TB For Final

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
3) Why are some mutual insurers referred to as ʺassessment mutualsʺ?
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
6) Which of the following statements about a reciprocal exchange is (are) true?
I. It usually specializes in 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
7) Which of the following statements about Lloydʹs of London is true?
A) Coverage is actually written by syndicates who belong to Lloydʹs 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
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
52 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. They are prohibited from being licensed as agents.
A) I only
B) II only
C) both I and II
D) neither I nor II
Answer: A
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
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
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
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
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 agentsʹ 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
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
16) The salespersons of a direct writer are considered to be
A) independent agents.
B) independent contractors.
C) employees.
D) brokers.
Answer: C
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
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 insurerʹs 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
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
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. ʺYouʹre a super salesperson, David,ʺ he was told, ʺWeʹre hiring you to do
one thing and one thing onlySELL!ʺ 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
21) Sarah owns a property and liability insurance agency. She is authorized to represent several
insurance companies and is compensated by commissions. Sarahʹs 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
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
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
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
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 insurerʹs 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
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
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
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
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
30) RST Insurance is an interesting company. It doesnʹt 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
31) One type of insurer is a community-oriented health insurer. In most states, this insurer is set-up as
a non-profit organization that provides coverage for hospital services, physiciansʹ and surgeonsʹ
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
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
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
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
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
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.ʹs 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
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
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
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
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
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
Chapter 6 Insurance Company Operations 61
5) The underwriting process begins with the
A) agent.
B) desk underwriter.
C) inspection report.
D) acceptance of the application.
Answer: A
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 applicantʹs income tax return.
Answer: D
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) agentʹs report.
Answer: A
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
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
10) All of the following are functions of the marketing department of an insurance company EXCEPT
A) to advertise the insurerʹs products.
B) to develop new products.
C) to identify production goals.
D) to make final underwriting decisions.
Answer: D
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
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
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
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
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
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
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 insurerʹs net worth belonging to policyowners.
Answer: B
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
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
20) Which of the following statements about treaty reinsurance is true?
A) Under a surplus-share treaty, 100 percent of the ceding insurerʹs liability must be transferred
to the reinsurer.
B) Using a quota-share treaty increases the ceding insurerʹs unearned premium reserve.
C) Under an excess-of-loss treaty, the reinsurer pays losses in full only if they are less than the
ceding insurerʹs retention limit.
D) Using a reinsurance pool provides financial capacity to write large amounts of insurance.
Answer: D
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
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
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
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
25) Functions of an insurance companyʹs 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
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 applicantʹs degree of risk. Jan is a(n)
A) underwriter.
B) actuary.
C) loss control engineer.
D) claims adjustor.
Answer: A
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) agentʹs report.
B) binder.
C) physical inspection.
D) inspection report.
Answer: D
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
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
30) New Liability Insurance Company began operations last year and has been very successful. The
companyʹs 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
31) Liability Insurance Company (LIC) was approached by a regional airline to see if LIC would write
the airlineʹs 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
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
33) Amy heads the legal staff of a large property and liability insurance company. Amyʹs 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
Amyʹs 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
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
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.
D) notice of loss.
Answer: B
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
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
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
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
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
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
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
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) agentʹs report.
D) physical inspection.
Answer: B
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 LMNʹs policyholdersʹ surplus?
A) $680 million
B) $340 million
C) $80 million
D) -$80 million
Answer: C
2) All of the following would appear in the asset section of an insurance companyʹs balance sheet
EXCEPT
A) loss reserves.
B) bonds.
C) common stock.
D) real estate.
Answer: A
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
Chapter 7 Financial Operations of Insurers 73
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
5) A property and casualty insurerʹs 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
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
7) One item that appears on an insurance companyʹs 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
insurerʹs
A) net income.
B) loss reserve.
C) admitted assets.
D) unearned premium reserve.
Answer: B
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
9) All of the following items would appear in the income section of an insurance companyʹs income
and expense statement EXCEPT
A) gain on sale of securities.
B) common stock dividends.
C) commissions.
D) premiums.
Answer: C
10) 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 JKLʹs loss ratio last year?
A) 70.0 percent
B) 75.0 percent
C) 83.3 percent
D) 90.0 percent
Answer: B
What was JKLʹs expense ratio last year?
A) 5.0 percent
B) 30.0 percent
C) 33.3 percent
D) 50.0 percent
Answer: C
What was JKLʹs combined ratio last year?
A) 100.0
B) 103.3
C) 105.0
D) 108.3
Answer: D
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
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 companyʹs financial statements?
A) as an asset
B) as a liability
C) as income
D) as an expense
Answer: A
15) MedProf Insurance markets medical malpractice insurance. The companyʹs combined ratio in 2006
was 95.4. Its expense ratio was 25.4. What was the companyʹs loss ratio?
A) 60.4
B) 70.0
C) 88.2
D) 120.8
Answer: B
16) To protect policyholders, state laws place limitations on a life insurance companyʹs 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 insurerʹs
A) policy reserve account.
B) asset valuation reserve account.
C) separate account.
D) policyholders surplus.
Answer: C
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
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
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
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
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
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
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
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
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
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
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
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 insuredʹs operations
will influence the insuredʹs future loss experience.
A) I only
B) II only
C) both I and II
D) neither I nor II
Answer: C
29) Which of the following statements about experience rating is (are) true?
I. The insuredʹs past loss experience is used to determine the premium for the next policy period.
II. Its use is generally limited to 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
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
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 Monopolyʹs 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
32) Small Town used to be just thata 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
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 ABCʹs director of ratemaking. Nathan
calculated the pure premium and presented this value as the final premium. After Nathanʹs
presentation, the director of ratemaking said, ʺYou left out something very important. If we sell
coverage at the pure premium rate, weʹll be out of business soon.ʺ What did Nathan overlook in his
calculations?
A) loadings
B) the underwriting cycle
C) seasonality of claims
D) investment income
Answer: A
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
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 XYZʹs 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
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 RSTʹs workers
compensation insurance to base the premium on RSTʹs actual loss experience during the current
period rather than on the companyʹs 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
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
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 XYZʹs 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
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
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
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
Chapter 9
Fundamental Legal Principles
1) Fundamental purposes of the principle of indemnity include which of the following?
I. To reduce 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
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
3) Samʹs 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 Samʹs loss?
A) $600
B) $900
C) $1200
D) $1800
Answer: B
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
Chapter 9 Fundamental Legal Principles 99
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
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
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
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 insuredʹs loss.
II. It reduces moral hazard.
A) I only
B) II only
C) both I and II
D) neither I nor II
Answer: B
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
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
11) When must an insurable interest legally exist in life insurance?
A) only at the time of the insuredʹs 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 insuredʹs death and at the inception of the policy
Answer: B
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
13) Sueʹs 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
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
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 insuredʹs right to collect benefits may be forfeited if the insured interferes with the
insurerʹs rights after a loss.
D) The insurer is required to exercise its subrogation rights.
Answer: C
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
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 insurerʹs option.
C) Loss payments are reduced by the degree of the concealment.
D) The insurer is immediately entitled to a higher premium.
Answer: B
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 insurerʹs option.
C) Loss payments are reduced by the degree of the misrepresentation.
D) The insurer is immediately entitled to a higher premium.
Answer: B
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
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
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
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
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
24) Which of the following statements about consideration in an insurance contract is (are) true?
I. The insuredʹs total consideration is submission of a completed application.
II. The insurerʹs 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
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
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 insurerʹs promise to perform.
Answer: B
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
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
29) Which of the following types of insurance policies can usually be assigned without the insurerʹs
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
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 insurerʹs 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
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 insurerʹs consent.
C) The insurer can sue the insured for failure to pay any premiums.
D) The policy is interpreted in the insuredʹs favor if the policy contains any ambiguities or
uncertainties.
Answer: D
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
33) The voluntary relinquishment of a legal right is called
A) subrogation.
B) adhesion.
C) estoppel.
D) waiver.
Answer: D
34) Frank would like to change jobs. He asked his companyʹs employee benefits director if his group
health coverage could be converted to individual coverage if he quit his job. The benefits director
said, ʺYes, you can convert to an individual policy, and the coverage is identical to your group
coverage.ʺ 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
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
36) Jacob sold his house to Shelia for $140,000 in cash. Jacob ʺthrew inʺ 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
37) Melodyʹs 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
38) When Ben applied for life insurance, he was asked on the application if he smoked or used tobacco
products. Ben answered ʺNo.ʺ In reality, Ben smokes two packs of cigarettes a day. The policy was
issued at the ʺpreferred, nonsmoker rate.ʺ 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
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. Robinʹs 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
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-than-average 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
41) Tedʹs insurance claim was denied by XYZ Insurance Company. When Ted inquired why the claim
was denied, he was told to, ʺRead the exclusion on page 5 of the policy.ʺ Ted read the exclusion. In
his opinion, the exclusion was poorly worded and vague. If a court of law agrees with Tedʹs
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
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
43) Which distinct legal characteristic of insurance contracts states that only the insurerʹs promise to
perform is legally enforceable?
A) contracts of adhesion
B) unilateral contracts
C) aleatory contracts
D) personal contracts
Answer: B
44) Some courts have ruled that an alternative to ʺreplacement cost less depreciationʺ 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
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
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
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
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
3) Which of the following statements about ʺall-risksʺ 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
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
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
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
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
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
Chapter 10 Analysis of Insurance Contracts 113
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
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
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
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
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
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)
B) exclusion period.
C) elimination period.
D) probationary period.
Answer: C
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
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
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
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
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
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
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
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
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
24) Helen and John both own automobiles on which they carry liability insurance. If Helen is negligent
and has an accident while driving Johnʹs 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) Johnʹs insurer will pay on an excess basis if Helenʹs insurance is insufficient to cover the
judgment.
C) Helenʹs insurance will pay on an excess basis if Johnʹs insurance is insufficient to cover the
judgment.
D) The policies will pay the judgment on the basis of contribution by equal shares.
Answer: C
25) Kate is covered under her employerʹs group health plan. She is also covered as a dependent under
her husbandʹs group health plan. Under the usual coordination-of-benefits provision, how will
each company respond to a claim filed by Kate?
A) Kateʹs plan is primary, and her husbandʹs plan is excess.
B) Her husbandʹs plan is primary, and Kateʹs 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
26) Ericʹs 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, ʺAs long as the cause of loss is not specifically
excluded in the policy, the loss is covered.ʺ Based on the agentʹs answer, what type of insuring
agreement appears in the policy?
A) unconditional coverage
B) named-perils coverage
C) extended-perils coverage
D) ʺall-risksʺ coverage
Answer: D
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, ʺAlthough
such a loss is usually covered, you are required under the terms of the contract to provide prompt
notification in case of loss.ʺ The prompt notification requirement is an example of a(n)
A) declaration.
B) definition.
C) insuring agreement.
D) condition.
Answer: D
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, ʺIʹll simply add an amendment to your contract that changes the basis of recovery
to replacement cost.ʺ The written provision the agent was referring to is called a(n)
A) endorsement.
B) coinsurance clause.
C) binder.
D) deductible.
Answer: A
29) Under the terms of Jennyʹs 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 Jennyʹs auto insurance policy?
A) calendar-year deductible
B) corridor deductible
C) straight deductible
D) aggregate deductible
Answer: C
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
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
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
33) Lauraʹs 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 Lauraʹs major medical policy?
A) $7,500
B) $7,900
C) $8,000
D) $10,000
Answer: C
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
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
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)
B) waiting period.
C) aggregate deductible.
D) straight deductible.
Answer: A
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

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19) Connie has a major medical policy with a $200 deductible and a 75 -25 coinsurance (percentage

33) Lauraʹs major medical insurance policy includes a $500 deductible and an 80 -20 coinsurance

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