
arising out of operation of watercraft not covered by an underlying policy.
Answer: A
Question Status: Previous Edition
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38) Which of the following statements is (are) true with regard to an unendorsed ISO Dwelling Form? I.
Each form provides $100,000 in personal liability coverage. II.
property coverage than the Dwelling 1 form.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
The Dwelling 3 form provides broader
Question Status: Previous Edition
Chapter 25 Commerical Property Insurance
1) All of the following are contained in the common policy declarations page of a commercial package policy
EXCEPT
A) a description of the insured property. B) the policy period.
C) the premium paid. D) the policy cancellation provisions.
Answer: D
Question Status: Previous Edition
2) Which of the following items is (are) contained in the common policy conditions page of the commercial
package policy? I.
The policy period. II. A provision describing the insurer!s right to audit the insured!s books
and records.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
3) All of the following are covered under the building and personal property coverage form EXCEPT A) the
insured!s stock and inventory when located inside the insured building.
B) equipment used to service the insured building. C) the insured!s use interest in improvements and betterments
if the insured is a tenant. D) property owned by key customers and key suppliers of the insured.
Answer: D
Question Status: Revised
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4) Which of the following statements about the building and personal property coverage form is (are) true?
I.
A limited amount of coverage is provided for pollutant cleanup and removal at the described premises if
the release or discharge of the pollutant results from a covered cause of loss. II. Fire department service charges
are specifically excluded because they are a normal cost of doing business.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Revised
5) All of the following are extensions of coverage under the building and personal property coverage form
EXCEPT
A) newly acquired or constructed property. B) valuable papers and records.
C) property off the premises. D) currency and securities.
Answer: D
Question Status: Previous Edition
6) Which of the following statements about the provisions of the building and personal property coverage form is
(are) true? I. A separate deductible must be satisfied for each building damaged in the same occurrence. II.
Under the replacement cost option, there is an automatic 10 percent deduction for depreciation.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Revised
7) One of the additional coverages under the building and personal property coverage form is "increased cost of
construction." The coverage is payable if
A) a skilled artisan is needed to duplicate the construction of the damaged property. B) a labor strike or materials
shortage increases construction costs.
C) an ordinance or building code increases the cost of construction.
D) the materials necessary to rebuild the damaged structure are more expensive than ordinary building materials.
Answer: C
Question Status: Previous Edition
8) What is the effect of the optional agreed value provision in the building and personal property coverage form?
A) It provides replacement cost coverage. B) It increases insured values along with inflation.
C) It suspends the coinsurance clause. D) It reduces the deductible to $50.
Answer: C
Question Status: Revised
9) All of the following causes of loss are included in the causes-of-loss basic form of the ISO commercial
package policy EXCEPT
A) fire. B) lightning.
C) explosion. D) flood.
Answer: D
Question Status: Previous Edition
10) Which of the following statements about the causes-of-loss special form of the ISO commercial package
policy is (are) true? I. The cause-of-loss special form insures against risk of direct physical loss. II.
Collapse
is included as an additional coverage.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
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11) Which of the following statements is (are) true concerning the value reporting form? I.
Failure to report
accurately suspends coverage. II. If the insurer is able to prove that business personal property, including
inventory, was under-reported before a loss, recovery is limited to the proportion that the last value reported
bears to the value that should have been reported.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Revised
12) Which of the following types of forms is used to insure fluctuations in business personal property? A) a value
blanket form
B) a value reporting form C) an inventory floater form D) an inventory business income form
Answer: B
Question Status: Revised
13) Which of the following statements about the business income coverage form is true? A) Business income is
defined as gross earnings before taxes.
B) Payroll is excluded unless it is specifically added. C) The form covers loss of business income and extra
expenses incurred during restoration. D) The form can be used by a manufacturing operation only.
Answer: C
Question Status: Revised
14) The building and personal property coverage form provides several optional coverages. Under one optional
coverage, no deduction is taken for depreciation when settling a covered loss. This optional coverage is called
A) extra expense. B) agreed value.
C) replacement cost. D) inflation guard.
Answer: C
Question Status: Previous Edition
15) Which of the following statements about the extra expense coverage form is (are) true? I. It provides
coverage for the increased cost that must be paid to continue operations during a period of restoration. II.
It provides coverage for lost profits for up to 90 days following a loss.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
16) XYZ, Inc. would suffer serious financial consequences if either of its two major customers were shut down
and could not purchase XYZ products. Which of the following types of consequential loss protection would
provide protection against this exposure?
A) leasehold interest B) extra expense
C) marine insurance D) business income from dependent properties
Answer: D
Question Status: Previous Edition
17) Which of the following forms is used to insure buildings that are under construction? A) builders risk
coverage form
B) floor plan coverage form C) new construction coverage form D) labor and materials coverage form
Answer: A
Question Status: Previous Edition
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18) Which of the following statements about the condominium commercial-unit owners coverage form is (are)
true?
I.
It provides coverage for the unit owner!s proportionate financial interest in the condominium building. II.
It provides coverage for fixtures and improvements which are part of the building and owned by the unit
owner.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
19) All of the following statements about business income insurance are true EXCEPT
A) Business income is defined as total sales that would have been made plus continuing normal operating
expenses.
B) Payroll is considered a continuing normal operating expense.
C) Business income insurance does not cover the physical damage caused by a peril which created the
interruption in business.
D) The business income coverage form can be purchased with a coinsurance requirement. Answer: A
Question Status: Previous Edition
20) Which of the following statements about the equipment breakdown protection coverage form is (are) true?
I.
The covered cause of loss is a breakdown of covered equipment, including boilers, machinery, and
electrical and mechanical equipment. II.
It provides coverage for the reasonable cost of expediting permanent
repair or replacement of damaged property.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
21) Spoilage because of loss of refrigeration at a frozen foods processor would be covered under A) equipment
breakdown insurance.
B) extra expense insurance. C) business income insurance. D) inland marine insurance.
Answer: A
Question Status: Revised
22) One of the filed inland marine forms is the accounts receivable coverage form. In which of the following
cases would the purchaser of this form be indemnified through the coverage?
A) If the purchaser cannot pay amounts owed because the purchaser has become insolvent.
B) If the purchaser cannot pay amounts owed because the purchaser has suffered an insured physical damage
loss.
C) If the purchaser cannot collect accounts receivable because of the destruction of records.
D) If the purchaser cannot collect accounts receivable because the purchaser extended credit to a poor credit
risks.
Answer: C
Question Status: Previous Edition
23) Which of the following statements describes a Difference in Conditions (DIC) Policy? A) It is a type of
commercial umbrella liability policy.
B) It is an all-risk policy that covers perils not insured by basic property insurance contracts.
C) It is designed to cover indirect losses for which the insured has direct damage coverage.
D) It is used to settle disputes when an insured has more than one insurance policy with differing policy
provisions.
Answer: B
Question Status: Revised
24) Which of the following statements about marine insurance coverages is true? A) Hull insurance limits
coverage to the breakdown of a ship!s machinery and equipment.
B) Cargo insurance protects the shipowner for the loss of earnings if a ship is lost or damaged and goods are not
delivered.
C) Freight insurance covers the owner of cargo if the cargo is damaged or destroyed.
D) Protection and indemnity insurance provides liability insurance to the ship owner for bodily injury and
property damage to third parties.
Answer: D
Question Status: Previous Edition
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25) All of the following are implied warranties in ocean marine insurance EXCEPT A) seaworthiness.
B) clear title. C) no deviation. D) legal purpose.
Answer: B
Question Status: Previous Edition
26) Which of the following statements about ocean marine insurance is true? A) It usually covers the peril of
war.
B) Hull insurance includes collision liability covering the ship!s owner if the ship collides with another ship.
C) Protection and indemnity (P&I) insurance covers the shipper of goods for cargo losses. D) A particular
average loss is a loss incurred only if a ship is totally lost or destroyed.
Answer: B
Question Status: New
27) All of the following are considered to be means of transportation and communication for purposes of inland
marine insurance EXCEPT
A) trains. B) tunnels.
C) transmission lines. D) television towers.
Answer: A
Question Status: Previous Edition
28) All of the following statements about filed inland marine forms are true EXCEPT
A) A mail coverage form covers securities in transit by first-class mail, registered or certified mail, or express
mail.
B) A commercial articles coverage form is used to insure photographic equipment and musical instruments.
C) A jewelers block coverage form is used by individuals to insure jewelry limited in coverage by the
homeowners form.
D) The signs coverage form covers neon, mechanical, and electrical signs.
Answer: C
Question Status: Previous Edition
29) A firm wishing to insure a single shipment of merchandise sent by a common carrier would purchase a(n)
A) annual transit policy. B) trip transit policy.
C) bailee!s liability policy. D) equipment floater.
Answer: B
Question Status: Previous Edition
30) Which of the following statements about the businessowners policy is (are) true? I. It is designed primarily
to meet the insurance needs of large manufacturing firms. II.
It is a package policy designed to meet the
basic property and liability needs of an insured in a single contract.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
31) All of the following statements about the businessowners policy are true EXCEPT
A) Coverage for business personal property includes coverage for leased personal property which the named
insured has a contractual responsibility to insure.
B) The amount of insurance on the buildings increases by a stated percentage each year. C) Additional coverages
include pollutant cleanup and removal. D) The policy must be written with a deductible of at least $2,000 for
property losses.
Answer: D
Question Status: Previous Edition
32) Renee is risk manager of XYZ Company. She purchased a Commercial Package Policy for her company and
added one of the optional coverages. This option suspends the coinsurance clause and substitutes a new
agreement covering any loss in the same proportion that the limit of insurance bears to a value specified in the
declarations. This provision is known as
A) waiver of inventory coverage. B) inflation guard coverage.
C) agreed value coverage. D) replacement cost coverage.
Answer: C
Question Status: Revised
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33) The inventory at Frank!s business fluctuates. Frank!s property insurance requires periodic reporting of
inventory values. Frank believes he can save money by under-reporting the inventory. Last period, Frank
reported $200,000 when the value was really $400,000. Shortly after filing the report, when the value was
$500,000, the inventory was destroyed. How much will Frank!s insurer pay, assuming no deductible?
A) nothing, as underreporting voids coverage B) $200,000
C) $250,000 D) $400,000
Answer: C
Question Status: Previous Edition
34) Rick is risk manager of Herald News, a daily newspaper in a competitive market. Rick wants to make sure
that if Herald!s printing facility is damaged or destroyed, the paper will continue to be published. What type of
insurance can Rick purchase to cover the added cost of continuing to print the paper after a physical damage loss
has occurred?
A) contingent business income coverage B) product liability insurance
C) business income from dependent properties coverage D) extra expense coverage
Answer: D
Question Status: Previous Edition
35) One type of commercial property insurance excludes perils which are covered by the basic coverages. Some
businesses buy this coverage to fill some gaps, including flood and earthquake, and to cover property in other
countries. This type of insurance is called
A) protection and indemnity insurance. B) building and personal property coverage form.
C) difference in conditions insurance. D) builders risk coverage form.
Answer: C
Question Status: Previous Edition
36) Inter-Ocean Transfer owns 12 large cargo ships which transport goods. Inter-Ocean can obtain physical
damage insurance on these vessels by purchasing
A) hull insurance. B) cargo insurance.
C) protection and indemnity insurance. D) freight insurance.
Answer: A
Question Status: Revised
37) An Inter-Ocean Transfer cargo ship was forced to jettison some cargo in heavy seas. The various interests in
the voyage at the time the property was jettisoned were
Value of the ship Value of lumber and wood chips Value of iron ore
$2.0 million $1.0 million $2.0 million
If $400,000 worth of iron ore was jettisoned, for how much of this amount would Inter-Ocean Transfer be
responsible under general average?
A) nothing B) $160,000 C) $200,000 D) $400,000
Answer: B
Question Status: Previous Edition
38) Tom opened a store in a mall. His store is located between a theater and a department store. Tom counts on
the theater and department store to generate walk-in business at his store. While his store has been successful,
Tom knows that if either or both of the other businesses closed, his store would suffer an economic loss. What
type of dependent property situation is illustrated in this scenario?
A) contributing location B) recipient location
C) manufacturing location D) leader location
Answer: D
Question Status: Previous Edition
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39) The exterior walls, the roof, and the plumbing, heating and air conditioning systems of a residential
condominium can be insured through the purchase of
A) builders risk insurance. B) condominium association coverage form.
C) dwelling property broad form. D) condominium commercial unit-owners insurance.
Answer: B
Question Status: Previous Edition
40) A navigation error caused a cargo ship to run aground on a reef. The ship, valued at $1.5 million, was
carrying $1.5 million in grain and $1.5 in electronic devices. The ship sustained $150,000 in physical damage. If
this loss is a "particular average" loss, how will the loss be settled?
A) the owners of each of the three interests are responsible for $50,000 B) the owner of the ship is responsible
for the entire $150,000 loss
C) the two cargo owners are each responsible for $75,000 of the loss
D) the owner of the ship is responsible for the first $100,000 of the loss, and the two cargo owners are each
responsible for $25,000 of the loss
Answer: B
Question Status: Previous Edition
Chapter 26 Commerical Liability Insurance
1) The phrase "general liability" is used to refer to the legal liability of a business arising from all of the
following EXCEPT
A) employee injuries. B) defective products.
C) liability assumed by contract. D) completed operations.
Answer: A
Question Status: Previous Edition
2) Liability arising out of work performed by independent contractors is referred to as A) contractual liability.
B) contingent liability. C) care, custody, and control liability. D) customer!s liability.
Answer: B
Question Status: Previous Edition
3) A customer was injured when a furnace exploded following its faulty installation by a heating and cooling
business. For the heating and cooling business, this is an example of
A) contingent liability. B) completed operations liability.
C) products liability. D) contractual liability.
Answer: B
Question Status: Previous Edition
4) Section I of the Commercial General Liability (CGL) Policy provides coverage for all of the following
exposures EXCEPT
A) bodily injury liability. B) advertising injury liability.
C) medical payments. D) automobile liability.
Answer: D
Question Status: Previous Edition
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5) Which of the following exposures is covered under a Commercial General Liability Policy with no
endorsements?
A) liability arising out of seepage of pollutants B) employment-related practices liability
C) personal injury liability D) aircraft liability
Answer: C
Question Status: Revised
6) Bay Gallery has a Commercial General Liability Policy with no endorsements. All of the following claims
would be covered under the policy EXCEPT
A) An artist sued the gallery for slander after an employee of the gallery said the artist!s work looks like it was
painted by an intoxicated monkey.
B) A customer is injured when a painting falls from the wall and strikes the customer.
C) A customer is injured after falling on a slippery floor at the gallery.
D) Paintings owned by an art collector that were being exhibited in the gallery were damaged by a child who was
visiting the gallery.
Answer: D
Question Status: Revised
7) Which of the following losses would be covered under a Commercial General Liability Policy that has no
endorsements? I.
Damage to products sold by the insured resulting from defective manufacture II. The cost
to recall defective products
A) I only B) II only
C) both I and II D) neither I nor II
Answer: D
Question Status: Revised
8) Which of the following is covered under an unendorsed Commercial General Liability Policy? I.
False
arrest of someone who a store owner wrongly believed was a shoplifter. II.
Publication of material which
violates an individual!s right to privacy.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Revised
9) In addition to the named insured, all of the following are insureds under the Commercial General Liability
Policy EXCEPT
A) suppliers of products to the named insured!s business. B) the insured!s employees while acting within the
scope of their employment.
C) the manager of the insured!s real estate. D) partners of the named insured.
Answer: A
Question Status: Revised
10) Which of the following is (are) covered under a claims-made policy? I.
Claims arising out of
occurrences which take place during the policy period, regardless of when the claim is made II.
Claims
first reported during the policy period, provided the event occurred after any retroactive date stated in the policy
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
11) A provision included in a claims-made commercial general liability policy provides coverage for claims filed
after the policy has expired. This provision is called a(n)
A) extended reporting period provision. B) agreed amount endorsement.
C) retroactive date provision. D) per-occurrence limit clause.
Answer: A
Question Status: Revised
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12) Which of the following statements about workers compensation insurance is (are) true? I. Under the workers
compensation part of the policy, the insurer agrees to pay the benefits required by the workers compensation law
of any state listed in the policy declarations. II.
The employers liability part of the policy provides workers
compensation benefits when employees are working in states other than those listed in the policy declarations.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
13) All of the following are reasons for an employer to purchase employers liability insurance EXCEPT A) to
cover the suits of dependents for loss of consortium.
B) to cover suits arising from injuries or diseases which are not covered under workers compensation laws.
C) to cover third-party over cases that arise from injuries to an employee. D) to cover suits by employees who
seek damages for discriminatory labor practices.
Answer: D
Question Status: Previous Edition
14) An employee of Nelson Manufacturing was injured by a defective machine Nelson purchased from Clark
Corporation. The employee!s tort action against Clark was successful. Clark, in turn, sued Nelson, alleging that
Nelson failed to provide proper operating instructions to the employee. This claim (Clark vs. Nelson) is covered
under Part Two of Nelson!s worker compensation and employer liability policy. Such claims are called
A) third party over cases. B) loss of consortium cases.
C) joint and several liability cases. D) mass tort cases.
Answer: A
Question Status: New
15) All of the following are coverage options under the physical damage insurance of the Business Auto
Coverage Form EXCEPT
A) comprehensive coverage. B) specified causes-of-loss coverage.
C) collision coverage. D) property damage liability coverage.
Answer: D
Question Status: Previous Edition
16) Which of the following statements about the liability coverage of the Business Auto Coverage Form is (are)
true?
I.
The insurer agrees to defend the insured and pay all legal defense costs arising out of an accident
involving a covered auto. II. The insured is covered for property damage and bodily injury arising out of the use
of a covered auto.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
17) The purpose of adding garagekeepers coverage to the Garage Coverage Form is to A) eliminate the care,
custody, and control exclusion under the policy.
B) eliminate the contractual liability exclusion under the policy. C) add workers compensation coverage for
persons working in the garage business. D) add comprehensive and collision coverage for vehicles held for sale.
Answer: A
Question Status: Previous Edition
18) All of the following statements about aviation insurance are true EXCEPT A) Physical damage coverage can
be written on an "all-risks" basis.
B) Liability coverage also applies to bodily injury arising out of the premises where the aircraft is stored.
C) Liability coverage applies to liability assumed by contract. D) Aviation insurance is a highly-specialized
market with relatively few insurers.
Answer: C
Question Status: Previous Edition
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19) Which of the following statements is (are) true concerning the self-insured retention (SIR) under a
commercial umbrella liability policy? I.
The SIR applies to all claims payable under the umbrella policy. II.
The SIR only applies to those claims for which the underlying policy has paid first, and the umbrella
policy is paying on an excess basis.
A) I only B) II only
C) Both I and II D) Neither I nor II
Answer: D
Question Status: New
20) Which of the following statements about the typical commercial umbrella policy is (are) true? I.
The
policy is designed to cover only those loss exposures specifically excluded by the underlying insurance contracts.
II.
The policy is excess over the required underlying coverages.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
21) Which of the following losses is generally covered under a commercial umbrella policy? A) liability arising
out of workers compensation laws
B) liability arising out of pollution C) liability arising out of use of a business auto. D) the cost of recalling
defective products
Answer: C
Question Status: Previous Edition
22) All of the following statements about liability coverage under the Businessowners Policy are true EXCEPT
A) Liability arising out of personal injury is covered as part of the insuring agreement. B) Medical payments
coverage is provided.
C) Employees acting within the scope of their employment are excluded from coverage. D) Coverage is included
for the legal costs of defending the insured.
Answer: C
Question Status: Revised
23) All of the following are covered under the liability coverage of a businessowners policy EXCEPT A)
personal injury liability
B) bodily injury liability C) advertising liability D) professional liability
Answer: D
Question Status: New
24) Which of the following statements about physicians, surgeons, and dentists liability insurance is true?
A) Liability coverage is restricted to accidental acts.
B) The policy eliminates the need for medical practitioners to purchase general liability insurance.
C) The insurer must obtain the consent of medical practitioners before the insurer can settle claims.
D) The policy covers the physician for the negligent acts of an employee. Answer: D
Question Status: Revised
25) Which of the following statements about errors and omissions insurance is (are) true? I.
professionals to protect against claims arising for negligent acts, errors, and omissions. II.
from fraudulent and dishonest acts are covered.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
It is purchased by
Claims arising
Question Status: Previous Edition
26) A-1 Electrical Service is an electrical contractor that employs 14 electricians. A-1 faces many loss exposures.
One general liability exposure arises out of faulty work that A-1 electricians may perform for customers at their
homes or businesses. This liability exposure is known as
A) premises and operations liability. B) products liability.
C) completed operations liability. D) contingent liability.
Answer: C
Question Status: Previous Edition
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27) Executives of a Fortune 500 firm blocked an acquisition attempt by a larger company. When the stockholders
learned they could have made large profits had the acquisition not been blocked, they filed a lawsuit against the
executives of the firm. What type of liability insurance protects the executives of the organization against such
suits?
A) dram shop liability insurance B) directors and officers liability insurance
C) employers liability insurance D) employment related practices liability insurance
Answer: B
Question Status: Revised
28) ABC Company purchased an ISO Commercial General Liability Policy. The agent who sold ABC the
coverage noted that the coverage trigger in this policy was different from the trigger in the previous policy. The
new policy covers only those claims which are first reported during the policy period, provided the event
occurred after a retroactive date. This type of policy is known as
A) extended reporting coverage. B) claims-made coverage. C) accident only coverage.
D) occurrence coverage. Answer: B
Question Status: Previous Edition
29) HRC Company purchased an unendorsed ISO Commercial General Liability (CGL) policy. All of the
following claims would be covered under the CGL policy EXCEPT
A) workers compensation liability. B) property damage liability.
C) personal and advertising injury liability. D) bodily injury liability.
Answer: A
Question Status: Previous Edition
30) Ted Thomas is risk manager of XYZ Company. He is concerned his company might be sued by current or
former employees alleging wrongful termination, failure to promote, racial or gender discrimination, or sexual
harassment. What type of liability insurance can Ted purchase to cover these types of claims?
A) workers compensation insurance B) employer liability insurance
C) employment-related practices liability insurance D) directors and officers liability insurance
Answer: C
Question Status: Previous Edition
31) Medical malpractice insurance written on a claims-made basis can leave a surgeon vulnerable to malpractice
claims if the surgeon retires, changes insurers, or drops coverage. A provision can be added to the claims-made
form that protects the surgeon for future claims arising from incidents that occurred while the claims-made
policy was in force. This provision is called a(n)
A) cut-through endorsement. B) retroactive liability endorsement.
C) agreed amount endorsement. D) extended reporting form endorsement.
Answer: D
Question Status: New
32) Which of the following statements is true concerning the ISO employment-related practices liability form?
A) coverage is provided without a co-payment provision B) legal defense costs are included as part of the policy
limit
C) wrongful termination is excluded from coverage D) liability to employees is excluded from coverage
Answer: B
Question Status: Revised
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33) Jenkins Company purchased a commercial umbrella policy with a $10 million limit and a $100,000 selfinsured retention. The insurer required Jenkins Company to carry a $1 million per-occurrence limit on its general
liability policy and a $1 million per-occurrence limit on its business auto policy. A Jenkins driver was negligent
while operating a company vehicle and killed another motorist. The court ruled that Jenkins must pay $5 million.
How much of this amount will be paid by the umbrella policy?
A) $1.0 million B) $3.9 million C) $4.0 million D) $5.0 million
Answer: C
Question Status: Previous Edition
34) David Florrell started a public accounting firm. David is concerned that accountants on his staff may give
incorrect accounting advice, and the accounting firm may be sued. What type of liability insurance should David
purchase to protect against such claims?
A) errors and omissions insurance B) directors and officers liability insurance
C) general liability insurance D) employers liability insurance
Answer: A
Question Status: Previous Edition
35) Holiday DeCor Company is insured by a commercial general liability policy (CGL). Holiday DeCor rented a
storage facility for one month to store some excess inventory. While visiting the storage facility, a Holiday
DeCor employee discarded a cigarette. The resulting fire severely damaged the storage facility. Which statement
is true regarding coverage of this damage under the CGL?
A) There is no coverage as the damage occurred at a rented premises. B) There is no coverage because property
damage liability is excluded.
C) The damage is covered under the fire legal liability coverage. D) There is no coverage because an employee
of Holiday DeCor caused the loss.
Answer: C
Question Status: New
36) Which of the following statements is (are) true with respect to the treatment of legal defense costs under the
ISO Commercial General Liability policy? I.
Legal defense costs usually are counted against the policy
limit. II.
Once the insurer has paid out the applicable limit of liability, the insurer!s duty to defend ends.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Revised
37) Which of the following statements concerning directors and officers liability insurance (D&O) is true?
I.
D&O policies usually cover the personal liability of directors and officers. II.
D&O policies exclude
coverage for claims brought by employees and by stockholders.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: A
Question Status: Previous Edition
38) Jennifer was just asked to serve on the Board of an insurance company. Jennifer is concerned that if the
company is mismanaged, the policyowners, stockholders, and employees might sue the management team. What
type of liability insurance will protect Jennifer from such claims if she accepts a position on the insurance
company!s Board?
A) commercial general liability insurance B) employment-related practices liability insurance
C) workers compensation and employer liability insurance D) directors and officers liability insurance
Answer: D
Question Status: Previous Edition
Chapter 26
Commercial Liability Insurance
319
Chapter 27 Crime Insurance and Surety Bonds
1) In the ISO Commercial Crime Coverage form, theft is defined as the A) unlawful taking of money, securities,
or property to the deprivation of the insured.
B) unlawful taking of property from a person by someone who has caused or threatened to cause bodily harm or
who has committed an unlawful act witnessed by the person.
C) unlawful taking of money or securities through the alteration of a negotiable instrument.
D) unlawful taking of property from inside the premises by someone who unlawfully enters or leaves the
premises as evidenced by marks of forcible entry or exit.
Answer: A
Question Status: Previous Edition
2) In the ISO Commercial Crime Coverage form, robbery is defined as the A) unlawful taking of money,
securities, or property to the deprivation of the insured.
B) unlawful taking of property from a person by someone who has caused or threatened to cause bodily harm or
who has committed an unlawful act witnessed by the person.
C) unlawful taking of money or securities through the alteration of a negotiable instrument.
D) unlawful taking of property from inside the premises by someone who unlawfully enters or leaves the
premises as evidenced by marks of forcible entry or exit.
Answer: B
Question Status: Previous Edition
3) In the ISO Commercial Crime Coverage form, safe burglary is defined as the A) unlawful taking of money,
securities, or property to the deprivation of the insured.
B) unlawful taking of property from a person by someone who has caused or threatened to cause bodily harm or
who has committed an unlawful act witnessed by the person.
C) unlawful taking of money or securities through the alteration of a negotiable instrument.
D) unlawful taking of property from within a locked safe or vault by someone who enters the safe or vault as
evidenced by marks of forcible entry upon the exterior.
Answer: D
Question Status: Previous Edition
4) Which of the following statements is (are) true with regard to the ISO commercial crime coverage forms?
I.
The discovery version only covers losses which occur during the policy period. II.
The loss-sustained
version covers losses which occur during the policy period and are discovered during the policy period or within
one year after the policy expires.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: B
Question Status: Previous Edition
5) A burglar took some blank checks during a break-in at XYZ Company. He was careful to make sure that the
theft would be difficult to discover. Three months later, he wrote himself a check for $20,000 and signed the
company treasurer!s name on the check. After the check was cashed, the loss was discovered. Which ISO crime
form would cover this loss?
A) Inside the PremisesÁTheft of Money and Securities B) Money Orders or Counterfeit Currency
C) Forgery or Alteration D) Outside the Premises
Answer: C
Question Status: Previous Edition
6) All of the following are ISO commercial crime coverage exclusions EXCEPT A) dishonest acts committed by
a named insured or partner of the named insured.
B) indirect loss resulting from covered losses. C) theft committed by an employee of the named insured. D)
losses from unauthorized trading in stocks and bonds.
Answer: C
Question Status: Previous Edition
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7) Bernice is an underwriter. She is reviewing a commercial crime coverage application. The coverage will be
written using the discovery form. Bernice is concerned that a large undiscovered loss may exist prior to the
policy!s inception date. Which provision should Bernice add to the policy to protect against liability for such
previous losses?
A) extended reporting endorsement B) loss sustained during prior insurance provision
C) waiver of inventory provision D) retroactive date endorsement
Answer: D
Question Status: Previous Edition
8) Which of the following statements is (are) true with respect to financial institution bonds? I.Fidelity Coverage
covers losses resulting from the dishonest acts of employees. II. Financial institutions usually insure their crime
exposures through financial institutions bonds rather than through commercial crime coverage forms.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
9) The head teller of a bank embezzled $50,000 from the bank. Which insuring agreement in a financial
institution bond is designed to cover such losses?
A) Insuring Agreement AÁFidelity B) Insuring Agreement BÁOn Premises
C) Insuring Agreement CÁIn Transit D) Insuring Agreement DÁForgery or Alteration
Answer: A
Question Status: Previous Edition
10) An armed robber pulled a gun at Fourth National Bank. He made off with over $10,000 in cash. Which
insuring agreement in a financial institution bond is designed to cover such losses?
A) Insuring Agreement AÁFidelity B) Insuring Agreement BÁOn Premises
C) Insuring Agreement CÁIn Transit D) Insuring Agreement DÁForgery or Alteration
Answer: B
Question Status: Previous Edition
11) A Pony Express Armored Car was transporting bank receipts from six branch banks to the main bank.
Shortly after picking up receipts at the last branch bank, a group of robbers staged a daring robbery. They shot
two guards and took over $90,000 in cash. Which insuring agreement in a financial institution bond is designed
to cover such losses?
A) Insuring Agreement AÁFidelity B) Insuring Agreement BÁOn Premises
C) Insuring Agreement CÁIn Transit D) Insuring Agreement DÁForgery or Alteration
Answer: C
Question Status: Revised
12) Fifth National Bank decided to loan $200,000 to Fred Franklin. As collateral for the loan, Fred posted stock
certificates. When Fred defaulted on the loan, Fifth National tried to sell the stock. They discovered the stock
certificates were phony. Which insuring agreement in a financial institution bond is designed to cover such
losses?
A) Insuring Agreement BÁOn Premises B) Insuring Agreement CÁIn Transit
C) Insuring Agreement DÁForgery or Alteration D) Insuring Agreement EÁSecurities
Answer: D
Question Status: Previous Edition
13) Smith is Manager of ABC Stores. Jones, ABC!s Security Director, visited Smith to ask some questions.
During questioning, Smith admitted that he stole $10,000 in merchandise. He was disciplined, but not fired. The
loss was not reported to the insurer. Six weeks later, Smith was observed on a surveillance camera stealing over
$50,000 in jewelry from an ABC store. ABC immediately reported the loss to its crime insurer. Which ISO crime
coverage condition may prevent ABC from collecting for this loss?
A) termination as to any employee B) discovery form
C) loss sustained form D) loss sustained under prior insurance
Answer: A
Question Status: Previous Edition
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14) Last National Bank believed it had been properly authorized to transfer $250,000 to the off -shore account of
one of its corporate customers. The authorization was fraudulent, however, and the transferred funds were stolen.
Under which commercial crime coverage insuring agreement would such a loss be covered?
A) Money Orders and Counterfeit Currency B) Forgery or Alteration
C) Outside the Premises D) Funds Transfer Fraud
Answer: D
Question Status: Previous Edition
15) Jack, owner of Jack!s Bar and Grill, was robbed while attempting to deposit receipts at his bank!s night
depository. Jack had purchased an ISO commercial crime coverage form. This loss would be covered under
which insuring agreement?
A) Inside the PremisesÁTheft of Money and Securities B) Outside the Premises
C) Money Orders and Counterfeit Currency D) Inside the PremisesÁRobbery or Safe Burglary of Other Property
Answer: B
Question Status: Previous Edition
16) In the context of a surety agreement, the party who agrees to perform certain acts or fulfill certain obligations
is called the
A) fidelity. B) obligee.
C) surety. D) principal.
Answer: D
Question Status: Previous Edition
17) In the context of a surety agreement, the party who agrees to answer for the debt, default, or obligation of
another party is called the
A) principal. B) obligee.
C) surety. D) fidelity.
Answer: C
Question Status: Previous Edition
18) Which of the following statements about surety bonds is (are) true? I. The surety has a legal right to recover a
loss payment it makes on behalf of a defaulting principal. II.
The obligee is the party who benefits from the
bond if the principal fails to perform.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
19) Which of the following surety bonds can be classified as a contract bond? A) fiduciary bond
B) public official bond C) court bond D) bid bond
Answer: D
Question Status: Previous Edition
20) Which of the following statements about various types of surety bonds is true?
A) A judicial bond guarantees that a public official will faithfully perform his or her duties for the protection of
the public.
B) A payment bond guarantees that the bonded person will appear in court.
C) A license and permit bond guarantees that the bonded party will comply with all the laws and regulations
governing his or her activities.
D) A bid bond guarantees that the principal will complete a construction project on time. Answer: C
Question Status: Previous Edition
21) A bond that guarantees that the person responsible for the property of another will faithfully exercise his or
her duties is called a
A) fiduciary bond. B) performance bond.
C) court bond. D) contract bond.
Answer: A
Question Status: Previous Edition
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22) Appliance World sells small appliances. The store purchased an ISO crime coverage policy. Last night,
someone used a crowbar to pry open a locked door, leaving marks of forced entry. The thief took a number of
appliances. The loss that Appliance World suffered would be called
A) burglary. B) shoplifting.
C) larceny. D) robbery.
Answer: A
Question Status: Revised
23) Which of the following statements is (are) true with respect to the differences between insurance and surety
bonds? I.
Insurance is a two-party contract; surety involves three parties. II. Insurers usually do not have the
right to recover a loss payment from an insured, while a surety does have the legal right to recoup a loss
payment.
A) I only B) II only
C) both I and II D) neither I nor II
Answer: C
Question Status: Previous Edition
24) All of the following statements about a surety are true EXCEPT A) A surety theoretically expects no losses
to occur.
B) The principal is the party who agrees to answer for the debt, default, or obligation of another party.
C) The surety has the legal right to recover a loss payment from the defaulting principal. D) There are three
parties to a surety bond: the principal, the surety, and the obligee.
Answer: B
Question Status: Previous Edition
25) Graham is a cashier at a convenience store. A customer pulled a gun on him, and said that he would shoot
Graham unless he gave him all the money in the cash register. This crime, which is covered under the ISO
commercial crime coverage form, is called
A) extortion. B) murder. C) robbery.
D) burglary.
Answer: C
Question Status: Previous Edition
26) A cashier at Food World Supermarket accepted a phony $100 bill. Which ISO commercial crime coverage is
designed to cover such a loss?
A) Forgery or Alteration B) Money Orders and Counterfeit Paper Currency
C) Inside the PremisesÁTheft of Money and Securities D) Inside the PremisesÁRobbery or Safe Burglary of
Other Property
Answer: B
Question Status: Previous Edition
27) XYZ Insurance Company markets a wide range of coverages. One type of coverage provides monetary
compensation if a bonded party fails to perform certain acts. This coverage is called
A) property insurance. B) liability insurance.
C) fidelity bonding. D) surety bonding.
Answer: D
Question Status: Previous Edition
28) Al!s Electric Service is an electric contracting company in Metro City. The owner of the company, Al
Richards, posted a bond guaranteeing that all work performed by his company will comply with local building
codes. This bond is an example of a
A) fiduciary bond. B) license and permit bond.
C) contract bond. D) judicial bond.
Answer: B
Question Status: Previous Edition
29) State X hired Build-Right Construction to build a bridge. State X required that construction be completed
within 2 years after the contract was signed. Les Johnson is the president of Build -Right. State X required that
Build-Right!s promise to perform be guaranteed by a third party. Build-Right purchased a performance bond
from Rock Solid Indemnity. The bond requires Rock Solid to be responsible if Build-Right does not have the
project completed on time. In this scenario, which party is the principal?
A) State X B) Build-Right Construction
C) Les Johnson D) Rock Solid Indemnity
Answer: B
Question Status: Previous Edition
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30) State X hired Build-Right Construction to build a bridge. State X required that construction be completed
within 2 years after the contract was signed. Les Johnson is the president of Build -Right. State X required that
Build-Right!s promise to perform be guaranteed by a third party. Build-Right purchased a performance bond
from Rock Solid Indemnity. The bond requires Rock Solid to be responsible if Build-Right does not have the
project completed on time. In this scenario, which party is the obligee?
A) State X B) Build-Right Construction
C) Les Johnson D) Rock Solid Indemnity
Answer: A
Question Status: Previous Edition
31) State X hired Build-Right Construction to build a bridge. State X required that construction be completed
within 2 years after the contract was signed. Les Johnson is the president of Build -Right. State X required that
Build-Right!s promise to perform be guaranteed by a third party. Build-Right purchased a performance bond
from Rock Solid Indemnity. The bond requires Rock Solid to be responsible if Build-Right does not have the
project completed on time. In this scenario, which party is the surety?
A) State X B) Build-Right Construction
C) Les Johnson D) Rock Solid Indemnity
Answer: D
Question Status: Previous Edition
32) In a surety arrangement, the party who benefits from the bond if the bonded party fails to perform is the
A) principal. B) obligee.
C) claimant. D) obligor.
Answer: B
Question Status: Previous Edition
33) Tenth National Bank extended a $2 million loan to ABC Development Company. Tenth National accepted a
mortgage on a building as collateral for the loan. The mortgagee!s signature on the loan, however, was a forgery.
The resulting loss is covered by which financial institution bond coverage?
A) Insuring Agreement A -- Fidelity B) Insuring Agreement D -- Forgery or Alteration
C) Insuring Agreement D -- Securities D) Insuring Agreement G -- Fraudulent Mortgages
Answer: D
Question Status: New
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