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Insurance Basics

Practice questions on insurance basics for the property exam, each with an answer and explanation.

Study questions and answers

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1. A homeowner faces the possibility of a fire that could only cause a loss, never a gain. This is an example of:

  1. Speculative risk
  2. Fundamental risk
  3. Dynamic risk
  4. Pure risk
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D. Pure risk
Pure risk involves only the chance of loss or no loss. Only pure risks are insurable; speculative risks such as gambling or investing are not.

2. A windstorm that damages a roof is best described as a:

  1. Hazard
  2. Risk
  3. Peril
  4. Moral hazard
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C. Peril
A peril is the cause of a loss, such as wind, fire, or theft. A hazard is a condition that increases the chance of a loss.

3. Oily rags stored next to a furnace in a basement are an example of a:

  1. Physical hazard
  2. Moral hazard
  3. Morale hazard
  4. Peril
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A. Physical hazard
A physical hazard is a tangible condition of the property that increases the chance of a loss.

4. An insured becomes careless about locking doors because she knows any stolen property is covered. This is a:

  1. Physical hazard
  2. Moral hazard
  3. Morale hazard
  4. Speculative risk
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C. Morale hazard
A morale hazard is indifference or carelessness because insurance exists. A moral hazard involves dishonesty, such as intentionally causing a loss.

5. A business owner who sets fire to a failing store to collect the insurance is an example of:

  1. Morale hazard
  2. Physical hazard
  3. Adverse selection
  4. Moral hazard
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D. Moral hazard
Moral hazard comes from a person's dishonesty or character, such as intentionally causing or exaggerating a loss.

6. Insurers can predict losses more accurately as the number of similar exposure units grows. This is the:

  1. Law of large numbers
  2. Principle of indemnity
  3. Doctrine of proximate cause
  4. Rule of adhesion
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A. Law of large numbers
The law of large numbers says that the larger the group of similar risks, the closer actual losses come to expected losses.

7. The tendency of people with a greater chance of loss to seek insurance more than others is called:

  1. Risk retention
  2. Adverse selection
  3. Moral hazard
  4. Risk sharing
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B. Adverse selection
Adverse selection is why insurers underwrite. Without it, the pool would be weighted toward poorer-than-average risks.

8. A homeowner buys an insurance policy to cover her house against fire. Which risk management method is she using?

  1. Avoidance
  2. Reduction
  3. Transfer
  4. Retention
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C. Transfer
Buying insurance transfers the financial consequences of a loss to the insurer.

9. Installing smoke detectors and a sprinkler system is an example of which risk management technique?

  1. Risk reduction
  2. Risk avoidance
  3. Risk transfer
  4. Risk sharing
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A. Risk reduction
Reduction lowers the chance or size of a loss without eliminating the exposure. Choosing a large deductible would be a form of retention.

10. An insurer owned by its policyholders, which may return excess premium as dividends, is a:

  1. Stock insurer
  2. Reciprocal insurer
  3. Mutual insurer
  4. Lloyd's association
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C. Mutual insurer
A mutual insurer is owned by its policyholders. A stock insurer is owned by stockholders who receive any dividends.

11. Members who insure one another through an attorney-in-fact form a:

  1. Reciprocal exchange
  2. Mutual insurer
  3. Fraternal benefit society
  4. Risk purchasing group
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A. Reciprocal exchange
In a reciprocal, subscribers exchange insurance with each other and an attorney-in-fact manages the exchange.

12. An insurer organized under the laws of another country but doing business in this state is considered:

  1. Foreign
  2. Domestic
  3. Alien
  4. Nonadmitted
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C. Alien
Domestic insurers are formed in this state, foreign insurers in another state, and alien insurers in another country.

13. Coverage placed with a nonadmitted insurer, usually after admitted insurers have declined the risk, is called:

  1. Reinsurance
  2. Self-insurance
  3. Residual market coverage
  4. Surplus lines
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D. Surplus lines
Surplus lines insurers are not licensed (admitted) in the state but may write risks that admitted insurers will not accept, through a surplus lines licensee.

14. An agreement in which a reinsurer automatically accepts a share of every risk of a certain type written by the ceding insurer is:

  1. Facultative reinsurance
  2. Treaty reinsurance
  3. Retrocession
  4. Excess of loss coverage
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B. Treaty reinsurance
Treaty reinsurance covers a whole class of business automatically. Facultative reinsurance is negotiated one risk at a time.
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