Module 1 Flashcards
Principles of Insurance
What does risk represent?
The possibility of a loss—or a negative deviation from a desired outcome.
What is a peril?
The cause of loss.
What is a hazard?
A hazard increases the potential for loss.
One type of risk is a possible loss to your house. Here, the perils might include hurricane, tornado, flood, or fire. Assume a loss occurs due to the peril of fire in which your home is significantly damaged. A related ? might be the oily shop rags piled in the corner of the garage next to the space heater. This hazard increases the potential of a fire occurring.
hazard.
What are static risks?
Risks that are relatively constant over time and do not change based on external factors or actions. These risks are typically predictable, often related to the nature of the activity, environment, or system involved. Static risks are generally considered part of the inherent nature of certain activities or conditions.
**typically result from factors other than changes in the economy and can be insured.
What are dynamic risks?
Risks that arise from changes in circumstances, environments, or activities. These risks are variable and influenced by evolving conditions such as economic, social, technological, or organizational changes. Unlike static risks, dynamic risks are often unpredictable and require continuous monitoring and adaptation to manage effectively.
**Insurance does not typically cover dynamic risks.
What are fundamental risks?
Risks that affect large groups of people or entire communities, societies, or economies. These risks are typically beyond the control of any one individual or organization and arise from widespread social, economic, natural, or political conditions. Because they are broad in scope and impact, they often require collective or governmental intervention for mitigation and management.
What are particular risks?
Risks that affect specific individuals, organizations, or localized areas rather than entire communities or societies. These risks are often the result of specific circumstances or actions and are more controllable at the individual or organizational level.
What are pure risks?
Involves only the chance of loss or no loss; in other words, there is no chance of gain. The possibility that a person’s home will burn represents a pure risk because there is no chance of gain but only the chance of loss or no loss. Pure risks are insurable.
What are speculative risks?
Involves both the chance of loss and the chance of gain. Gambling is a classic example of speculative risk because it presents both the chance of loss and the chance of gain. Speculative risks are not insurable.
How many steps are in the risk management process?
7
What two methods of handling risk are grouped under Risk Control?
Avoidance & Reduction
What two methods of handling risk are grouped under Risk Financing?
Retention & Transfer
What is risk control?
A risk management technique that seeks to minimize the risk of loss.
What is risk financing?
A risk management technique that pays the costs of losses incurred.
Avoiding owning an aggressive dog, installing security systems, fencing off pools with locks, maintaining clear walkways, and hiring a driver at night for seniors are all risk ?/? techniques.
avoidance/reduction.
What are the advantages of risk avoidance and reduction?
Savings in premiums and potential liability claims.
What are the disadvantages of risk avoidance and reduction?
It is not always possible to avoid a risk and sometimes the lifestyle choices a client would have to make, such as not driving, create an unattractive or challenging alternative.
What is self-insurance?
A method of risk retention.
Large businesses use risk retention and financial planners typically rely upon a specialist to make sure that the business risks are covered for their clients who are business owners.
Self-insurance is a method of risk retention that has several requirements:
The organization should have enough homogeneous exposure units to make losses somewhat predictable.
Adequate funds must be accumulated to cover plan losses.
The self-insurer must be able to administer the insurance functions, such as analysis of potential claims, disbursement of payments to providers, and objective determination of claim validity, as efficiently as an insurance company would.
The self-insurer must be able to competently manage investment of the self-insurance fund.
In order to transfer risk, there must be ?
a party willing to accept the risk in return for a payment.
When an insurance company considers providing coverage for a given type of risk exposure, it gathers as much information on the risk exposure as it can so it is able to:
determine if the exposure meets the requirements of an insurable risk,
decide whether it is practical for the insurer to provide insurance against this particular risk, and
establish how the insurance should be priced.
What is an insurable risk?
A situation or condition that meets certain criteria, making it possible for an insurance company to provide coverage. These criteria ensure that the risk can be evaluated, priced, and managed effectively.
Risk analysis and pricing are done by actuaries who use several factors to determine what the company must charge for coverage (i.e., the premium amount). Anticipated losses are one of the most important pricing factors. Two critical assumptions are used in evaluating these loss statistics:
The elements of an insurable risk have been met and adverse selection can be controlled.
Clearly identifying the elements of an insurable risk and determining whether they are present is a crucial part of the underwriting process, which is considered from the perspective of the insurance company. That is, the insurer is trying to determine which risks it will or will not insure. The elements of an insurable risk include the following:
There must be a sufficiently large number of homogeneous exposure units to make losses reasonably predictable (i.e., the law of large numbers).
The loss resulting from the risk must be definite and measurable.
The loss must be fortuitous or accidental.
The loss must not be catastrophic to the company.
What is the law of large numbers?
A fundamental principle in probability and statistics that states:
As the size of a sample increases, the average of the results obtained from the sample is more likely to converge to the true average (expected value) of the entire population.
In simpler terms, the larger the group or dataset being analyzed, the closer the observed outcomes will align with the expected outcomes over time.
What is the reason for dollar limits on policies?
If the potential loss cannot be measured, the insurance company cannot know how much is needed to pay claims. That is the reason for dollar limits on policies. For a risk to be insurable, losses must be fortuitous (i.e., accidental), with the exception of life insurance. A planned loss generally involves a criminal act (e.g., arson).
The requirement that a loss not be catastrophic tends to cause some confusion. For clarity, remember that insurable risk requirements are stated from the perspective of the ?
insurance company.
What are the seven factors that insurance companies use to limit an insurer’s liability covering losses?
- Insurable interest.
- Actual cash value of the loss.
- Policy limits or face value.
- Other insurance.
- Coinsurance.
- Deductibles.
- Subrogation.
What is an insurable interest?
Simply stated, insurable interest exists when the interested party will suffer a financial loss if the insured loss occurs. In other words, the policyholder must demonstrate that some sort of reasonable relationship exists with the insured and that they will experience financial or emotional suffering if the insured dies.
What is “actual cash value of the loss”?
Actual cash value (ACV), which is used with property losses, is the replacement cost minus depreciation.
What are/is the “policy limits or face value”?
The policy limit or face value of a policy is the maximum amount that will be paid when the insured loss occurs. With most forms of insurance, the policy will pay for losses up to the amount of coverage. With life insurance, it is the amount that is paid when the death occurs.
What is “other insurance”?
This provision states that when a loss occurs, and there is more than one insurance policy covering the same loss, the insured will not profit from the loss. Either one policy is considered primary with the other paying for any uncovered loss, or the policies pay prorated shares of the loss.
What is coinsurance?
Coinsurance may be a splitting of costs, or it may refer to a minimum percentage of insurance that is required to avoid being penalized for inadequate property insurance when there are partial losses.
What is a deductible?
A deductible is a retained risk. It is the portion of insured losses that the insured is expected to pay before the insurance company pays anything.
What is subrogation?
Subrogation is the right of an insurance company that has paid for a loss to recover its payments if it is determined that a different insurance company or person is responsible for the loss and is required to pay for it. This prevents the insured from collecting twice for the same loss.
A client’s risk management plan is composed of ?, ?, and ?.
Social insurance, public insurance, and private insurance.
What is social insurance?
Mandatory insurance administered by the government, with benefits mandated by law. The purpose of social insurance is to protect people from large fundamental risks. Examples include Social Security, Medicare, Medicaid, and workers’ compensation.
What is public insurance?
Designed to enhance public trust in financial institutions. Similar to social insurance, public insurance is usually mandatory and administered by the government or by quasigovernmental institutions. The Federal Deposit Insurance Corporation (FDIC), Pension Benefit Guaranty Corporation (PBGC), and Securities Investor Protection Corporation (SIPC) all administer types of public insurance.
What is private insurance?
Insurance marketed by private insurance companies. Examples of private insurance include disability, health, long-term care insurance, property insurance, liability insurance, and life insurance. Some of these types of coverage may be mandatory as a result of state laws or lender requirements. For example, states may require automobile liability insurance coverage if you choose to register a motor vehicle.
Insurance companies use various distribution channels to provide their products and services. These individuals are generally referred to as producers. The major types of producers are:
independent agents,
captive agents,
career agents,
producing general agents,
brokers,
surplus-line or excess-line brokers or agents, and
solicitors.
What is an insurance producer?
A licensed individual or business entity authorized to sell, solicit, or negotiate insurance policies on behalf of an insurance company. Insurance producers act as intermediaries between insurance companies and consumers, helping individuals and businesses find coverage that meets their needs.
What is an independent agent?
Generally represent several insurance companies doing business under the American or independent agency insurance system. These independent agents decide where they will place their business, dividing the policies they sell among those various companies they represent while, ideally, basing that on the needs of the client and the suitability of the companies.
What is a captive agent?
An insurance agent who works exclusively for one insurance company. These agents are bound by contract to sell and promote the insurance products of that specific company and generally cannot represent or sell policies from other insurers.
What are career agents?
Insurance agents who are employed by a specific insurance company, typically on a long-term or full-time basis, to sell its products. They are similar to captive agents in that they exclusively represent one company, but the term “career agent” often implies a deeper, more structured relationship with the insurer, including benefits like career development opportunities, training programs, and incentives.
What are producing general agents (PGAs)?
Individuals or entities that act as intermediaries between insurance companies and independent agents or brokers. PGAs typically manage a network of agents and are responsible for overseeing their sales activities while also selling insurance products directly to clients. They often have a more substantial role in terms of business operations and management compared to regular agents.
What kind of agent do the following correspond with?
generally produce the majority of their income by selling insurance personally,
do not have specified territories, and
have authority to hire agents to work for them if they wish.
producing general agents (PGAs)
? are individuals who are licensed with and represent many insurers. A broker is the agent of an insurance buyer.
Brokers.
A broker represents a prospective insured and generally cannot bind the prospective insured to an insurance contract. The knowledge, actions, and assertions of the broker are between the broker and the client. The insurer is neither bound by them nor deemed to have any notice of them. Therefore, while the broker can bind herself, the broker cannot bind the insurer. Because of this, the insurer would not have legal liability arising from actions between the broker and the prospective insured.
What are surplus & excess lines brokers?
Handle any type of insurance that cannot be purchased using normal distribution channels within a given state. An individual may not be able to obtain coverage from an admitted (in-state) insurer. A surplus-line agent has the authority to go outside the state and place the business with a surplus-line (nonadmitted) insurer if the necessary coverage cannot be obtained from an insurer admitted in the state. These are found almost exclusively in the property and casualty field.
The insurer is legally liable for the acts of its agents performing their duties, even if:
agents make fraudulent statements unknown to or unauthorized by the insurer.
In the law of agency, there is no presumption that one person can legally act as an agent for another unless a basis for such an assumption is clearly established. An agent’s authority to legally bind a principal (the insurer, in this case) stems from three sources:
Express authority
Implied authority
Apparent authority
What is express authority?
Express authority refers to the specific powers and permissions explicitly granted to an individual or entity by a principal, often through a written or oral agreement. In the context of insurance, express authority is the authority given by an insurance company (the principal) to an agent or representative to act on its behalf in specific ways.
What is implied authority?
Implied authority refers to the power of an agent to perform actions that are not explicitly stated in their contract but are reasonably necessary to fulfill their express authority and carry out their duties effectively. It is a form of authority that is assumed as part of the agent’s role, even though it is not formally documented.
What is apparent authority?
Apparent authority refers to the authority an agent appears to have based on the actions, statements, or representations of the principal (e.g., an insurance company). It is the power an agent seems to possess in the eyes of a third party, even if that authority was not explicitly granted by the principal.
Which authority is the following situation an example of?
An agent who is terminated from employment with the insurer but still is allowed to possess policy illustration software, business cards, and application forms can be presumed to be acting on behalf of the insurer. Therefore, any acts by the agent would bind the insurer unless the insurer notifies the clients that the agent’s employment has been terminated.
Apparent Authority
NOTE: The example encompasses both implied and apparent authority. From the perspective of the client, he presumed the agent had the authority, which is apparent authority. The failure of the insurer to take action against the agent creates implied authority.
What is ratification?
Ratification is the act of approving or affirming an action that was taken on behalf of a principal by another party (e.g., an agent), even though the agent did not have proper authority to perform the action at the time it occurred. By ratifying the act, the principal retroactively grants authority and accepts responsibility for the action.
For example, an insurer may stipulate that its agents must not write insurance on a certain class of applicant (thus putting such an action outside the scope of the agents’ authority). If an agent then writes coverage on an applicant in the prohibited class and the insurer, with full knowledge of the prohibited action, accepts the premium, then the insurer has ratified the agent’s act, and modified the agent’s powers. From then on, the insurer is bound by that act of the agent. Thus, the agent’s act and the insurer’s ratification of that act have modified the agency agreement.
What are the three main “global” purposes for regulation?
to maintain competition, to prevent abuse of consumers, and to minimize market failures.
State regulation of insurance companies involves all three areas of government:
legislative, executive/administrative, and judicial.
A state legislature passes laws that govern conduct of the insurance business in the state. These laws cover the requirements involved in:
organizing an insurance company, standards of solvency, regulation of rates and investments, and licensing of agents.
The ?, headed by the state insurance Commissioner, sets regulations implementing legislation and administers compliance.
state insurance department (executive/administrative)
? interpret and apply the laws and regulations applicable to insurers and interpret policy provisions. They also provide insurers with recourse for a review of the actions of regulators and the constitutionality of laws passed by the legislature.
State courts (judiciary)
The role each branch of government plays with regard to insurance is no different than for any other lawmaking process. The legislative branch ?, the executive branch ?, and the judicial branch ?.
makes laws; enforces the law; interprets the law when disputes arise
What is Public Law 15?
Public Law 15, also known as the McCarran-Ferguson Act of 1945, is a key piece of U.S. legislation that establishes the regulation of insurance as primarily the responsibility of individual states rather than the federal government. This law was enacted to clarify the role of state and federal regulation following a Supreme Court decision in United States v. South-Eastern Underwriters Association (1944), which ruled that insurance transactions could be subject to federal antitrust laws.
While federal agencies, regulations, and legislation certainly influence the regulation of insurance, the ? are tasked with direct regulation of the insurance industry within their respective borders.
states
What is the National Association of Insurance Commissioners (NAIC)?
The U.S. standard-setting and regulatory support organization created and governed by the chief insurance regulators from the 50 states, the District of Columbia, and five U.S. territories.
The purpose of the ? in establishing the accreditation program is to increase the reliability of the oversight of insurance companies by various states.
NAIC
What is an aleatory contract?
An aleatory contract is a legal agreement between two parties where one party’s performance is dependent on an uncertain event, such as an accident, natural disaster, or death. The term “aleatory” comes from the Latin word aleatorius, which means “pertaining to a gambler”.
Aleatory contracts are commonly used in insurance policies, where the insurer is not required to pay the insured until a triggering event occurs. For example, an insurance policy may not pay out if a vehicle is not damaged or stolen.
What is a contract of adhesion?
A “contract of adhesion” in insurance refers to a standard form insurance policy where the terms and conditions are drafted entirely by the insurance company, leaving the insured with little to no ability to negotiate or modify the contract; essentially, the insured must “adhere” to the terms presented on a “take it or leave it” basis, due to the unequal bargaining power between the parties involved.
Insurance contracts are ? in that the insurance company pays on the condition that a covered loss occurs.
conditional
Under the principle of ?, insureds are restored to the financial position they were in before they suffered their losses.
indemnity
What is the collateral source rule?
The “collateral source rule” is a legal principle in tort law that prevents a defendant from reducing a plaintiff’s damages award by the amount of compensation they received from sources other than the defendant, such as health insurance, meaning the plaintiff can still seek full recovery even if they have already been partially compensated by a third party; essentially, it ensures the wrongdoer bears full responsibility for the harm caused, regardless of other sources of payment for the plaintiff’s injuries.
Insurance contracts are ? because the nature of the risk is related to the individual who owns the contract.
personal contracts
Contracts may be ? or ?.
unilateral or bilateral.
When either party to the contract can enforce the contract in a court of law, the contract is ?.
bilateral
If only one party can enforce the contract, it is ?.
unilateral
What is utmost good faith?
“Utmost good faith,” also known as “uberrimae fides” in Latin, is a legal principle that requires all parties involved in a contract to act honestly and disclose all material information relevant to the agreement, particularly applied in insurance contracts where a higher standard of transparency is expected between the insurer and policyholder; essentially, it means both parties must fully disclose all important facts without any misleading or withheld information.
The insurance company can make the following three claims if it believes that utmost good faith was not maintained:
Misrepresentation
Warranties
Concealment
What is misrepresentation?
Occurs when a false statement is made that at least partially induces the company to issue the contract. For a misrepresentation to void a contract, it must be material, or significant.
What is a warranty?
A statement by the applicant that all of the information on the application is absolutely true. Under strict application of the warranty doctrine, any mistake, however insignificant, would permit the company to void or rescind the contract. With very limited exceptions, however, the courts will not permit such an extreme application of the doctrine to insurance contracts.
What is concealment?
The intentional withholding of material information, violates the requirement of utmost good faith even if no specific question arises about that information.
“I promise to paint the fence by Tuesday, and you promise to pay me $75.”
This is an example of what kind of contract?
bilateral
“If you paint the fence by Tuesday, I will pay you $75.”
This is an example of what kind of contract?
unilateral
What elements need to be in place for a contract to be legally enforceable?
Offer and acceptance.
Consideration.
Legal object.
Competent parties.
Legal form.
The purpose of the contract is also known as the ? of the contract.
legal object
A ? is not enforceable and lacks one or more of the requirements of an enforceable contract.
void contract
A ? is a contract where one party has the option of voiding the contract, but the other party is bound.
voidable contract.
For example, where a contract is made with a minor, the contract is voidable by the minor; until the minor reaches the age of majority, he can void the contract, but if not voided it remains a legal contract. If one of the two people making the contract is legally incompetent, the incompetent person cannot be forced to hold up his end of the contract. The incompetent person may, however, force the other person to live up to his part of the contract. When one of the parties to a contract is legally incompetent because of age, illness, inebriation, or some other reason, the contract most likely is valid but may be voided by the incompetent person (i.e., such a contract is not void, but it is voidable by the incompetent individual).
Insurance policies have four basic sections. They are:
declarations,
insuring agreement,
exclusions, and
conditions.
There will be times when two parties to a contract are in conflict that cannot be resolved without the legal system. There are a number of legal concepts that come into play when handling ?, including those involving insurance contracts. First, the court has to determine what the parties intended. Then, it has to seek an equitable way of implementing these intentions.
contract disputes
What is the parol evidence rule?
The parol evidence rule is a legal principle in contract law that prevents parties from introducing evidence of prior or contemporaneous oral agreements that contradict the terms of a final written contract, essentially stating that the written contract represents the complete understanding between the parties and any prior discussions are inadmissible in court to alter its terms.
The ? means that a party, by her own actions (or the actions of her agent), has voluntarily relinquished or surrendered a known right. It assumes that parties, with full knowledge of the material facts do, or fail to do, something that is inconsistent with their rights under the contract or inconsistent with an intention to rely on such rights. No action is required of the other party.
doctrine of waiver
What is the below an example of?
ABC Insurance Company receives an application that does not meet its underwriting criteria but issues a policy anyway. If a subsequent claim is filed, ABC is barred from denying the claim because it waived its right to deny the claim by issuing the policy.
doctrine of waiver
What is the doctrine of estoppel?
The doctrine of estoppel is a legal principle that prevents a person from asserting a claim or right that contradicts their previous statements, actions, or behaviors if such inconsistency would unfairly harm another party who relied on the original conduct or representation.
What is the below an example of?
Alan, a claim adjuster for XYZ Company, agrees to pay a claim, even though the insured did not comply with policy conditions by failing to protect property after an accident. By agreeing to pay the claim, Alan, who is considered an agent of the insurer, is waiving the insurance company’s rights. As a result, if XYZ Company later tries to deny a related claim, it will be estopped from doing so.
Waiver & estoppel.
Once the court has decided what the understanding was between the parties, or at least what it feels is fair under the circumstances, it may implement its decision by using one of two ?, rescission and reformation.
equitable remedies
? is an equitable remedy by which the original contract is deemed null from its beginning. The party seeking relief must show fraud, impossibility, misrepresentation of a material fact, concealment in the application, or mutual mistake as to a material fact.
Rescission
? is the equitable remedy by which the written instrument between the parties is changed to express the original intentions of the parties.
Reformation
What is the below an example of?
Assume a life insurance policy misprint states a death benefit of $1 million, instead of the $100,000 amount both parties intended and that the insured paid for. If the insured’s heirs try to enforce the policy according to its terms, the insurer should have no problem having a court reform the policy to reflect the intention of the parties.
Reformation
To distinguish between rescission and reformation, remember that with rescission, the contract is assumed to ?. The party seeking relief would not have entered into the contract had she known about the problem. With reformation, the original contract between the parties is ?. Therefore, one of the parties seeks to have the writing changed to reflect what was originally intended.
have never existed; simply not accurately stated in the original writing
What is a waiver provision?
A waiver provision is a clause in a contract that allows one party to voluntarily relinquish or forgo a right, claim, or privilege under the agreement. This provision defines the conditions and implications of such a waiver and ensures that the party waiving its rights cannot later attempt to enforce them, provided the waiver is made knowingly and intentionally.
What is the difference between a waiver provision and the doctrine of waiver?
It is important to note that, although the names are similar, the waiver provision mentioned in the preceding paragraph and the doctrine of waiver discussed previously are two different concepts. A waiver provision has effect because it is placed in the contract. It is intended to prevent a company’s agents from intentionally or unintentionally waiving a privilege or benefit the company would otherwise have. The doctrine of waiver, on the other hand, is based on equity, applies without being explicitly mentioned in the contract, allows waiver of a known right, and has far broader application than a waiver provision.
What is a tort?
A tort is a civil wrong or wrongful act (other than a breach of contract) that causes harm or loss to another person. The person who suffers the harm may seek compensation or remedy through the legal system.
What is a tortfeasor?
A tortfeasor is an individual, company, or entity that commits a tort—an act that causes harm or injury to another person or their property. The tortfeasor is legally responsible (liable) for the harm caused and may be required to compensate the injured party through damages or other legal remedies.
What is an unintentional tort?
An unintentional tort is a type of civil wrong that occurs when one party’s actions, often due to negligence or carelessness, unintentionally cause harm or injury to another person. Unlike intentional torts, there is no deliberate intent to cause harm, but the party responsible can still be held legally liable for their actions (or inactions).
Unintentional torts generally are those activities that involve negligence. There are four elements of negligence:
A duty is owed.
– Example: Individuals have the duty to drive their vehicles in a safe manner.
The duty was breached.
– Example: The individual rear-ended another car.
There were actual damages.
– Example: The other car had broken taillights and a crushed bumper.
There was proximate cause, which is an uninterrupted sequence of events that brought about the damage.
– Example: The individual was texting, didn’t see the other driver, and rear-ended him.
What is an attractive nuisance?
Refers to something about a property (e.g., a swimming pool) that is likely to attract and possibly injure children. Property owners must use a high degree of care to discover others on their properties. They must also take steps to prevent harm, such as installing fences and locks.
What is negligence per se?
A legal doctrine in tort law that establishes negligence when a defendant violates a statute, regulation, or ordinance that is specifically designed to protect a certain class of people from a certain type of harm. Under this doctrine, the violation itself is considered sufficient to prove that the defendant breached their duty of care.
What is absolute liability?
The standard imposed when a person or organization is held responsible for any damages, even when there has been no negligence. This generally is a case in which people cause extra-hazardous situations through their activities (e.g., keeping wild animals, blasting). This is also known as strict liability.
It is important to remember that liability and fault are not ?. Liability can exist in the absence of fault (e.g., absolute liability), and clients need to be aware of this potential risk exposure.
synonymous
What is vicarious liability?
When someone is held liable for the acts of another (e.g., the person’s child, employee, or agent). While this aspect is usually seen with parents and children, it essentially extends to anyone acting as your agent.
Assume a child is playing baseball and accidently hits a baseball through a neighbor’s window. In this instance, the parents would have ?. Additionally, employees, essentially doing anything for the employer, even on their own time, would be imputed back to the business. Examples include delivering documents to clients or bringing equipment to a job site.
vicarious liability
What is contributory negligence?
Under the doctrine of contributory negligence, if any negligence on the part of the injured party contributes to the injury, it absolves the other party of liability. This is the strictest approach and has been replaced by comparative negligence.
What type of negligence does the below situation represent?
Matthew is speeding in his car and another driver cuts him off, causing an accident. Matthew would not be able to recover damages from the other driver if the court determines he is at fault for even 1% because he was speeding.
contributory negligence
What is comparative negligence?
An alternative to the contributory negligence defense; comparative negligence reduces the defendant’s liability in some proportion based on the injured party’s contribution to the total negligence causing the injury. For example, if a jury determines that the injured party was 20% to blame for the injury, the plaintiff’s award might be reduced by 20%.
What is last clear chance?
A modification of contributory negligence. Here, contributory negligence on the part of the injured party will not bar recovery if the other party, immediately prior to the accident, had a last clear chance to prevent the accident but failed to seize the chance.
What is field underwriting?
Field underwriting is the process of gathering information about a potential policyholder before submitting a formal application to an insurance underwriter.
What is a moral hazard?
A result of a client being unethical or misrepresenting himself in order to obtain insurance or to induce the payment of a claim.
What type of hazard do the below circumstances represent?
Sherri, your client, advises you that she has not been issued any traffic tickets, but in fact, she had a couple of DUIs.
Joshua, who has a building insured with DEF Insurance Company, is behind on his mortgage payments. He considers burning the building to receive payments from the insurance company.
moral hazards
What is a morale hazard?
Simply put, is indifference. An insured might leave her car unlocked in a bad part of town, or leave the car running while she runs into the convenience store with the attitude that, “it’s okay, it’s insured.”
What is adverse selection?
Occurs when individuals with a higher risk of needing to make a claim are more likely to purchase an insurance policy, while individuals with lower risk are less likely to do so, leading to a situation where the insurance company is disproportionately exposed to higher risk customers, potentially causing higher premiums for everyone involved.
What does the below represent?
Auto insurance companies want to minimize the number of high-risk candidates; their goal is to have a pool of insureds that represents the average of the population, not one that is skewed toward the high-risk population. People who drive a great deal more than average and/or have a less-than-stellar driving record are more likely to seek insurance to help pay for their greater likelihood of having a claim.
adverse selection
Two concepts—? and ?—are the cornerstones of the actuarial basis of life and health policies.
mortality and morbidity
? refers to the incidence of death. ? refers to the incidence of losing one’s health through illness or injury.
Mortality; Morbidity
? are statistical figures that show an average life expectancy for a given group of people.
mortality rates
Life insurance policy premiums are based on three factors:
mortality rates, investment income, and expenses.
? is a measure of the rate of disability.
morbidity
Life insurance underwriters are concerned with ? rates while disability insurance underwriters consider ? rates.
mortality; morbidity
What is the loss adjustment process?
A series of steps that are taken when an insured property loss occurs.
What is indemnification?
When individuals suffer a financial loss, they generally expect their insurance company to make them whole. This process is known as indemnification, and it involves the loss adjustment process.
What is an adjuster?
An essential part of the claim process is the adjuster, who is responsible for investigating insurance claims and determining the amount of payment to be made.
Most insurance policies contain the following seven provisions regarding the insured’s duties during the loss adjustment:
Notice of loss. The insured is required to give notice of a loss to allow the insurer to investigate it.
Protection of property. A provision (i.e., a policy condition) that requires the insured to protect the damaged property after a loss.
Inventory. An itemized report that must contain the quantity, a description, either the actual cash value (ACV) or replacement cost, and the amount of loss of the damaged property. ACV is the replacement cost of property less depreciation.
Evidence. The insured may be required to show the damaged property to the insurer as often as is reasonably required.
Proof of loss. To document a loss, most insurers supply the insured with proof of loss forms for completion.
Assistance and cooperation. The insured is required to cooperate with and provide assistance to the insurer when a loss occurs. Cooperation and assistance include attending hearings and trials, presenting evidence, and supplying medical reports.
Appraisal. An appraisal is necessary to avoid litigation when the insured and insurer cannot agree on the ACV or amount of the loss.
Generally, there are three steps that a claims adjuster, on behalf of the insurer, follows in the loss adjustment process:
Investigation. During the investigation, all relevant information is evaluated.
Proof of loss. This may require helping the insured complete the necessary forms.
Payment or denial of the claim. Based on the adjuster’s findings, the claim may be paid (in whole or in part) or denied.
What is abandonment?
Involves surrendering ownership of damaged property to the insurance company so that a total loss can be claimed.
What is salvage?
Takes place when the insurer takes ownership of the property and sells it to reduce its loss.
What is a pair or set option?
Gives the insurer the right to repair or replace any part, to restore a pair (e.g., of earrings) or set (e.g., of silverware) to its value before the loss, or to pay the difference between the ACV of the property before and after the loss. For example, this clause stipulates that a loss of one earring is not a total loss of the set. The insurer, in this case, does not have to replace both earrings, but it will try to reach an equitable settlement with the insured.
The quality of the agent chosen is extremely important and while there is no simple method for selecting a good agent, factors that should be considered include:
competence, inclination to service, experience, training, education, specialization, and reputation.
All rating agencies provide insight into insurance company strength, but ? is the only one that specializes in rating insurance companies. This differentiates them from the others.
A.M. Best
There are ? financial ratios that were chosen by the NAIC to help it keep tabs on insurance companies.
12
Insurance companies are not all owned or operated in the same manner. There are two primary forms of company ownership and several other less well-known forms. The primary forms of ownership are ? and ?.
mutual companies and stock companies
? companies are owned by the policyowners. ? companies, as the name implies, are owned by stockholders.
mutual; stock
Which of these incidents would be best described as a hazard?
A. After a storm, a tree falls on your car.
B. You park your car on a steep incline without setting the parking brake.
C. You own a luxury automobile.
D. Your car hits a light pole after skidding on ice.
B. You park your car on a steep incline without setting the parking brake.
Explanation: Parking your car on a steep incline without setting the parking brake increases the potential for loss; therefore, it is a hazard. Skidding on ice and hitting a light pole and damage from wind are perils (i.e., the cause of the loss that is insured against), not hazards. One could argue that owning a luxury car is a hazard, particularly if the luxury automobile is one highly desired by prospective thieves, but the mere fact that you own a particular automobile does not increase the risk of loss. Rather, the best answer is not setting the parking brake, which clearly increases the probability of the car colliding with another object.
Which of the following statements regarding insurance terminology is CORRECT?
A. Peril is the indifference to loss that creates carelessness and increases the chance of loss due to the existence of insurance.
B. A hazard is the cause of financial loss.
C. Speculative risk involves the chance of loss or no loss.
D. Insurance is a device used to manage risk by having a large pool of people share in the financial losses suffered by members of the pool.
D. Insurance is a device used to manage risk by having a large pool of people share in the financial losses suffered by members of the pool.
Explanation: Insurance is a device used to manage risk by having a large pool of people share in the financial losses suffered by members of the pool. Pure risk involves the chance of loss or no loss. A peril is the cause of financial loss. A morale hazard is the indifference to the loss that creates carelessness and increases the chance of loss due to the existence of insurance.
Ricky, age 32, has a clean driving record. He recently purchased a car for $1,500. What is the most appropriate risk management technique for handling the collision exposure of Ricky’s car?
A. Avoidance
B. Transfer
C. Retention
D. Diversification
C. Retention
Explanation: With respect to collision coverage for the car, Ricky should opt to retain the risk. The car is only worth $1,500.
What is the type of authority that an insurance company does not expressly give to agents, but agents normally possess because it is reasonably necessary for them to carry out their duties?
A. Implied authority
B. Apparent authority
C. Express authority
D. Ultimate authority
A. Implied authority
Explanation: Implied authority is the authority that insurance companies do not expressly give to agents. However, agents typically possess it because it is reasonably necessary for them to carry out their duties. Express authority is typically in writing. Apparent authority involves an agent waiving a provision in a contract and the insurance company knowing about it but doing nothing to prevent the agent from doing so.
Which of the following statements regarding the roles of the NAIC in regulating insurance is CORRECT?
I. Through the NAIC, the 50 state Commissioners exchange information and ideas and coordinate regulatory activities.
II. The NAIC makes recommendations for legislation and policy.
III. The NAIC has the legal authority to require that states adopt its regulations.
A. I only
B. III only
C. I and II
D. I, II, and III
C. I and II
Explanation: The NAIC makes recommendations for legislation and policy, but the organization does not have the legal authority to require that states adopt its regulations.
Jacob negligently strikes Gary’s car and causes considerable property damage. In turn, Gary’s insurance company reimburses him for this loss. Which legal doctrine permits Gary’s insurance company to sue Jacob to recoup its losses?
A. The right of subrogation
B. The collateral source rule
C. The rescission rule
D. The right of reformation
A. The right of subrogation
Explanation: The right of subrogation permits Gary’s insurance company to sue Jacob. Reformation is a right of the insurance company to amend the contract when the contract fails to express the actual intent of the parties. This should be compared with rescission, in which the insurance contract is considered null and void from its beginning because of fraud or misrepresentation on the part of the insured.
Which statement correctly describes a contract of indemnity?
A. Contracts of indemnity will reimburse the insured only for a small portion of the actual amount of the loss.
B. Contracts of indemnity will reimburse the insured for more than the actual amount of the loss.
C. Contracts of indemnity will not reimburse the insured for any amount.
D. Contracts of indemnity will reimburse the insured only up to the actual amount of the loss.
D. Contracts of indemnity will reimburse the insured only up to the actual amount of the loss.
Explanation: Contracts of indemnity will reimburse the insured only up to the actual amount of the loss. The notable exception to this rule is a life insurance contract which pays a stated death benefit or face value.
Which statement regarding the legal characteristics of insurance contracts is CORRECT?
I. Insurance contracts are unilateral contracts.
II. Insurance contracts are contracts of adhesion meaning that the policyowner can only accept or reject the contract and cannot modify its terms.
III. Insurance contracts are aleatory contracts meaning that the outcome is affected by chance and the dollars collected by the parties must be equal.
A. I only
B. I and II
C. I, II, and III
D. II and III
B. I and II
Explanation: Statements I and II are correct. Statement III is incorrect. Insurance contracts are aleatory contracts meaning that the outcome is affected by chance and that the dollars collected by the parties are usually unequal.
XYZ Food Company had a reckless employee who was driving a company-owned truck too fast and, as a result, hit a picket fence, knocked down several mail boxes, and crashed into an oak tree. XYZ Food Company’s insurer paid several thousand dollars in damages for these losses. Which term best describes XYZ’s position?
A. Vicarious liability
B. Comparative negligence
C. Contributory negligence
D. Assumption of the risk
A. Vicarious liability
Explanation: XYZ Food Company is vicariously liable for any damages caused by XYZ’s employees. Even though the employee caused the damage, the company is responsible for his actions when he drives a company vehicle.
Which of the following terms is correctly described?
A. Moral hazard: unethical practices designed to induce the payment of a claim.
B. Morale hazard: lack of confidence that a potential loss is adequately covered.
C. Adverse selection: a standard underwriting approach so those that most need insurance can receive it.
D. Underwriting process: the process of ensuring claims are settled equitably.
A. Moral hazard: unethical practices designed to induce the payment of a claim.
Explanation: Moral hazards are unethical practices designed to induce the payment of a claim. A morale hazard has more to do with indifference rather than unethical behavior. Adverse selection is something insurance companies attempt to avoid so that it is not only the people likely to have a claim who purchase insurance. The underwriting process is the process of evaluating risks to determine if they are reasonable to accept and to what degree.
Which of the following is not considered a rating agency?
A. The NAIC
B. Standard & Poor’s
C. Moody’s
D. A.M. Best
A. The NAIC
Explanation: The NAIC compiles a watch list, but does not rate insurance companies. Moody’s, Standard & Poor’s, and A.M. Best are all rating agencies.
Which of the following can most properly be described as a hazard?
A. A fire damages the roof of your home.
B. A flood knocks down a tree which causes damage to your boat.
C. A storm completely destroys your backyard barbeque and all of your lemon trees.
D. An oily rag is left in your garage which catches fire and destroys your home.
D. An oily rag is left in your garage which catches fire and destroys your home.
Once you have identified and established risk mgmt goals, what is the next step in the risk mgmt process?
A. Develop a risk mgmt plan.
B. Implement the recommendations.
C. Gather pertinent data to determine risk exposures.
D. Analyze and evaluate the information to identify risk exposures.
C. Gather pertinent data to determine risk exposures.
Linda recently purchased a brand new luxury sedan. Which of the following risk mgmt techniques would be most appropriate for handling the collision exposure of her new sedan?
A. Retention
B. Avoidance
C. Transfer
D. Risk Diversification
C. Transfer
Daryl is an agent for the Accountable Insurance Company (AIC). During the most recent year, the company instructed its agents not to write fire insurance policies on day care centers. However, when Day Care Center of America applied for a policy, Daryl bound the coverage. The Day Care Center of America was destroyed by a fire one month later. What is the obligation of AIC in this situation?
A. AIC is required to pay because Daryl had express authority to bind the company.
B. AIC is required to pay because Daryl had an ostensible authority (i.e. apparent) to do what the public reasonably believed he could do.
C. AIC is not required to pay because Daryl is the agent of the insured.
D. AIC is not required to pay because Daryl failed to disclose his full knowledge of the situation.
B. AIC is required to pay because Daryl had an ostensible authority (i.e. apparent) to do what the public reasonably believed he could do.
Which of these provides direct regulation of the insurance industry?
A. The NAIC
B. The IRS
C. Dodd-Frank
D. State Departments of Justice
D. State Departments of Justice
Which of these is a legal requirement for an enforceable insurance contract?
A. The parties to the contract must give up goods or services of equal value.
B. The applicant must be given the right to alter or change provisions in the contract.
C. The applicant must be considered a competent party to make a valid contract.
D. The insured must be of majority age for the contract to be valid.
C. The applicant must be considered a competent party to make a valid contract.
Nancy is driving recklessly and hits Cindy’s car. In addition to holding Nancy responsible for the damages to Cindy’s car, her medical bills, and her pain and suffering, the court also imposes an extra $500k in damages. The extra $500k in damages would be an example of which of the following?
A. Special Damages
B. General Damages
C. Punitive Damages
D. Negligent Damages
C. Punitive Damages
Which of the following statements regarding insurable interest is CORRECT?
I. For life insurance, an insurable interest must exist only when the policy is issued.
II. For property and casualty insurance, an insurable interest must exist only when a loss is claimed.
III. For life insurance, an insurable interest must exist both when the policy is issued and the insured dies.
IV. For property and casualty insurance, an insurable interest must exist both when the policy is issued and when the loss is claimed.
A. I and II
B. I and IV
C. II and III
D. III and IV
B. I and IV
Which of these could Joanna insure?
I. Her home that she already owns.
II. Her neighbor’s home.
III. The life of her husband.
IV. Her adult son’s boat.
A. I only
B. I and III
C. II and IV
D. I, II, and IV
B. I and III
Which of these is NOT something you would look for when selecting an insurance agent?
A. Competence
B. Financial Strength
C. Inclination to Service
D. Education
B. Financial Strength
Which of the following cannot bind coverage for insurance on behalf of an applicant?
A) A career agent
B) A broker
C) A captive agent
D) An independent agent
B) A broker
Brokers represent the insured, and for exam purposes, brokers cannot bind coverage since they do not represent a specific company.
What is the stated amount of money the insured is required to pay on a loss before the insurer will make any payments under the policy?
A) The exclusion
B) The endorsement
C) The rider
D) The deductible
D) The deductible
A deductible is the amount of money an insured is required to pay on a loss before the insurer will make any payments under the policy. Deductibles help eliminate small claims, reduce premiums, and decrease morale hazards. Deductibles are used mainly in property, health, and automobile insurance contracts. Disability policies use an elimination period, which is a waiting period—measured in days—that must be satisfied before benefits become payable. This elimination period essentially acts as a time deductible.
In settling an insured’s loss, the duties of the insured do NOT include which of the following?
A) Providing proof of loss
B) Accepting any settlement offered by the insurer
C) Protecting property
D) Providing notice of loss
B) Accepting any settlement offered by the insurer
The insured is not obligated to accept any settlement offered by the insurer. The duties of the insured include providing notice of loss, protecting property, and providing proof of loss.
Which of the following insurance concept definitions is CORRECT?
A) A contract of adhesion is one in which the terms can be modified.
B) An indemnity contract is one that allows the policyowner to be reimbursed for more than the actual amount of the loss.
C) An aleatory contract is one in which one party might receive benefits substantially greater in value than the benefits received by the other party.
D) Unilateral contracts require a promise to perform from both the insurance company and the insured.
C) An aleatory contract is one in which one party might receive benefits substantially greater in value than the benefits received by the other party.
The answer is an aleatory contract is one in which one party might receive benefits substantially greater in value than the benefits received by the other party. Insurance is an aleatory contract. As such, one party (the insured) may receive benefits substantially greater in value than those of the other party (the insurance company).
Which of the following best defines insurable interest?
A) It determines how much insurance is needed to protect against a loss of income.
B) An interested party will suffer a financial loss if the insured loss occurs.
C) Exercising a right to the economic benefits of an asset, such as a life insurance policy.
D) Permanent life insurance policy cash values increase over time.
B) An interested party will suffer a financial loss if the insured loss occurs.
Insurable interest exists when an interested party will suffer a financial loss if the insured loss occurs.
Which of the following statements regarding the roles of the National Association of Insurance Commissioners (NAIC) in regulating insurance is CORRECT?
I. The NAIC is composed of the state insurance commissioners from all 50 states.
II. The NAIC makes recommendations for legislation and policy.
III. The NAIC has the legal authority to require states to adopt its regulations.
A) II only
B) I, II, and III
C) I and II
D) III only
C) I and II
The NAIC makes recommendations for legislation and policy, but it does not have the authority to require states to adopt its regulations.
Which of the following terms best describes the probability of an insured becoming disabled?
A) Disability rate
B) Morbidity rate
C) Accident and sickness rate
D) Mortality rate
B) Morbidity rate
The answer is the morbidity rate. Morbidity rate is the probability of a person becoming disabled.
Ronnie has been working and saving for a car since he was 13. He recently turned 16, obtained a driver’s license, and purchased a car for which he paid cash. He went to his insurance agent’s office and purchased the required car insurance. The agent did not notice that he is only 16. In the event of a claim, which option is available to the insurance company?
A) Refuse to pay the claim because the contract is voidable.
B) Tell Ronnie to submit the claim on his parents’ auto insurance policy.
C) Void the contract because Ronnie is a minor.
D) Pay the claim.
D) Pay the claim.
The answer is pay the claim. The company must pay the claim. A voidable contract is a contract where one party has the option of voiding the contract, but the other party is bound. In this case, where a contract is made with a minor, the contract is voidable by the minor, but if it isn’t voided, it remains a legal contract. The insurance company cannot void the contract and must pay the claim.
All of the following are steps in the risk management process except
A) identifying the insurance required to cover every risk.
B) monitoring the plan for any changes and/or updates.
C) identifying risk management goals.
D) analyzing and evaluating the information to identify risk exposures facing the client.
A) identifying the insurance required to cover every risk.
The answer is identifying the insurance required to cover every risk. While insurance is certainly an option for handling risk, it is not and should not be the only option utilized to cover every risk.
Which of the following is NOT a method of managing risk?
A) Retention
B) Reduction
C) Transfer
D) Elimination
D) Elimination
Elimination is not a method of managing risk. The four methods of managing risk are avoidance, retention, reduction, and transfer.
Ken owns a hardware store that fills customers’ propane tanks. You are Ken’s insurance agent and are explaining insurance terms to Ken. Which of the following statements is CORRECT?
I. Fire is a peril.
II. Leaving oily rags in a hardware store’s repair shop area is a hazard.
III. The handling of propane is a hazard.
IV. A pure risk is one that involves only the chance of loss or no loss; in other words, there is no chance of gain.
A) I only
B) I, II, and III
C) II only
D) I, II, III, and IV
D) I, II, III, and IV
Which of the following statements regarding maximum possible loss and probability of loss is CORRECT?
I. The maximum possible health care loss or claim is unlimited.
II. The probability of experiencing long-term care costs below age 60 is high.
III. The maximum loss to personal property is limited to its value.
A) I, II, and III
B) II and III
C) II only
D) I and III
D) I and III
The answer is I and III. The probability of experiencing long-term care costs below age 60 is low.
Which of the following organizations rate life insurance companies?
I. Standard and Poor’s
II. A.M. Best, Inc.
III. Fitch
IV. Moody’s
A) I, II, III, and IV
B) II only
C) I, III, and IV
D) I, II, and IV
A) I, II, III, and IV
The answer is I, II, III, and IV. All of these organizations rate insurance companies.
Which of the following is the role of the judicial branch in regulating the insurance industry within a state?
A) To enforce the laws in place relative to the insurance industry
B) To create model legislation relative to the insurance industry
C) To pass laws relative to the insurance industry
D) To interpret and apply the laws in place relative to the insurance industry
D) To interpret and apply the laws in place relative to the insurance industry
The answer is to interpret and apply the laws in place relative to the insurance industry. The legislative branch votes on and passes laws relative to the insurance industry. These laws are enforced by the executive branch, and disputes concerning the interpretation or application of the laws is handled by the judicial branch. The NAIC provides model legislation that may or may not be enacted by several states.
Which of the following definitions best describes vicarious liability?
A) Legal responsibility for acts under the negligence per se rule
B) Legal responsibility extended to someone other than the person who caused the injury
C) Legal responsibility for extraordinarily dangerous activities
D) Legal responsibility for criminal acts
B) Legal responsibility extended to someone other than the person who caused the injury
The answer is legal responsibilities extended to someone other than the person who caused the injury. Vicarious liability is legal responsibility extended to someone other than the person who caused the injury. For example, parents may be liable for torts committed by their children, and employers can be liable for torts committed by their employees.
Which of the following is NOT a provision frequently contained in the sections of insurance policies that address the insured’s duties relating to loss settlement?
A) Proof of loss
B) Notice of loss
C) Protection of damaged property
D) Negotiation of settlement with a third party
D) Negotiation of settlement with a third party
The answer is negotiation of settlement with a third party. Negotiation of a settlement with a third party is not a duty of the insured that relates to loss settlement. Evidence, notice of loss, protection of damaged property, and proof of loss are all duties of the insured relating to loss settlement.
Which of the following are important when selecting an insurance producer?
I. Competence
II. Training
III. Specialization
IV. Length of service with the company
A) I, II, and III
B) II and III
C) I, II, III, and IV
D) IV only
A) I, II, and III
The answer is I, II, and III. Options I, II, and III, along with experience, inclination to service, education, and a good reputation, are important when selecting an insurance producer. The length of time with a single insurance company may indicate nothing more than the ability to keep one’s job. Experience, which should be sought in an insurance producer, is intentionally developed expertise.
Which of the following are examples of managing risk through risk retention?
I. Having a coinsurance provision in medical insurance
II. Increasing the amount of an automobile insurance deductible
III. Increasing the benefit period on disability income insurance
IV. Having a waiver of premium rider on life insurance
A) I and II
B) I and IV
C) II and III
D) III and IV
A) I and II
The answer is I and II. Options I and II are both methods of retention, as coinsurance and increased deductibles leave the insured with the potential for greater out-of-pocket expenses. Increasing a benefit period and adding a waiver of premium rider are forms of risk transfer.
Which of the following types of risk is most suited to treatment by insurance?
A) Low probability, low severity
B) High probability, low severity
C) Low probability, high severity
D) High probability, high severity
C) Low probability, high severity
The answer is low probability, high severity. Insurance (or the transference of risk) is most suited to those losses that have a low probability or frequency of occurring and potentially high severity.
What is the process of evaluating risks to determine if they are reasonable to accept and to what degree?
A) Insurance underwriting
B) Actuarial pricing
C) Loss assessment
D) Loss adjustment
A) Insurance underwriting
The answer is insurance underwriting. A loss must occur for a loss assessment or loss adjustment. Actuarial pricing is a determination of how a insurance should be priced.
What are the below examples of?
If a business wants to ensure that it will not have windows broken by vandals, it can avoid the risk by not having windows. An individual who does not want to get hurt playing a particular sport can avoid playing that sport.
Risk avoidance.
What are the below examples of?
If a business wants windows but is still concerned about vandals, it may choose to have windows made of a material that is very difficult to break. If an individual wants to play a sport, but wants to limit potential damage, they can wear protective gear.
Risk reduction.
What is the below an example of?
There are situations where the potential loss is small, and the business or individual believes any losses that occur can be covered out of pocket. It is also possible that the cost of transferring the risk is high, so there may be no reasonable alternative. In these cases, the individual or business retains the risk. If a loss occurs, the individual or business pays the cost.
Risk retention.
What is the below an example of?
This is primarily insurance but can also be accomplished through waivers or subcontracting. With insurance, the risk of loss is transferred to an insurance company in exchange for a relatively small cost, the premium. Health, life, disability, and liability risks are examples that are generally transferred.
Risk transfer.
Which of the following statements regarding the principles of risk and insurance are CORRECT?
I. Risk is a condition in which there is a possibility of an adverse result from the expected desired outcome.
II. A hazard is the cause of a financial loss and is the actual event for which the individual purchases insurance.
III. A peril is a condition that increases the probability that a financial loss will occur.
IV. Pure risk involves only the chance of loss or no loss.
A) I, II, and III
B) I, II, III, and IV
C) I and II
D) I and IV
D) I and IV
Explanation: Risk is the condition in which there is a possibility of an adverse result from the expected desired outcome. A peril is the cause of a financial loss, and a hazard is a condition that increases the chance of financial loss. Pure risk is the risk that only involves the chance of loss or no loss.
Which of the following statements best describes a morale hazard?
A) An unintentional tort in the form of an action or omission that leads to the injury of another party
B) An act or condition that increases the likelihood of the occurrence of a peril and/or increases the severity of a loss if a peril does occur
C) A condition of carelessness or indifference on the part of an individual as to whether a loss occurs and/or the size of a loss if one does occur
D) A client being unethical or misrepresenting themselves in order to obtain insurance or to induce the payment of a claim
C) A condition of carelessness or indifference on the part of an individual as to whether a loss occurs and/or the size of a loss if one does occur
Explanation: A morale hazard is a condition of carelessness or indifference as to whether a loss occurs and/or the size of a loss if one does occur. Moral hazard is a result of an individual being unethical or misrepresenting himself in order to obtain insurance or to induce the payment of a claim.
Which of the following are methods of managing risk?
I. A professional athlete retiring early to avoid potential medical problems
II. The use of an emergency savings fund to cover unexpected expenses
III. Wearing a seatbelt and driving only in good weather conditions
IV. A surgeon utilizing disability insurance to cover lost earnings
A) II, III, and IV
B) I, II, III, and IV
C) III and IV
D) I and II
B) I, II, III, and IV
Explanation: The answer is I, II, III, and IV. All of these are examples of risk management techniques. The professional athlete is using “avoidance” to mitigate the risk of injury. An emergency savings fund is an example of an individual retaining some of the risk and associated costs before utilizing insurance. Wearing a seatbelt and driving in good weather conditions is an example of reducing risk. The use of disability insurance by the surgeon is an example of transferring risk.
Which of the following statements regarding self-insurance by a business is CORRECT?
A) The self-insurer must be able to competently manage the investment of the self-insurance fund.
B) The organization should have enough homogeneous exposure units to make losses unpredictable.
C) Small-to-medium-sized companies commonly utilize self-insurance to avoid the cost of traditional insurance premiums.
D) Self-insurance funds generally should be held in the businesses’ general funding account.
A) The self-insurer must be able to competently manage the investment of the self-insurance fund.
Explanation: The self-insurer must be able to competently manage the investment of the self-insurance fund. Relatively few firms are good candidates for self-insurance, which is a method of risk retention. For example, small-to-medium sized firms tend to rely on insurance to cover losses, with only large companies utilizing self insurance methods. If funds are set aside, they should be held in emergency accounts rather than the general business checking account. The organization that self-insures should have enough homogeneous exposure units to make losses somewhat predictable.
Which of the following is the role of the NAIC in regulating the insurance industry within a state?
A) Creating accreditation programs to maintain state regulation of the insurance industry
B) Interpreting and applying the laws in place relative to the insurance industry
C) Creating model legislation relative to the insurance industry
D) Enforcing the laws passed by Congress in relation to insurance
A) Creating accreditation programs to maintain state regulation of the insurance industry
Explanation: The answer is creating accreditation programs for state adoption in order to maintain state regulation of the insurance industry, rather than Congress. The legislative branch votes on and passes laws relative to the insurance industry. These laws are enforced by the executive branch, and disputes concerning the interpretation or application of the law is handled by the judicial branch. The National Association of Insurance Commissioners provides model legislation that may or may not be enacted by the several states.
An insurance contract requires an exchange of value to be considered a legally binding document. What is the term used to describe this requirement?
A) Payment of premiums
B) Offer and acceptance
C) Consideration
D) Compensation
C) Consideration
Explanation: The answer is consideration. Consideration occurs when there is an exchange of value. The insurance contract requires an exchange of value to be legally binding. For most insurance, the promise to pay the premium is usually sufficient consideration to make the contract binding; however, for life insurance, the premium must be paid before the insurance contract is binding for the insurer. The submission of a completed insurance application (offer) plus the payment of the first premium (consideration) to the insurance company will generally create a binding contract if the application would pass standard underwriting requirements.
Barbara left her car parked on top of a hill while visiting at a friend’s house. Unfortunately, she forgot to apply her emergency brake, and her car rolled down the hill, injuring two children who were playing in the street.
Which of the following doctrines may influence Barbara’s liability in this situation?
A) Negligence and assumption of risk
B) Assumption of risk only
C) Negligence only
D) Attractive nuisance
A) Negligence and assumption of risk
Explanation: The answer is negligence and assumption of risk. The doctrine of attractive nuisance is exemplified by a homeowner not fencing in a below-ground swimming pool and then children drowning in the pool. Barbara, by failing to apply her emergency brake at the top of a hill, was negligent. However, the children are also assuming risk by playing in the street.
Which of the following describes the tendency of persons with a higher-than-average chance of loss to seek insurance at standard rates, which, if not controlled by underwriting, results in higher-than-expected loss levels?
A) Physical hazard
B) Contributory negligence
C) Moral hazard
D) Adverse selection
D) Adverse selection
Explanation: This describes adverse selection. Physical hazard is a physical condition that increases the chance of loss. Under the doctrine of contributory negligence, if any negligence on the part of the injured party contributes to the injury, it absolves the other party of liability. A moral hazard is a result of individuals being unethical or misrepresenting themselves to obtain insurance or to induce the payment of claims.
A client decides to purchase health insurance. They settle on a high-deductible-based policy. This is an example of which risk management method?
A) Risk reduction only
B) Risk retention only
C) Risk retention and transfer
D) Risk transfer only
C) Risk retention and transfer
Explanation: The answer is risk retention and transfer. The client is transferring the risk to the health insurance company through the use of a policy; however, they are also retaining some of the risk by utilizing a high-deductible-based plan. A high-deductible-based plan requires the insured to pay more out-of-pocket expenses before insurance coverage takes effect.
The right of an insurer to recover damages from a third party for a loss covered by insurance is
A) insurable interest.
B) indemnity.
C) subrogation.
D) coinsurance.
C) subrogation.
Explanation: Subrogation is the right of an insurance company that has paid for a loss to recover its payments if it is determined that a different insurance company or person is responsible for the loss and is required to pay for it. This prevents the insured from collecting twice for the same loss. Coinsurance may be a splitting of costs, or it may refer to a minimum percentage of insurance that is required to avoid being penalized for inadequate insurance when there are partial losses. Insurable interest exists when the interested party will suffer a financial loss if the insured loss occurs. Indemnity involves placing a person back in the position they would have been had the loss not occurred.
Which of the following is likely an example of insurable interest?
I. Client A purchases life insurance on their foster child, who is currently attending college
II. Client B purchases a life insurance policy on the lives of several senior citizens at a local assisted living facility
A) Neither I nor II
B) I only
C) II only
D) Both I and II
B) I only
Explanation: Although not blood related, a foster child still shares a relationship with Client A through legal means. Client B likely does not have insurable interest unless a relationship can be proved on the basis of blood, marriage, or business.
Which of the following is a representative of the insured and cannot bind the insurer?
A) A broker
B) A registered representative
C) An independent agent
D) A producing general agent
A) A broker
Explanation: The answer is a broker. Brokers represent potential insureds. Agents represent insurance companies.
Which of the following is the role of the executive branch in regulating the insurance industry within a state?
A) To create model legislation relative to the insurance industry
B) To pass laws relative to the insurance industry
C) To interpret and apply the laws in place relative to the insurance industry
D) To enforce the laws in place relative to the insurance industry
D) To enforce the laws in place relative to the insurance industry
Explanation: The answer is to enforce the laws in place relative to the insurance industry. The legislative branch votes on and passes laws relative to the insurance industry. These laws are enforced by the executive branch, and disputes concerning the interpretation or application of the law is handled by the judicial branch. The National Association of Insurance Commissioners provides model legislation that may or may not be enacted by the several states.
The insurance provision that states that the insured will split the costs of a loss to some degree, usually on a percentage basis, describes which of the following?
A) A split-cost arrangement
B) A deductible
C) Coinsurance
D) Rider supplement
C) Coinsurance
Explanation: The answer is coinsurance. The question defines coinsurance, which is a splitting of costs. A deductible is what the insured must pay before the insurance company pays anything. It is possible to have a loss that is valued at an amount below the deductible, and nothing would be owed by the insurance company. It is not possible for the insurance company and the insured to not split costs when coinsurance applies.
Which of the following definitions of a term used in insurance contract law is CORRECT?
A) Adhesion: if you wrote the contract, you are bound by any ambiguities you created.
B) Personal: the dollars that exchange hands are of unequal amounts.
C) Indemnity: the insurance company pays on the condition of a loss.
D) Aleatory: only one party can enforce the contract.
A) Adhesion: if you wrote the contract, you are bound by any ambiguities you created.
Explanation: A contract of adhesion maintains that, if you wrote the contract, you are bound by any ambiguities you created.
Augusto is not paying attention when driving to work and runs a stop sign, narrowly missing Regena. Although frightened by the event, Regena continues driving and uses her cell phone to call her spouse to tell him what just happened. While dialing the phone, she crashes into a telephone pole. Would she be able to hold Augusto liable for the damage to her car?
A) Yes, because Augusto breached his duty to avoid damaging Regena’s car.
B) No, because Augusto’s actions were not the proximate cause of Regena’s loss.
C) No, because Augusto did not owe Regena a duty to drive his car in a safe manner.
D) Yes, because there were actual damages as a result of Augusto’s actions.
B) No, because Augusto’s actions were not the proximate cause of Regena’s loss.
Explanation: To be liable for an unintentional tort, four elements of negligence must exist. First, a duty is owed, and second, that duty is breached. Then, there must be actual damages and, finally, the breach must be the proximate cause for the damage. In this case, Augusto had a duty to drive his car in a safe manner, and he and breached that duty when he ran the stop sign. While Regena’s car did, in fact, have actual damages, the proximate cause of the damage was her trying to use her cell phone while driving. Proximate cause is an uninterrupted sequence of events that brings about damage, and Regena using her cell phone interrupted that sequence. Had she swerved to avoid Augusto and hit a telephone pole, then the proximate cause would have been Augusto’s actions and he could be found negligent.
Which of the following statements describing insurance terms are CORRECT?
I. A misrepresentation is carelessness or indifference on the part of an individual pertaining to whether a loss occurs and/or the size of a loss if one does occur.
II. A morale hazard is a false and material statement made by an applicant for insurance, providing a basis for the insurer to make the contract voidable.
A) Neither I nor II
B) Both I and II
C) I only
D) II only
A) Neither I nor II
Explanation: Neither statement I nor II is correct. Statement I is incorrect because it describes a morale hazard. Statement II is incorrect because it describes a misrepresentation.
Which of the following are insurance company rating services?
I. Moody’s
II. A.M. Best
III. Standard and Poor’s
IV. NASDAQ
A) I and II
B) I, II, and III
C) I, II, III, and IV
D) II and IV
B) I, II, and III
Explanation: The answer is I, II, and III. All except NASDAQ are insurance company rating services.
One of the steps in the risk management process is to “gather pertinent data to determine risk exposures.” Potential sources of necessary information include which of the following areas?
I. 401(k) and other retirement statements
II. Inventory of possessions and animals
III. Volunteer activities
IV. Personal illness
A) I, II, III, and IV
B) II, III, and IV
C) I, II, and III
D) I and IV
B) II, III, and IV
Explanation: 401(k) and other retirement statements are a part of the employee benefit and retirement planning process, but not the risk management process. All other statements are examples of the risk management process.
Once you have analyzed and evaluated the information to identify a client’s risk exposures, what is the next step in the risk management process?
A) Craft and implement the insurance recommendations
B) Communicate the evaluated information
C) Develop a risk management plan
D) Monitor the plan for needed changes
C) Develop a risk management plan
Explanation: The steps in the risk management process are to: 1) identify and establish risk management goals, 2) gather pertinent data to determine risk exposures, 3) analyze and evaluate the information to identify risk exposures, 4) develop a risk management plan, 5) communicate the recommendations, 6) implement the recommendations, and 7) monitor the recommendations for needed changes.
Which of the following states that the insured should not profit from a covered loss, but should be restored to approximately the same financial position before the occurrence of the loss?
A) Rule of adhesion
B) Principle of indemnity
C) Collateral source rule
D) Principle of insurable interest
B) Principle of indemnity
Explanation: The answer is principle of indemnity. The principle of indemnity has two purposes: to prevent the insured from profiting from insurance claims and to reduce moral hazards.
Which statement is correct with regard to insurance producers?
A) Agent B is licensed to represent one common insurer and several subsidiary companies of that insurer. They are a broker(s).
B) Agent D is allowed to use normal distribution channels within a given state, but must refer to a specialist when going out of state. They are a surplus-line broker/agent.
C) Agent A represents several companies under common ownership, but with different operating business names. They are a captive agent.
D) Agent C is limited to where they will place their business, but can operate with a maximum of five carriers. They are an independent agent.
C) Agent A represents several companies under common ownership, but with different operating business names. They are a captive agent.
Explanation: The answer is captive agents. Captive agents sell for direct writers, including their subsidiaries if under common ownership. Examples include State Farm, Allstate, and Farmers Insurance. Brokers can represent multiple companies. Independent agents have no cap on the number of carriers they can work with. Surplus-line broker/agents can operate in and out of state.
Which of the following generally produce the majority of their income by selling insurance personally, do not have specified territories, and can hire agents to work for them if they wish?
A) Independent agents
B) Surplus line agents
C) Producing general agents
D) Captive agents
C) Producing general agents
Explanation: This describes a producing general agent (PGA).
Which of the following provides model legislation that may or may not be enacted by several states?
A) HIPAA
B) The National Association of Insurance Commissioners (NAIC)
C) The Dodd-Frank Act
D) The IRS
B) The National Association of Insurance Commissioners (NAIC)
Explanation: The answer is the National Association of Insurance Commissioners (NAIC). The NAIC does not regulate the insurance industry, but rather, provides model legislation that may or may not be enacted by several states. It is not a federal law or agency.
Which of the following terms is correctly matched with its definition?
A) Reformation: an equitable remedy by which the original contract entered into by the parties is deemed null from its beginning.
B) Doctrine of waiver: prevents a party from asserting a right to which he would otherwise be entitled where, because of his own actions or behavior, he misled someone (even though unintentionally) who relied on the understanding created, thereby to his own detriment.
C) Adhesion: one party writes the contract, and the other party has no say in the matter—she only accepts or rejects the contract.
D) Doctrine of estoppel: a party, by her own actions (or the actions of her agent), has voluntarily relinquished a known right.
C) Adhesion: one party writes the contract, and the other party has no say in the matter—she only accepts or rejects the contract.
Explanation: The answer is adhesion: one party writes a contract, and the other party has no say in the matter—she only accepts or rejects the contract. This is an accurate description of adhesion.
Which of the following includes the five elements of an insurance contract?
A) Offer and acceptance, measurable risk, legal object, legal capacity, and legal form
B) Offer and acceptance, consideration, legal object, legal capacity, and catastrophic loss
C) Offer and acceptance, consideration, legal object, accidental loss, and legal form
D) Offer and acceptance, consideration, legal object, legal capacity, and legal form
D) Offer and acceptance, consideration, legal object, legal capacity, and legal form
Explanation: The five elements of an insurable contract are offer and acceptance, consideration, legal object, legal capacity, and legal form.
Your client, Margarita, had an upstairs window of her home broken by hail. She reported the claim, and for the two weeks following the storm, the weather had been quite nice. She rarely went into the room with the broken window and did nothing to cover the opening. During the third week following the incident, there was a severe rainstorm, and water came into the opening, damaging the floor of the room with the broken window and the ceiling of the room beneath it. On what grounds could the insurance company refuse to pay for the damaged floor and ceiling?
A) Margarita waived her right to collect for damages.
B) Margarita failed to protect the property when she had adequate time to do so.
C) Margarita is estopped from collecting for damages.
D) Margarita failed to provide assistance and to cooperate with the insurance company.
B) Margarita failed to protect the property when she had adequate time to do so.
Explanation: The insurance company will pay for the broken window and any other damage from the hail storm, but could deny the claim for the damaged floor and ceiling since Margarita failed to protect the property when she had ample time to do so.
Debbie recently lost one of her diamond earrings, and she filed an insurance claim. Which of the following is NOT an option for the insurer?
A) Pay the difference between the actual cash value of the earrings before and after the loss
B) Require Debbie to surrender the remaining earring before receiving a check
C) Replace both earrings
D) Replace the lost earring
B) Require Debbie to surrender the remaining earring before receiving a check
Explanation: The answer is require Debbie to surrender the remaining earring before receiving a check. Options available to the insurer to settle a claim like this include replacing both earrings, replacing just the lost earring, or simpy issuing a check for an amount equal to the value of the lost earring. The insurance company can ask but cannot require Debbie to surrender the other earring. It can reduce the settlement amount by the salvage value of the single earring if she does not surrender it.
Which of the following is the CORRECT definition of the term adverse selection?
A) The tendency of persons with the lowest risk of loss to also be the most likely to purchase insurance, thereby causing the insurer the greatest cost in terms of claims
B) The tendency of persons with the highest risk of loss to also be the most likely to purchase insurance, thereby causing the insurer the greatest profit
C) The tendency of persons with the lowest risk of loss to also be the most likely to purchase insurance, thereby causing the insurer the greatest profit
D) The tendency of persons with the highest risk of loss to also be the most likely to purchase insurance, thereby causing the insurer the greatest cost in terms of claims
D) The tendency of persons with the highest risk of loss to also be the most likely to purchase insurance, thereby causing the insurer the greatest cost in terms of claims
Explanation: The answer is the tendency of persons with the highest risk of loss to also be the most likely to purchase insurance, thereby causing the insurer the greatest cost in terms of claims. Adverse selection is the tendency for those most likely to incur losses to seek insurance.
Which of the following are important when selecting an insurance producer?
I. Experience
II. Training
III. Education
IV. Production awards earned
A) I, II, III, and IV
B) II and III
C) IV only
D) I, II, and III
D) I, II, and III
Explanation: The answer is I, II, and III. Options I, II, and III, along with competence, inclination to service, specialization, and a good reputation, are important when selecting an insurance producer. The production awards earned are an indication of sales ability, but not necessarily what should be sought in an insurance producer.
