Part I Principles and Practice of Insurance

I. Risk and Insurance

i. Concept of Risk

A. Meaning of Risk

B. Classification of Risk

C. Risk Management

ii. Functions and Benefits of Insurance

II. Legal Principles

i. The Law of Contract

A. Definition

ii. The Law of Agency

A. Definition

B. How Agency Arises

C. Authority of Agents

D. Duties Owed by Agent to Principal

E. Duties Owed by Principal to Agent

F. Termination of Agency

III. Principles of Insurance

i. Insurable Interest

ii. Utmost Good Faith

iii. Proximate Cause

iv. Indemnity

v. Contribution

vi Subrogation IV. Structure of Hong Kong Insurance Industry

i. Types of Insurance Business

ii. Size of Industry

iii. Insurance Intermediaries

iv. The Hong Kong Federation of Insurers

V. Regulatory Framework of Insurance Industry

i. Regulation of Insurance Companies in Hong Kong

A. Insurance Companies Ordinance

B. Code of Conduct for Insurers

C. Guidelines on Complaint Handling

D. Insurance Claims Complaints Bureau

ii. Regulation of Insurance Intermediaries in Hong Kong

A. Roles and Responsibilities of Insurance Agents and Brokers

B. The Code of Practice for the Administration of Insurance Agents

VI. Ethical and Other Related Issues

i. Insurance Intermediaries' Duties to Policyholders

ii. Protection of Personal Data

iii. Issues Regarding Equal Opportunity

iv. Prevention of Corruption

v. Prevention of Insurance Fraud

1.An insurance company estimates its objective risk for 10,000 exposures at 10 percent.
Assuming the probability of loss remains the same, what would happen to the objective risk if
the number of exposures were to increase to 1 million?

(a) It would decrease to 1 percent.

(b) It would decrease to 5 percent.

(c) It would remain the same.

(d) It would increase to 20 percent.

2. Taylor Tobacco Company is concerned that the company may be held liable in a court of law
and forced to pay a large damage award. The characteristics of the judicial system that increase
the frequency and severity of losses is known as

(a) moral hazard.

(b) particular risk

(c) speculative risk

(d) legal hazard.

3.Katelyn was just named Risk Manager of ABC Company. She has decided to create a risk
management program which considers all of the risks faced by ABC—pure, speculative,
operational, and strategic—in a single risk management program. Such a program is called a(n)

(a) financial risk management program.

(b) enterprise risk management program.

(c) fundamental risk management program.

(d) consequential risk management program.

4.Which of the following statements about speculative risks is true?

(a) They are almost always insurable by private insurers.

(b) They are more easily predictable than pure risks.

(c) Their occurrence may benefit society.

(d) They involve only a chance of loss.

5.Which of the following types of risks best meets the requirements for being insurable by
private insurers?

(a) market risks

(b) property risks

(c) financial risks

(d) political risks

6.All of the following are social costs associated with insurance EXCEPT

(a) the expense of doing business.

(b) fraudulent claims.

(c) inflated claims.

(d) increased cost of capital.

7. All of the following are social costs associated with insurance EXCEPT

(a) the expense of doing business.

(b) fraudulent claims.

(c) inflated claims.

(d) increased cost of capital.

8.Why is a large number of exposure units generally required before a pure risk is insurable?

(a) It prevents the insurer from losing money.

(b) It eliminates intentional losses.

(c) It minimizes moral hazard.

(d) It enables the insurer to predict losses based on the law of large numbers.

9.LMN Insurance markets homeowners insurance. The LMN homeowners policy combines
property and casualty insurance in the same contract. Insurance policies combining property and
casualty coverage in the same contract are called

(a) mono-line policies.

(b) multi-year policies.

(c) multiple-line policies.

(d) manuscript policies.

10.Bronson Company manufactures tools that it sells to wholesalers. Bronson is concerned that it
may be unable to collect money the company is owed by the wholesalers. To address this risk,
Bronson Company could purchase

(a) a fidelity bond.

(b) general liability insurance.

(c) allied lines insurance.

(d) credit insurance.

11. All of the following are risk management objectives prior to the occurrence of loss EXCEPT

(a) economy.

(b) continued operations.

(c) reduction of anxiety.

(d) meeting externally imposed obligations.

12.A restaurant owner leased a meeting room at the restaurant to a second party. The lease
specified that the second party, not the restaurant owner, would be responsible for any liability
arising out of the use of the meeting room, and that the restaurant owner would be “held
harmless” for any damages. The restaurant owner’s use of the hold-harmless agreement is an
example of

(a) retention.

(b) self-insurance.

(c) insurance.

(d) noninsurance transfer.

D

13.All of the following are disadvantages of using insurance 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 a loss occurs.

(d) Attitudes toward loss control may become lax.

14.Which of the following types of loss exposures are best met by the use of avoidance?

(a) low-frequency, low-severity

(b) low-frequency, high-severity

(c) high-frequency, low-severity

(d) high-frequency, high-severity

15.Acme Company has three identical manufacturing plants, one on the Texas Gulf Coast, one in
southern Alabama, and one in Florida. Each plant is valued at $50 million. Acme’s risk manager
is concerned about the damage which could be caused by a single hurricane. The risk manager
believes there is an extremely low probability that a single hurricane could destroy two or all
three plans because they are located so far apart. What is the maximum possible loss associated
with a single hurricane?

(a) $0 million

(b) $50 million

(c) $100 million

(d) $150 million

16.All of the following are financial risks which may be faced by business organizations
EXCEPT

(a) interest rate risk.

(b) commodity price risk.

(c) product liability risk.

(d) currency exchange rate risk.

17. All of the following can be classified as casualty insurance EXCEPT

(a) marine insurance.

(b) general liability insurance.

(c) workers compensation insurance.

(d) burglary and theft insurance.

18.A large property and liability insurance company merged with a bank and then acquired a
stock brokerage company. This type of merger and acquisition activity is categorized as

(a) insurance company consolidation.

(b) cross-industry consolidation.

(c) financial risk management.

(d) insurance brokerage consolidation.

19. A computerized data base that permits risk managers to store and analyze risk management
data is called a

(a) risk management information system.

(b) risk management Intranet.

(c) risk management web site.

(d) risk map.

20. A comprehensive risk management plan that addresses an organization’s pure risks,
speculative risks, strategic risks, and operational risks is called a(n)
(a) risk management information system.

(b) financial risk management plan.

(c) speculative risk management plan.

(d) enterprise risk management plan.

1 A sudden demand by depositors for notes and coin is an example of:

(a) Liquidity risk

(b) Currency risk

(c) Payment risk

(d) Capital risk

(e) Asset risk

2 The idea behind a capital adequacy ratio is that banking risk should be borne by:

(a) Directors

(b) Borrowers

(c) Creditors

(d) Shareholders

(e) Managers

3 'Reinsurance' refers to the practice by insurance companies of:

(a) Terminating existing policies

(b) Issuing new policies

(c) Insuring the same risk twice

(d) Buying insurance from another firm

(e) Renewing existing policies

4 By taking out insurance cover an individual:

(a) Transfers the risk to someone else

(b) Reduces the cost of an accident

(c) Reduces the certainty of major loss

(d) Converts the possibility of large loss to certainty of a small one

(e) Reduces the risk of an accident

5 Diversification is one way in which insurance companies can protect themselves against:

(a) Parameter change

(b) Moral hazard

(c) Positively correlated risks

(d) Random fluctuation

(e) The law of large numbers

6 A retirement annuity is particularly attractive to someone who has:

(a) High longevity risk

(b) A severe illness

(c) A large family

(d) Low longevity risk

(e) Financial myopia

7 A 'pay as you go' pension system is unsuitable for a private firm because:

(a) Employees are not willing to pay

(b) There is a disincentive effect for current workers

(c) The benefits are insufficient

(d) The firm may cease trading

(e) The dependency ratio is too high

8 Pension and life insurance funds hold few short-term assets because:

(a) Long-term assets are more profitable

(b) Short-term assets are too risky

(c) Most people live for a long time

(d) Short-term assetsare too dear

(e) Their cashflows are predictable

9 A unit trust fund is established with assets of £200m divided into 150m units. The value of the
underlying assets rises to £250m. The value of each unit is:

(a) £1.33

(b) £0.80

(c) £0.60

(d) £1.25

(e) £1.66

10 Investment trusts often expose investors to higher capital risk than unit trusts because:

(a) Investment trusts are less diversified

(b) Unit trusts hold more bonds

(c) Investment trusts have higher operating costs

(d) Investment trusts can be 'geared'

(e) Investment trusts invest in overseas shares

1-a 2-d 3-d 4-d 5-d 6-a 7-d 8-e 9-e 10-d

1 In order for an agency relationship to exist, there must be:

(a) A written agreement, however made

(b) A written agreement, drawn up by a solicitor

(c) Nothing as an agency relationship can be made verbally

(d) A power of attorney

Agency of necessity may arise if the following conditions are satisfied:

1. While one party has possession of another party's goods an emergency occurs
2. This forces that party to take action regarding the goods for the benefit of their owner
3. The party in possession of the goods has knowledge of the owner's wishes in respect of
the goods
4. It is impossible to communicate with the owner first.

2 Which ones are correct?

(a) 1, 2, 3

(b) 1, 2, 4

(c) 2, 3, 4

(d) All

3 G.T. Hodges & Sons v Hackbridge Residential Hotel (1939) established:

(a) The agent is entitled to indemnity

(b) That the agent does not have an automatic right to payment
(c) The agent is not entitled to indemnity

(d) The agent does have an automatic right to payment

4 When the objective of a short term agency has been performed, this results in:

(a) Both parties may agree to terminate the agency

(b) Nothing as the agency still continues

(c) The agency automatically ends

(d) One party may be allowed to revoke the agreement

5 Which of the following is not a type of power of attorney?

(a) Lasting

(b) Enduring

(c) Irrevocable

(d) Continuing

1-c 2-b 3-b 4-c 5-d

1. Insurance is a tool that can lessen risk.

a. social

b. mental

c. economic

d. accident

e. exposure

2. Underwriting is
a. selling insurance at a premium less than that of the competition.

b. payment of a claim.

c. a method for developing policy wording.

d. the determination of which exposures to insure.

e. none of these.

3. In determining available resources to offset economic needs, you would generally not
consider

a. social security benefits.

b. earning potential of financially independent children.

c. earning potential of surviving spouse.

d. savings.

e. employer-provided group life insurance.

4. Term life insurance is characterized by

a. level annual premiums throughout life.

b. premium amounts related to age.

c. inappropriateness for most person’s life insurance needs.

d. non-convertibility.

e. cash value.

5. Jose died at age 45 leaving a wife (age 36) and two sons (ages 10 and 12). His wife,
Maria, is not gainfully employed. Which of the following is true regarding their Social Security
benefits assuming Jose was covered by Social Security?

a. The sons will receive Social Security benefits until they are age 18.

a. Maria can receive benefits for 6 more years.

 c. Marie can receive benefits when she is 60.

d. a and b

e. a, b, and c

6. is a common provision in many term policies.

a. A reward clause

b. A renewable clause

c. Cash value

d. A limited clause

e. An arbitration clause

7. Decreasing term insurance usually has a decreasing face value and

a. a decreasing premium.

b. a level premium.

c. an increasing premium.

d. a fluctuating premium.

e. none of the above.

8. If the objective of your life insurance program is to get the greatest death protection for
your insurance dollars, you should choose insurance.

a. term

b. universal

c. limited pay

d. industrial

e. whole life
9. Eric will make premium payments on his insurance policy until he dies, and if he cancels
the policy he will receive the cash value. His plan is a life policy.

a. term

b. straight life

c. whole life insurance

d. universal

e. none of the above

10. The insurance portion of a universal life policy is made up of

a. mortgage insurance.

b. group insurance.

c. limited payment.

d. term insurance.

e. variable insurance.

11. An insured usually chooses variable life insurance in order to

a. provide more flexible coverage.

b. emphasize the savings portion.

c. lessen the savings feature of life insurance.

d. substitute for fixed-dollar insurance protection.

e. reduce insurance premiums.

12. Which of the following would be the most cost effective method of insuring business
partners who want to provide funds to buy the other’s share of the business when one of them
dies?
 a. Joint-life insurance

b. Survivorship insurance

c. Group life insurance

d. Variable life insurance

e. Universal life insurance

13. A grace period permits the policyholder to retain full insurance (even though the
premium has not been paid) for

a. a year.

b. 6 months.

c. 3 months.

d. 2 months.

e. 1 month.

14. Marilyn Simms died with a $200,000 life insurance policy. Her husband, Jack, was the
primary beneficiary and their children, Mimi (age 24) and Ann (age 30), were the contingent
beneficiaries. All three survived Marilyn. How would the policy proceeds be distributed?

a. $200,000 to Jack

b. $100,000 each to Mimi and Ann

c. $100,000 to Jack and $50,000 each to Mimi and Ann

d. $66,666 each to Jack, Mimi, and Ann.

e. $150,000 to Jack and $250,000 each to Mimi and Ann.

15. Nonforfeiture rights of policyholders guarantee a

a. policy face value.

 b. death benefits for survivors.

c. cash value.

d. premium refund.

e. premium reductions.

Chapter Answers

Multiple Choice Answers

1. C 6. B 11. B

2. D 7. B 12. A

3. B 8. A 13. E

4. B 9. B 14. A

5. E 10. D 15. C

1 The largest item on the liability side of the balance sheet for life insurance companies is:

A) policy loans

B) unearned premium

C) surrender value

D) endowment
 E) policy reserves

2 The customers most eager to apply for an insurance contract will be those most likely to have a
claim against the insurance company. This is the essence of the _______________ problem in
insurance.

A) capital adequacy

B) mis-matched maturity

C) liquidity

D) adverse selection

E) default risk

3 ________________ is a problem that can arise in the insurance business. The source of the
problem is the customer's behavior after an insurance contract is in place.

A) Risk arbitrage

B) Moral hazard

C) Mis-matched security maturities

D) Adverse selection

E) Pure arbitrage

4 ______________________ is basically "pure" life insurance.

A) Variable life

B) Universal life

C) Endowment life

D) Whole life

E) Term life
5 Life insurance companies show a tendency to have:

A) short-term assets and short-term liabilities

B) short-term assets and long-term liabilities

C) long-term assets and long-term liabilities

D) long-term assets and short-term liabilities

E) short-term assets and almost no liabilities (short or long term)

6 Major lines of property-casualty insurance would include all of the following except:

A) Homeowners multiple peril

B) Automobile liability

C) Fire insurance

D) Universal variable life

E) Commercial multiple peril

7 _________________ is the term referring to a phenomenon in the property-casualty insurance

business—when a claim may occur many years after the relevant insured event.

A) Mis-matched claim

B) Social inflation

C) Underwriting cycle

D) Adverse selection

E) Long-tail loss

8 _______________ is essentially insurance acquired by insurance companies.

A) A long-tail loss

B) Investments in stock and bonds

 C) Reinsurance

D) The McCarran Ferguson Act

E) Unearned premiums

9 The __________________ combines pure life insurance with a savings element. If the insured
lives to some specified time, he/she receives the policy's face value.

A) industrial life policy

B) P&C policy

C) credit life policy

D) endowment life policy

E) group life policy

10 In property/casualty insurance, the actual losses incurred on an insurance line, divided by the
premiums earned, is called the:

A) long-tail loss

B) loss ratio

C) combined ratio

D) operating ratio

E) underwriting ratio

1-e 2-d 3-b 4-e 5-c 6-d 7-e 8-c 9-d 10-b

1. The largest portion of health care costs pay for

a. hospital expenses. d. nursing home costs.

b. prescription drugs. e. medical equipment.

 c. physicians’ services.

2. Jackie pays $20 every time she visits her doctor. She is covered by a(n)

a. HMO. d. Indemnity plan.

b. IPA. e. Could be any of these except the indemnity plan.

c. PPO.

3. An Individual Practice Association differs from a HMO in that

a. you have no choice of the physician.

b. they are located in a central facility.

c. associated doctors operate from their own offices.

d. they are less likely to be found in small communities.

e. none of these.

4. If your employment is terminated, COBRA provides for

a. cancellation of all group insurance benefits.

b. continuation of group insurance benefits until you are reemployed.

c. permanent continuation of group health insurance.

d. temporary continuation of group insurance benefits; you pay premiums.

e. temporary continuation of group insurance benefits; employer pays premiums.

5. Health insurance coverage can include

a. group plans. d. veteran’s benefits.

 b. workers’ compensation. e. all of the above.

c. social security..

6. Medicare is a government-sponsored health care plan composed of Part A and Part B.

Part A covers

a. hospital expenses. d. prescription drugs.

b. doctor’s bills. e. all of the above.

c. custodial nursing home expenses.

7. Workers’ compensation is a state that provides benefits for

a. unemployed workers.

b. workers suffering injury or illness on the job.

c. any injury suffered by a worker at any time.

d. injuries resulting from employer’s negligence.

e. none of these.

8. Physicians expense insurance usually covers

a. consultation with a specialist. d. all of the above.

b. outpatient x-rays. e. none of the above.

c. outpatient laboratory tests.

9. A comprehensive major medical insurance would not normally

a. have a large deductible.

b. include basic hospital coverage.

c. provide surgical expense coverage.

 d. include medical expense coverage.

e. be written under a group contract.

10. Given a $500 annual deductible, a $4,000 lid on the coinsurance, 80/20 coinsurance, and
a $250,000 policy limit, how much of a $15,000 medical bill will be paid by the insured?

a. $500

b. $2,900

c. $3,400

d. $4,000

e. $4,500

11. Miscellaneous sources of health care coverage include

a. homeowners insurance.

b. automobile insurance.

c. veterans benefits.

d. all of the above.

e. none of the above.

12. A “coordination of benefits” provision in a health insurance policy provides which of the
following benefits?

a. Allows the policyholder to be double-covered for the same loss.

b. Provides broader coverage than a policy without such provision.

c. Often results in lower cost insurance premiums.

 d. Drops pre-existing conditions clauses from a policy.

e. All of the above.

13. The insurance designed to help with nursing home or in-home care due to chronic illness
is called

a. Medicare.

b. major medical.

c. comprehensive major medical.

d. nursing home care.

e. none of these.

14. Which of the following is not a desirable feature in a long-term care policy?

a. Inflation protection

b. Optional renewability clause

c. Duration of benefits of 6 years

d. Coverage for Alzheimer’s disease

e. Coverage for preexisting conditions.

15. All of the following except a are highly recommended for a long-term
disability income policy.

a. guaranteed renewable clause

b. cost-of-living adjustment

c. long duration of benefit

d. short waiting period

e. waiver of premium
Chapter Answers

Multiple Choice Answers

1. A 6. A 11. D

2. E 7. B 12. C

3. C 8. D 13. E

4. D 9. A 14. B

5. E 10. C 15. D