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Appendix A Risk Management and Insurance

TRUE/FALSE 1. In the context of insurance, risk is defined as the uncertainty of injury or loss. ANS: T 2. DIFF: 1 PAGE: A-2 TYPE: KN

All pure risks are insurable. ANS: T DIFF: 1 PAGE: A-2 TYPE: KN

3.

Gambling is a form of pure risk. ANS: F DIFF: 1 PAGE: A-2 TYPE: KN

4.

In the case of speculative risk there is a chance of either a profit or loss. ANS: T DIFF: 1 PAGE: A-2 TYPE: KN

5.

Insurance can be purchased only to protect an individual or business from speculative risk. ANS: F DIFF: 1 PAGE: A-3 TYPE: KN

6.

While it is difficult, it is possible for a business or individual to avoid all of the risks they face. ANS: F DIFF: 1 PAGE: A-3 TYPE: KN

7.

Installing an automatic sprinkler system in an office building is a way for a firm to reduce risk. ANS: T DIFF: 2 PAGE: A-3 TYPE: AP

8.

Raising the deductibles on auto and homeowners insurance are examples of how to reduce risk. ANS: F DIFF: 2 PAGE: A-3 TYPE: AP

9.

One of the most common forms of self-insurance is in the area of employer-provider health insurance. ANS: T DIFF: 1 PAGE: A-4 TYPE: KN

10.

Insurance is one way of transferring risk.

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Appendix A

ANS: T 11.

DIFF: 1

PAGE: A-4

TYPE: KN

What an insurance company earns on its reserves has little impact on either insurance premiums or company profits. ANS: F DIFF: 1 PAGE: A-4 TYPE: KN

12.

Insurance premiums are designed to cover losses, pay the insurance companys operating expenses, and help build up reserves. ANS: T DIFF: 1 PAGE: A-4 TYPE: KN

13.

In order to buy insurance, you have to demonstrate that you stand to suffer some sort of a loss. This concept is known as insurable risk. ANS: F DIFF: 1 PAGE: A-4 TYPE: KN

14.

Your neighbor probably doesnt have an insurable interest in your home. ANS: T DIFF: 1 PAGE: A-4 TYPE: KN

15.

In order for a risk to be insurable, losses have to be predictable. ANS: T DIFF: 1 PAGE: A-5 TYPE: KN

16.

In order for the insurer to provide protection at a cheaper rate, the risk should be spread over a narrow geographical area in order to provide ease of risk assessment. ANS: F DIFF: 1 PAGE: A-5 TYPE: KN

17.

The law of large numbers is a concept that states that seemingly random events will follow a predictable pattern if enough events are observed. ANS: T DIFF: 1 PAGE: A-5 TYPE: KN

18.

The use of mortality tables in setting life insurance rates is an example of the law of large numbers in action. ANS: T DIFF: 1 PAGE: A-5 TYPE: KN

19.

Losses dont have to be financially measurable in order to be insurable. ANS: F DIFF: 1 PAGE: A-5 TYPE: KN

20.

Some losses are easier for insurance companies to predict than others. ANS: T DIFF: 1 PAGE: A-6 TYPE: KN

21.

Life insurance companies have a more difficult time predicting losses than do property and liability insurance companies.

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Risk Management and Insurance

ANS: F 22.

DIFF: 1

PAGE: A-6

TYPE: KN

Unemployment insurance benefits are set by the federal government and vary little from state to state. ANS: F DIFF: 1 PAGE: A-6 TYPE: KN

23.

Public insurance programs include Social Security and Medicare. ANS: T DIFF: 1 PAGE: A-6 TYPE: KN

24.

Unemployment insurance programs are funded through general tax revenues. ANS: F DIFF: 1 PAGE: A-7 TYPE: KN

25.

Virtually all workers in the United States are eligible for Social Security benefits. ANS: T DIFF: 1 PAGE: A-7 TYPE: KN

26.

All private insurance companies are now stockholder owned and, therefore, are run like any other business. ANS: F DIFF: 1 PAGE: A-7 TYPE: KN

27.

One basic principle of buying insurance is to protect against large losses, not small ones. ANS: T DIFF: 1 PAGE: A-8 TYPE: KN

28.

It is usually less expensive to buy several narrow insurance policies than one broad policy. ANS: F DIFF: 1 PAGE: A-8 TYPE: KN

29.

Americans spend more on auto insurance each year than they do on any other type of property and liability insurance. ANS: T DIFF: 1 PAGE: A-8 TYPE: KN

30.

Standard homeowners insurance policies cover losses due to earthquakes, but not due to floods. ANS: F DIFF: 1 PAGE: A-8 TYPE: KN

31.

Flood insurance is offered as a supplement to a standard homeowners policy by many states. ANS: F DIFF: 1 PAGE: A-8 TYPE: KN

32.

Most states require that drivers carry a minimum amount of auto insurance.

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Appendix A

ANS: T 33.

DIFF: 1

PAGE: A-8

TYPE: KN

If a driver runs a red light and hits another car. The drivers liability coverage would pay to repair the other car. ANS: T DIFF: 1 PAGE: A-8 TYPE: KN

34.

Liability coverage is usually attached to auto insurance policies. Homeowners and businesses have to purchase liability coverage separately. ANS: F DIFF: 1 PAGE: A-9 TYPE: KN

35.

The majority of Americans are covered by private group health insurance, most of which is provided by their employers. ANS: T DIFF: 1 PAGE: A-9 TYPE: KN

36.

Private individual health insurance policies are more affordable than group policies for those under age 40. ANS: F DIFF: 1 PAGE: A-9 TYPE: KN

37.

While managed care plans are growing rapidly, most people are still covered by fee-forservice health insurance plans. ANS: F DIFF: 1 PAGE: A-9 TYPE: KN

38.

Health maintenance organizations (HMOs)dont really provide health insurance, they provide health care. ANS: T DIFF: 1 PAGE: A-9 TYPE: KN

39.

A preferred provider organization (PPO) is generally a more flexible health insurance plan than is a heath maintenance organization (HMO). ANS: T DIFF: 1 PAGE: A-10 TYPE: KN

40.

Social Security provides disability benefits that are generally sufficient for most workers. ANS: F DIFF: 1 PAGE: A-10 TYPE: KN

41.

The odds of a worker developing a disability between now and when he or she retires are much higher than the odds of that same worker dying before he or she retires. ANS: T DIFF: 1 PAGE: A-10 TYPE: KN

42.

Everyone needs some life insurance protection. ANS: F DIFF: 1 PAGE: A-11 TYPE: KN

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Risk Management and Insurance

43.

A term life insurance policy provides death benefits along with some sort of a savings feature. ANS: F DIFF: 1 PAGE: A-11 TYPE: KN

44.

Term life insurance policies are cheaper than other types of life insurance policies. ANS: T DIFF: 1 PAGE: A-11 TYPE: KN

45.

Few companies take out life insurance policies on senior executives due to a lack of an insurable interest. ANS: F DIFF: 1 PAGE: A-11 TYPE: KN

MULTIPLE CHOICE 46. An example of speculative risk is ____________. a. building a home in a tornado prone area b. betting on a horse running in the Kentucky Derby c. the possibility of developing heart disease d. driving your car in downtown Chicago ANS: b 47. DIFF: 2 PAGE: A-2 TYPE: AP

Investing in the stock of a dot.com company is an example of ____________. a. speculative risk b. pure risk c. insurable risk d. transferable risk ANS: a DIFF: 2 PAGE: A-2 TYPE: AP

48.

Which of the following is an example of pure risk? a. Quitting your job and going to business school. b. Investing in Wal-Marts stock. c. Playing blackjack in a Las Vegas casino. d. Developing cancer. ANS: d DIFF: 1 PAGE: A-2 TYPE: KN

49.

You can purchase insurance to protect against ______________. a. all pure risks b. all speculative risks c. some pure risks d. some speculative risks ANS: c DIFF: 1 PAGE: A-3 TYPE: KN

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Appendix A

50.

When you purchase insurance, you are _____________. a. avoiding risk b. reducing risk c. assuming risk d. transferring risk ANS: d DIFF: 1 PAGE: A-3 TYPE: KN

51.

You bought a new car equipped with side-impact air bags. You have ____________. a. avoided risk b. reduced risk c. assumed risk d. transferred risk ANS: b DIFF: 2 PAGE: A-3 TYPE: AP

52.

Systech Group just doubled the deductible on its commercial insurance policy. The firm has ____________. a. avoided risk b. reduced risk c. assumed risk d. transferred risk ANS: c DIFF: 2 PAGE: A-3 TYPE: AP

53.

Olaf makes a point of never driving his car to work after a snow or ice storm. He takes public transit instead. Olaf is _____________. a. avoiding risk b. reducing risk c. assuming risk d. transferring risk ANS: a DIFF: 2 PAGE: A-3 TYPE: AP

54.

A city refuses to allow any building in flood prone areas. The city is trying to help residents ______________. a. reduce risk b. avoid risk c. assume risk d. transfer risk ANS: b DIFF: 1 PAGE: A-3 TYPE: AP

55.

Should a worker die prematurely, who would have the most direct insurable interest? a. A cousin b. The employer c. The spouse d. A neighbor ANS: c DIFF: 1 PAGE: A-4 TYPE: KN

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Risk Management and Insurance

56.

One of the most common forms of self-insurance is ______________. a. auto insurance b. employer-provided health insurance c. life insurance d. homeowners insurance ANS: b DIFF: 1 PAGE: A-4 TYPE: KN

57.

Concerning insurance reserves, all of the following statements are correct EXCEPT _________. a. the insurance company must be invested in money market instruments b. the insurance companies build reserves to pay for unexpected losses c. the return on reserves can generate profits for the insurance company d. the return on reserves can help lower premiums ANS: a DIFF: 1 PAGE: A-4 TYPE: KN

58.

Which of the following is not considered to be a random or accidental event? a. Developing cancer b. A tornado c. Suicide d. An earthquake ANS: c DIFF: 3 PAGE: A-5 TYPE: AP

59.

The concept that seemingly random events will follow a predictable pattern if enough events are observed is called ______________. a. expected value b. mortality law c. the law of random numbers d. the law of large numbers ANS: d DIFF: 1 PAGE: A-5 TYPE: KN

60.

Insurance companies pay billions of dollars in claims resulting from hurricane damage each year. Most insurance companies easily survive financially. Which insurable risk criteria saves these companies? a. Risk should be spread over a wide geographic area. b. The likelihood of loss should be reasonably predictable. c. The loss should be financially measurable. d. The loss should be accidental. ANS: a DIFF: 1 PAGE: A-5 TYPE: KN

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Appendix A

61.

Losses are easiest to predict for _________ insurance companies. a. health b. life c. auto d. homeowners ANS: b DIFF: 1 PAGE: A-6 TYPE: KN

62.

An insurance company insures 100,000 homes in a metropolitan area. On average, it predicts that 1 percent of insured homeowners will file claims each year. These claims average $20,000. Calculate the annual premium per home, assuming the insurance company wants to set premiums so that they only cover expected losses. a. $100 b. $150 c. $200 d. $400 ANS: c DIFF: 3 PAGE: A-6 TYPE: AP

63.

All of the following types of insurance are provided by public agencies EXCEPT _________. a. flood insurance b. crop insurance c. unemployment insurance d. life insurance ANS: d DIFF: 1 PAGE: A-6 TYPE: KN

64.

Mutual life insurance companies tend to be ______________. a. life insurance companies b. health insurance companies c. auto insurance companies d. commercial insurance companies ANS: a DIFF: 1 PAGE: A-7 TYPE: KN

65.

Who owns a mutual insurance company? a. Stockholders b. Policyholders c. The government d. Senior management ANS: b DIFF: 1 PAGE: A-7 TYPE: KN

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Risk Management and Insurance

66.

Which of the following perils is not covered by a standard homeowners insurance policy? a. Fire b. Theft c. Hurricane wind damage d. Earthquakes ANS: d DIFF: 1 PAGE: A-8 TYPE: KN

67.

Americans spend more money each year on _________ than any other type of property and liability insurance. a. homeowners insurance b. personal liability insurance c. auto insurance d. commercial insurance ANS: c DIFF: 1 PAGE: A-8 TYPE: KN

68.

A standard commercial insurance policy would protect the business against losses due to all of the following except _______________. a. the premature death of a senior executive b. employee dishonestly c. non-performance of contracts d. fire ANS: a DIFF: 1 PAGE: A-8 TYPE: KN

69.

Approximately how many states require drivers to carry a minimum amount of auto insurance? a. Around one-quarter b. Around one-half c. Around three-quarters d. Virtually all states ANS: d DIFF: 1 PAGE: A-8 TYPE: KN

70.

Who actually provides flood insurance to property owners? a. The states b. The federal government c. Private insurance companies d. Local governments ANS: b DIFF: 1 PAGE: A-8 TYPE: KN

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Appendix A

71.

Assume you run a stop sign and hit another car. What would pay to repair the car you hit? a. Your collision insurance b. The other drivers collision insurance c. Your liability insurance d. The other drivers liability insurance ANS: c DIFF: 2 PAGE: A-9 TYPE: AP

72.

Which is the largest source of health insurance? a. Private group health insurance b. Private individual health insurance c. Medicare d. Medicaid ANS: a DIFF: 1 PAGE: A-9 TYPE: KN

73.

Approximately what percentage of employers offers some type of health insurance as a fringe benefit? a. About 50 percent b. About 67 percent c. About 75 percent d. About 80 percent ANS: d DIFF: 1 PAGE: A-9 TYPE: KN

74.

Around ______ million Americans are enrolled in some form of managed care program and this number is ________. a. 150; remaining constant b. 150; growing each year c. 100; remaining constant d. 100; growing each year ANS: b DIFF: 2 PAGE: A-9 TYPE: KN

75.

An arrangement whereby all of your health care is provided in return for a fixed fee is called a(n) ______________. a. indemnity plan b. fee for service plan c. health maintenance organization d. preferred provider organization ANS: c DIFF: 1 PAGE: A-9 TYPE: KN

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Risk Management and Insurance

76.

An arrangement whereby you choose your doctor, pay for your treatment, and are reimbursed is called a ______________. a. fee for service plan b. health maintenance organization (HMO) c. preferred provider organization (PPO) d. managed care plan ANS: a DIFF: 1 PAGE: A-9 TYPE: KN

77.

An arrangement whereby employees are provided medical care by local health care providers at a discount is called a(n) _____________. a. indemnity plan b. fee for service plan c. health maintenance organization d. preferred provider organization ANS: d DIFF: 1 PAGE: A-9 TYPE: KN

78.

Which of the following is an advantage of a managed care plan? a. Flexibility in the choice of health care providers b. Less paperwork c. Easy access to medical specialists d. Easy to change primary care doctor ANS: b DIFF: 1 PAGE: A-9 TYPE: KN

79.

A health maintenance organization (HMO) would routinely pay for all of the following EXCEPT _____________. a. immediate treatment by a specialist b. regular medical exams c. immunizations d. prescription drugs ANS: a DIFF: 2 PAGE: A-9 TYPE: AP

80.

Which of the following statements is correct? a. HMOs cover more people than PPOs do. b. PPOs are available only on an individual basis, not through employers. c. PPOs are more flexible than HMOs. d. HMOs have higher out-of-pocket expenses than PPOs do. ANS: c DIFF: 1 PAGE: A-10 TYPE: KN

81.

Which type of insurance do many people often overlook? a. Life insurance b. Disability income insurance c. Auto insurance d. Liability insurance ANS: b DIFF: 1 PAGE: A-10 TYPE: KN

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Appendix A

82.

Which of the following statements is correct? a. Social Security disability benefits are fairly easy to get. b. Private disability policies are less expensive than group disability policies for those under age 40. c. Group disability policies are difficult to quality for. d. Most employers offer some disability coverage as a fringe benefit. ANS: d DIFF: 1 PAGE: A-10 TYPE: KN

83.

What percentage of Americans owns some form of life insurance? a. About75 percent b. About 66 percent c. About 50 percent d. Less than 50 percent ANS: a DIFF: 1 PAGE: A-10 TYPE: KN

84.

Which of the following statements is correct? a. Term insurance policies are more difficult to qualify for than other types of life insurance. b. Term insurance premiums decline over time. c. Term insurance is less expensive than cash value policies. d. Term insurance is available only through employers. ANS: c DIFF: 1 PAGE: A-11 TYPE: KN

85.

A 35 year-old father of two determines that he needs $300,000 worth of life insurance coverage. According to many experts, what is his best choice? a. A cash value group policy b. An individual term policy c. An individual group policy d. A cash value individual policy ANS: b DIFF: 2 PAGE: A-11 TYPE: AP

ESSAY QUESTIONS 86. What is risk? Explain the difference between pure risk and speculative risk, and give an example of each. ANS: Risk is defined as uncertainty concerning injury or loss. Pure risk involves only the chance of loss whereas speculative risk involves the chance of gain or loss. An example of pure risk is the chance that a business will experience a loss due to a fire. There is nothing to gain, only the potential for loss. An example of speculative risk is investing in an IPO. The investment has the potential of both gains and losses. DIFF: 2 PAGE: A-2, A-3 TYPE: AP

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Risk Management and Insurance

87.

Describe the four ways an individual or business can deal with risk. ANS: Risk can be avoided; risk can be reduced; risk can be assumed (self-insurance); and risk can be transferred. Avoiding risk means taking a conservative approach to life, such as abstaining from smoking or not locating a new production facility in a flood prone area. Reducing risk means taking preventive measures. Many companies, for example, develop safety programs to educate employees about potential hazards. Assuming risk means accumulating sufficient funds to cover potential losses. Transferring risk involves purchasing insurance. DIFF: 3 PAGE: A-3, A-4 TYPE: AP

88.

List and briefly explain the three basic principles that underlie insurance. ANS: The three basic principles that underlie insurance are the concept of insurable interest, the concept of insurable risk, and the law of large numbers. In order to obtain an insurance policy, an applicant must demonstrate an insurable interest, which means that the applicant must stand to suffer a loss, financial or otherwise. Insurable risk refers to the requirements that a risk must meet in order for the insurer to provide protection. There are five basic requirements that a risk must meet: the likelihood of loss should be reasonably predictable; the loss should be financially measurable; the loss should be accidental; the risk should be spread over a wide geographic area; and the insurance company has the right to set standards for accepting risk. The law of large numbers is a concept that seemingly random events will follow a predictable pattern if enough events are observed. The law of large numbers is used to predict losses and set insurance premiums. DIFF: 3 PAGE: A-4, A-5 TYPE: AP

89.

What are some general guidelines when buying insurance for yourself or for your business? ANS: According to the experts, you should follow four general guidelines when buying insurance. First, insure against big losses, not small ones. Second, buy insurance policies with broad coverage, not narrow coverage (broad policies are far more cost effective). Third, shop around since insurance premiums can vary substantially. Finally, buy insurance only from financially strong insurance companies. If an insurance company goes bankrupt, youll be left with no coverage and little hope of getting any of your premiums back. DIFF: 2 PAGE: A-8 TYPE: AP

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Appendix A

90.

Compare the basic features of fee-for-service health insurance plans with managed care plans. ANS: In a fee for service health insurance plan, the insured picks his or her health care providers, pays for the services, and then is reimbursed by the insurance company. Virtually all fee for service plans charge deductibles and co-payments. The main advantages of fee for service plans are flexibility, choice, and more control. Managed care plans pay most of the insured health care bills. In return, the plan has more control over the terms and conditions of the health care provided. Choices of doctors and other health care providers are more limited and access to specialists may be more limited. The main advantages of managed care plans include less paperwork, generally lower out of pocket costs, and payment for routine exams and immunizations. DIFF: 2 PAGE: A-9, A-10 TYPE: AP

COMPLETION Directions: Complete each of the following sentences using the terms listed. A. B. C. D. E. F. G. H. I. J. 91. risk pure risk speculative risk insurance insurable risk insurable interest law of large numbers property and liability insurance disability income insurance life insurance _____ is the general category of insurance that provides protection against financial losses due to a number of perils. ANS: H 92. DIFF: 1 PAGE: A-9 TYPE: KN

_____ is a situation where only the possibility of loss exists. ANS: B DIFF: 1 PAGE: A-2 TYPE: KN

93.

_____ is the process of transferring risk for an individual or business to a specialized firm in exchange for a series of payments. ANS: D DIFF: 1 PAGE: A-6 TYPE: KN

94.

_____ is the uncertainty of injury or loss. ANS: A DIFF: 1 PAGE: A-2 TYPE: KN

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Risk Management and Insurance

95.

The concept that seemingly random events will follow a predictable pattern if enough events are observed is called the _____. ANS: G DIFF: 1 PAGE: A-5 TYPE: KN

96.

Insurance that replaces lost income when a wage earner cannot work due to an accident or illness is _____. ANS: I DIFF: 1 PAGE: A-10 TYPE: KN

97.

_____ is a situation where there is both the possibility of gain and loss. ANS: C DIFF: 1 PAGE: A-2 TYPE: KN

98.

To purchase insurance, an applicant must demonstrate that he or she stands to suffer a loss, financial or otherwise. This is known as _____. ANS: F DIFF: 1 PAGE: A-4 TYPE: KN

99.

In order to be a(n) _____, a risk must meet certain criteria. ANS: E DIFF: 1 PAGE: A-5 TYPE: KN

100.

_____ protects people against financial losses that occur with premature death. ANS: J DIFF: 1 PAGE: A-10 TYPE: KN

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