Fundamentals of Risk and Insurance, 11th Edition Test Bank

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SECTION CMULTIPLE-CHOICE QUESTIONS

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Section C - 2Multiple Choice QuestionsChapter 11.The term "hazard" refers to(a)the same thing as the term peril.(b)a condition that increases the chance of loss.(c)uncertainty regarding loss.(d)the same thing as probability of loss.2.From the viewpoint of society and the economy, the most desirable means of dealing with risk is(a)transfer.(b)retention.(c)loss prevention.(d)sharing.3.Hazards are usually classified into three categories. They are:(a)perils, risks, and uncertainties.(b)physical, mental, and moral.(c)moral, morale, and physical.(d)personal, property, and liability.4.To be technically correct, we should define "fire" as(a)a peril.(b)a hazard.(c)a risk.(d)any of the above is equally correct.5.Pure risk is characterized by(a)a chance of loss and a chance of gain.(b)a chance of loss or no loss only.(c)the chance of gain or no loss only.(d)none of the above.6.The distinction between fundamental and particular risks is important because(a)normally only particular risks are insurable.(b)whether a risk is fundamental or particular may determine how society will deal with it.(c)fundamental risks are a source of gain to society.(d)none of the above.7.The possibility of loss resulting from a flood is an example of(a)a static fundamental risk.(b)a dynamic fundamental risk.(c)a static particular risk.(d)a dynamic particular risk.8.Unemployment would generally be considered to be(a)a static fundamental risk.(b)a dynamic fundamental risk.(c)a static particular risk.(d)a dynamic particular risk.

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Section C - 39.The definition of "risk" suggested in the text views risk as(a)a condition of the real world.(b)a state of mind.(c)subjective uncertainty.(d)none of the above.10.A peril, as distinguished from a hazard, is defined as(a)a condition that increases the likelihood of loss.(b)the cause of a loss.(c)the same thing as risk.(d)none of the above.11.A business firm with an inventory of obsolete stock and high notes payable might represent(a)a moral hazard.(b)a morale hazard.(c)a legal hazard.(d)none of the above.12.Pure risks are generally classified as(a)physical risks, moral risks, and morale risks.(b)fundamental risks, dynamic risks, and particular risks.(c)speculative risks, enterprise risks, and financial risks.(d)personal risks, property risks, liability risks, and risks arising out of the failure of others.13.Because she knows she has insurance to cover losses from theft, Jones rarely locks the door to herhouse. Her behavior is an example of(a)moral hazard.(b)morale hazard.(c)physical hazard.(d)none of the above.14.A fire caused $50,000 damage to Smith’s house, and the family was forced to spent $10,000 tolivein rented housing while it was being repaired. Which of the following best describes Smith’s loss?(a)direct property loss of $60,000(b)direct property loss of $50,000, uninsured loss of $10,000(c)direct property loss of $50,000, indirect property loss of $10,000(d)direct property loss of $50,000, liability loss of $10,000

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Section C - 415.In property insurance terminology, all the following are considered hazards except:(a)a fire which is started in a waste paper basket.(b)a steam iron left on unattended.(c)matches left within reach of small children.(d)oily rags stored near a heater.16.Pure risk is considered distasteful by most persons because(a)it can be a source of worry and concern.(b)there is nothing you can do about it.(c)most pure risks result in losses.(d)none of the above.17.The terrorist attack on the World Trade Center on September 11, 2001 led to a debate over whethersuch risks are(a)dynamic or static.(b)pure or speculative.(c)fundamental or particular.(d)none of the above.18.The hazard that reflects the tendency in some jurisdictions for judges and juries to favor a plaintiff inlitigation is properly classified as(a)a moral hazard.(b)a morale hazard.(c)a legal hazard.(d)none of the above.19.Classify the following as pure or speculative risk:(1) Change in market price for Farmer Smith’s crops(2) Change in consumer demand for ABC’s products(3) Collision damage to Jones’ care(a)(1) speculative, (2) pure, (3) pure(b)(1) speculative, (2) speculative, (3) pure(c)(1) pure, (2) speculative, (3) pure(d)none of the above20.According to the FBI, the fastest growing form of white collar crime is.(a)substance abuse.(b)arson.(c)identify theft.(d)insurance fraud.

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Section C - 5Multiple Choice QuestionsChapter 21.Traditional risk management is concerned primarily with(a)dynamic risks.(b)pure risks.(c)fundamental risks.(d)speculative risks.2.The evolution of risk management is traceable to(a)the introduction of decision theory in business college curricula.(b)systems safety in the aerospace program.(c)the field of corporate insurance buying.(d)all of the above.3.Traditional risk management(a)is synonymous with corporate insurance buying.(b)draws on several other disciplines but is a distinct discipline and function.(c)is somewhat narrower in scope than insurance management.(d)more than one of the above.4.The termenterprise risk managementrefers to(a)management of risks related to derivatives and futures.(b)management of financial risks(c)integrated management of a firm’s pure and speculative risks.(d)management of risks for profit-making organizations.5.The risk that a firm’s IT systems will fail is an example of(a)credit risk.(b)operational risk.(c)strategic risk.(d)compliance risk.6.Financial risk management encompasses management of(a)operational risk, strategic risk, and credit risk(b)credit risk, market risk, and liquidity risk(c)compliance risk, credit risk, and strategic risk(d)pure risk, speculative risk, and strategic risk7.Henri Fayol’s place in the history of risk management arises from(a)his introduction of the term “risk management.”(b)his work in the field of systems safety.(c)his work in the field of operations research.(d)his recognition of risk management as one of six broad functions of business.8.Which of the following techniques for dealing with risk may be said to represent a special variation ofother techniques?(a)reduction.(b)sharing.(c)transfer.(d)retention.

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Section C - 69.Risk management contributes to organization profit(a)by reducing the cost of losses.(b)by allowing the organization to engage in certain speculative risks.(c)by preserving the organization’s operating effectiveness.(d)all of the above.10.Involuntary retention occurs when(a)the risk is not recognized.(b)insurance does not cover the intended exposure.(c)loss control measures are improperly implemented.(d)all of the above.11.Risk avoidance should be used in those instances in which(a)no other alternative is available.(b)the exposure has catastrophic potential and the risk cannot be reduced or transferred.(c)when the frequency of loss is low.(d)when the probability or frequency cannot be determined.12.As it exists today, risk management represents the merging of the specialties(a)insurance, actuarial science, and decision theory.(b)loss prevention, loss control and loss financing.(c)decision theory, risk financing, and risk control.(d)Intuitive decisions, conventions, and instinctive reactions.13.The type of retention that is always undesirable is(a)unfunded retention.(b)unintentional retention.(c)voluntary retention.(d)all forms of retention are undesirable.14.The two broad approaches to dealing with risk are(a)risk retention and risk transfer.(b)risk avoidance and risk transfer.(c)risk control and risk financing.(d)insurance management and risk management.15.Which of the following statements about risk management is correct?(a)risk management has relevance for organizations of all sizes.(b)risk management has an anti-insurance bias and seeks to minimize the use of insurance indealing with risk.(c)risk management is concerned primarily with the risk problems of giant corporations.(d)risk management is a function of business and as such has little relevance for the individual.16.The two most important of the pre-loss and post-loss objectives are(a)meeting social responsibility and meeting external obligations.(b)continued growth and earning stability.(c)survival and economy.(d)earning stability and reduction in anxiety.

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Section C - 717.The step in the risk management process that is most likely to be overlooked is(a)determination of objectives.(b)risk identification.(c)evaluating risks.(d)selection of the risk treatment device.18.The most difficult step in the risk management process is likely to be(a)determination of objectives.(b)risk identification.(c)evaluating risks.(d)selection of the risk treatment device.19.A risk management policy statement(a)provides a framework within which the risk manager may make decisions.(b)should permit the risk manager some latitude.(c)should be a product of the board of directors with advice from the risk manager.(d)all of the above.20.The ultimate goal of risk management is to(a)minimize insurance expenditures.(b)make certain that uninsured losses do not occur.(c)minimize the adverse effects of losses and uncertainty connected with risks.(d)eliminate financial loss.

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Section C - 8Multiple Choice QuestionsChapter 31.From the insured's perspective, the purchase of insurance is an example of(a)avoidance.(b)retention.(c)transfer.(d)combination.2.From the insurer's perspective, the operation of the insurance mechanism is an example of(a)avoidance.(b)retention.(c)transfer.(d)combination.3.Although insurance may be defined in various ways, the two fundamental characteristics of theinsurance mechanism are(a)premiums and policies.(b)transfer and sharing.(c)combination and sharing.(d)loss prevention and transfer.4.Probability may be defined as(a)a measure of the likelihood of an occurrence.(b)a measure of the degree of uncertainty.(d)the number of losses that occur annually.(e)all of the above.5.The four elements of an insurable risk(a)require that the probability of loss be known.(b)include the requirement of economic feasibility.(c)must be present or the exposure cannot be insured.(d)are desirable, but some insurable risks do not possess them.6.Property insurance policies typically exclude coverage for losses caused by war. This is becausea)the courts have defined the term war broadly.(b)losses from war are potentially catastrophic.(c)insuring war creates an adverse selection problem.(d)none of the above7.There are two basic approaches to the interpretation of probability. In insurance we are primarilyconcerned with(a)the subjective interpretation.(b)the a priori interpretation.(c)the relative frequency interpretation.(d)the Bayesian interpretation.8.According to the law of large numbers, as the number of exposure units is increased(a)the chance of loss declines.(b)the chance or probability of loss increases.(c)the accuracy of predictions should be better.(d)the accuracy of predictions should remain about the same.

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Section C - 99.Adverse selection is a term used to describe(a)the choice of the wrong insurance to fit a specific need.(b)an underwriting error on the part of an insurance company.(c)the tendency of the poorer than average risks to seek insurance to a greater extent than do thebetter than average risks.(d)a loss situation in which the chance of loss cannot be determined.10.An insurer insures 1000 houses, with 10 expected losses and a standard deviation of 2. Otherthings being equal, the insurer may be 99% certain that the number of losses will be(a)10.(b)between 7 and 13.(c)between 4 and 16.(d)between 0 and 22.11.Adverse selection(a)is generally considered to be unavoidable.(b)affects the accuracy of insurer's predictions.(c)creates a random pattern of insured exposures.(d)has little effect on the operation of the insurance mechanism.12.The combination of a large number of exposure units by an insurer is important for the operation ofinsurance because:(a)it allows the insurer to make accurate predictions.(b)it spreads losses among the members of the group.(c)it makes the insurer's aggregate risk less than a summation of the risks of the individuals.(d)all of the above.13.The term "self-insurance"(a)semantically represents a definitional impossibility.(b)has become a well-established part of insurance terminology.(c)is a convenient way of distinguishing retention programs that utilize insurance techniques fromthose that do not.(d)all of the above.14.For the insurance company, a meaningful measure of risk is(a)the probability that a loss will or will not occur.(b)the possible deviation of actual from predicted results.(c)the relationship of premium to average loss.(d)none of the above.15.The surety company issuing a bond to a principal(a)performs what is essentially an insurance function.(b)promises to indemnify the principal against loss.(c)is similar in many respects to the co-signer of a note.(d)none of the above.16.The three broad general classes into which the types of insurance may be classified are(a)social insurance, private insurance, and public welfare.(b)social insurance, private insurance, and public guarantee programs.(c)social insurance, life insurance, and property and liability insurance.(d)life insurance, social insurance, and property and casualty insurance.

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Section C - 1017.The type of insurance that is characterized by individual equity and contractual arrangements isgenerally referred to as(a)social insurance.(b)private insurance.(c)public guarantee insurance programs.(d)public welfare insurance.18.Insurance which is required by law(a)is classified as a social insurance coverage.(b)is classified as a compulsory-private insurance coverage.(c)may be social or private, depending on other characteristics.(d)is usually classified as a public guarantee program.19.Social insurance is distinguished from private or voluntary insurance primarily in that social insurance(a)is provided by the government.(b)is compulsory.(c)attempts to redistribute income in favor of certain classes and is usually compulsory.(d)is financed primarily out of the government's general revenues.20.The insurance mechanism operated by the Federal Deposit Insurance Corporation(a)is not really insurance in the true sense of the term.(b)is a private insurance program sold by a government agency.(c)is a public guarantee insurance program.(d)is a social insurance program.

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Section C - 11Multiple Choice QuestionsChapter 41.Retention is the most appropriate treatment for a risk in which there is(a)a low probability and a high potential severity of loss.(b)a low probability and low potential severity of loss.(c)a high probability and high potential loss severity.(d)none of the above.2.The primary consideration in deciding how to deal with a particular risk is(a)the potential loss severity and one's ability to bear it.(b)the probability that the loss will occur.(c)the expected value of the loss.(d)the cost of insurance.3.There are three basic rules of risk management proposed in the text. The first and most important ofthese is(a)insure bigger risks, prevent the smaller ones.(b)don't risk more than you can afford to lose.(c)consider the odds.(d)don't risk a lot for a little.4.The risks most suited to treatment by insurance are those in which there is(a)a high probability and a low potential severity.(b)a low probability and a high potential severity.(c)a high probability and a high potential severity.(d)a low probability and a low potential severity.5.Those risks most suited to treatment by loss prevention are those in which(a)the probability is low and the potential severity is high.(b)the probability and severity are both low.(c)the probability and severity are both high.(d)the probability is low and the potential severity is moderate.6.With respect to the purchase of insurance, the rule "consider the odds" suggests that one should(a)preserve premium dollars for exposures with a high probability of loss.(b)insure against losses that are most likely to occur.(c)protect against losses in which the probability is high first.(d)avoid trading dollars with insurers.7.The decision to select risk reduction such as loss prevention and control techniques in preference tosome other technique(a)is usually the cheapest way to deal with risk.(b)follows the same principles as the choice of other techniques.(c)is sometimes dictated by consideration other than benefits and costs.(d)will always be cost-effective in the long run.

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Section C - 128.A $250,000 building has a .10 probability of being destroyed completely, and there are no partiallosses. The premium to insure the building is $30,000. Complete the decision matrix below toreflect the cost for each decision under each state. What are the values of X and Y?StateDecisionNo LossLossInsureXRetainY(a)X =−$3,000, Y =−$25,000(b)X =−$30,000, Y =−$250,000(c)X =−$30,000, Y =−$25,000(d)None of the above9.A $250,000 building has a .10 probability of being destroyed completely, and there are no partiallosses. The premium to insure the building is $30,000. Which of the following is true?(a)The expected cost of retention is $250,000, and the expected cost of insurance is $30,000.(b)The expected cost of retention is $25,000, and the expected cost of insurance is $30,000.(c)The expected cost of retention is $25,000, and the expected cost of insurance is $3,000.(d)None of the above10.One of the implications of Pascal’s Wager for risk management is that(a)the probability of an event is the most important factor to be considered.(b)decisions related to uncertainty require some notion of probability.(c)the magnitude of the potential loss is an important consideration.(d)the minimax regret strategy has little, if any, theoretical justification.11.The expected value strategy is appropriate(a)when the probability of loss is unknown.(b)when the potential loss severity is unknown.(c)when the potential loss is within an acceptable range.(d)when the potential loss is catastrophic.12.In selecting an insurer, the major consideration should be(a)the company's attitude toward claims.(b)the cost of the company's products.(c)financial stability.(d)competence of the company's agents.13.Risk retention(a)is often combined with risk transfer and risk control measures.(b)is often combined with risk avoidance.(c)is generally the lowest cost approach to dealing with risk.(d)is generally the highest cost approach to dealing with risk.

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Section C - 1314.The cost of financing risk(a)is the cost of retained losses.(b)is the combined cost of retained losses and risk control measures.(c)is not quantifiable.(d)is often measured in terms of opportunity cost.15.The most appealing feature of self-insurance is(a)the favorable tax treatment of self-insurance reserves.(b)the potential saving of insurer administrative costs and premium taxes.(c)the elimination of insurer charges for handling claims.(d)that fact that losses are decreasing.16.The type of captive for which the deduction of payments by the parent is most likely to be disallowedby the Internal Revenue Service is(a)an association captive.(b)a trade association insurance company (TAIC).(c)a pure captive.(d)a risk retention group.17.Risk retention groups(a)are regulated by the federal government.(b)are subject to the same regulatory standards as other insurers.(c)are exempt from state regulation.(d)are not covered by state insolvency funds.18.Insurance purchasing groups authorized by the Risk Retention Act of 1986(a)are also referred to as risk retention groups.(b)are prohibited from operating in states that prohibit group liability insurance.(c)are risk bearing organizations that purchase insurance for members and also bear part of therisk of the members.(d)none of the above.19.Self-insurance may be cheaper for some organizations than commercial insurance in the long-runbecause(a)self-insurance avoids certain expenses associated with the traditional commercial insurancemarket.(b)the organization’s loss experience may be better than the average experience on whichcommercial insurance rates are based.(c)self-insurers can avoid the “social load” that results from statutory mandates.(d)all of the above.20.The most important factors in selecting an insurance company, in order of importance are:(a)financial stability, treatment of policyholders, and cost.(b)cost, financial stability, and treatment of policyholders.(c)agent, cost, and financial stability(d)treatment of policyholders, cost, and agent.

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Section C - 14Multiple Choice QuestionsChapter 51.Lloyd's of London(a)is the parent company of the so-called American Lloyds.(b)is a mutual insurance company.(c)is a capital stock insurance company.(d)is similar in its operation to the New York Stock Exchange.2.The type of insurance company in which insureds are also insurers, and in which the members of thegroup assume liability for losses individually rather than collectively is(a)a reciprocal.(b)a pure assessment mutual.(c)any mutual insurer.(d)Lloyd's of London.3.A major difference between stock and mutual insurers is:(a)stock insurers are incorporated and mutual insurers are not.(b)mutual insurers are not taxed, while stock insurers pay tax.(c)stock insurers are owned by their stockholders, while mutual insurers are owned by theirpolicyholders.(d)stock insurers pay dividends to policyholders and mutual insurers do not.4.The oldest of the modern fields of insurance is probably(a)fire insurance.(b)life insurance.(c)casualty insurance.(d)marine insurance.5.The distinguishing features of the reciprocal exchange include(a)the fact that it is incorporated.(b)unlimited liability of the members.(c)the attorney-in-fact.(d)a higher than average rate for the insurance it sells.6.A fraternal insurer is(a)a type of capital stock company.(b)a type of reciprocal exchange.(c)a type of mutual insurer.(d)it may be any of the above.7.Advisory organizations or rating bureaus(a)are more common in life insurance than in property and liability insurance.(b)establish rates to which all member companies must adhere.(c)were made illegal by the McCarran Ferguson Act.(d)collect loss statistics from member companies to use in the development of advisory loss costsor advisory rates.8.Brokers differ from insurance agents in that(a)brokers are compensated by their clients on a fee basis, while agents receive a commissionfrom the company.(b)brokers are not agents of the company, and therefore cannot bind the company.(c)brokers operate primarily in the life insurance field, while agents operate in both the lifeinsurance field and the property and liability field.(d)agents may bind a company orally, while brokers have the authority to bind only in writing.

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Section C - 159.The traditional disadvantages of the mutual insurance structure that have become more apparent inrecent years include the fact that(a)mutual insurers have limited mechanisms for accessing capital.(b)the structure of mutual insurers is not particularly flexible.(c)mutuals cannot use stock to acquire other companies.(d)all of the above.10.Multiple line operation(a)has been the dominant form of operation in the American insurance industry since about thetime of the civil war.(b)involves the combination of property insurance, liability insurance, life insurance, and healthinsurance by a single insurance company.(c)was retarded primarily by the reluctance of insurance companies to engage in such operations.(d)extends the concept of diversification to the insurance field, permitting the combination ofproperty and liability insurance by a single company.11.The distribution system which places great emphasis on the "ownership of renewals" is referred to as(a)the brokerage system.(b)the direct writing system.(c)the captive agent system.(d)the American Agency or independent agency system.12.Underwriting syndicates are formed by insurance companies(a)to deal with large concentrations of value.(b)to eliminate competition for better classes of business.(c)to operate as cartels, dividing the market according to a plan.(d)to provide subsidized insurance to groups of applicants who cannot afford the aggregate lossesof the group.13. Insurance company “fleets” or groups(a)collectively write an insignificant share of total premiums in this country.(b)refer to the ocean marine segment of the insurance market.(c)may include life insurers and property and liability insurers.(d)all of the above.14.Which of the following is not true with respect to the property and liability insurance industry?(a)there are few barriers to entry by new competitors.(b)competition has produced changes in market share of competitors over time.(c)the business is highly cyclical.(d)profits have consistently been above those in other industries.15.Price competition in the insurance industry(a)occurs primarily at the insurer level where prices are set.(b)occurs at the agency level through the selection of insurers.(c)is sometimes based on the selectivity an insurer exercises.(d)All of the above.16.Except in the states of Illinois and Kentucky, Lloyds of London would be classified as(a)an admitted foreign company.(b)an admitted alien company.(c)a nonadmitted foreign company.(d)a nonadmitted alien company.

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