Chapter 25—Insurance and Pension Fund Operations
1. Which of the following statements is incorrect?
a.
Insurance provides a payment to the insured under conditions specified by the insurance
policy contract.
b.
Individuals who are less exposed to specific conditions that cause financial damage are
more likely to purchase insurance against those conditions.
c.
Insurance can cause the insured to take more risks because they are protected.
d.
Insurance companies employ underwriters to calculate the risk of specific insurance
policies.
2. The insurance premium is ____ related to the uncertainty about the size of the payments; the premium
is also ____ for group plans.
a.
higher; lower
b.
higher; higher
c.
lower; higher
d.
lower; lower
3. Those insurance companies whose claims are ____ predictable need to maintain ____ liquidity.
a.
less; less
b.
more; more
c.
less; more
d.
none of the above
4. A ____ life insurance company is owned by its policyholders; most life insurance companies are ____.
a.
stock-owned; mutual
b.
mutual; mutual
c.
stock-owned; stock-owned
d.
mutual; stock-owned
5. A life insurance policy that protects the policyholder until death, or as long as premiums are promptly
paid is a
a.
whole life policy.
b.
term policy.
c.
universal life policy.
d.
B and C
6. ____ insurance provides insurance for a policyholder only over a specified period.
a.
Term
b.
Whole life
c.
Universal
d.
A and C
7. Which type of life insurance policy does not build a cash value for policyholders?
a.
whole life
b.
term
c.
universal life
d.
all of the above build a cash value
8. Which type of life insurance policy specifically accommodates the needs of people who need more
insurance now than later?
a.
whole life
b.
term
c.
decreasing term
d.
universal life
9. Which type of life insurance policy specifies a limited period of time over which the policy will exist,
and builds a cash value for policyholders over time?
a.
whole life
b.
term
c.
universal life
d.
decreasing term
10. Which type of life insurance policy can offer flexibility on the size and timing of premium payments?
(The policyholder can decide the size of payments each period.)
a.
whole life
b.
term
c.
universal life
d.
decreasing term
11. Under ____, the benefits awarded by the life insurance company to a beneficiary vary with the assets
backing the policy.
a.
whole life insurance
b.
term insurance
c.
variable life insurance
d.
universal life insurance
12. ____ is not a typical source of funds to life insurance companies.
a.
Deposit insurance premiums
b.
Annuity plans
c.
Investment income
d.
Life and health insurance premiums
13. ____ represent the most popular asset of life insurance companies.
a.
Corporate bonds
b.
Treasury securities
c.
Corporate stock
d.
State and local bonds
14. Which of the following is not a common use of funds by life insurance companies?
a.
government securities
b.
corporate bonds
c.
stocks
d.
commercial paper
15. Which of the following is not a ratio (or group of ratios) commonly used by insurance regulators to
detect any problems in time to search for a remedy before the company deteriorates further?
a.
liquidity ratios
b.
operating expense ratios
c.
profitability ratios
d.
all of the above are used by regulators
16. The ratio of an insurance company’s net profit to policyholders’ surplus is called
a.
liquidity ratio.
b.
return on net worth.
c.
net underwriting margin.
d.
return on assets.
17. Because life insurance companies carry a large amount of ____ securities, the market value of their
asset portfolio can be ____ to interest rate fluctuations.
a.
short-term; insensitive
b.
short-term; very sensitive
c.
long-term; insensitive
d.
long-term; very sensitive
18. Life insurance companies can attempt to reduce their exposure to interest rate risk by
a.
increasing their proportion of long-term assets.
b.
diversifying the age distribution of their customer base.
c.
increasing their proportion of short-term assets.
d.
concentrating on an older age distribution of their customer base.
19. Which of the following is a difference in characteristics between life insurance companies and
property and casualty insurance companies?
a.
Property and casualty policies are longer term.
b.
The type of policies offered by life insurance companies are less focused.
c.
Future compensation amounts paid on property and casualty policies are more difficult to
forecast.
d.
Life insurance companies need to maintain a more liquid asset portfolio.
20. The most common use of funds for property and casualty insurance companies is
a.
municipal securities.
b.
Treasury bills.
c.
corporate stock.
d.
commercial paper.
21. Which of the following is not a difference between PC insurance and life insurance?
a.
PC policies often last ten years or more, as opposed to the short-term life insurance
policies.
b.
PC insurance encompasses a wide variety of activities, while life insurance is more
focused.
c.
Forecasting the amount of future compensation to be paid is more difficult for PC
insurance than for life insurance.
d.
All of the above are differences between PC insurance and life insurance.
22. ____ effectively reallocates a portion of an insurance company‘s return and risk to other insurance
companies.
a.
Reinsurance
b.
Cash flow underwriting
c.
Factor insurance
d.
Universal insurance
23. Individuals who are insured under a managed health care plan can usually choose any provider of
health care services.
a. True
b. False
24. ____ usually require individuals to choose a primary care physician.
a.
Indemnity plans
b.
Health maintenance organizations
c.
Preferred provider organizations
d.
None of the above
25. ____ insurance covers losses due to dishonest employees.
a.
Key employee
b.
Credit line
c.
Malpractice
d.
Fidelity bond
26. ____ insurance covers losses due to lawsuits by dissatisfied customers.
a.
Fidelity bond
b.
Credit line
c.
Surety bond
d.
Business interruption
27. Which of the following is not involved in the regulation of the insurance industry?
a.
the National Association of Insurance Commissioners (NAIC)
b.
the Insurance Regulatory Information System (IRIS)
c.
the Federal Deposit Insurance Corporation (FDIC)
d.
All of the above are involved in the regulation of the insurance industry.
28. All regulation of insurance companies is performed by
a.
federal agencies.
b.
the National Association of Insurance Commissioners.
c.
the Insurance Regulatory Information System.
d.
state agencies.
29. In a(n) ____ insurance policy, the benefits awarded by the life insurance company to the beneficiary
differ, depending on the assets backing the policy.
a.
universal life
b.
whole life
c.
variable life
d.
group life
e.
none of the above
30. The most common type of mortgage held by life insurance companies are ____ mortgages.
a.
commercial
b.
residential
c.
farm
d.
none of the above
31. The ____ facilitates cooperation among the various state agencies whenever an insurance issue is a
national concern.
a.
Securities and Exchange Commission
b.
Federal Deposit Insurance Corporation
c.
National Association of Insurance Commissioners
d.
National Association of Securities Dealers
e.
none of the above
32. Life insurance companies can reduce their exposure to ____ risk by diversifying the age distribution of
their customer base.
a.
interest rate
b.
market
c.
credit
d.
liquidity
33. Pension funds whose contributions are dictated by the benefits that will eventually be provided are
called ____ plans.
a.
defined benefit
b.
defined contribution
c.
beneficiary
d.
guarantor-insured
34. A pension plan that provides benefits that are determined by the accumulated contributions and return
on the fund’s investment performance is called a ____ plan.
a.
defined benefit
b.
defined contribution
c.
beneficiary
d.
guarantor-insured
35. A ____ plan allows a firm to know with certainty the amount of funds to contribute. The ____ plan
allows a firm to know with certainty the amount of benefits that must be provided.
a.
defined benefit; defined benefit
b.
defined contribution; defined contribution
c.
defined contribution; defined benefit
d.
defined benefit; defined contribution
36. There are more defined ____ pension plans; there are more participants in defined ____ plans.
a.
benefit; contribution
b.
contribution; benefit
c.
contribution; contribution
d.
benefit; benefit
37. If pension fund investment decisions are made with the objective of generating cash flows at the same
time as planned outflow payments, the fund follows a ____ strategy. When comparing matched
funding and projective funding, ____ is more flexible for portfolio managers.
a.
matched funding; matched funding
b.
projective funding; matched funding
c.
projective funding; projective funding
d.
matched funding; projective funding
38. Pension funds managed by life insurance companies are normally referred to as
a.
trust portfolios.
b.
insured plans.
c.
matched plans.
d.
projective plans.
39. Pension portfolios managed by trusts are expected to offer ____ returns than those managed by
insurance companies and have a(n) ____ degree of risk.
a.
lower; higher
b.
lower; lower
c.
the same; equal
d.
higher; lower
e.
higher; higher
40. The asset composition of private pension portfolios is most heavily concentrated in
a.
corporate bonds.
b.
mortgages.
c.
common stock.
d.
money market securities.
41. Investing in a bond index portfolio is an example of a(n) ____ approach. Investing in an equity
portfolio that mirrors the stock market is an example of a(n) ____ approach.
a.
passive; active
b.
active; active
c.
active; passive
d.
passive; passive
42. Pension funds managed by life insurance companies concentrate on
a.
common stock.
b.
bonds and mortgages.
c.
preferred stock.
d.
money market instruments.
43. Pension portfolios managed by trusts concentrate on
a.
common stock.
b.
bonds.
c.
mortgages.
d.
money market instruments.
44. To reduce interest rate risk, pension fund managers can
a.
shift from variable-rate to fixed-rate bonds.
b.
increase the average maturity on fixed-rate bonds.
c.
decrease the average maturity on fixed-rate bonds.
d.
reduce the investment in money market securities.
45. Most pension fund contributions are contributed by the
a.
employer.
b.
employee.
c.
state government.
d.
federal government.
e.
none of the above
46. The adverse selection problem as related to the insurance industry means that people who have
insurance are less likely to suffer losses than people who do not have insurance.
a. True
b. False
47. The moral hazard problem as related to the insurance industry means that some people take more risks
once they are insured.
a. True
b. False
48. Policyholders who prefer to invest their savings themselves will likely opt for whole life insurance
over term insurance.
a. True
b. False
49. Group insurance policies are very popular for employers and employees.
a. True
b. False
50. Real estate values usually have little impact on the market value of a life insurance company’s asset
portfolio, and only affect property and casualty insurance companies.
a. True
b. False
51. Property and casualty insurance and life insurance are similar in terms of the predictability of payouts
to cover claims.
a. True
b. False
52. Public pension funds can be classified by the manner in which contributions are received and benefits
are paid.
a. True
b. False
53. A defined-benefit plan provides benefits that are determined by the accumulated contributions and the
fund’s investment performance.
a. True
b. False
54. In recent years, defined-contribution plans have commonly been replaced by defined-benefit plans.
a. True
b. False
55. Projective funding limits the manager’s discretion, allowing only investments that match future
payouts.
a. True
b. False
56. Taking speculative positions in stock options is generally not considered appropriate for retirement
funds because of the high degree of risk involved.
a. True
b. False
57. The composition of the stocks in a pension fund’s portfolio is determined by the fund’s portfolio
managers.
a. True
b. False
58. The ____ facilitates cooperation among the various state agencies whenever an insurance issue is a
national concern.
a.
Securities and Exchange Commission
b.
Federal Deposit Insurance Corporation
c.
National Association of Insurance Commissioners
d.
National Association of Securities Dealers
e.
none of the above
59. ____ insurance protects the policyholders until death or as long as premiums are promptly paid.
a.
Whole life
b.
Variable life
c.
Term life
d.
Annuity life
e.
None of the above
60. ____ life insurance specifies a period of time over which the policy will exist but also builds a cash
value for policyholders over time.
a.
Whole
b.
Variable
c.
Term
d.
Universal
e.
None of the above
61. The primary source of life insurance company income is a result of
a.
life insurance premiums.
b.
annuity plans.
c.
health insurance premiums.
d.
investment income.
e.
none of the above
62. Property and casualty (PC) insurance differs from life insurance in all of the following ways, except
a.
PC policies often last one year or less, as opposed to the long-term or even permanent life
insurance policies.
b.
PC insurance is more focused than life insurance.
c.
the amount of future compensation to be paid on PC insurance is more difficult to forecast
than that paid on life insurance.
d.
All of the above are differences between PC and life insurance.
63. With a(n) ____ plan, contributions are dictated by the benefits that will eventually be provided.
a.
matched funding
b.
projective funding
c.
defined-benefit
d.
defined-contribution
e.
none of the above
64. In a ____ strategy, investment decisions are made with the objective of generating cash flows that
match planned outflow payments.
a.
matched
b.
mixed
c.
projective
d.
none of the above
65. Pension portfolios managed by trusts offer potentially ____ returns than insured plans and have a ____
degree of risk.
a.
higher; lower
b.
higher; higher
c.
lower; lower
d.
lower; higher
e.
none of the above
66. If a pension fund holds long-term, fixed-rate bonds, the market value of the portfolio will ____ during
periods when interest rates ____.
a.
increase; increase
b.
decrease; increase
c.
decrease; decrease
d.
none of the above
67. A pension fund’s bond portfolio is not directly affected by
a.
general stock market conditions.
b.
changes in the risk-free rate.
c.
changes in the risk premium.
d.
the abilities of the portfolio managers.
e.
All of the above are factors affecting the performance of a pension fund’s bond portfolio.
68. In periods when the risk-free interest rate ____ substantially, the required rate of return by bondholders
____, and most bond portfolios managed by pension funds perform ____.
a.
declines; declines; poorly
b.
declines; increases; well
c.
declines; declines; well
d.
declines, increases; poorly
e.
none of the above
69. The adverse selection problem in insurance occurs because:
a.
those who are most likely to need insurance are also most likely to purchase it.
b.
some insurance companies set their premiums too high, causing them to lose customers.
c.
some insurance companies do not select investment that generate suffcient funds for the
companies to pay insurance claims.
d.
people who purchase insurance are less likely to engage in risky behavior.
70. The practice of adapting insurance prices to interest rates by lowering premiums when interest rates
rise and raising premiums when interest rates decline is called:
a.
cyclical rate adjusting.
b.
collateralizing premiums.
c.
cash flow underwriting.
d.
reinsurance.
71. Underfunded pensions are primary a problem with defined-contribution pension plans.
a. True
b. False
72. The problems that some state government agencies are experiencing with underfunded pension plans
can be attributed to:
a.
making unrealistic promises about pensions to employees in the past.
b.
overestimating the return that the plans’ investments would earn.
c.
changing from defined-benefit plans to defined-contribution plans.
d.
A and B
73. The government agency that guarantees that participants in defined-benefit plans will receive their
benefits upon retirement is the:
a.
Federal Pension Insurance Corporation.
b.
Pension Benefit Guaranty Corporation.
c.
Office of Pension Insurance.
d.
Employee Pension Protection Bureau.
74. A pension fund manager might hedge against interest rate movements by selling bond futures
contracts.
a. True
b. False
75. Mortgage insurance protects:
a.
homeowners against damage to their home such as from storms or fire.
b.
homeowners in the event that they cannot make their mortgage payments.
c.
the lender who provided the mortgage in the event that the homeowner defaults on the
mortgage.
d.
all of the above
76. When long-term interest rates are very low, the future returns that a pension fund can earn on
long-term low-risk bonds are __________ if the bonds are held to maturity; if the bonds are not held to
maturity, there is ____________ potential for their prices to increase.
a.
low; significant
b.
low; not much
c.
high; significant
d.
high; not much