Name_________________________________________

FIN342 Risk Management and Insurance

MIDTERM #1
Spring 2012
Dr. Vickie Bajtelsmit
Be sure to indicate all your answers clearly in the space provided. The test is closed book, closed
notes. In some cases you are allowed to choose among certain questions. NO EXTRA CREDIT
will be given for answering more than the number of questions allowed. Please note the point
values on each question and allocate your time accordingly. Be sure to allow time for answering
the essay section.
.
Honor Statement
All the answers that I have given on this exam are my own work product.
Signature_______________________________________________

I.
II.
III.
IV.

Multiple Choice
Matching
Short Answers
Essay

TOTAL

(40)
(14)
(28)
(18)

_______

100

_______

_______
_______

I. Multiple Choice (40 points total, 2 points each): Indicate in the space provided the best answer for each
question or the answer that best completes the sentence. If you think that any of the multiple choice questions are
unduly ambiguous or that there is not a correct answer to the questions, put an asterix (*) next to the question and
write an explanation for your answer.
_____1. Which of the following is NOT a pure risk?
A. hail damage to a roof
B. employee injured lifting heavy boxes
C. lost revenue due to recession
D. fire damage to store inventory in a warehouse
_____2. Which of the following is an example of a direct loss for a family that sustained damages to their home in
one of the recent wildfires in Colorado?
A. cost of laundering clothes to remove smoky smell
B. cost of staying in a hotel while their home is being repaired
C. lost profits from temporary shutdown of their home business
D. All of the above are direct losses
_____3. What is the primary rationale for strict state regulation of insurance prices?
A. To allow insurers can make sufficient profit
B. To reduce overly competitive price competition
C. To protect consumers from excessive prices
D. To ensure availability of insurance in the state.
_____4. The overall objective of risk management in for profit corporations is:
A. diversification
B. minimizing expenses
C. shareholder value maximization
D. loss control
_____5. If you fail to identify a potential risk and therefore do not take action to manage it, what method of risk
management have you implicitly chosen?
A. none, because you havent taken any action to manage the risk
B. avoidance
C. loss control
D. retention
_____6. What type of risk management method is most appropriate for low frequency, high severity losses?
A. insurance
B. avoidance
C. retention
D. prevention
_____7. In the property and casualty insurance market, when insurance is readily available at reasonable prices, the
market is said to be:
A. Soft
B. Hard
C. Cyclical
D. Profitable

_____8. If you live in a fire-prone region and you have cleared away all the trees and brush that are near your home,
what method of risk management have you chosen?
A. avoidance
B. prevention
C. reduction
D. transfer
_____9. When a life insurance agent is allowed to secure coverage for an insured, subject to the results of a medical
exam, but effective on the date of the application, this is called:
A. adhesion
B. binder
C. conditional binder
D. subrogation
_____10. If you want to have property insurance coverage for your $20,000 wedding ring, you must:
A. buy a separate policy for the ring
B. pay additional premium for a rider on your homeowners policy
C. agree to a higher deductible
D. buy it from Lloyds of London
_____11. Your health insurance requires that you pay 20% of all of your medical costs. This is called:
A. deductible
B. coinsurance
C. contributory
D. indemnity
_____12. The combined ratio measures:
A. return on investment for insurance company stockholders
B. the extent to which premiums are enough to cover losses, expenses, and profit
C. underwriting profits for insurers
D. the combined effect of frequency and severity
_____13. Which type of insurance agent can provide clients with the widest selection of insurance product to meets
their needs?
A. direct writer
B. exclusive agent
C. independent agent
D. general agent
_____14. Mutual insurance companies are:
A. financed primarily by sale of bonds
B. owned by policyholders
C. usually smaller that stock companies
D. all of the above

_____15. Accurate risk classification by insurers reduces the impact of:

A. moral hazard
B. adverse selection
C. both moral hazard and adverse selection
_____16. Deductibles and coinsurance are methods used by insurers to reduce the impact of:
A. moral hazard
B. adverse selection
C. both moral hazard and adverse selection
_____17. If an applicant for health insurance lies about his medical history in order to obtain insurance, the insurer
can later void the contract ONLY IF
A. the policyholder makes claims related to the undisclosed prior condition
B. it conducts a reasonable investigation and determines that it would not have issued the policy if it had known the
true medical history
C it conducts a reasonable investigation within the time allowed in the policy, usually one or two years, and
determines that it was a material misrepresentation
D. none of the above. If the policy has been issued, its too late for the insurer to protest because it could have
investigated beforehand and chose not to.
_____18. Insurance policies commonly exclude specific perils or specific property. Which of the following is NOT
one of the reasons for exclusions in insurance contracts?
A. Keep premium costs down for policyholders who do not want or need to cover the excluded perils.
B. Make more profit.
C. Some perils are considered uninsurable
D. Coverage can be better provided by other contracts
_____19. Which of the following is a reason for the inclusion of deductibles in insurance contracts?
A. eliminate small claims
B. reduce premiums
C. reduce moral hazard
D. all of the above
_____20. If an insurance buyer has intentionally concealed information from the insurer, the legal remedy in most
states is that:
A. the policyholder can be sued for bad faith
B. the insurer can void the contract
C. the insured can be charged with criminal fraud

II. Insurance Terminology Matching (14 points total, 2 points each) Indicate the letter
corresponding with the best answer from the list of terms below to best complete the sentence.
Letter
correspondin
g to correct
term
1.
2.
3.
4.
5.
6.
7.

Definitions

The insurance principal that an insurer will pay no more than the actual loss
suffered.
Insurance policies are this type of contact because applicants cannot negotiate
terms, but rather must accept or reject a standard written contract.
Life insurance contracts are this type of contract because they pay a stated
amount when death occurs.
A clause in a property insurance policy that requires a policyholder to carry
insurance equaling a certain percentage (such as 80%) of his propertys value.
A clause in an insurance contract that gives an insurer to right to stand in place
of the insured for the purpose of claiming an indemnity from a third party for a
loss covered by insurance.
The standard insurers are held to in dealings with their policyholders. Violation
of this standard can result in large jury verdicts against an insurer.
The selection, risk classification, and pricing of applicants for insurance.

Choose from the following:

a. Adhesion
b. Binder
c. Coinsurance
d. Deductible
e. Indemnity
f. Insurable interest
g. Subrogation
h. Underwriting
i. Valued
j. Good faith

II. Short Answer. (28 points total, individual point values as indicated)In the space
provided, briefly answer each of the following questions. Be sure to answer all the parts of each
question.
1. (8 points total) In addition to expected claims costs, insurers consider several other factors in
determining a fair insurance premium to charge. Identify each of these factors. For each,
indicate whether it will increase or decrease the premium (+/-), all else equal.
a.

b.

c.

d.

2. (8 points) Identify and give an example of four (4) of the components of the cost of risk for a
large restaurant chain such as Texas Roadhouse.
a.

b.

c.

d.

3. (12 points total) You are the owner/manager of a business that is deciding whether to insure
or retain your workers comp risk. You have enough information on past claims to know that
your expected total claims cost per year is $10,000 and the standard deviation of claims cost per
year is $5,000.
Explain how the insurers expected loss and risk will be different from yours if they have a pool
of 100 policyholder firms that have identical loss distributions to your own? (Partial credit for
correct relative answer (increase/decrease/same); full credit for the correct numerical answer.)
a) insurers total losses for the pool?

b) insurers loss per exposure unit?

c) standard deviation of total losses for the pool?

d) standard deviation of loss per exposure unit?

IV. Essay: (18 points total) In a brief, well-organized, and legible essay, answer only one of the
following questions in the space provided on this page (continuing on the back as necessary).
1. Explain the requirements of an insurable risk and apply them to answer the following
questions:
a. Why are pure risks usually insurable but speculative risks are not?
b. Why are losses from natural disasters sometimes difficult to insure even though they
are pure risks?
2. Explain how Lloyds of London differs from stock and mutual insurance companies on each of
the following dimensions:
a. ownership structure
b. types of insurance underwritten
c. source of capital
d. where it sells insurance