Finance 160:163 Insurance Operations Fall 2009 Dr. A. Frank Thompson Exam 1

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1 Finance 160:163 Insurance Operations Fall 2009 Dr. A. Frank Thompson Exam 1 Directions: Please answer the following 25 multiple choice questions and 2 short essay questions designed to test your knowledge of the basic concepts in insurance operations, fundamental principles of insurance contracting, distribution and administration, the regulatory framework of insurance, types of insurers and insurance policies, in addition to elementary concepts related to insurance operations [Chapters 1-7]. Please give your answers to the essay questions in the space provided, feel free to use the back side of the page if required. 1. The proximate cause of loss is: (a) a loss event not covered within an insurance policy (b) the first peril in a chain of events resulting in loss (c) a loss that occurs in close proximity to an insured (d) a loss from risks that are catastrophic in nature (e) the last peril in a chain of events resulting in loss 2. A pure risk is defined as: (a) anything that increases either the severity or frequency of loss (b) a risk that produces a loss where the outcome is either a loss or no loss (c) the possibility that a loss will occur (d) the proximate cause of loss (e) a loss that increases in risk due to technological change 3. Leaving your key in the ignition in your unlocked car in the UNI Dome parking lot is an example of a: (a) named peril (b) moral hazard (c) morale hazard (d) homogeneous risk (e) indirect loss 4. All of the following are direct losses EXCEPT: (a) the roof is blown off your house (b) a house loses shingles during a windstorm (c) you have to rent a new apartment after the one you are living in is destroyed in a fire (d) you are sued for $50,000 following an auto accident with another driver (e) a friend sustains a broken arm due to slipping on a piece of ice from your refrigerator requiring medical treatment 5. One measure of a casualty insurer s ability to cover its incurred losses, loss adjustment expenses and incurred underwriting expenses out of earned premiums is: (a) the financial basis combined ratio (b) the trade basis loss ratio (c) the incurred cost operating ratio (d) the Herfendahl combined ratio (e) the profitability ratio 6. Which of the following is NOT an example of a pure risk? (a) a potential liability claim on the financial advice you gave a client (b) potential theft of a motorcycle (c) potential loss on your investment in 10 shares of Berkshire Hathaway stock (d) potential loss of your wallet containing a stock certificate worth $5,000 (e) potential loss of your laptop computer from the library while studying for your risk management and insurance exam

2 Dr. A. Frank Thompson Exam 1 Page Which of the following is a suitable definition of insurance? (a) a credit card available to protect you in the event of a rainy day (b) a financial contact whereby an individual pays a small certain payment known as the premium, in exchange for being indemnified against large uncertain losses, known as the contingency insured against (c) a financial arrangement that redistributes the costs of expected losses amongst the owners of an insurance company (d) an investment contract designed to allow the insured to earn a fair rate of return on investment commensurate with risk (e) a contractual agreement in which the insurer agrees to pay the insured only if the insured requests the money 8. Risk avoidance is the best risk management tool when the chance of loss is and the loss severity is. (a) high, high (b) low, low (c) low, high (d) high, low (e) certain, low 9. A type of insurance agency system whereby the agent owns the list of clients, and receives income primarily from commissions is: (a) a direct writing agency system (b) a independent commission system (c) a field service agency system (d) an independent agency system (e) an e-market agency arrangement 10. A mutual insurance company is: (a) an insurer that is owned by the policyholders, and may pay dividends to them (b) owned by shareholders who purchase stock in the business (c) a non-profit business organization (d) not required to file a statutory accounting statement with the insurance commissioner (e) required to abide by a file and use provision in order to set new premium rates 11. Insurance underwriting might best be defined as: (a) the process of selling IPO securities to new investors (b) the selection of who is to be insured and the determination of an appropriate premium based on risk (c) the determination of coverage after an insured files a claim (d) the process of examining the accounting records of an insurer prior to filing the statutory statement (e) determination of how much to pay on a particular loss based on the principle of indemnification 12. Insurance or risk transfer in best used in risk management when the frequency of loss is and the severity of loss is. (a) low, high (b) high, low (c) low, low (d) high, high (e) high, speculative

3 Dr. A. Frank Thompson Exam 1 Page The most difficult and important step in risk management process and one that can lead to a risk manager being terminated if it is not conducted properly is: (a) risk identification, particularly those risks that are foreseeable (b) finding the least costly insurer to cover all the risks that may impact an organization (c) determining an appropriate premium for the pure and speculative risks (d) selecting the best method for handling risk (e) hiring a highly trained accountant to create a tax-sheltered captive within the organization 14. A reciprocal insurance organization: (a) is a large property-liability insurance company with headquarters in London (b) sells insurance directly to the public through the mail (c) sells only inland and outland marine coverage to insure transportation risks (d) a type of insurer with an attorney in fact where the liability for losses is transferred to members of the organization (e) is a marketplace where separate underwriting syndicates accept risk exposures for their own accounts 15. The department within the insurance organization responsible for the calculation of insurance rates, developing rating plans, and estimating loss reserves is: (a) the actuarial department (b) the claims department (c) the investments department (d) the reinsurance department (e) paid loss retrospective rating department 16. A direct writing agency system for selling insurance: (a) allows agents to sell a variety of insurance policies from any number of insurers (b) utilizes the internet to sell insurance policies to customers (c) involves paying agents on a strictly commission basis (d) requires that an insurance agent sell only policies issued by one insurer, in return the agent receives a salary plus some commission income (e) permits an agent to work as a broker for a prospective insured 17. Taking a $1,000 deductible on your individual health insurance policy is an example of: (a) risk avoidance (b) loss reduction (c) risk assumption (d) risk transfer (e) hedging 18. The principle of utmost good faith: (a) holds only the insurer to a higher standard of honesty in the execution of the insurance contract (b) generally does not apply in employee life insurance since these covers are administered under group underwriting (c) requires that the insurer fulfill on the promises made in the insurance contact, and that the insured provide accurate information on the insurance application and not withhold information considered material to the contract (d) means that there will be an inequality between the actual value of payments amongst the policy participants (e) requires that the insurer provide the insured with a written contract in order for the policy to come into existence

4 Dr. A. Frank Thompson Exam 1 Page A type of reinsurance contract whereby one insurer transfers a portion of its insurance coverage on issued policies to another insurer based on a previously negotiated arrangement based on mutually agreed upon underwriting standards is called: (a) a facultative reinsurance treaty (b) an automatic reinsurance treaty (c) a stop-loss reinsurance contract (d) a pro-rata reinsurance arrangement (e) an excess loss, facultative reinsurance 20. The type of accounting statement required by state insurance commissioners in order for an insurer to be admitted to sell cover is: (a) a qualified statement of insurance (b) a GAAP financial report (c) a prior approval financial statement (d) a statutory statement (e) a supervisory insurance 21. The principle of indemnity in insurance means: (a) a person has the right to sue an insurer for loss when they are not satisfied with the payment of a claim (b) that a person may not collect more than his/her actual financial loss in the event of damage caused by an insured peril (c) that a person will not be reimbursed for a loss unless he can show proof of loss (d) an employer is always responsible for the careless acts on an employee (e) a adjusters may not be held liable for twice the claim if a settlement has already been reached on a policy 22. The goal of risk management is to: (a) Maximize insurance expenditures (b) Make certain that uninsured losses do not occur (c) Minimize the adverse consequences of losses and uncertainty connected with pure risks (d) Get the best buys in the field of insurance (e) Eliminate financial loss 23. The U.S. Supreme Court Case that established that insurance was not interstate commerce, and could not be federally regulated, but rather could only be regulated by the states was: (a) Paul versus Virginia (b) Munn versus Virginia (c) The Southeastern Underwriters case (d) Townsend versus New Hampshire (e) McCarran-Ferguson

5 Dr. A. Frank Thompson Exam 1 Page 5. Short Answer Essay Questions: 1. Compare and contrast the various forms of insurance organizations, tell what differences there are in terms of tax treatment, accounting, dividends and mode of ownership for each type of insurer. Why were mutual companies the first major insurers to operate in the US? Why has there been such a dramatic transition to stock insurers away from the mutual form of organization?

6 Dr. A. Frank Thompson Exam 1 Page 6. Short Answer Essay Question: 2. Discuss the fiduciary obligations an insurer has to its policyholders. Is there an agency problem with respect to the insurer s investment of policyholder funds? Based on Partnoy s book, FIASCO, why should insurers scrupulously avoid the use of derivatives within their insurance operations? Dr. A. Frank Thompson, September 30, 2009 All Rights Reserved.

7 Fall 2009 Exam 1 Answer Key: 1. B. 2. B 3. C 4. C 5. A 6. C 7. B 8. A 9. D 10. A 11. B 12 A 13. A 14. D 15. A 16. D 17. C 18. C19. B 20. D 21. B 22. C 23. A