1: Multiple-Choice Workbook Flashcards
- What assets typically are not used to establish an emergency fund?
a. cash in a basement safe
b. money market deposit accounts
c. checking accounts
d. U.S. government bonds
(LO 1–4)
- d. Because they are not as liquid as pure money market instruments and their values are not fixed (unless held to maturity), U.S. government bonds would
not normally be used for an emergency fund. Savings accounts, money market deposit accounts, and checking accounts are all used. However, care should be used regarding checking accounts. Checking account funds that are earmarked for current expenses are not available for emergencies. Keeping cash in a basement safe is not necessarily the best place for the funds. However, the point here is not about where the cash should be kept. Rather, the point is that cash and cash equivalents, wherever housed, are good vehicles for funding an emergency fund.
(LO 1–4)
- Paul and Patti Russell have a mortgage balance of $95,000 on their home, with monthly payments of $850 (principal, interest, taxes, and insurance—
PITI). They have an auto loan balance of $5,000, with monthly payments of $250. In addition, they have a credit card balance of $2,000, on which they pay $225 each month. The Russells’ net income for the past year was $35,000. Their gross income was $48,000.
Are the Russells using excessive amounts of debt?
a. Yes, because monthly house payments (PITI) are 28% of net income.
b. Yes, because total monthly debt payments are more than 28% of gross income.
c. No, because monthly house payments (PITI) are only 38% of net income and total monthly debt payments are only 33% of gross income.
d. No, because monthly house payments (PITI) are less than 28% of gross income and total monthly debt payments are only 33% of gross income.
(LO 1–3)
- d. Paul and Patti are not using excessive amounts of debt because monthly house payments (PITI) are less than 28% of gross income and total monthly debt payments are only about 33% of gross income. Option a. is incorrect because the ratio is based on gross income, not net income. Option b. is incorrect because the ratio allows for 36%, and c. is incorrect because both ratios should be calculated using gross income.
(LO 1–3)
- Thom Jeffers invested $25,000 in an account earning 7% annual interest, compounded monthly. How much will the account be worth if the money is left in the account for 10 years?
a. $26,497
b. $42,500
c. $49,179
d. $50,242
(LO 3–2)
- d. (Note: For help with calculations, please review the material in Introduction to the Time Value of Money.)
a. is incorrect because interest was calculated monthly, but years (term) was calculated annually.
Option b. is incorrect because interest was multiplied by 12, and years were divided by 12 (should have been reversed).
Option c. incorrectly calculated for annual
compounding.
(LO 3–2)
- During her retirement, Marta Blanca wants to receive payments of $2,500 at the beginning of each month to supplement her pension plan benefits. Marta estimates she will need to receive this monthly payment for 35 years. If an 8.5% annual return is earned on investments, compounded monthly, what amount does Marta need to have at the time of her retirement to fund her needs?
a. $334,734
b. $337,106
c. $6,488,916
d. $6,534,879
(LO 3–3)
- b.
Option a. is incorrect because, while the calculation was done correctly, payments were calculated at the end of each period.
Option c. was solved for future value, not present value, with payments at the end of each period, and
Option d. was solved for future value, not present value, with payments at the beginning of each period.
(LO 3–3)
- Kay Bennett invested $16,000 in an account earning 9% annual interest, compounded quarterly. How many years will it take for the account to be worth $100,000?
a. 21 years
b. 22 years
c. 24 years
d. 83 years
(LO 3–4)
- a.
Option b. was incorrectly solved using annual interest and term.
Option c. was solved by multiplying both interest and term by 4.
Option d. was solved using quarterly interest and term, and not dividing the result by 4.
(LO 3–4)
- Jenny Milton recently purchased a condominium as an investment for $150,000. She assumes she will be able to sell the condo in eight years for $225,000. If her expectations are correct, what average annual interest rate will have been earned on the investment?
a. 5.2%
b. 6.0%
c. 50.0%
d. 65.5%
(LO 3–5)
- a.
Option b. was solved for term (instead of interest), using eight years as interest.
Option c. was solved for one year only.
Option d. was incorrectly solved, with $150,000 entered as a payment and $225,000 as present value.
(LO 3–5)
- Anne Smyth plans to purchase a house in six years. She wants to accumulate $30,000 for a down payment. If her investments have an average annual rate of return of 8%, how much should she deposit at the beginning of each of the next six years to reach her goal of $30,000?
a. $3,787
b. $4,089
c. $6,009
d. $6,489
- a.
Option b. is incorrect because it was calculated with payments at the end of each period.
Option c. is incorrect because it was solved with $30,000 entered as present value, not future value.
Option d. was incorrectly solved with $30,000 entered as present value, not future value, and with payments at the end of each period.
(LO 3–6)
- Arianna Tannu has just won the lottery. She will have to decide whether to receive periodic annual payments of $100,000 at the beginning of each year for 20 years, or a lump-sum payment. Arianna estimates that inflation will average 5% over the next 20 years and that she can earn a 6% compound annual after-tax return on her money. What lump sum does Arianna need to receive today to equal the $100,000 annual payments at the beginning of each year for 20 years?
a. $1,146,992
b. $1,215,812
c. $1,813,237
d. $1,830,506
(LO 3–7)
- b. This is a simple PVAD calculation. Inflation is irrelevant to this calculation, because the payments are level.
With the calculator in BEGIN mode, enter 6% (i), 20 (n) and 100,000 (pmt). Solve for present value.
Option a. was calculated in the END mode, and
c. and d. were in the END and BEGIN modes, respectively, using the inflation-adjusted interest rate.
(LO 3–7)
- John Roberts wants to purchase a restaurant. Stated in terms of today’s dollars, he will need an additional $750,000 in three years to have sufficient funds to finance this objective. John assumes that inflation will average 4% throughout this period and that he can earn a 7% compound annual after-tax return on investments. What serial payment should John invest at the end of each of the next three years to accomplish his goal? (Year 1, Year 2, Year 3)
a. $242,648; $252,354; $262,448
b. $242,925; $252,642; $262,748
c. $252,354; $262,448; $272,946
d. $252,642; $262,748; $273,258
(LO 3–8)
- d.
Option a. incorrectly used an initial 3% return, with no adjustment for the first year of inflation, then used 4% inflation to determine the next two year’s amounts.
Option b. used the correct inflation-adjusted rate of return, but with no additional adjustment for the first year of inflation.
Option c. was solved with an adjustment for the first year of inflation, but used a 3% return.
(LO
3–8)
- One of the steps in the risk management process is to “gather pertinent data to determine risk exposures.” Which one of the following statements regarding this step is correct?
a. The primary purpose of this step is to identify all risk exposures so that the proper insurance may be put in place.
b. Generally speaking, the only documents required in this step are insurance policies.
c. Some of the data gathered will be qualitative in nature. There may be no specific answers to some risk management questions, and a discussion with the client is necessary to determine his or her attitude toward risk.
d. A data survey form that is to be used when interviewing the client should cover all financial information in detail. Clients will be able to provide
this without referring to documentation.
e. One of the best times to tell a client what is wrong with his or her insurance policies is during this step in the process.
(LO 4–1)
- c. The client’s attitudes and desires will provide guidance as to the correct choices to be made.
Option a. is incorrect because insurance is only one method of handling risk. Identifying all potential areas of risk exposure ensures that appropriate risk management techniques will be used.
Option b. is incorrect because financial statements, wills, trusts, tax returns, and other related documents are all necessary to adequate data gathering.
Option d. is incorrect because most detailed financial information should be obtained from original documents; few individuals carry this type of information in their heads.
Option e. is incorrect because this is a data gathering stage. After evaluating the client’s data and existing methods of handling risk, the financial planner assists the client in developing a new, more appropriate risk management program. Identifying shortcomings of the client’s existing insurance coverage facilitates this process.
(LO 4–1)
- In trying to explain the risk management process to a new client, you told him that gathering pertinent data was a very important step. He asked why. Which one of the following is not a reason why gathering data is an
important step in the risk management process?
a. It may identify sources of risk exposure.
b. It may identify the extent to which risks have been managed so far.
c. It may identify assets and liabilities of the client.
d. It may determine the status of any wills or trusts.
e. It may analyze the retirement income shortage of the client.
(LO 4–1)
- e. Determining the client’s desired retirement income falls within the second step of the (overall) financial planning process—gathering client data, including goals—rather than being a part of the risk management process.
(LO 4–1)
- Your client, Yanni Vaisman, is concerned about his new camera being damaged. It is a great camera to use, but it will be a collector’s item in years to come. You suggest a number of options. Which one of the following options is correctly linked with the method of handling risk noted in parentheses?
a. Keep the camera in its case, locked in a safe deposit box (risk transfer).
b. When not using the camera to take photographs, keep it in its case and do not use it in high winds (risk avoidance).
c. When traveling, make sure that you or your wife is carrying the camera at all times (risk sharing).
d. Include the camera under a personal articles floater on your homeowners policy (risk retention).
e. Do not let anyone else handle the camera (risk reduction).
(LO 4–6)
- e. If Yanni is the only one to use the camera, the chances of it being damaged are significantly reduced.
Option a. is incorrect because this is risk avoidance—it would eliminate the possibility of damage.
Option b. is incorrect because this is risk reduction—it reduces the chance of damage.
Option c. is incorrect because risk sharing is when more than one person shares the risk of loss, as would be the case when a business is incorporated. In c., Yanni and his wife merely share the task of keeping track of the camera.
Option d. is incorrect because this is risk transfer—the floater covers the camera and puts the burden of loss of value by damage, loss, or theft on the insurance company.
(LO 4–6)
- David Smyth owns a radio tower maintenance firm. He is the employee most qualified to do the physical maintenance work on the towers, but he is also essential in the office because of his other knowledge and abilities. For that reason, he does not work on the towers. Because the company would find it difficult to pay the bills if David were disabled, it recently purchased business overhead insurance with David as the insured. What are two methods the company is using to handle risk?
a. risk avoidance and risk reduction
b. risk retention and risk reduction
c. risk avoidance and risk sharing
d. risk sharing and risk retention
e. risk avoidance and risk transfer
(LO 4–6)
- e. The elimination of tower work is risk avoidance, and the disability insurance is risk transfer. Risk reduction would involve doing things such as clipping on to a tether while working on a tower or wearing a helmet. Risk sharing, by definition, involves business structure, such as incorporation (financial risk exposure is limited to the amount of your investment in the corporation). No mention is made of a deductible, so risk retention is not a
factor.
(LO 4–6)
- Which of the following statements is NOT true concerning the impact of the Affordable Care Act?
a. Individuals can now sign up at any time and get coverage with no preexisting condition clauses.
b. COBRA only allows a company to charge 102% cost of the insurance to an employee.
c. Policies are easier to compare because they have been standardized into Bronze, Silver, Gold, Platinum, and Comprehensive.
d. All policies must have unlimited or a minimum of $5 million cap on total lifetime expenses.
(LO 7–2)
- d. Individuals cannot sign up at any time, but if they sign up within the time frame for qualifying events or during open enrollment, they can acquire coverage with no preexisting condition restrictions, which makes it easier to change employment.
Option b. is false because it relates to COBRA not the Affordable Care Act. Be sure to check if the statement is true as it relates to the topic. This is one of the consistent errors those sitting for the comprehensive exam make.
Option c. is incorrect because the last category should be catastrophic not comprehensive.
(LO 7–2)
- Which of the following is one of the rules of risk management?
a. Buy as much insurance as you can afford.
b. Insure only those items that may cause a catastrophic loss.
c. Insure all items where there is a certainty of loss.
d. Don’t risk more than you can afford to lose.
(LO 4–1)
- d.
Option a. is incorrect because it is possible to be overinsured. While you may be able to afford insurance on something, it isn’t necessarily reasonable to
purchase the insurance (e.g., damage insurance on a car worth only $400).
Option b. is incorrect because while it is wise to insure things that could result in a catastrophic loss, it is also wise to insure against certain noncatastrophic losses—e.g., by obtaining health insurance with only a $250 deductible. A $1,000 deductible would not be catastrophic, but the savings in premium may not justify the fourfold increase in potential out-of-pocket cost.
Option c. is incorrect because this is an improper application of the rule of risk management that states “consider the odds.” If it is virtually certain that a loss will occur, the insurance will cost the amount of the loss plus administrative costs; thus, it would not be very cost effective.
(LO 4–1)
- Many risk management statements seem correct at first glance, but upon further evaluation, they are seen to be incorrect. Of the following four options, which one is a real rule of risk management?
a. Purchase the insurance with the highest premium-to-loss ratio first.
b. Consider each loss that may result from separate perils instead of the overall loss.
c. Insure against large losses where the severity of the loss cannot be reduced.
d. Substitute insurance premiums for uncertain losses.
(LO 4–1)
- c.
Option a. is incorrect because the highest premium-to-loss ratios apply to losses that are certain to occur. This is not economical. The premium approaches the cost of the loss as the probability of the loss approaches
certainty.
Option b. is incorrect because the overall loss takes precedence over each specific loss.
Option d. is incorrect because it is a method, rather than a rule, of managing risk.
(LO 4–1)
- Which one of the following statements would be appropriate in explaining the underwriting process?
a. The underwriting process involves nothing more than accepting or rejecting an application for insurance.
b. Underwriting is the process of selecting and classifying risk exposures.
c. Underwriting is a formality and is generally an unimportant part of the insurance purchasing process.
d. The underwriting process attempts to eliminate all risks that might result in a loss.
e. Substandard risks are persons who are not insurable.
(LO 4–5)
- b. Selecting and classifying risk exposures is the specific purpose of underwriting.
Option a. is incorrect because the process does allow special rates for risks that are better or worse than average risks; it goes well beyond merely accepting or rejecting an application.
Option c. is incorrect because underwriting is a key function carried out by an insurance company.
Inadequate underwriting may lead to inadequate rates, thus leading the company into unacceptable losses.
Option d. is incorrect because the process of underwriting attempts to match actual losses with expected losses, to be supported by adequate premiums. If the process were to eliminate all
potential losses, no life insurance would ever be sold. The goal is to avoid having too many bad risks.
Option e. is incorrect because a person who is a substandard risk, as identified in the underwriting process, is generally insurable at premiums that are higher than standard. A person who is not insurable is classified as an uninsurable risk rather than as a substandard risk.
(LO 4–5)
- Which one of the following is not an element of an insurable risk?
a. There must be enough similar exposure units to make the losses reasonably predictable.
b. The loss must not be catastrophic.
c. Don’t risk a lot for a little.
d. The loss must be unexpected or due to an accident.
e. The loss must be clear and have a measurable dollar value.
(LO 4–4)
- c. This is a rule of risk management, not an element of an insurable risk.
(LO 4–4)
- Madeline Farwitte inherited a home with an old steam locomotive in its exceptionally large yard. She put up a fence and signs in an effort to keep people from climbing on it and getting injured. In spite of her efforts, one of the neighborhood children climbed the fence and was hurt while playing on the engine. Under which one of the following legal liability theories is Madeline likely to
be found responsible for the injury?
a. absolute liability
b. contributory negligence
c. negligence
d. negligence per se
e. vicarious liability
(LO 4–7)
- a. The train engine creates a dangerous condition. Proof of negligence is not required for Madeline to be held liable for any injuries incurred due to the presence of the engine on her property. The train also fits the definition of being an attractive nuisance (if this had been one of the options, it would have been a correct answer).
Option b. is incorrect because contributory negligence applies when attempting to determine if the person injured was partly at fault for the injury.
Option c. is incorrect because negligence is the failure to use reasonable care under the circumstances.
Option d. is incorrect because negligence per se applies when an individual causes a loss by violating a rule or regulation that was put in place to prevent the specific loss that was caused.
Option e. is incorrect because vicarious liability relates to one person being liable for the actions of another, such as a parent being liable for the actions of his or her children.
(LO 4–7)
- Which one of the following phrases describes an unintentional tort?
a. a libelous attack
b. an act of vengeance
c. a criminal act
d. a civil wrong
(LO 4–7)
- d. A tort is a civil wrong, over which the court may have jurisdiction (a noncriminal wrongdoing).
Options a. and b. are incorrect because a libelous attack and an act of vengeance would be intentional torts, and possibly criminal acts.
Option c. is incorrect because criminal acts are considered to be public wrongs and not torts (i.e., not civil).
(LO 4–7)
- Fred Stemple was backing his car down his driveway. In an effort to avoid his son’s bicycle, he ran into his neighbor’s fence. Which one of the following theories of liability would likely be used to make Fred pay for the
damage?
a. absolute liability
b. strict liability
c. negligence per se
d. professional liability
e. negligence
(LO 4–7)
- e. Fred would be liable for an unintentional tort known as negligence.
Option a. is incorrect because the doctrine of absolute liability applies where a condition exists that increases the potential for loss or harm to such an extent that even in the absence of negligence, the person creating the condition will be liable for any losses sustained.
Option b. is incorrect because strict liability generally applies to product liability cases.
Option c. is incorrect because the question does not identify that Fred’s actions violated a statute specifically designed to protect his neighbor’s fence.
Option d. is incorrect because even if Fred were a professional driver, he was backing his personal auto out of his own driveway; he was not acting in a professional capacity.
(LO 4–7)
- Bill approached Jim, his friend of 24 years, with a proposition. Bill offered to pay Jim $1,000 to slash the tires on the new car of his next door neighbor, in retaliation for the neighbor’s dog barking at him. Jim agreed to the offer. Which requirement is not in place to make this an enforceable contract?
a. competent parties
b. consideration
c. legal form
d. legal object
e. offer and acceptance
(LO 4–8)
- d. No contract that involves illegal activity is enforceable.
Option a. is incorrect because both parties are at least age 24 and can be presumed to be “competent.”
b. is incorrect because the $1,000 was the consideration for the performance of the slashing.
Option c. is incorrect because an oral contract is a legal form for some contracts.
Option e. is incorrect because Bill made an offer and Jim accepted.
(LO 4–8)
- Dyann Farmer entered into an insurance contract. Which one of the following is required to make it enforceable?
a. It must be in standard printed form.
b. The policy must contain any conditions and clauses agreed upon by the insured.
c. The premium must be reasonable for the promise made by the insurance company.
d. Dyann must have the right to negotiate any provision of the contract.
(LO 4–8)
- c. The premium and the promise are deemed to be adequate consideration for one another. Policies do not have to be in writing, nor does the insured have any right to negotiate the terms of the contract.
(LO 4–8)
- Your client has asked you to explain some of the terms she has heard that are characteristic of insurance contracts. Which one of the following terms is defined correctly?
a. Insurance is a personal contract because it must be owned by a person.
b. Insurance policies are unilateral contracts because only one of the parties may be required to uphold its obligations in a court of law.
c. Insurance policies are contracts of adhesion because the insurance company can attach any provisions it wants at any time.
d. Insurance policies are aleatory contracts since they only pay when a loss is suffered by the policy owner.
(LO 4–9)
- b.
Option a. is incorrect because personal contracts are limited in their transferability; they are not classified as personal simply because they are owned by a person (additionally, a corporation or trust can own a policy). An insured may generally not transfer a policy without the consent of the insurer.
Option c. is incorrect because contracts of adhesion are those written by the insurance company and offered to the policy applicant “as is.” The insured is rarely given the opportunity to negotiate the terms of the contract.
Option d. is incorrect because aleatory contracts are those that are governed by chance and where the exchange of dollars is unequal. The concept of a loss being covered only when monetary consequences are suffered by the owner of the policy is related to indemnity.
(LO 4–9)
- Which one of the following insurance policy provisions is defined correctly?
a. Subrogation is a provision that defines what perils come under the policy.
b. The misrepresentation provision allows the insurer to cancel the policy if it is found that the applicant lied in order to induce the company to issue the policy.
c. The concealment provision only protects the insurer if the applicant gives a false answer to a direct question.
d. The conditions section of a policy details the specific perils that are covered.
(LO 4–8)
- b.
Option a. is incorrect because the subrogation clause prevents the insured from collecting the same amount of reimbursement for a loss from both his or her insurance company and the negligent party.
Option c. is incorrect because concealment can occur if an applicant fails to disclose obviously relevant information, even if no direct question regarding that information is asked.
Option d. is incorrect because the conditions section of a policy describes the duties and rights of the insured and the insurer.
(LO 4–9)
- Carl and Jeri signed a contract for Jeri to provide certain consulting services for Carl’s business. Six months later, Jeri realized that Carl had intentionally failed to tell her about some significant conflicts that would arise if she carried out the terms of the contract. What concept, doctrine, or remedy is likely to be used to correct the problem?
a. doctrine of estoppel
b. doctrine of specific performance
c. remedy of rescission
d. remedy of reformation
e. waiver doctrine
(LO 4–10)
- c. There was misrepresentation in the negotiation of the contract.
Option a. is incorrect because the doctrine of waiver and estoppel applies when an insurer voluntarily gives up one or more of its rights upon issuance of a policy, and the applicant relies on statements made by the insurer or agent.
Option b. is incorrect because specific performance is a remedy where an individual uses the courts to force the other party to a contract to carry out his/her part of the agreement.
Option d. is incorrect because this remedy is used where the parties agree that the contract needs to be rewritten to reflect their understanding of the agreed-upon terms.
Option e. is incorrect because the waiver doctrine is used in the instance where, if the insurance company failed to exert its right to deny one claim, it may not later exert that right to deny a similar claim. (LO 4–10)
- Carmen and David Zener received eight place settings of their sterling silver flatware pattern as wedding presents. Since the silverware cost nearly $500 per place setting, they wanted to make sure it was adequately insured. The Zeners called their agent, Newcome Star, and asked what needed to be done to ensure that they had adequate insurance coverage. Newcome, an agent with Foremost Insurance Company, assured them that since they had less than 10 place settings, they were adequately insured. If the silverware is stolen, which one of the following legal remedies will
most likely be used to assure that the loss is covered?
a. doctrine of estoppel
b. waiver doctrine
c. last clear chance
d. rescission
e. reformation
(LO 4–9)
- a. The agent, representing the company, made a statement on which the Zeners relied. The insurance company cannot later state that the agent made a
mistake and deny the claim (the insurer would be estopped from denying the claim).
Option b. is incorrect because waiver is used in the instance where, if the insurance company failed to exert its right to deny one claim, it may not later exert that right with a similar claim.
Option c. is incorrect because last clear chance is a liability defense raised in a case where a person either attempted or failed to attempt to make one final effort to prevent someone from suffering a loss.
Option d. is incorrect because rescission is a remedy where a contract is nullified—as if it had never existed.
Option e. is incorrect because reformation is a remedy in which a contract is changed to meet the original agreement of the parties.
(LO 4–9)
- Which one of the following situations involving legal issues that affect financial planners has an outcome that is correct?
a. A financial planner who recommends a specific investment that later plummets in value may have to cover the client’s losses under the doctrine of absolute liability.
b. Gerald, a financial planner, has been making trades for his client’s account for six months. His client, David, has been aware of the trades, but does not understand the process very well, so he has said nothing about the activity. David’s silence provides express authority for Gerald to continue these trades.
c. In hurrying to get to an appointment with a client, Winston backed his car into another car. He gave the owner of the car the name and number of his professional liability carrier since he was on his way to a business appointment. This was an appropriate action.
d. Suzanne recommended that her client, Jeff, move money from XLS mutual fund to YRP mutual fund to obtain a better return. Even though Jeff clearly did not understand the risks involved in YRP mutual fund, he agreed to follow Suzanne’s recommendation. To protect herself, Suzanne had Jeff sign a statement that she would not be held responsible if YRP drops in value. This statement will probably not help her if Jeff loses money and sues.
e. Jack was not making as much money as he wanted. Therefore, he siphoned a little out of each of his clients’ accounts on a regular basis, correctly figuring that if he were ever caught, his professional liability
insurance would make them whole.
(LO 4–11)
- d. Disclaimers of this overly broad type rarely hold up in court. If Jeff were a sophisticated investor, if Suzanne’s recommendation were nothing more than pointing out different histories for the two investments, and if Jeff made the decision, then Suzanne might have had some protection.
Option a. is incorrect because a financial planner making bad recommendations may be guilty of negligence. The doctrine of absolute liability applies even where there is no fault or negligence, but a dangerous condition exists that by itself increases the chance of loss.
Option b. is incorrect because this is an instance of implied authority.
Option c. is incorrect because Winston’s auto policy may be required to cover this claim. No damage was done in the pursuit of his profession.
Option e. is incorrect because not even professional liability insurance will protect someone from his or her illegal actions.
(LO 4–11)
- Paula Best wanted the objectivity of an insurance broker, so she called Larry Stone. Larry was an agent with MRP Insurance Company and a broker with
six other companies. Paula had a 1965 Mustang in perfect condition with only 20,000 original miles. She showed Larry that the car had a market value
of over $10,000, based on written offers she had received for the car. Paula wanted the car covered for its full market value. Larry told her that if he just
added the car to her personal auto policy with MRP, she would be adequately protected. When the car was nearly demolished in a freak hailstorm while on
its trailer at an outdoor car show, she submitted a claim. Which one of the following describes what MRP will do?
a. MRP will pay the full market value because Larry Stone was an agent, and Paula relied on his statements that the coverage met her stated needs.
b. MRP will deny the claim because Larry is a broker and he made statements that were not true.
c. MRP will pay the full market value because the coverage was appropriate for the situation.
d. MRP will pay only the actual cash value of the car, because the auto policies clearly state that claims are paid on an actual cash value basis.
e. MRP will deny the claim because the car is clearly not used as a personal automobile and should have been insured as a collectible.
(LO 4–10)
- a. However, it is likely that Paula will have to get a lawyer involved since the basic automobile coverage would not pay this amount. The doctrine of estoppel applies in this case.
Option b. is incorrect because Larry is an agent with MRP and a broker with other companies, which is a common occurrence.
Option c. is incorrect because the coverage is not appropriate; a valued policy should have been written.
Option d. is incorrect because although this will be MRP’s first response, Paula should prevail based on the doctrine of estoppel.
Option e. is incorrect because MRP may attempt this argument too, but as long as Paula can prove that she told Larry what she wanted, MRP will be liable for the market value of the car.
(LO 4–10)
- Preston Wells called Joanna Barnes, an insurance broker, to obtain coverage on his 30-foot sailboat. Joanna told him to send in a binder premium of $75. She told him that by doing so, he would be covered and that he should go ahead and enjoy the boat. Joanna submitted an application for insurance to Boater’s Insurance Corp. for issuance of the policy. Boater’s instead declined the coverage. The day Joanna learned this, Preston called and told her a sudden wind had come up, causing him to lose control of his boat. He then smashed into another sailboat, causing substantial damage to both boats. Who will be responsible for the damages?
a. Boater’s Insurance Corp. will have to pay the damages since it did not notify Preston that he was not covered.
b. Preston will have to pay because no insurance policy is in force until the insurance company accepts the risk.
c. Boater’s will have to pay since Joanna collected a premium from Preston.
d. Technically, Joanna will have to pay because, as a broker, she personally bound coverage for Preston but was unable to place the coverage before the accident.
e. Joanna will not have to pay because she had transferred the risk to the
insurance company by submitting the application.
(LO 4–12)
- d. Boater’s Insurance Corp. was never a party to an insurance contract with Preston. Since Joanna is a broker, she retains the risk until she is able to place the insurance with a carrier. Submitting an application is not transferring the risk; it is merely a request for the company to accept the risk. As a practical matter (but not for exam purposes), most states effectively make a broker an agent for purposes of issuing an insurance policy. This means that, in Preston and Joanna’s case, Boater’s Insurance would have to pay, because in the process of placing the insurance, Joanna effectively was given the authority of an agent. (Remember though, this has no bearing on exam questions, which will test the fundamental principle rather than any variations.)
Option b. is incorrect because Joanna bound the coverage even though she was unable to place the risk before Preston’s accident.
(LO 4–12)
- Which one of the following statements is not one of the insured’s duties related to property insurance?
a. timely notice of loss
b. protection of property
c. assistance and cooperation
d. immediately repairing the property and submitting receipts for reimbursement
(LO 9–1)
- d. This is the correct answer.
Option a. (timely notice of loss) is a duty the insured owes the insurance company along with option b. (protection of property) and c. (assistance and cooperation). The insured does not have the right to repair the property prior to an adjustor’s examination, so this is the incorrect statement. (LO 9–1)
- Chuck purchased Chuck’s Garage, Bar & Grill five years ago for $120,000. After extensive repairs, the building’s current replacement value is $240,000.
Chuck originally insured the building for its original replacement cost of $120,000 and has not increased the coverage. His policy has an 80% coinsurance clause and a $1,000 deductible. Last week a fire in the kitchen caused $60,000 of damage.
How much will the insurance company pay Chuck for his loss?
a. $29,000
b. $36,500
c. $36,875
d. $59,000
e. $60,000
(LOs 9–1 and 9–2)
- b. This is the correct computation:
Payment = ((Amount of insurance owned/Amount of insurance required)*Loss) - Deductible
Amount of insurance required = $240,000 x .8 = $192,000
Payment = (($120,000 / $192,000)*$60,000) - $1,000
Payment = $36,500
- Karla Needles purchased a building to house her quilting supply business. The purchase price eight years ago was $75,000. After she upgraded the
building with improvements and changes were made in traffic patterns around the building, she was told she could sell the property for $250,000. Due to the value of the land, the replacement cost would be $160,000. Over the years, she has increased the property insurance to its current level of $130,000. Last week, a gas leak caused an explosion, which blew out an entire wall of the building. The cost to repair the building will be $57,000. Her policy has an 80% coinsurance clause and a $1,000 deductible. How much will her insurance company pay toward repair of the damage?
a. $28,640
b. $45,313
c. $56,000
d. $56,891
e. $57,000
(LOs 9–1 and 9–2)
- c. The building is insured for 81.25% of its replacement cost. Since the amount of insurance exceeds 80% of the replacement cost (.8 x $160,000 = $128,000), the company will pay the amount of the loss, less the deductible.
When adequate insurance is maintained, there is no coinsurance penalty. It is also good to remember that carrying more insurance than the minimum required (i.e., 80% in this case) will not result in more money than the actual claim being paid (e.g., based on having 81.25% coverage, which translates to 102% of the required 80% coverage, Karla would not receive $56,891).
(LO 9–10)
- Dana Walker owns a building that she purchased for $600,000. Its current replacement cost is $1.5 million. The building is covered for fire-related
perils by ZRP Insurance Company to $900,000, with an 80% coinsurance provision and a $2,000 straight deductible. Last week, a fire broke out in the building, causing $800,000 in covered damage. What amount will ZRP Insurance Company pay for this loss?
a. $478,000
b. $598,000
c. $598,500
d. $798,000
e. $800,000
(LOs 9–1, and 9–2)
- b. This is computed as follows:
(.75 x $800,000) – $2,000 = $598,000
Amount of insurance required = $1,500,000 x .8 = $1,200,000
Percentage of current insurance vs. insurance required = $900,000/$1,200,000 = .75
(LO 9–10)
- Which one of the following factors is the least important to consider when selecting an insurance agent?
a. Agent David Willis with Qualified Plan Associates has an impressive list of satisfied clients and wants to be considered as a source of insured pension plans for your clients.
b. Barbara Clarke, an insurance broker, has completed eight of the 10 Chartered Property and Casualty Underwriter courses.
c. You have heard from a number of your clients that Bill Ewe, CLU, always does what he promises, and usually a little more.
d. Mary B. Argento has consistently won awards for the greatest increase in sales in her agency.
e. Agent Sam Johnson’s home office has numerous experts available for phone consultation, and they periodically make field visits.
(LO 4–13)
- d. The ability to wins sales awards certainly helps the agent, but is of little, if any, value in determining whether to do business with that agent. In each of the other options the individual excels in service, knowledge, and/or experience. All of these are helpful in choosing an agent with whom to work.
(LO 4–13)
- Which of the following is a characteristic of term life insurance?
a. It provides benefits to a living insured when the policy term ends.
b. It has a flexible premium and an adjustable death benefit.
c. It covers the insured for a specified period of time.
d. It provides guaranteed, permanent coverage for the entire term of the life of the insured.
(LO 5–2)
- c. As the name implies, term life insurance covers the insured for a specified period of time or term.
Option a. describes an endowment,
Option b. describes UL, and
Option d. describes whole life (even though some term policies may be renewed for a very long time).
(LO 5–2)
- The grace period provision in a life insurance policy is a period during which
a. the policy remains in force following an insured’s failure to pay a premium.
b. an insurer may postpone payment of the cash surrender value requested by the insured.
c. the insured may reinstate a lapsed policy subject to meeting specified requirements.
d. the insurer may not deny a claim because of concealment by the insured.
(LO 5–3)
- a. The grace period allows the policy to remain in force following an insured’s failure to pay a premium. Option b. defines the delay clause, option c. defines the reinstatement provision, and option d. refers to the incontestability period.
(LO 5–3)
- Stan and Sarah Straus want to make sure they will have enough funds available to send their daughter Hannah to college. Hannah is 6 years old and will begin a four-year college program at age 18. The annual tuition today is $8,200. Stan and Sarah estimate that the annual inflation rate for college tuition will be 6% and that they can get an 8% after-tax return on their money. If Stan or Sarah were to die today, what would be the amount of insurance needed to provide for Hannah’s education?
a. $25,018
b. $26,210
c. $25,490
d. $64,189
(LOs 3–7 and 6–2)
- c. This is calculated by inflating the $8,200 at 6% for 12 years = $16,500.
Then calculate the PVAD (BEG) for four years using the inflated cost and the inflation-adjusted interest rate = $64,189. Finally, calculate the PV of that number discounted at the after-tax rate of return for 12 years = $25,490. The formula to determine the correct interest rate to use in the second step is: 1 + rate of return, divided by 1 + rate of inflation, minus 1, times 100 (1.08/1.06 – 1 × 100 = 1.8868).
Step 1: 12 N; 6 I/YR; 8,200 PV; FV=16,500
Step 2: 4 N, 1.8868 I/YR; 16,500 PMT; 0 FV; PVAD=64,189
Step 3: 12 N; 8 I/YR; 0 PMT; 64,189 FV; PV=25,490
Option a. was calculated in the end mode.
Option b. was calculated by multiplying $8,200 by four, inflating that amount for 12 years at 6% and discounting the result at 8%. This is similar to an alternate method of calculating the college expense by inflating the total cost to the year of graduation and then discounting.
Option d. is the PVAD calculated for option b. without discounting it back 12 years at 8%.
(LOs 3–7 and 6–2)
