Introduction to Risk Management and Insurance, 10e (Dorfman/Cather)
Chapter 6 Fundamentals of Insurance
1) The insurance mechanism:
A) redistributes the cost of insured losses
B) intends to make profits for social insurance policies
C) only applies to private insurance companies
D) is defined by law
2) The scope of insurance:
A) limits the tax-deductibility of premiums
B) is limited to social insurance
C) is not clearly defined
D) does not include weddings
3) The Financial Definition of insurance:
A) is that insurance is a contract in which one party agrees to compensate another party for
losses covered by the contract
B) is that insurance is a financial agreement that transfers the risk of insured losses to a risk pool
by an insurer
C) differs from state to state
D) is that it is any pool for which the insurance mechanism works
4) The Legal Definition of insurance:
A) is that insurance is a contract in which one party agrees to compensate another party for
losses covered by the contract
B) is that insurance is a financial agreement that transfers the risk of insured losses to a risk pool
by an insurer
C) differs from state to state
D) originally comes from tort law
5) Legally insurance is a branch of:
A) contract law
B) tort law
C) Neither A nor B is correct.
D) Both A and B are correct.
6) Participants in the private insurance market include all of the following except:
A) insurance buyers
B) insurance companies
C) insurance regulators
D) the FDIC
7) Which of the following is not provided on the private insurance market?
A) Bank deposit insurance
B) Life insurance
C) Health insurance
D) Commercial lines insurance
8) Which of the following is not a type of property and liability insurance?
A) Boiler and machinery insurance
B) Personal lines insurance
C) Health insurance
D) Commercial lines insurance
9) Which of the following is not a type of property and liability insurance?
A) Bank deposit insurance
B) Commercial lines insurance
C) Business interruption coverage
D) Wedding insurance
10) Which of the following statements is not correct about the insurance premium?
A) The forecast of policyholders’ losses is the starting point for the calculation of the risk
premium for an insurance policy.
B) The fair rate of return, which is a part of the insurance premium, is governed by law.
C) Loading expenses increases the insurance premium.
D) Most investment income of insurance companies comes from low risk investments, which
reduces the insurance premium.
11) Which of the following statements is correct about the fair rate of return for insurance
companies?
A) The fair rate of return is measured using the expense ratio.
B) The fair rate of return is governed by law.
C) The fair rate of return reduces the insurance premiums charged by insurance companies.
D) The fair rate of return compensates the insurance companies for the risk that they take.
12) Which of the following statements is correct about the loading expenses for insurance
companies?
A) The loading expenses are measured using the expense ratio.
B) The loading expenses are governed by law.
C) The loading expenses reduce the insurance premiums charged by insurance companies.
D) The loading expenses compensate the insurance companies for the risk that they take.
13) Which of the following is the correct calculation of the insurance premium?
A) Insured Loss Claims + Loading Expenses + Fair Rate of Return – Investment Income
B) Insured Loss Claims + Loading Expenses + Investment Income – Fair Rate of Return
C) Insured Loss Claims – Loading Expenses – Investment Income + Fair Rate of Return
D) Insured Loss Claims – Loading Expenses + Fair Rate of Return + Investment Income
14) The efficient insurance market requires all of the following conditions except:
A) numerous sellers and buyers
B) well-informed consumers
C) numerous purchase substitutes (homogeneity)
D) a government subsidy for lower-income citizens
15) Smoking cigarettes is an example of:
A) moral hazard
B) peril
C) speculate risk
D) none of the above
16) It may be correctly claimed that insurers usually do not pay for losses because:
A) it is the insured’s money that is used to pay the claims
B) most insurers do not pay claims until the insured sues them
C) almost all claims are caused by fraud
D) insurers estimate claims actuarially in advance in order to avoid payments
17) Which of the following is a true statement?
A) Insurers are significant financial intermediaries in the U.S. economy.
B) Property insurers are prohibited from insuring commercial real estate.
C) The insurance companies in the U.S. are estimated to be very profitable.
D) Both A and C above are true statements.
18) All of the following are perils except:
A) heart attack
B) theft
C) forgery and embezzlement
D) incorrect instructions on the label of a pesticide
19) Proximate cause means:
A) the first insured peril in a chain of events leading to a loss
B) the event nearest the peril in time
C) the event nearest the peril in space
D) the event nearest the loss in time and space
20) All of the following are costs to society arising from an insurance system’s operation except:
A) payments for losses caused by fraudulent claims
B) payments for losses caused by exaggerated claims
C) use of land, labor and capital to operate the insurance companies
D) payments for losses caused by windstorms such as tornadoes
21) The aggregate increased costs to society of operating the insurance mechanism includes all
of the following except:
A) cost of operating the insurance company
B) losses due to uninsured flood losses
C) the occurrence of intentional losses to collect insurance
D) the tendency of insureds to exaggerate the amount of actual losses in the claim process
22) Which of the following is not a direct social benefit of the insurance mechanism?
A) Increased business and social stability
B) Better allocation of society’s resources
C) Better choice of optimum size of business operations
D) Lower federal and state income taxes
23) A difference between a contract issued on a “named peril” basis versus an “open peril” or
“all-risk” basis is:
A) the “named peril” contract usually covers more perils
B) the “named peril” contract is usually more expensive than the “open peril” contract
C) in the “named peril” contract the insured must prove the peril is covered where in the “open
peril” contract the burden of proof is on the insurer to show no coverage
D) in the “open peril” or “all risk” contract there are no exclusions to loss
24) Which of the following factors is not considered when an insurance rate or premium is
calculated?
A) The cost of the actual losses
B) The cost of the insurance salesman and other company expenses
C) Investment earnings on prepaid premiums
D) The decision by the U.S. Supreme Court in 1943
25) Bodacious D, a famous singer, is performing at a concert. He does not have his body guards
and security team present for the concert. A crazed fan runs up on stage, declares her love for
Bodacious D, and throws herself at him. Bodacious D lands on the floor, and breaks his back.
Which of these is the HAZARD(S), and which is the PERIL?
A) The peril is not having a body guard present; the hazard is the crazed fan.
B) The peril is being attacked by the fan, and the hazard is not having a body guard present.
C) The peril is not having a body guard present, and the hazard is being pushed to the floor.
D) The peril is both the crazed fan and the lack of security; there is no hazard in this case.
26) Under an open perils insurance policy:
A) covered perils are spelled out, usually using a numbered list
B) any piece of property not excluded is covered
C) absolutely all risks of losses are covered, those having an illegal purpose
D) all perils not excluded are covered
27) If insurance did not exist in the United States, which of the following might reasonably be
expected to happen?
A) Banks would lower their interest rates on home mortgages and auto loans.
B) Moral hazards would decrease.
C) The occurrence of perils would decrease.
D) In general, only large businesses would be able to survive.
28) If insurance did not exist in the United States, which of the following might reasonably be
expected to happen?
A) Banks would lower their interest rates on car loans.
B) Moral hazards would increase.
C) The occurrence of perils would decrease.
D) In general, only small businesses would be able to survive.
29) Drinking a lot of alcohol before swimming could cause a person to drown. In this context,
which of the following is the hazard?
A) Drinking too much
B) Knowing how to swim
C) Drowning
D) Death
30) Billy is driving to the beach for spring break. Before leaving on his trip, he takes some cold
medicine that makes him sleepy. He falls asleep at the wheel and collides with another car on the
highway and breaks his leg. In this context, which of the following is the hazard?
A) Spring break
B) Knowing how to drive
C) Taking the medicine
D) Broken leg
31) Warren is the president of The Huge Insurance Company. His Vice-President in charge of
Finance comes to him one day and says “Warren, our combined ratio for the year is 105%.”
Warren replies, “Let’s party!” Why isn’t Warren upset about the high combined ratio?
A) The company probably made enough money on its investments to make up for the
underwriting losses.
B) The company has actually made a 5% profit on its insurance business.
C) The combined ratio really isn’t that important… it only measures the combined productivity of
all regional offices the company owns.
D) The combined ratio is not an important indicator of underwriting results.
32) Rusty is the president of The Huge Insurance Company. His Vice-President in charge of
Finance comes to him one day and says “Rusty, our combined ratio for the year is 95%.” Rusty
replies, “Wooo hooo, profit sharing bonuses for everyone!” Why isn’t Rusty upset about this
combined ratio?
A) The company probably made enough money on its investments to make up for the
underwriting losses.
B) The company has actually made a profit on its insurance business.
C) Rusty is not very bright and doesn’t understand what the combined ratio really means.
D) The combined ratio is not an important indicator of underwriting results.
33) Midlands Insurance has 100 policyholders. It expects that this year’s losses for all of its
policyholders will total $111,000. The predicted expenses of operating the insurance pool are
$46,000, expected investment earnings are $20,000, and the actuary determines that there is no
need to charge for a risk reserve this year. What should the premium for each of Midland’s 100
policyholders be?
A) $1,110
B) $1,370
C) $1,570
D) $1,770
34) The combined ratio is:
A) the loss ratio plus the expense ratio
B) a measure of underwriting losses
C) the loss ratio divided by the expense ratio
D) a measure of capital gains and dividend returns
35) A burglar enters Marcia’s home and steals $10,000 worth of appliances. Marcia tells the
insurance company that the appliances were worth $20,000. This overstatement of the loss is an
example of:
A) a morale hazard
B) a peril
C) insurance fraud
D) carelessness
36) The expense ratio equals:
A) total underwriting expenses divided by insured losses
B) net income divided by total expenses
C) total expenses divided by net income
D) total expenses divided by premiums written
37) From the insurance company’s perspective, what is the difference between written premium
and earned premium?
A) There is no difference; they are effectively the same thing.
B) Written premiums are those that belong to the insurer; earned premiums do not belong to the
insurer.
C) Written premiums are the total premiums collected by the insurer; earned premiums are those
that belong to the insurer.
D) Written premiums reflect the total amount of coverage provided to insureds; earned premiums
reflect the net profit of the insurer.
38) All of the following are federally-sponsored insurance activities in the U.S. except:
A) Social Security
B) Unemployment Trust Fund
C) Federal Deposit Insurance Corporation
D) Universal Health for Children Organization
39) If you were a life insurance underwriter, which of the following underwriting criteria would
you MOST prefer to use because of its reliability?
A) The applicant’s response to the question Have you ever tested positive for HIV?
B) The applicant’s response to the question Have you smoked any tobacco products within the
last year?
C) The opinion of the patient’s family doctor as to the overall health of the patient
D) The results of blood and urine tests taken by your company’s own physicians
40) If you were an underwriter of personal auto insurance, which of the following underwriting
criteria would you most prefer to use because of its incentive value?
A) Gender
B) Age
C) Driving record
D) Health
41) Which of the following reasons for canceling a wedding would likely not be covered by a
typical wedding insurance policy?
A) Bride gets food poisoning
B) Church suffers a fire loss the day before the wedding
C) Ggroom decides he doesn’t want to get married
D) Caterer is unable to provide food for the reception
42) Private insurance can be classified according to coverage. Distinct types mentioned in the
text include all the following except:
A) Property
B) Commercial Lines
C) Auto
D) Submarine
43) The scope of the insurance market is clearly defined.
44) Life insurance provides protection from the peril of death.
45) Commercial Property Policies are a type of Personal Lines Insurance.
46) The lack of annuities for life insurance is a serious problem in the U.S.
47) Marine insurance protects property in transit from damage.
48) The loading expenses plus a fair rate of return minus any investment income is the starting
point for the calculation of the risk premium for an insurance policy.
49) Most investment income of insurance companies comes from medium to high risk
investments in order to reduce the price of insurance as much as possible.
50) By applying the law of large numbers the insurance companies can predict the loading
expenses.
51) Change of Law insurance is a type of health insurance.
52) Explain briefly why insurance functions as an antimonopoly device.
53) An insurance contract creates duties for the insurer, but only the insured has contractual
rights.
54) Insurance increases the number of intentional losses that occur in society.
55) Discuss the building blocks of an insurance premium.
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56) What is cash flow underwriting? Why is it a concern for insurance companies?
57) What are considered the benefits and the costs to society of operating an insurance
mechanism?
58) What are the two broad categories of the private insurance industry? Break down the broad
categories into their main parts.