Principles of Risk Management and Insurance - Chapter 7

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Financial Operations of Insurers
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1

LMN Mutual Insurance Company has total liabilities of $300 million. The company has total assets of $380 million. What is LMN's policyholders' surplus?

  1. A) $680 million
  2. B) $340 million
  3. C) $80 million
  4. D) -$80 million

Answer: C

2

Which of the following would not appear in the asset section of an insurance company's balance sheet?

  1. A) loss reserves
  2. B) bonds
  3. C) common stock
  4. D) real estate

Answer: A

3

Under one method of estimating a loss reserve, the reserve is based on life expectancy, duration of disability, and similar factors. This method of estimating loss reserves is called the

  1. A) judgment method.
  2. B) tabular value method.
  3. C) loss ratio method.
  4. D) average value method.

Answer: B

4

Reasons for the unearned premium reserve include which of the following?

  1. To pay losses that occur during the policy period.
  2. To pay premium refunds to policyholders in the event of cancellation.
  3. A) I only
  4. B) II only
  5. C) both I and II
  6. D) neither I nor II

Answer: C

5

A property and casualty insurer's loss reserve includes estimates for all of the following EXCEPT

  1. A) claims anticipated but not yet incurred.
  2. B) claims reported and adjusted but not yet paid.
  3. C) claims reported and filed but not yet adjusted.
  4. D) claims incurred but not yet reported to the company.

Answer: A

6

Which of the following statements about methods for estimating loss reserves for property and casualty insurers is (are) true?

  1. The judgment method involves the use of a statutory formula to estimate the loss reserve.
  2. The average value method is used when the number of claims is large and the claims are settled quickly.
  3. A) I only
  4. B) II only
  5. C) both I and II
  6. D) neither I nor II

Answer: B

7

One item that appears on an insurance company's financial statements is a liability that represents an estimate of the claims reported and adjusted but not yet paid, claims reported and filed but not yet adjusted, and claims incurred but not yet reported to the company. This liability is called the insurer's

  1. A) net income.
  2. B) loss reserves.
  3. C) admitted assets.
  4. D) unearned premium reserve.

Answer: B

8

A loss reserve established for each individual claim when it is reported to a property and casualty insurance company is call a(n)

  1. A) admitted asset.
  2. B) incurred-but-not-reported (IBNR) reserve.
  3. C) unearned premium reserve.
  4. D) case reserve.

Answer: D

9

Which of the following items would appear in the income section of an insurance company's income and expense statement?

  1. A) underwriting expense
  2. B) bonds
  3. C) loss reserves
  4. D) premiums

Answer: D

10

JKL Insurance Company reported the following information on its accounting statements last year:

Premiums Written $90,000,000

Loss Adjustment Expenses $5,000,000

Underwriting Expenses $30,000,000

Premiums Earned $100,000,000

Incurred Losses $70,000,000

What was JKL's loss ratio last year?

  1. A) 70.0 percent
  2. B) 75.0 percent
  3. C) 83.3 percent
  4. D) 90.0 percent

Answer: B

11

JKL Insurance Company reported the following information on its accounting statements last year:

Premiums Written $90,000,000

Loss Adjustment Expenses $5,000,000

Underwriting Expenses $30,000,000

Premiums Earned $100,000,000

Incurred Losses $70,000,000

What was JKL's expense ratio last year?

  1. A) 5.0 percent
  2. B) 30.0 percent
  3. C) 33.3 percent
  4. D) 50.0 percent

Answer: C

12

JKL Insurance Company reported the following information on its accounting statements last year:

Premiums Written $90,000,000

Loss Adjustment Expenses $5,000,000

Underwriting Expenses 30,000,000

Premiums Earned $100,000,000

Incurred Losses $70,000,000

What was JKL's combined ratio last year?

  1. A) 100.0
  2. B) 103.3
  3. C) 105.0
  4. D) 108.3

Answer: D

13

Which of the following statements about property and casualty insurance company operating results is (are) true?

  1. An insurance company can have a combined ratio greater than 1 (or 100 percent) and still be required to pay income taxes.
  2. By all measures, the property and casualty insurance industry is highly profitable when compared to other industries.
  3. A) I only
  4. B) II only
  5. C) both I and II
  6. D) neither I nor II

Answer: A

14

Life insurance policyholders may borrow the cash value from their life insurance policies. Where are life insurance policy loans shown on a life insurance company's financial statements?

  1. A) as an asset
  2. B) as a liability
  3. C) as income
  4. D) as an expense

Answer: A

15

MedProf Insurance markets medical malpractice insurance. The company's combined ratio in 2015 was 95.4. Its expense ratio was 25.4. What was the company's loss ratio?

  1. A) 60.4
  2. B) 70.0
  3. C) 88.2
  4. D) 120.8

Answer: B

16

To protect policyholders, state laws place limitations on a life insurance company's investments. The assets backing interest-sensitive products, such as variable life insurance and variable annuities, are not subject to these restrictions. Assets backing interest-sensitive products are placed in a special account called the life insurer's

  1. A) policy reserve account.
  2. B) policy loan account.
  3. C) separate account.
  4. D) policyholders surplus.

Answer: C

17

Which of the following statements is (are) true concerning investments of property and casualty insurers and life insurers?

  1. Property and casualty insurance companies place greater emphasis on liquidity than do life insurers.
  2. Life insurance company investments are, on average, of longer duration than property and casualty insurance company investments.
  3. A) I only
  4. B) II only
  5. C) both I and II
  6. D) neither I nor II

Answer: C

18

Which of the following is an expense for a life insurance company?

  1. A) loss reserves
  2. B) death benefits paid to a beneficiary
  3. C) unrealized capital gains
  4. D) realized capital gains

Answer: B

19

All of the following statements about business objectives in designing a rating system are true EXCEPT

  1. A) The rating system should encourage loss control activities.
  2. B) The rating system should be independent of long-run changes in economic conditions.
  3. C) The rating system should be simple to understand.
  4. D) The rating system should be stable over short periods so that consumer satisfaction can be maintained.

Answer: B

20

All of the following statements about regulatory objectives of insurance rate making are true EXCEPT

  1. A) One purpose of rate adequacy is to maintain the solvency of insurers.
  2. B) Rates unfairly discriminate if loss exposures that are similar with respect to losses and expenses are charged substantially different rates.
  3. C) Insurers know in advance if the coverages marketed will be profitable, so rate regulation is not needed.
  4. D) Rates are excessive if policyholders are paying substantially more than the actual value of their protection.

Answer: C

21

The unit of measurement used in property and casualty insurance pricing is called the

  1. A) unit rate.
  2. B) premium.
  3. C) exposure unit.
  4. D) experience unit.

Answer: C

22

The portion of an insurance premium allocated to expenses, profit, and a margin for contingencies is called the

  1. A) loading.
  2. B) pure premium.
  3. C) gross premium.
  4. D) experience rate.

Answer: A

23

Which of the following statements about judgment rating is true?

  1. A) It involves the manual rating of exposures.
  2. B) It is used when the loss exposures are so diverse that a class rate cannot be calculated.
  3. C) It is a form of experience rating.
  4. D) It is only used when credible loss statistics are available.

Answer: B

24

Under one type of merit rating, the class or manual rate is adjusted upward or downward based on past loss history. This type of merit rating is called

  1. A) schedule rating.
  2. B) judgment rating.
  3. C) experience rating.
  4. D) retrospective rating.

Answer: C

25

All of the following statements about class rating are true EXCEPT

  1. A) Exposures with similar characteristics are placed in the same underwriting class.
  2. B) The rate charged for each class reflects the average loss experience for that class.
  3. C) The complexity of class rating makes it inappropriate for personal lines coverages.
  4. D) It is based on the assumption that future losses to insureds will be determined by the same classification factors currently in use.

Answer: C

26

Ratemakers at ABC Insurance Company calculated the pure premium to be $280 for a risk they were considering insuring. What is the gross rate for this risk, assuming a 30 percent expense ratio?

  1. A) $364
  2. B) $400
  3. C) $430
  4. D) $520

Answer: B

27

Which of the following statements is (are) true about the loss ratio method of class rating?

  1. The pure premium is calculated, and it is loaded to cover expenses, profit, and contingencies.
  2. The actual loss ratio is compared to the expected loss ratio, and the rate is adjusted accordingly.
  3. A) I only
  4. B) II only
  5. C) both I and II
  6. D) neither I nor II

Answer: B

28

Which of the following statements about schedule rating is (are) true?

  1. It involves the determination of a basis rate for each exposure, which is then modified by credits or debits.
  2. It is based on the assumption that certain physical characteristics of the insured's operations will influence the insured's future loss experience.
  3. A) I only
  4. B) II only
  5. C) both I and II
  6. D) neither I nor II

Answer: C

29

Which of the following statements about experience rating is (are) true?

  1. The insured's past loss experience is used to determine the premium for the next policy period.
  2. Its use is generally limited to small firms whose actual experience lacks credibility.
  3. A) I only
  4. B) II only
  5. C) both I and II
  6. D) neither I nor II

Answer: A

30

Which of the following statements about retrospective rating is true?

  1. A) The premium for the current period is determined by the loss experience in prior periods.
  2. B) The premium for the current period is determined by the loss experience during the current period.
  3. C) The premium for the current period is determined by predicted future loss experience.
  4. D) The premium for future periods is determined by the loss experience for the current period.

Answer: B

31

Monopoly Insurance is the only company marketing a certain line of insurance in a state. After complaints from several consumers, the State Insurance Department investigated Monopoly's rates. The regulators determined that Monopoly was taking advantage of being the only insurer offering the line by charging more than double the actuarial cost of the coverage. Which regulatory rating objective was Monopoly violating?

  1. A) Rates must be adequate.
  2. B) Rates should encourage loss control.
  3. C) Rates must not be excessive.
  4. D) Rates must not unfairly discriminate.

Answer: C

32

Small Town used to be just that—a small town 6 miles from Large City. Over the years, the area between Small Town and Large City has developed, and now Small Town is part of the suburbs surrounding Large City. An auto insurer that operated in the area had a large increase in auto claims from Small Town insureds. The insurer did not adjust its rates, and this year will lose money because of claims attributable to higher population density. Which business rating objective did this insurer fail to meet?

  1. A) simplicity
  2. B) stability
  3. C) responsiveness
  4. D) encouragement of loss control

Answer: C

33

Nathan was hired as an actuary with ABC Insurance. Nathan was asked to calculate the annual premium for a new product and to explain his calculations to ABC's director of ratemaking. Nathan calculated the pure premium and presented this value as the final premium. After Nathan's presentation, the director of ratemaking said, "You left out something very important. If we sell coverage at the pure premium rate, we'll be out of business soon." What did Nathan overlook in his calculations?

  1. A) loading for expenses
  2. B) the underwriting cycle
  3. C) seasonality of claims
  4. D) investment income

Answer: A

34

XYZ Insurance Company expects $500,000 in claims and loss adjustment expenses for each 1,000 properties that it insures in a certain category of business insurance. What pure premium should XYZ charge for each property insured?

  1. A) $69.99
  2. B) $166.67
  3. C) $350.00
  4. D) $500.00

Answer: D

35

XYZ Insurance Company uses class rating to determine the rate to charge for insurance. For one type of insurance, the pure premium XYZ actuaries calculated is $75 per unit. If XYZ's expense ratio is 25 percent, what is the gross rate for this coverage?

  1. A) $37.50
  2. B) $55.25
  3. C) $75.00
  4. D) $100.00

Answer: D

36

A manufacturing company just hired a new risk manager, and she has instituted several employee safety programs. She has persuaded the insurer writing the company's workers compensation insurance to base the premium on the company's actual loss experience during the current coverage period rather than on the company's historical performance. This type of plan is called a(n)

  1. A) retrospectively rated plan.
  2. B) class rated plan.
  3. C) experience rated plan.
  4. D) judgment rated plan.

Answer: A

37

An Econodeath Insurance Company actuary calculated the present value of the expected death claim the company will pay if it sells whole life insurance to a 30-year-old woman. This value is called the

  1. A) net level premium.
  2. B) gross premium.
  3. C) net single premium.
  4. D) life insurance policy reserve.

Answer: C

38

Which of the following statements concerning regulatory objectives of rate making is (are) true?

  1. Rates must not be unfairly discriminatory.
  2. Rates must be adequate.
  3. A) I only
  4. B) II only
  5. C) both I and II
  6. D) neither I nor II

Answer: C

39

Which of the following statements about the combined ratio is true?

  1. A) It is equal to the loss ratio minus the expense ratio.
  2. B) A combined ratio greater than 1 (or 100 percent) means an underwriting loss has occurred.
  3. C) The combined ratio considers the company's investment income.
  4. D) A combined ratio less than 1 (or 100 percent) indicates an underwriting loss has occurred.

Answer: B

40

In schedule rating, each building is individually evaluated based on several rating factors. One factor refers to the possibility that the building will be damaged or destroyed by a fire that starts at an adjacent property and spreads to the building. This rating factor is known as

  1. A) occupancy.
  2. B) protection.
  3. C) maintenance.
  4. D) exposure.

Answer: D

41

A strip-mall includes eight identical-sized retail units. All of the units were built at the same time and each has an identical sprinkler system. Unit number two is a dry cleaning business. Unit number three is a bar and grill. Unit number four is a dress shop. The owners of these three units are all insured by the same insurance company, but the property insurance premiums vary significantly. Which of the following rating factors best explains the difference in premiums?

  1. A) exposure
  2. B) protection
  3. C) construction
  4. D) occupancy

Answer: D

42

A property and liability insurance company's loss reserve and unearned premium reserve are

  1. A) assets.
  2. B) liabilities.
  3. C) income.
  4. D) expenses.

Answer: B

43

In schedule rating, each building is individually rated on several factors. One factor refers to the quality of the city's water supply and fire department, and the risk control devices installed in the building. This factor is called

  1. A) exposure.
  2. B) occupancy.
  3. C) protection.
  4. D) housekeeping.

Answer: C

44

A property and liability insurance company's loss ratio and expense ratio, respectively, for 2013 – 2015 were:

2013: 74% 31%

2014: 68% 33%

2015: 66% 30%

Which of the following statements is true about the company's underwriting results for this time period?

  1. A) The insurer made money from its underwriting activities each year.
  2. B) The insurer's profitability from underwriting has been deteriorating each year.
  3. C) The insurer's profitability from underwriting has been improving each year.
  4. D) The insurer lost money from its underwriting activities each year.

Answer: C

45

One liability on a property and liability insurance company's balance sheet is for the costs associated with settling and paying reserved claims. This liability is the

  1. A) pre-paid expense reserve.
  2. B) loss reserve.
  3. C) unearned premium reserve.
  4. D) loss adjustment expense reserve.

Answer: D

46

The assets of a property and liability insurance company are primarily

  1. A) investments such as stocks and bonds.
  2. B) loss reserves.
  3. C) plant and equipment.
  4. D) premiums paid by policyholders.

Answer: A

47

ABC Insurance Company's investment income ratio last year was 4.2 percent. The company's combined ratio last year was 102.6 percent. What was ABC's overall operating ratio?

  1. A) 96.8 percent
  2. B) 98.4 percent
  3. C) 103.2 percent
  4. D) 106.8 percent

Answer: B

48

One life insurance company reserve is designed to smooth the company’s reported surplus over time by absorbing fluctuations in security prices that are not attributable to changing interest rates. This reserve is called the

  1. A) asset write-off reserve.
  2. B) reserve for amounts held on deposit.
  3. C) unearned premium reserve.
  4. D) asset valuation reserve.

Answer: D