Chapter 1

Question 1

Rider

Answer 1

A form Changing the provisions and attached to a policy (also known as an endorsement).

Question 2

Risk Management

Answer 2

The process of analyzing exposures that create risk and designing programs to minimize the possibility of a loss.

Question 3

Insurable Events

Answer 3

Any event, whether past or present, which may cause loss or damage to a person having an insurable interest or create a liability against him/her.

Question 4

Risk

Answer 4

A condition in which a chance of loss exists. The two types of risk are

a) Speculative - chance of gain or loss
b) Pure Risk - only the chance of loss and no chance of gain.

Question 5

Loss Exposure

Answer 5

The extent to which one may be affected by a peril

Question 6

Peril

Answer 6

The cause of a possible loss.

Question 7

Hazard

Answer 7

A specific situation that increases the probability of a loss arising from a peril or that may influence the extent of the loss. There are 3 types of hazards.

1) Physical
2) Moral - Dishonesty - giving false information on an application.
3) Morale - indifference - driving without seat belts, smoking, driving too fast.

Question 8

Methods of Handling Risk

Answer 8

RRATS
Risk Reduction - Reducing but not preventing
Risk Retention - self insurance - retaining responsibility for the loss.
Avoidance - not being involved in the activity
Transfer - to another company
Sharing - pooling the risk of a large number of persons.

Question 9

Requisites of an Ideally Insurable Risk

Answer 9

large number of homogenous units to make losses reasonably predictable.
Loss must be calculable
Loss must be accidental
Cause Financial Hardship
Exclude catastrophic perils such as war, nuclear hazard and illegal operations.

Question 10

Principle of Indemnity

Answer 10

The insured is restored to the same financial condition as prior to the loss. The insured should not profit from or lose from an insurance transaction.

Question 11

Law of Large Numbers

Answer 11

A principle stating that the larger the number of exposures considered, the more closely the losses reported will equal the probability of loss. The probability of loss is more predictable, thus a loss ratio is more readily available.

Question 12

Reinsurance

Answer 12

Primary Insurer who originates the application (ceding company) and the company or companies who share in the risk (reinsurance insurers).

a) Automatic - Ceding company transfers the amount of insurance in excess of retention level.
b) Facultative - Negotiation between ceding and reinsurance company.

Question 13

Adverse Selection

Answer 13

The insuring of risks that are more prone to losses than the average (standard risk). These risks tend to seek or continue insurance at a higher participation than does an average (standard) or above average (preferred) risk.

Question 14

Hold Harmless Agreement

Answer 14

Contractual agreement removing the liability of one party from a second party. Used mostly in group health replacements and could be considered a measure of risk avoidance.

Question 15

Insurable Interest

Answer 15

On one’s own life is usually unlimited.
Possibility of an economic loss due to sickness or death. In life insurance, insurable interest must exist at the time of application, but not necessarily at time of loss.

Question 16

Buy-Sell Agreement

Answer 16

An agreement among owners of a firm that provides the continuation of a business upon the premature death of an owner.

Question 17

Cash Value

Answer 17

Money accumulated in a permanent policy which the policyowner may borrow as a policy loan or receive if the policy is surrendered before maturity. Surrender charges may be assessed at policy surrender. Upon maturity or endowment that cash value is paid to the policy-owners.

Question 18

Non-participating Policies

Answer 18

Do not pay dividends

Question 19

Personal Uses of Life Insurance

Answer 19

VESCEL
Viatical Settlements - life insurance policies purchased from a terminally ill insured.
Estate Creation - dependents and beneficiaries
Survivor Protection - dependents
Cash Accumulation - accessible to owner
Estate Conservation
Liquidity - upon death to pay creditors, taxes, and final expenses.

Question 20

Determining Amount of Personal Life Insurance Needed

Answer 20

Human Life Approach - actual future earnings

Needs Analysis Approach - Immediate Death

Question 21

Human Life Approach

Answer 21

Individual's After Tax earnings
Individual's annual expenses
Value of personal assets
Number of years remaining at work
Ages of all family members to determine dependency period
time value of money
Present salary of all wage earners.

Question 22

Needs Analysis Approach

Answer 22

Coverage needed upon premature death.
All financial needs caused by immediate death.
Subtract assets available
Determine age of dependents.
Regardless of age, some needs are permanent, such as retirement, disability funds, and funeral expenses while some are disappearing such as mortgage and education.

Question 23

Income Objective

Answer 23

Capital Liquidation - assumes both principal and interest are liquidated over the relevant time to provide income for the dependents.
Capital Retention/Conservation - assumes the desired income will be generated by the investment earnings only, thus retaining or conserving the principal or capital invested.

Question 24

Buy-Sell Agreement

Answer 24

Contractually establishes a price with the intent to purchase, at a predetermined value, the assets of a business should one of the contract participants predecease other participants. Sole Proprietorship, Partnership, or closed corporation stockholders.
Cross Purchase
Entity Plan

Question 25

Key Person

Answer 25

Life insurance purchased to offset the expense and financial losses due to the death of a valued employee. This policy will provide funds for decreased cash flow, recruiting costs, cost of training and cost of replacing key employee. If owner is beneficiary, premiums are not considered business expense by the IRS.

Question 26

Deferred Compensation

Answer 26

This is an incentive plan in which an employer promises to pay key employees certain amounts of money at a specified future date.
Income deferred
If employee dies, life pays employer to pay heirs.
If employee lives, used to pay compensation. Surrendered.

Question 27

Supplemental Executive Retirement Plan - SERP

Answer 27

A non-qualified deferred compensation that allows employers to provide additional retirement income to key, highly compensated employees.

Question 28

Split Dollar Plans

Answer 28

Not Tax Qualified
Upon an employee’s termination of employment the policy may be purchased from the employer at an agreed price.
Insures the employee’s life with premium payments split between an employee and the employer.
If death occurs while this employer, employer receives death benefit equal to cash value or premiums paid. Balance is paid to employee’s beneficiary.
A certain time should elapse.

Question 29

Executive Bonus Plans

Answer 29

Arrangements under a Corporate Cross Purchase Buy-Sell Agreement where the corporation bonuses the premium to each shareholder to cover the cost of the policies they own on the other shareholder’s lives.
Each shareholder reports the premium he/she is bonused as additional compensation that presumably is deductible by the corporation.
Premiums are treated as compensation, not dividends.
Forbids, surrenders, withdrawals or other actions unless endorsed by the corporation.

Question 30

Minimum Deposit Plans

Answer 30

This is a process where the policy loans are used to pay the premiums on cash value life insurance policies under a systematic plan of borrowing.
Loans are to be for the amount of each premium and no more.
Interest to be paid in cash in order to receive a deduction.

Question 31

Third Party Ownership

Answer 31

Parent owns a policy on an under age child.
Buy-Sell Agreement
Key Person

Question 32

Classes of Life Insurance Policies

Answer 32

Group
Individual
Ordinary Life
Industrial (Home Service)
Permanent
Term
Participating/Non-participating
Fixed/Flexible/Variable

Question 33

Group

Answer 33

Provides protection for an employee’s named beneficiary or creditor. The coverage may be changed only within the confines of the Master Policy. The coverage is normally written in a renewable term basis, providing no cash value or living benefits as found in individual policies.

Question 34

Individual

Answer 34

Cash Value, may generate income in the form of an annuity. Individual life policies may build or preserve an estate or provide a living benefit for the terminally ill.

Question 35

Ordinary Life Insurance

Answer 35

Any type of life insurance that is not group, industrial or government insurance. A large number of people are insured with an ordinary life.

Question 36

Industrial Home Service

Answer 36

Small policies normally $250-$1,000 were originally sold to pay funeral expenses.
Monthly Debit Ordinary Policy (MDO). Used today with values of $5,000 to $25,000. Also called debit agent.

Question 37

Permanent

Answer 37

A durable policy that remains level in amount and premium. Doesn’t require renewability and normally provides protection to age 100 or until the policy is surrendered or cancelled. Premiums are always higher than those of Term. It has cash value and death benefit.

Question 38

Term

Answer 38

lowest of premium outlay, and designed for someone with large insurance needs but small cash flow. Temporary, no cash value and it is level or decreasing. Used to meet short term obligations or mortgages.

Question 39

Participating

Answer 39

Pays non-taxable returns of premium to mutual owners.

Question 40

Nonparticipating

Answer 40

Stockholders with all future values guaranteed.

Question 41

Fixed

Answer 41

The policy has a fixed amount of coverage, benefits, and premium. Without riders, future inflationary trends and money values will depreciate the policy’s effectiveness.

Question 42

Flexible

Answer 42

Universal & Variable Universal Life, gives more flexibility in terms of premiums, investment objectives, and other policy benefits. Protection against inflation.

Question 43

Variable

Answer 43

Uses separate accounts for the cash value accumulation. These are normally mutual funds.