Chapter 1

Question 1

With regard to insurance, risk can be defined as:
A) uncertainty regarding financial gain.
B) certainty regarding financial gain.
C) uncertainty regarding loss.
D) certainty regarding loss.

Answer 1

Answer: C
Risk refers to the uncertainty of financial loss. Insurance replaces the uncertainty of risk with certain guarantees of financial stability.

Question 2

A condition or situation that presents a possibility of loss is a (an):
A) law of large numbers.
B) named certainty.
C) exposure.
D) proximate cause.

Answer 2

Answer: C
A condition or situation that presents a possibility of loss is an exposure. Insurance policies are designed to cover loss, either a direct loss or an indirect loss.

Question 3

How is uncertainty regarding loss best described?
A) Peril.
B) Risk.
C) Insurance.
D) Hazard.

Answer 3

Answer: B
In the strict insurance definition, risk is the uncertainty regarding financial loss. Insurance is used to minimize the risk of uncertainty by spreading the risk over a large enough number of similar exposures to predict the individual chance of loss.

Question 4

A chance, possibility, or uncertainty of loss is known as a:
A) risk.
B) hazard.
C) peril.
D) proximate cause.

Answer 4

Answer: A
Risk is the uncertainty regarding the occurrence of financial loss. A peril is the actual cause of a loss and is specifically identified in the policy. A hazard is a situation or condition that may increase the possibility of a loss occurring. Proximate cause is the action that produces a loss through an unbroken chain of events.

Question 5

Self-insurance is an example of what kind of risk treatment?
A) Avoidance.
B) Reduction.
C) Transference.
D) Retention.

Answer 5

Answer: D
Self-insurance is a form of risk retention because the individual personally retains the risk and must accept the economic loss if the risk becomes a reality.

Question 6

Treating risk by purchasing insurance is an example of what type of risk management?
A) Avoidance.
B) Reduction.
C) Retention.
D) Transfer.

Answer 6

Answer: D
Purchasing insurance is the most common method of transferring risk. The burden of carrying the risk and indemnifying the financial or economic loss is transferred from the individual to the insurance company through the insurance contract.

Question 7

Robert and Carolyn live in a busy city and decide that not owning a car is the solution to not experience having a car stolen. Which of the following methods describes this philosophy?
A) Retention.
B) Transfer.
C) Loss control.
D) Avoidance.

Answer 7

Answer: D
An individual may avoid the risk of a loss by not engaging in an activity or owning property. By not owning a car, Robert and Carolyn will not risk having it stolen.

Question 8

Transferring is a method of handling risk. Which of the following best describes the concept of transfer?
A) Purchasing insurance.
B) Increasing a deductible to share the loss with the insurance company.
C) Signing a hold harmless agreement to share the liability.
D) Buying a car with a friend to share the risk.

Answer 8

Answer: A

Transfer means shifting the risk of a loss to another, usually an insurance company.

Question 9

Which of the following is an example of reduction as a method of handling risk?
A) Buying insurance to reduce the risk.
B) Installing a burglar alarm.
C) Increasing a deductible.
D) Reducing coverage.

Answer 9

Answer: B

Reduction may be accomplished through loss prevention and loss control. A burglar alarm will control or reduce the loss.

Question 10

The purpose of insurance is to:
A) eliminate hazards.
B) reduce adverse selection.
C) transfer risk.
D) eliminate risk.

Answer 10

Answer: C
The purpose of insurance is to protect against losses caused by pure risk. This is accomplished through the insurance contract, which requires one party to pay a specified sum to another if a previously identified event occurs. For the cost of a premium, a person or entity can purchase protection offered by the insurance contract and transfer risk to the insurer.

Question 11

The law of large numbers states that the:
A) smaller the number of risks combined into one group, the less uncertainty there will be as to the amount of loss that will be incurred.
B) smaller the number of risks combined into one group, the larger the loss will be to any one individual in that group.
C) larger the number of risks combined into one group, the smaller the loss will be to any one individual in that group.
D) larger the number of risks combined into one group, the less uncertainty there will be as to the amount of loss that will be incurred.

Answer 11

Answer: D
The law of large numbers operates under the principle that the larger the number of similar risks combined into one group, the less uncertainty there will be as to the amount of loss that group will incur. Thus, an insurance company is able to determine in advance the approximate number of claims it will receive in a given time period for a given risk and place its business on a nonspeculative basis.

Question 12

Which of the following is NOT a source of information important to an underwriter?
A) Agent or producer comments.
B) Consumer reports.
C) Motor vehicle reports.
D) Employer reference.

Answer 12

Answer: D

The four primary sources of information include the agent or producer, consumer reports, government records, and financial rating services.

Question 13

The risk that involves the chance of both loss and gain is:
A) speculative risk.
B) pure risk.
C) impure risk.
D) whole risk.

Answer 13

Answer: A

Speculative risk involves the chance of both loss and gain. For example, the placement of a bet at a racetrack is a speculative risk.

Question 14

Which one of the following statements pertaining to risk is NOT correct?
A) Only pure risks are insurable.
B) A stock market venture is an example of a pure risk.
C) Pure risk involves only the chance of loss; there is never a possibility of gain or profit.
D) Uncertainty regarding financial loss is the definition of risk; therefore, it is characteristic of both pure and speculative risks.

Answer 14

Answer: B
A stock market venture involves the chance of both gain and loss and is, therefore, a speculative risk. Pure risk involves only the chance of loss.

Question 15

Which one of the following risks is insurable?
A) Partial.
B) Pure.
C) Speculative.
D) Whole.

Answer 15

Answer: B

Only pure risks are insurable because they involve the chance of loss only.

Question 16

Which of the following is NOT an example of an insurable interest?
A) Person’s interest in the home she owns.
B) Dry cleaner’s interest in his customers’ clothing in his custody, care, or control.
C) Person’s interest in property she hopes that her uncle will leave to her in his will.
D) Person’s interest in the improvements he has added to his leased apartment.

Answer 16

Answer: C

A person does not have an insurable interest in property that he neither possesses nor owns.

Question 17

If John’s father transfers ownership of a house to John, which one of the following statements regarding insurance on the house is CORRECT?
A) John must purchase the house from his father to obtain an insurable interest in it.
B) John’s father must retain his policy on the house.
C) John’s father must assign his policy to John as well.
D) John can buy insurance because he has an insurable interest.

Answer 17

Answer: D
A person has an insurable interest in property when the loss of or damage to the property will result in financial loss to the person. Because John’s father has transferred ownership of the house to John, he now owns and controls the property. Any loss or damage to the house will result in a financial loss to John. Therefore, John has an insurable interest in the house and should obtain insurance on the house in his name. Some companies will consider approving an assignment of an insurance policy from the old owner to the new owner, but this is not a universal practice.

Question 18

Which of the following is NOT an element of an insurable risk?
A) The loss must be catastrophic.
B) The loss must be due to chance.
C) The loss must be accidental from the insured’s perspective.
D) The loss must have a determinable value.

Answer 18

Answer: A
One of the criteria for an insurable risk is that it is not catastrophic. A principle of insurance holds that only a small portion of a given group will experience loss at any one time. Risks that would adversely affect large numbers of people or large amounts of property, such as wars, are typically not insurable.

Question 19

What is the actual cause of a loss?
A) Peril.
B) Hazard.
C) Proximate cause.
D) Risk.

Answer 19

Answer: A
The actual cause of a loss is called a peril and is identified or referred to in the insurance policy. Perils include such events as fire, wind, hail, and collision with another car. A named peril policy provides coverage only if a loss is caused by one of the perils specifically named or identified in the policy. An open perils policy provides coverage for all and any risks, unless specifically excluded.

Question 20

Which one of the following is an example of a peril?
A) Earthquake.
B) Gasoline stored on the premises.
C) Indifference.
D) Illness.

Answer 20

Answer: A

A peril is the actual cause of a loss. Examples of perils are fire, wind, hail, collision, and earthquake.

Question 21

Fire would be an example of a:
A) loss.
B) risk.
C) peril.
D) hazard.

Answer 21

Answer: C
Perils include events such as fire, wind, hail, or collision with another car. A hazard is a situation or condition that increases the possibility of a loss occurring . Hazards may be classified as physical (a material, structural, or operational feature), moral (dishonest or character defects), or morale (relating to the attitude of the insured). Risk is the uncertainty regarding the occurrence of financial loss.

Question 22

Faulty wiring causes a fire that destroys a building. The faulty wiring is considered to be a(n):
A) hazard.
B) peril.
C) indirect cause.
D) proximate cause.

Answer 22

Answer: A
A hazard is a situation or factor that increases the possibility of a loss occurring or increases the probable size of a loss.

Question 23

Which one of the following is considered a hazard?
A) Trash.
B) Lightning.
C) Fire.
D) Explosion.

Answer 23

Answer: A

A hazard is a situation or factor that increases the possibility of a loss.

Question 24

Which one of the following best defines a hazard?
A) Cause of a loss.
B) Unexpected loss.
C) Condition that increases the chance of a loss.
D) Uncertainty of a loss.

Answer 24

Answer: C

A hazard is a condition that increases the chance of a loss.

Question 25

Dishonesty on the part of an insured is an example of:
A) a morale hazard.
B) a moral hazard.
C) a peril.
D) a physical hazard.

Answer 25

Answer: B
A peril is the specific event that causes a loss. A hazard is any factor that increases the chance of loss. A moral hazard involves dishonesty on the part of the insured (e.g., planning arson to collect the insurance claim). A morale hazard involves carelessness or indifference, such as not using a seatbelt or not locking one’s door.

Question 26

Which one of the following hazards can be described as a careless attitude or general indifference on the part of the insured toward the occurrence of loss?
A) Moral.
B) Legal.
C) Morale.
D) Physical.

Answer 26

Answer: C
A hazard is a situation or factor that increases the possibility of a loss occurring. A morale hazard is a careless attitude or general indifference on the part of the insured toward the occurrence of loss.

Question 27

Driving too fast and not wearing a seat belt are examples of:
A) morale hazard.
B) physical hazard.
C) risk.
D) moral hazard.

Answer 27

Answer: A
Hazards may be classified as physical (a material, structural, or operational feature), moral (dishonest or character defects), or morale (relating to the attitude of the insured). Driving too fast and not wearing a seat belt indicate a thoughtless, careless, or arrogant attitude on the part of the driver. Risk is the uncertainty regarding the occurrence of financial loss.