General Insurance Principals

Question 1

Which statement is correct about insurance regulation?

1. The federal government alone regulates the insurance industry.
2. The federal government primarily regulates the insurance industry, and state governments regulate some aspects of it.
3. State governments alone regulate the insurance industry.
4. State governments primarily regulate the insurance industry, and the federal government regulates some aspects of it.

Answer 1

4. State governments primarily regulate the insurance industry, and the federal government regulates some aspects of it.

Though some aspects are regulated at the federal level, insurance is primarily regulated at the state level. Every state maintains an agency called the department of insurance (sometimes called a division of insurance) for this purpose.

Question 2

Which of the following presents a situation of pure risk?

1. Knowing that his family depends on his income, Franklin wants to insure his life.
2. Wanting to increase his retirement savings, Saul invests his life savings in the stock market.
3. Ralph takes a second mortgage on his house and uses the proceeds to gamble.
4. Wanting better job security, Ron cashes in his life insurance policy to start a business

Answer 2

1. Knowing that his family depends on his income, Franklin wants to insure his life.

Only pure risk is insurable. Pure risk may result only in a loss, unlike speculative risk, which may result in loss or gain.

Question 3

An insurer sends a premium statement to a former policyowner. However, the policy has lapsed for non-payment of premiums. Believing that the policy is still in effect, the policyowner pays the premium, which the insurer accepts. The insured then suffers a loss and makes a claim on the policy. What legal doctrine prevents the insurer from denying the claim?

1. twisting
2. discrimination
3. materiality
4. estoppel

Answer 3

4. estoppel

Estoppel compels a party to relinquish a right it had no intention to relinquish when through its words, actions, or inactions, another party was reasonably led to act in a manner such that to allow the first party to enforce its right would be unfair to the relying party.

Question 4

Which type of insurance company pays dividends to its stockholders?

1. stock company
2. mutual company
3. fraternal benefit society
4. reciprocal insurer

Answer 4

1. stock company

Stock insurance companies are owned by stockholders, just like many other major public companies. They pay dividends, when declared, to their stockholders.

Question 5

Emily postpones buying a life insurance policy, believing that her family will use its savings to pay her final expenses if she dies prematurely. Which method is she using to deal with risk?

1. retention
2. avoidance
3. reduction
4. transfer

Answer 5

1. retention

Rather than taking measures to reduce the risk to her family, such as buying life insurance, Emily has chosen to accept the exposure to the risk. This method of handling risk is known as risk retention.

Question 6

Jeremy has had an individual health insurance policy for many years because of his family’s history of cancer. The tendency of someone like Jeremy to buy and maintain insurance is known as:

1. implied selection
2. adverse selection
3. exposure reduction
4. risk avoidance

Answer 6

2. adverse selection

Adverse selection is the tendency of persons more likely to have a claim to buy and keep insurance. For example, individuals with a family history of cancer may be more likely to buy health insurance and to keep it in force than individuals without such family history.

Question 7

Adam is an independent agent and solicits policies for several insurers. What kind of relationship does he have with each insurer?

1. fiduciary
2. dependent
3. presumptive
4. consultant

Answer 7

1. fiduciary

Adam has a fiduciary relationship with every insurer with whom he does business. This means that he must avoid conflicts of interest and must act in good faith and with integrity in his dealings with various insurance companies. Even brokers have a contractual relationship with the companies they use.

Question 8

When an insurance company appoints an agent to represent it, who are the parties to the agency relationship?

1. insurer and insured
2. principal and agent
3. producer and agent
4. principal and participant

Answer 8

2. principal and agent

A principal is the party on whose behalf the agent acts. An agent is the party who acts on behalf of another, the principal.

Question 9

When classifying insurance risks, insurance underwriters most often use the:

1. numerical rating system
2. judgment method
3. adverse selection system
4. risk assessment scale

Answer 9

1. numerical rating system

Under the numerical rating system, credits are added for favorable risk factors. Debits are subtracted for adverse or unfavorable factors. This system has largely replaced the judgment method.

Question 10

Which entity does not rate the solvency of insurance companies?

1. A-M Best
2. Duff and Phelps
3. Lloyd’s of London
4. Standard and Poor

Answer 10

3. Lloyd’s of London

A-M Best, Duff and Phelps, and Standard and Poor’s are all rating agencies. Lloyd’s of London is an association of individuals and companies that underwrite insurance on their own accounts.

Question 11

An agent who sells insurance for an insurance company that does not have a certificate of authority to operate in the state represents:

1. an alien insurer
2. a non-admitted insurer
3. an unregistered insurer
4. a limited lines insurer

Answer 11

2. a non-admitted insurer

A company not holding a certificate of authority in the state in which it does business is a non-admitted insurer in that state.

Question 12

Life and health insurance companies regulate themselves through each of the following entities or organizations EXCEPT:

1. National Association of Life Underwriters
2. American Society of Chartered Life Underwriters
3. International Association of Health Underwriters
4. Financial Industry Regulatory Authority

Answer 12

4. Financial Industry Regulatory Authority

The Financial Industry Regulatory Authority (FINRA), formerly known as the National Association of Securities Dealers (NASD), regulates agents who sell variable life products. It does not apply to most life insurance products.

Question 13

An insurable risk is not:

1. ascertainable
2. catastrophic
3. uncertain
4. an economic hardship

Answer 13

2. catastrophic

A catastrophic loss is not the determining factor. The potential loss must be ascertainable for the risk to be insurable.

Question 14

An insurance policy provides financial protection against:

1. hazards
2. risks
3. losses caused by perils
4. losses caused by hazards

Answer 14

3. losses caused by perils

Hazards are dangers, such as slippery floors or unhealthy habits. Hazards lead to or cause perils, which in turn cause loss. Exposure refers to the state of being subject to a possible loss.

Question 15

Which is not necessary to create a legal contract?

1. consideration
2. offer
3. acceptance
4. warranty

Answer 15

4. warranty

Warranties, or statements guaranteed by an applicant to be true, may be part of an insurance application underlying the insurance contract. However, an applicant’s statements on a contract are generally considered to be representations and not warranties.

Question 16

Johnson Industries funds its workers’ compensation program. It will use these funds to pay employee’s claims. What type of insurer is Johnson Industries?

1. reciprocal insurer
2. risk retention group
3. self-insurer
4. mutual insurer

Answer 16

3. self-insurer

Johnson Industries is a self-insurer because it retains certain risks and pays its employees’ workers’ compensation claims.

Question 17

A person who smokes heavily and drinks alcohol to excess exhibits what kind of an insurance risk?

1. physical hazard
2. legal hazard
3. moral hazard
4. planned hazard

Answer 17

3. moral hazard

Physical hazards are risks that arise from a person’s health or conditions. Moral hazards arise from a person’s traits, habits, or characteristics that increase the chance of a loss.

Question 18

Why would a business self-insure instead of buying an insurance policy?

1. to avoid having to comply with state insurance laws
2. to cover against an occasional high-severity loss
3. to insure against frequent low-severity losses
4. to reduce its tax liabilities

Answer 18

3. to insure against frequent low-severity losses

A large company that is willing and financially able to assume certain risks can self-insure by creating a reserve fund and using that money to pay claims. This type of system is used for frequently occurring claims such as workers’ compensation or pension plans.

Question 19

Which is not a necessary element of a legally enforceable contract?

1. offer
2. acceptance
3. exchange of consideration
4. beneficiary

Answer 19

4. beneficiary

For a contract to be legally enforceable, its basic elements must include offer and acceptance and exchange of consideration. A named beneficiary is not essential.