Introduction to Risk Management and Insurance, 10e (Dorfman/Cather)
Chapter 11 Insurance Contracts
1) In property insurance, to collect for a loss, insurable interest must exist:
A) at the beginning of the contract
B) at all times
C) when the insurer waives it
D) at the time of the loss
2) If there were a $200,000 loss and a $500 straight deductible, the insured would pay:
A) $500
B) $199,500
C) $200,000
D) $200,500
3) Dane Cook has a $50,000 property loss. His insurance policy’s coverage limit is $35,000, and
has a $500 deductible applied to the loss. How much will Dane collect?
A) $50,000
B) $49,500
C) $35,000
D) $34,500
4) Gerald Tee has a $50,000 property loss. His insurance policy’s coverage limit is $35,000, and
has a $500 deductible applied to the policy. How much will Gerald collect?
A) $50,000
B) $49,500
C) $35,000
D) $34,500
5) Deductibles serve three major purposes, and two of those are:
A) reduce moral hazards; save on claims handling expenses
B) reveal moral hazards; eliminate morale hazards
C) reduce morale hazards; save on claims handling expenses
D) reveal morale hazards, eliminate moral hazards
6) If there were a $22,000 loss and a $700 straight deductible, the insurer would pay:
A) $700
B) $21,300
C) $22,000
D) $0
7) Which part of the insurance contract personalizes the coverage to the individual’s exposure?
A) Exclusions
B) Insuring agreements
C) Declaration page
D) Conditions
8) The purpose of the insuring agreement of an insurance policy is to:
A) specify the perils covered
B) list reasons allowing the insurer to cancel the policy
C) present the language giving force to the contract
D) indicate who can collect for a covered loss
9) Exclusions are contained in insurance policies for all the following reasons except:
A) to eliminate catastrophic perils
B) to eliminate coverage of property or perils for which the insurer wants an extra premium
C) to control moral hazard
D) to exclude the influence of reinsurance arrangements
10) To determine if a loss is covered by a property insurance contract, you should look at all of
the following except:
A) all applicable exclusions
B) the subrogation clause
C) what property is covered
D) the dollar limitations for recovery
11) Which of the following is not a reason for using deductibles in property insurance?
A) They reduce the morale hazard
B) They eliminate payment for frequent small losses
C) They allow consumers to customize contracts based on financial considerations
D) To split large losses in excess of the policy limits equitably between the insured and the
insurer
12) Which of the following items is not a benefit of standard insurance policies?
A) Smaller insurers can offer cheaper insurance than larger companies if standard policies are
used.
B) Litigation should be reduced as policy meaning becomes understood.
C) Consumers are more likely to learn the meaning of standard policies.
D) Data collection and loss rate computation are easier and more accurate.
13) Which of the following is not likely to be found on a declarations page?
A) Duties following a loss
B) Identity of the named insured
C) List of coverages provided by the contract
D) Name of the insurer
14) Which of the following is false concerning concealment?
A) Would be illustrated by a false answer to a question
B) To make a contract avoidable must be material
C) Typically involves an element of deception
D) The result is treated very much like material misrepresentations in insurance law
15) All the following features are unique to insurance contracts (versus other business contracts)
except:
A) insurable interest
B) subrogation
C) utmost good faith
D) consideration
16) In most property insurance contracts assignment is:
A) specifically prohibited
B) permitted, but requires additional premium
C) not mentioned, but is not permitted because insurance contracts are personal contracts
D) valid with the written consent of the insurer
17) Mr. Jiminez wants his 16 year old son to buy a life insurance policy as an investment for
college. He asks you if it is legal for a minor child to purchase and own life insurance. You
correctly respond by saying:
A) minors never have capacity to enter contracts
B) minors always have capacity to enter contracts
C) the courts have ruled that it is illegal for minors to purchase life insurance
D) the courts have ruled both ways on minors’ ability to own life insurance
18) The personal feature of property insurance contracts means that:
A) subrogation always applies
B) ambiguities in the wording will always be construed against the insurer
C) insurance contracts cannot be freely transferred to other parties
D) the buyer of insurance must have insurable interest in property before the policy is issued
19) The principle of utmost good faith:
A) holds the insurer to a higher standard of honesty
B) does not apply in life insurance
C) holds the insured to a higher standard of honesty
D) requires the insurer and insured to enter the contract with utmost good faith
20) Jasmine phones her agent to obtain auto insurance. The agent binds coverage over the phone,
and tells her she will have a $250 collision deductible. When the insurer issues the policy, the
underwriter imposes a $1,000 deductible because of Jasmine’s poor driving record, then mails
her the policy. She does not read it or notice this change until she has an accident six months
later. She then demands that the insurer only require a $250 deductible rather than a $1,000
deductible, since she did not approve this change. Which legal principle of insurance contracts
would be the insurer’s most convincing reason for refusing to honor the $250 deductible?
A) Contract of adhesion
B) Parol evidence rule
C) Indemnity
D) Utmost good faith
21) The ________ clause in an insurance policy says that when the insurer indemnifies the
insured for a loss, it takes over the insured’s right to collect payment from any negligent third
party that may have caused the loss.
A) indemnity
B) proof of loss
C) adhesion
D) subrogation
22) Which of the following does not support the principle of indemnity?
A) Actual cash value
B) Contract of adhesion
C) Insurable interest
D) Subrogation
23) If a property insurance agent goes to Maria’s door, convinces her to apply for insurance and
write a check for the policy premium, which of the following has occurred?
A) Offer, acceptance
B) Soliciting an offer, offer, acceptance, consideration
C) Offer, counter offer, acceptance, consideration
D) Offer, consideration
24) An affirmative warranty states that:
A) something is true only at the present time
B) something will be true in the future
C) all information provided on the application for coverage is affirmed to be truthful
D) none of the above
25) What is the principle of indemnity?
A) A court precedent that gives insureds the right to sue their insurers if they get bad claims
service
B) The rule that a person may not collect more than his actual loss in the event of damage caused
by an insured peril
C) The rule that a person will not be reimbursed for a loss unless he can show proof of loss
D) A way of requiring a person to pay a premium
26) A binder is:
A) part of most property insurance contracts
B) a release of any additional claims against the insurer
C) a legal response when the insurer informs the insured a claim is denied
D) a temporary contract
27) Which of the following is not an exception to the rule that insurance contracts are contracts
of indemnity?
A) Life insurance
B) Replacement cost insurance
C) Functional replacement
D) Valued insurance policies
28) The parol evidence rule says:
A) oral statements made prior to the issuance of an insurance policy are not a part of the contract
B) oral statements made after a policy is issued are not a part of the contract
C) after an oral agreement is put into writing, it becomes a contract of adhesion
D) none of the above
29) If an insured has actual cash value coverage, how much would he collect given the following
facts?
1) Replacement cost of the building is $200,000,
2) Replacement cost of the loss is $30,000,
3) Estimated total useful life is 30 years, and
4) Building has been in use 15 years.
A) $70,000
B) $45,000
C) $30,000
D) $15,000
30) A misrepresentation:
A) always voids a contract
B) makes a contract voidable if it is material
C) is sometimes referred to as a “concealment”
D) is legally treated the same way as a breach of warranty
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31) In which case is there no insurable interest?
A) Barbie’s 25% ownership in an oil well
B) A dry cleaner in its customers’ clothes
C) A bank (creditor) in property used to secure a loan
D) A school principal in the lives of the students attending his school
32) Choose the best example of a promissory warranty.
A) The cargo is not flammable
B) This vessel is seaworthy
C) The building’s fire sprinkler system works and will work
D) The dump truck is in good condition
33) The functional replacement provision in some property insurance policies is used when:
A) replacing a lost item is impossible
B) replacing a lost item is much cheaper than expected
C) replacing a building will cost much more than its market value
D) an insured set of objects is collectively worth more than the sum of its individual components
34) Christopher purchases an insurance contract with the following warranty attached: “the
burglar alarm system will be in good working order.” What type of warranty is this?
A) The statement is not a warranty
B) Implied affirmative
C) Express affirmative
D) Express promissory
35) The principle of indemnity:
A) is illegal in many countries
B) reduces the occurrence of overstating claims
C) only applies in life and health insurance
D) eliminates insurance fraud
36) Which one of the following is true concerning consideration in property insurance?
A) Dollars must change hands from the insured to the insurer before a contract exists.
B) The only valid consideration is cash payment of all premiums in full.
C) Abiding by the contractual language and paying the premium is the consideration the insured
provides.
D) If the premium is not paid at the time of a loss, the insured is given a 30-day grace period to
pay.
37) Which of the following is correct concerning when insurable interest must exist?
A) In property and liability insurance, it must exist at the inception of the contract.
B) It is seldom required in property insurance unless there are liens on the property.
C) It must exist at the time of death of the insured for the beneficiary to collect in life insurance.
D) In life insurance, it must exist at the inception of the policy but it is not necessary at the time
of the loss.
38) Which one of the following is false concerning subrogation?
A) It reinforces the principle of indemnity.
B) It holds rates below what they would otherwise be.
C) It places the burden of loss on one or more responsible parties.
D) The insured can never receive any money collected through subrogation.
39) The fact that insured have reasonable expectations has typically resulted in:
A) a reduction in the scope of insurance coverage
B) an increase in morale hazard
C) difficulties preventing adverse selection
D) insurers having to cover things they never anticipated covering
40) A void contract is:
A) voided by the insurer
B) voided by the insured
C) voided by law
D) voided by the court
41) Which term below describes a contract in which there is an unequal dollar consideration?
A) Commutative
B) Aleatory
C) Adhesion
D) Unilateral
42) The doctrine of proximate cause:
A) forces the insurer to pay for all claims arising out of an unbroken sequence of events if any
one of the subsequent perils following the original excluded peril was covered
B) forces the insurer to pay for all claims arising out of an unbroken sequence of events if the
original insured peril was covered
C) forces the insurer to pay for the loss when the proximate cause of the event is the insured’s
fault
D) divides any loss payment among parties proximately affected by the loss
43) Under a contract of adhesion:
A) subrogation is not allowed
B) ambiguous features are interpreted against the writer of the contract
C) ambiguous features are interpreted always against the insurer
D) ambiguous features are decided based upon the intent of the parties when the contract was
entered
44) All of the following are requirements of a contract of insurance except:
A) the contract must be in writing
B) it must be for a legal purpose
C) there must be legal capacity of the parties
D) there needs to be an offer and an acceptance
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45) Luis arrives home from work one day to discover that his apartment building is on fire. He
drives directly to an insurance agency to buy renters insurance, since he realized he didn’t have
coverage for this loss. Luis does not tell his agent that the building is on fire. There is also not a
question on the application for coverage that asks if Luis’ apartment is currently on fire. Luis
pays the first premium, and the agent issues a coverage binder. Which of the following
statements is/are true?
I. Luis committed a misrepresentation, so coverage may be voided at the option of the insurer.
II. Luis breached a warranty, but the insurer will have to prove he did so fraudulently in order to
deny coverage.
III. Luis committed a concealment that was material to the risk, thus his coverage can be voided
by the insurer as long as the insurer can prove that he concealed the fact with fraudulent
intentions.
A) I
B) I and III
C) III
D) II and III
46) Actual cash value is defined as:
A) replacement cost minus accounting depreciation
B) replacement cost minus depreciation
C) actual replacement cost
D) original purchase price minus depreciation
47) The principle of insurable interest is important because it:
A) makes insurance companies more profitable
B) supports the principle of indemnity
C) prevents insurers from unfairly denying insurance claims
48) Tiffany, who is married to Saul, takes out a $1,000,000 life insurance policy on Saul’s life in
2008. Two years later they get divorced and Tiffany immediately remarries. Saul is not required
to pay any alimony or child support to Tiffany after the divorce. In 2015, Saul dies. What will
Tiffany collect on the life insurance policy, assuming she continued to pay all premiums due
following their divorce?
A) $0, because Tiffany has no insurable interest
B) $1,000,000, because Tiffany had insurable interest in Saul’s life when the policy was
purchased
C) $1,000,000, because Tiffany had insurable interest in Saul’s life at the time of his death
D) $0, because Saul was not ordered to pay alimony to Tiffany
49) While driving home from work, Bailey’s car is struck from behind by a van full of drunken
college students. Asimov is the driver of the van. The resulting damage to Bailey’s car totals
$7,000. Bailey files a claim under his own auto insurance policy to have his car repaired, but his
insurance policy only covers $6,000 of the $7,000 loss. Bailey pays the remaining $1,000 of the
loss out of his pocket. Which of the following is a true statement?
A) Bailey has no legal right of subrogation against Asimov for the $1,000 that he had to pay out
of his pocket.
B) Bailey’s insurer has no legal right of subrogation against Asimov for the $6,000 of damages it
had to pay to Bailey.
C) Bailey has the right under the principle of indemnity to now sue Asimov personally for the
$7,000 damages to his car.
D) Both Bailey and his insurer have subrogation RIGHTS against Asimov for the damages he
(Asimov) caused.
50) Willy Dye goes applies for life insurance. The agent takes Willy’s application and his first
premium payment, and issues Willy a conditional receipt for the payment. The next day Willy is
run over by a sewage truck and killed. An autopsy shows that Willy was in excellent physical
condition, and would thus have been issued an insurance policy had he lived. What will the
insurer do?
A) Pay Willy’s beneficiary the full death benefit because coverage existed from the date the
receipt was issued
B) Not pay Willy’s beneficiary because he died before the policy could actually be issued
C) Not pay Willy’s beneficiary because a conditional receipt does not take effect until after the
underwriting process is completed
D) Pay the beneficiary an amount equal to the premiums Willy paid for the policy
51) Sarah has a house valued at $200,000 and insured for $180,000. It is totally destroyed by
fire, due to the negligence of Courtney. Sarah recovers $180,000 from her insurer, which then
subrogates against Courtney. Suppose the courts decide that Courtney must pay $100,000 in
damages, because that’s all the money she has. How much of this $100,000 can the insurer keep,
assuming that the policy has no special provision regarding the distribution of subrogation
amounts?
A) $0 (The entire $100,000 must be passed on to Sarah)
B) $20,000 (Sarah gets the other $80,000)
C) $80,000 (Sarah gets the other $20,000)
D) $100,000 (Sarah will get no additional funds)
52) Joe has a dispute with his insurance company regarding how much he is entitled to recover
on a claim. Joe believes he is entitled to get $8,000 based upon his interpretation of the policy
wording. The insurer says the claim is not covered by the policy. Joe sues and a court of law
decides that the policy wording is vague and ambiguous, and rules that the loss IS covered. What
legal characteristic of insurance resulted in the court’s decision?
A) Insurance is aleatory.
B) Insurance is a contract of indemnity.
C) Insurance is a contract of adhesion.
D) Insurance is personal.
53) Shicara owns a jewelry store. In exchange for a discount on her burglary insurance premium,
she promises the insurer that her trained guard dog will be on the premises at all times, even
when the store is closed. One evening she takes the dog home with her instead of leaving him at
the store, and a burglar breaks in and steals everything. The insurance company finds out the dog
wasn’t in the store when the burglary happened, and denies the claim. WHY does the insurer do
this?
A) Because Shicara committed a material misrepresentation
B) Because Shicara breached a warranty
C) Because Shicara committed a concealment
D) Because Shicara violated the principle of adhesion
54) Evan has his house insured for $200,000. He sells the house to Ann for $225,000. Three days
after the sale is complete the house is destroyed by fire. Evan has not canceled his homeowner’s
insurance policy, so he decides to file a claim for losses caused by the fire. What will most likely
happen?
A) Evan will collect $200,000 in insurance payments.
B) Evan will collect $200,000 in insurance payments ONLY IF Ann has not yet purchased a
homeowner’s policy of her own.
C) Evan will collect nothing because he has no insurable interest.
D) Ann will collect $200,000 from Evan’s insurer.
55) “Binders” are typically used with:
A) life and health insurance
B) property and liability insurance
C) life and liability insurance
D) health and property insurance
56) Dana loans her brother, Marcus, $500,000 with which to start a movie production company.
The business assets are shown in the loan agreement as collateral for the loan. Dana can insure
Marcus’s life because:
A) the principle of insurable interest exists in this situation
B) the principle of utmost good faith exists in this situation
C) she and Marcus are brother and sister
D) This is a trick question; she cannot insure his life, but she can insure the business assets.
57) A statement of opinion by the insured on a life insurance application:
A) is a sufficient reason to allow an insurer to later void the contract
B) is illegal, and insurers must not request such information
C) is not a sufficient reason for an insurer to later void the contract
D) provides reliable information to the underwriter
58) The parol evidence rule:
A) allows statements made before the policy is sold to affect policy coverage
B) benefits the insured more than the insurer
C) makes written evidence more important than oral evidence
D) makes oral evidence more important than written evidence
59) Jerry has a property insurance policy on a building that would cost $200,000 to replace. His
insurance policy is written on an actual cash value basis. His building suffers fire damage that
has a replacement cost of $50,000. The building is 2 years old, with an estimate useful life of 20
years. How much will he collect for the fire damage?
A) $5,000
B) $10,000
C) $25,000
D) $45,000
60) Which one of the following is false concerning the standardization of insurance policies?
A) It reduces the risk for the insurance companies resulting from the principle of adhesion.
B) It holds rates below what they would otherwise be.
C) It reduces adverse selection.
D) It increases flexibility.
61) Which one of the following is not a basic part of an insurance contract?
A) Deductibles
B) Conditions
C) Declarations
D) All of the above are a basic part of an insurance contract.
62) Property insurance policies are standardized for all the following reasons except:
A) to improve the accuracy of insurance rates
B) to help reduce costs to consumers
C) to eliminate competition between insurers
D) to reduce litigation over policy meaning
63) In property insurance the insured must have an insurable interest when the loss occurs and
need not have it when the policy is taken out in order to collect.
64) Since the automobile insurance policy is written by the insurer, ambiguities are interpreted in
favor of the insurer.
65) Standardization increases the possibility that some insurance needs go unmet.
66) Since the homeowners’ insurance policy is written by the insurer, ambiguities are interpreted
in favor of the insured.
67) Exclusions are not a basic part of an insurance contract.
68) There is no subrogation in life insurance.
69) If insurance policies were not designed to support the principle of indemnity, then we would
have fewer moral hazards in our society.
70) The principle of indemnity says that the insured should profit from insurance.
71) Ambiguities in the wording of an insurance contract are always construed against the writer.
72) A binder must meet all the requirements of a valid contract.
73) Conditional receipts are associated with life insurance rather than non-life insurance.
74) “Actual cash value” means “historical cost less depreciation.”
75) Concealment or fraud before, during, or after a loss generally allows an insurer to contest
property insurance contracts.
76) Standardized insurance policies make it easier to calculate an insurance rate than do non-
standardized policies.
77) When entering into a legally enforceable insurance contract consideration must exist.
Explain what consideration is and the form it takes in insurance contracts.
78) Explain the principle of indemnity. How does one measure indemnity?
79) Explain the principle of subrogation. Provide a mathematical example of its use.
80) What is the doctrine of utmost good faith? What situations arise out of its application?
Explain.
81) Explain what a contract of adhesion is. How does the doctrine of reasonable expectations
influence adhesion?
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82) Explain the purpose of the declaration page found in insurance contracts.
83) What are some of the reasons exclusions are found in insurance contracts?
84) Describe the purposes of deductibles.