Exercise Question, FIN360, part I

1. A condition that increases the chance of loss is called a(n)

a. Peril
b. indirect (consequential) loss
c. direct loss
d. hazard
Answer: D
2. An earthquake is an example of a
a. moral hazard.
b. peril.
c. physical hazard.
d. objective risk.
Answer: B
3. Dense fog that increases the chance of an automobile accident is an example of a
a. speculative risk.
b. peril.
c. physical hazard.
d. moral hazard.
Answer: C
4. A publishing company solicits manuscripts for publication. The publishing company is
concerned that an author might plagiarize material and that the person who was plagiarized
might sue the publisher. To address this risk, the contract with the author includes a holdharmless agreement. Through this agreement, the author, rather than the publisher, is held
liable for plagiarism. In this situation, the publisher is using the hold-harmless agreement as
what type of risk treatment measure?
a. risk retention
b. risk transfer
c. risk avoidance
d. risk selection
Answer: B
5. A risk that affects the entire economy, or a large number of persons or groups within the
economy, is called a(n)
a. speculative risk
b. nondiversifiable risk
c. diversifiable risk
d. objective risk
Answer: B
6. Dean's Discount Store has been experiencing problems with shoplifting losses. Dean decided
to install a camera monitoring system and to use magnetic price tags on products. If a tag is

not demagnetized before the product bearing the tag leaves the store, an alarm bell sounds.
These measures are examples of
a. risk transfer
b. risk retention
c. loss control
d. risk avoidance
Answer: C
7. An individual may commit an act that results in bodily injury or damage to someone's
property. A court of law may order the person responsible for the wrongful act to pay
damages to the party who was injured. This type of risk is called the
a. property risk
b. nondiversifiable risk
c. speculative risk
d. liability risk
Answer: D
8. Kyle opened a sporting goods store. After a fire damaged the store, Kyle was forced to close
the business for four weeks while repairs were completed. The loss of profits that could have
been earned if the business had remained open is best described as a(n)
a. Peril
b. direct loss
c. hazard
d. indirect (consequential) loss
Answer: D
9. Which of the following statements is (are) true with respect to pure risks?
I. Pure risks may produce either a profit or a loss.
II. Premature death and damage to property caused by a fire are pure risks.
a. both I and II
b. neither I nor II
c. I only
d. II only
Answer: D
10. The spreading of losses incurred by a few individuals over a larger group, so that average
loss is substituted for actual loss, is known as
a. fortuitous loss
b. pooling of losses
c. transfer of risk
d. loss indemnification
Answer: B
11. All of the following are ideal characteristics for a risk to be privately insurable EXCEPT
a. there must be a large number of similar exposure units

b. the chance of loss must be calculable

c. losses should not be catastrophic
d. the loss should be within the insureds control
Answer: D
12. Claire does not own health insurance. For the past two weeks, she has been experiencing
sharp abdominal pain. Given her condition, she would like to purchase health insurance.
When higher-than-average risks (like Claire) are insured at average premiums, losses are
higher than anticipated. What is this problem called?
a. moral hazard
b. adverse selection
c. speculation
d. attitudinal hazard
Answer: B
13. Insurers use a process of selecting and classifying insurance applicants to prevent individuals
who have a higher-than-average probability of loss from obtaining insurance at average rates.
This process is called
a. Marketing
b. Underwriting
c. Producing
d. Adjusting
Answer: B
14. All of the following risks are privately insurable EXCEPT
a. adverse commodity price movements
b. legal liability arising out of negligent use of a car
c. fire damage to personal property
d. financial insecurity caused by the premature death of the family breadwinner
Answer: A
15. The first step in the risk management process is to
a. implement and administer the program.
b. identify loss exposures.
c. analyze potential losses.
d. select the appropriate techniques for handling losses.
Answer: B
16. All of the following risk treatment techniques are classified as risk control methods EXCEPT
a. loss prevention.
b. loss reduction.
c. avoidance.
d. insurance.
Answer: D

17. Tindall Company manufactures electronic components. Managers of the company are
considering several diversification options. One possibility is production of prescription
drugs. When Tindall Company managers learned of the potential legal liability that could
result from the manufacture and sale of prescription drugs, the managers rejected the idea
and decided to consider other diversification options. How did Tindall Company choose to
deal with the risk of legal liability arising from the manufacture and sale of prescription
drugs?
a. risk retention
b. risk avoidance
c. risk transfer
d. loss control
Answer: B
18. Harris Petroleum, a fuel storage and delivery business, occasionally has difficulty in
obtaining affordable pollution liability insurance. Jane Elmore, Risk Manager of Harris
Petroleum, decided to form an insurance subsidiary for the purpose of writing pollution
liability insurance for Harris Petroleum, as well as other insurance coverages. The insurance
subsidiary will be based in Bermuda for regulatory reasons. What is such a subsidiary called?
a. a captive insurance company
b. a risk retention group
c. a social insurance company
d. a fraternal insurer
Answer: A
19. All of the following are methods used to pay retained losses EXCEPT
a. funded reserve.
b. insurance.
c. current net income.
d. credit line.
Answer: B
20. Which of the following statements is (are) true with respect to identifying potential loss
exposures?
I. A physical inspection of company plants and operations can help to identify major loss
exposures.
II. Historical claims data can help to identify major loss exposures.
a. II only
b. neither I nor II
c. I only
d. both I and II
Answer: D
21. Risk managers must consider the range of outcomes that could occur. The worst loss that is
likely to happen is called
a. the probable maximum loss.

b. the severity maximum loss.

c. the frequency maximum loss.
d. the maximum possible loss.
Answer: A
22. Rather than purchasing computers and software, ABC Company entered into a lease
agreement with Computer Solutions Company (CSC). Under terms of the lease, CSC
provides computers and software and is responsible for damage to the computers and
software. ABC uses the lease to shift responsibility for hardware and software losses to CSC.
ABCs use of the lease illustrates which method of dealing with risk?
a. noninsurance transfer
b. risk retention
c. insurance transfer
d. risk avoidance
Answer: A
23. Denise purchased a dining room set for $2,800 and insured it on an actual cash value (ACV)
basis. At the time the dining room set was destroyed by a covered peril, the set was 40
percent depreciated. A replacement set will cost $3,000. Assuming no deductible, how much
will Denise collect from her insurer?
a. $3,000
b. $1,800
c. $1,880
d. $2,800
Answer: B
24. Property insurance contracts have all of the following distinct legal characteristics EXCEPT
a. they are bilateral contracts.
b. they are aleatory contracts.
c. they are personal contracts.
d. they are contracts of adhesion.
Answer: A
25. Kyle purchased collision insurance on his new car. While Kyle was driving home from work,
another driver failed to stop at a stop sign and hit Kyles car. Kyle phoned his insurance agent
and reported the accident. The agent said, Dont worry, Kyle, well pay to get your car
fixed. And after we pay for the damage to your car, we will try to collect from the driver who
damaged your car. The process the agent described is called
a. waiver.
b. consideration.
c. subrogation.
d. estoppel.
Answer: C

26. The assignment of property insurance by the seller of the property to the purchaser of the
property is only valid if the insurer approves the assignment. The reason that the insurer must
approve the assignment of a property insurance policy is that
a. insurance contracts are personal contracts.
b. insurance contracts are contracts of utmost good faith.
c. insurance contracts are aleatory contracts.
d. insurance contracts are bilateral contracts.
Answer: A
27. Which of the following statements about the principle of insurable interest is (are) true?
I. In life insurance, the insurable interest requirement must be met only at the time of the
loss to receive life insurance proceeds after the insured has died.
II. The insurable interest requirement helps to reduce the problem of moral hazard.
a. neither I nor II
b. both I and II
c. I only
d. II only
Answer: D
28. When Maria applied for a life insurance policy, she answered No in response to the
question Have you visited a doctor for any reason during the previous 12 months? In fact,
Maria visited a doctor five weeks ago after experiencing chest pains. She was referred to a
specialist who determined that Maria has severe heart disease. If Maria dies shortly after the
life insurance policy is issued, on what grounds will the insurer be successful in denying the
claim
a. misrepresentation
b. waiver
c. concealment
d. warranty
Answer: A
29. An insurance contract must be accepted in its entirety and any ambiguity in the contract is
construed against the insurer. Because of these characteristics, we can describe insurance
contracts as
a. contracts of adhesion.
b. valued contracts.
c. aleatory contracts.
d. bilateral contracts.
Answer: A
30. Taylor Tobacco Company is concerned that the company may be held liable in a court of law
and ordered to pay a large damage award. The characteristics of the judicial system that
increase the frequency and severity of losses are known as
a. moral hazard.
b. particular risk.

c. speculative risk.
d. legal hazard.
Answer: D
31. All of the following statements about captive insurers are true EXCEPT
a. They may act as a profit center by insuring parties other than the parent company.
b. They provide a way to obtain types of insurance that may be unavailable from
commercial insurers.
c. They increase the volatility of the parent company's earnings.
d. They make it easier for a firm to have access to reinsurance.
Answer: C
32. All of the following are potential advantages of retention EXCEPT
a. lower expenses.
b. increased cash flow.
c. encouragement of loss prevention.
d. protection from catastrophic losses.
Answer: D
33. All of the following are disadvantages of noninsurance transfers EXCEPT
a. The party to whom the potential loss is transferred may be unable to pay.
b. The transfer may fail because the contract language is ambiguous.
c. The only potential losses that can be transferred are those that are not commercially
insurable.
d. The noninsurance transfer may be costly.
Answer: C
34. All of the following are disadvantages of using insurance in a risk management program
EXCEPT
a. There is an opportunity cost because premiums must be paid in advance.
b. Considerable time and effort must be spent selecting and negotiating coverages.
c. It results in considerable fluctuations in earnings after losses occur.
d. Attitudes toward loss control may become lax when losses are insured.
Answer: C
35. Which of the following is a fundamental purpose of the principle of indemnity?
a. to reduce moral hazard
b. to minimize physical hazards
c. to settle property insurance losses on a replacement cost basis
d. to require deductibles in all property insurance policies
Answer: A
36. All of the following are exceptions to the principle of indemnity EXCEPT
a. life insurance.
b. valued policies.
c. replacement cost property insurance.

d. actual cash value property insurance.

Answer: D
37. What is the legal significance of a material concealment by an insurance applicant?
a. The contract is automatically voided from its inception.
b. The contract is voidable at the insurer's option.
c. Loss payments are reduced by the degree of the concealment.
d. The insurer is immediately entitled to a higher premium.
Answer: B
38. A contract in which the values exchanged are not equal because chance is involved is called
a(n)
a. contract of adhesion.
b. unilateral contract.
c. conditional contract.
d. aleatory contract.
Answer: D
39. Ryan decided to review his personal risk management program. His car is 10 years old, and
he would receive little money from his insurer if the car was damaged or destroyed. Ryan
decided to drop the physical damage insurance on the car. From a risk management
perspective, dropping the physical damage insurance on the car is best described as
a. increasing the use of avoidance in the risk management program.
b. increasing the use of noninsurance transfer in the risk management program.
c. increasing the use of retention in the risk management program.
d. increasing the use of risk control in the risk management program.
Answer: C
40. Parker Department Stores has been hurt in recent months by a large increase in shoplifting
losses. Parker's risk manager concluded that while the frequency of shoplifting losses was
high, the severity is still relatively low. What is (are) the appropriate risk management
technique(s) to apply to this problem?
a. retention
b. loss control and retention
c. transfer through insurance
d. avoidance
Answer: B