Principles of Risk Management and Insurance: Principles of Risk Management and Insurance - Chapter 4 Flashcards

Which of the following is a financial risk that may be faced by a
business organization?
A) injuries suffered by employees at the workplace B)
lost income after a fire loss C) product liability
risk D) currency exchange rate risk

Answer: D

Which of the following statements about the scope of risk management
is (are) true?
Traditionally, risk management was limited in scope to
speculative loss exposures. In the 1990s, some businesses
began to expand the scope of risk management to include financial
risks. A) I only B) II only C) both I and
II D) neither I nor II

Answer: B

Mid-States Beef is a commercial feedlot business. Currently, the
company has over 10,000 cattle in feedlots. Mid-States is concerned
that the price of corn, the grain fed to the cattle, will increase
significantly. The risk that the price of corn may increase and harm
the profitability of Mid-States Beef's operations is a(n)
A) currency exchange rate risk. B) property
risk. C) commodity price risk. D) interest rate
risk.

Answer: C

An integrated risk management program is a risk management program
which combines
A) pure and speculative risks. B) property and
liability risks. C) personnel-related risk and property
risk. D) direct and indirect loss risk.

Answer: A

Regional Airline (RA) spends millions of dollars each year on jet
fuel. The company also has significant liability exposures. RA can
retain a large portion of its liability exposure if fuel costs are
low. The company can pay high fuel costs if retained liability losses
are low. RA cannot, however, absorb both high fuel costs and
high retained liability claims. RA's insurer designed an insurance
program where the insurer pays only if both contingencies
(high fuel costs and high retained liability claims) occur.
The contract the insurer designed is called a(n)
A) double indemnity rider. B) double trigger
option. C) multiple protection policy. D) other
insurance provision.

Answer: B

Which statement is (are) true with respect to enterprise risk
management programs?
They address traditional property, liability, and personnel
loss exposures. They do not address financial risks.
A) I only B) II only C) both I and II
D) neither I nor II

Answer: A

A comprehensive risk management program 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.

Answer: D

The property and liability insurance industry is characterized by a
repetitive pattern of loose underwriting standards with low premiums
followed by tight underwriting standards with high premiums. This
repetitive pattern is called the
A) underwriting by exception method. B) business
cycle. C) underwriting cycle. D) account
underwriting method.

Answer: C

Which statement is (are) true regarding property and liability
insurance market conditions?
Premiums are high when the insurance market is
"hard." Underwriting standards are tight when the
insurance market is "soft." A) I only B)
II only C) both I and II D) neither I nor II

Answer: A

Which of the following statements is true regarding insurance market
conditions and underwriting results?
A) A combined ratio greater than one (or 100 percent)
indicates profitable underwriting. B) In a "soft"
insurance market, more retention is used than in a "hard"
insurance market. C) Insurance rates are high and
underwriting standards are tight when the insurance market is
"hard." D) Property and liability insurance
premiums and underwriting standards do not fluctuate over time.

Answer: C

The relative level of surplus in the insurance industry is called the industry's
A) capacity. B) liabilities. C)
reserves. D) admitted assets.

Answer: A

Which of the following statements is (are) true regarding investment
returns and the underwriting cycle?
Investment returns have no impact upon the underwriting
cycle. Investment returns can lengthen the duration of a soft
market by offsetting underwriting losses. A) I only
B) II only C) both I and II D) neither I nor
II

Answer: B

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.

Answer: B

A company has a fleet of 200 vehicles. On average, 50 vehicles per
year experience property damage. What is the probability that any
vehicle will be damaged in any given year?
A) 10 percent B) 20 percent C) 25
percent D) 50 percent

Answer: C

RST Company has production facilities in Salt Lake City and
Cleveland. The probability that in any given year a fire will damage
the production facility in Salt Lake City is 5 percent. The
probability that in any given year a fire will damage the Cleveland
production facility is 4 percent. What is the probability that BOTH
production facilities will be damaged by fire in any given year?
A) 0.20 percent B) 2.00 percent C) 4.50
percent D) 9.00 percent

Answer: A

RST Company has production facilities in Salt Lake City and
Cleveland. The probability that in any given year a fire will damage
the production facility in Salt Lake City is 5 percent. The
probability that in any given year a fire will damage the Cleveland
production facility is 4 percent. What is the probability that AT
LEAST ONE of the production facilities will be damaged by fire in any
given year?
A) 0.20 percent B) 2.00 percent C) 8.80
percent D) 9.00 percent

Answer: C

Some events cannot occur together because the occurrence of one event
makes the occurrence of the second event impossible. Such events are called
A) dependent events. B) independent events.
C) conditional events. D) mutually exclusive
events.

Answer: D

Two buildings are located close together at a production facility.
The probability that either of these buildings will experience a fire
loss is 4 percent. However, if one building has a fire, the
probability that the second building will have a fire is 60 percent.
What is the probability that both buildings will have a fire?
A) 1.6 percent B) 2.4 percent C) 8.0
percent D) 64.0 percent

Answer: B

Which of the following statements is (are) true with regard to
probability analysis?
If two events are independent, the occurrence of one event
does not affect the occurrence of the second event. If two
events are dependent, the occurrence of one event affects the
occurrence of the second event. A) I only B) II
only C) both I and II D) neither I nor II

Answer: C

Jane is risk manager of ABC Manufacturing Company. She is trying to
decide whether to self-insure her company's workers compensation
exposure or to purchase insurance. Jane would like to use regression
analysis to predict the number of workers compensation claims that
will occur next year. The number of claims will be the dependent
variable in the regression. All of the following would be reasonable
independent variables to use EXCEPT
A) number of employees. B) number of hours
worked. C) total assets. D) payroll.

Answer: C

A method of characterizing the relationship between two or more
variables and then using the characterization to make a prediction is called
A) loss analysis. B) time value of money
analysis. C) regression analysis. D) capital
budgeting analysis.

Answer: C

A table showing losses that could occur and the corresponding chance
that each loss could occur is called a(n)
A) underwriting cycle. B) capital budget. C)
loss distribution. D) risk map.

Answer: C

Which of the following statements is (are) true with respect to the
time value of money?
Money received today is worth more than the same amount of
money received in the future. The present value of a future
amount is greater than the future amount. A) I only
B) II only C) both I and II D) neither I nor
II

Answer: A

Calculating the present value of a future amount is called
A) interpolating. B) discounting. C)
compounding. D) regression analysis.

Answer: B

The process of determining which set of investments in plant and
equipment to undertake is called
A) regression analysis. B) loss forecasting.
C) time value of money analysis D) capital
budgeting.

Answer: D

Which of the following statements is (are) true regarding the net
present value of a capital investment?
Net present value does not consider time value of money.
A positive net present value represents an increase in value to
the firm. A) I only B) II only C) both I
and II D) neither I nor II

Answer: B

Millie is risk manager of JKL Company. She is considering an
investment in a loss control project. The project will cost $40,000.
Assuming a 10 percent discount rate, the present value of the future
net cash flows that this project will generate is $60,000. What is the
net present value (NPV) of this project?
A) $20,000 B) $26,000 C) $60,000 D)
$100,000

Answer: A

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.

Answer: A

A grid charting the potential frequency and severity of losses is
called a
A) risk management information system. B) risk
management Intranet. C) risk management web site.
D) risk map.

Answer: D

Which of the following statements is (are) true with regard to the
use of technology in risk management programs?
Risk management Intranets are networks intended for an
internal audience. Risk management information systems can
be used to store and track workers compensation claims data.
A) I only B) II only C) both I and II
D) neither I nor II

Answer: C

Terrorists attacked the World Trade Center on September 11, 2001. The
attack simultaneously created large losses for life insurers, property
insurers, workers compensation insurers, health insurers, and
liability insurers. What name is given to an event that simultaneously
creates large losses in several lines of insurance?
A) speculative loss B) clash loss C)
retroactive loss D) consequential loss

Answer: B

Which of the following was a consequence of passage of the Financial
Modernization Act (Gramm-Leach-Bliley)?
A) Formation of insurers was made easier because capital
requirements were reduced. B) It became easier for insurers
to conduct business as they were no longer required to be licensed
in each state where they operate, but only in the state where they
are domiciled. C) Insurers were required to prepare
financial statements using generally accepted accounting principles
(GAAP) instead of using statutory accounting. D)
Depression-era barriers between underwriting risk, depository
functions, and securities underwriting were eliminated.

Answer: D

The transfer of insurable risk to the capital markets through the
creation of a financial instrument is called
A) coefficient of risk. B) securitization of
risk. C) financial risk management. D) enterprise
risk management.

Answer: B

LMN Insurance Company is concerned about its exposure to hurricane
losses for property risks it insured on the Gulf Coast. LMN borrowed
money from investors by issuing financial securities. LMN promised to
repay the money it borrowed with interest if hurricane losses do not
exceed a specified level. If hurricane losses exceed the specified
level, LMN will repay less than it borrowed and use the extra money to
fund hurricane losses. The securities that LMN issued are
A) call options. B) futures contracts. C)
weather options. D) catastrophe bonds.

Answer: D

Hedge Fund Company offers a mutual fund to investors. Fund managers
are concerned about fund volatility. They analyzed the fund to
determine the worst loss likely to occur in a calendar quarter,
assuming a 90 percent level of confidence. The worst probable loss is
known as the fund's
A) unrealized capital gain. B) value at risk.
C) beta coefficient. D) surrender value.

Answer: B

Reasons to adopt an enterprise risk management plan include all of
the following EXCEPT
A) to increase earnings volatility. B) to treat risks
facing the business in a more holistic way. C) to increase
net income. D) to gain an advantage over competitors.

Answer: A

Which of the following statements concerning the securitization of
risk is (are) true?
Securitization increases the capacity of the insurance
industry. Securitization can be used to protect against
catastrophic loss. A) I only B) II only
C) both I and II D) neither I nor II

Answer: C

Insurance Brokerage Company uses a computer-based method of
estimating the losses its clients will suffer if a severe storm or
earthquake occurs. This method of estimating losses is called
A) capital budgeting. B) securitization of risk.
C) risk mapping. D) catastrophe modeling.

Answer: D

Uncertainty pertaining to the organization's goals and objectives and
the organization's strengths, weaknesses, opportunities, and threats
is called
A) operational risk. B) strategic risk. C)
subjective risk. D) pure risk.

Answer: B

Consolidation in the insurance industry is a continuing trend. One
area where mergers and acquisitions frequently occur is between
marketing intermediaries who represent insurance purchasers. These
intermediaries are called
A) insurance adjusters. B) insurance agents.
C) insurance underwriters. D) insurance brokers.

Answer: D

Five Below Zero is a new ski resort in Colorado. Five Below Zero is
concerned that an abnormally warm winter will prevent the accumulation
of snow needed to have a profitable ski season. Five Below Zero
purchased a contract that will pay a lump sum if the daily high
temperature exceeds 30 degrees for more than 12 days between January
1st and March 31st. The contract Five Below Zero purchased is called a(n)
A) catastrophe bond. B) weather option. C)
interest rate swap. D) convertible bond.

Answer: B

Which statement is (are) true concerning catastrophe models?
Businesses other than insurance companies use catastrophe
models. Catastrophe models are able to precisely predict
disaster occurrences and loss values. A) I only B)
II only C) both I and II D) neither I nor II

Answer: A

Which of the following is a financial derivative that derives value
from specific insurable losses or from an index of values?
A) commodity futures contract B) corporate bond
C) catastrophe bond D) insurance option

Answer: D

An emerging concern for risk managers is the greater volatility that
has been observed in weather patterns�higher high temperatures, lower
low temperatures, record rainfall, drought, etc. Collectively, this
risk is called
A) seismic risk. B) hurricane risk. C)
speculative risk. D) climate change risk.

Answer: D

Which of the following statements regarding terrorism insurance is
(are) true?
There is a federal backstop if terrorism claims are
catastrophic. Private insurers market terrorism
insurance. A) I only B) II only C) both I
and II D) neither I nor II

Answer: C

The terrorism risk in the United States
A) is of no concern to private companies. B) is
limited to attacks by foreign nationals. C) can be
addressed through risk control and insurance. D) is an
uninsurable risk.

Answer: C

Which of the following is a demographic factor that has increased
losses from climate change in the United States?
A) The increasing life expectancy in the United States.
B) The increasing population in Southern states such as Florida,
Texas, and South Carolina. C) The declining fertility rate
(live births per women of child-bearing age) in the United
States. D) The growth in the number of families living below
the poverty line in the United States.

Answer: B

Last year, XYZ Insurance Company had a combined ratio of 102.4 and
lost $10.2 million on the insurance that it sold. The company,
however, was required to pay income taxes. The best explanation for
this apparent contradiction is that XYZ offset its underwriting loss with
A) increased loss reserves. B) investment
income. C) increased loss adjustment expenses. D)
unearned premiums.

Answer: B

ABC Company in considering a loss control investment. The project
will cost $100,000. It will generate an after-tax net cash flow of
$60,000 one year after investment and an after-tax net cash flow of
$60,000 two years after investment. The present value of $1 received
one year from today assuming a 6 percent rate is .9434. The present
value of $1 received two years from today assuming a 6 percent
interest rate is .8900. Assuming a discount rate of 6 percent, what is
the net present value (NPV) of this project?
A) $10,004 B) $13,195 C) $16,604 D)
$20,000

Answer: A

Which of the following statements about the risk of terrorism in the
United States is (are) true?
Congress created a federal backstop for terrorism claims.
Coverage for losses attributable to terrorism is not marketed by
private insurers in the U.S. A) I only B) II
only C) both I and II D) neither I nor II

Answer: A

When announcing that an enterprise risk management program would be
implemented at XYZ Company, the president of the company observed, �We
must overcome the silo mentality for the program to be successful.�
The �silo mentality� refers to
A) over-emphasis on pure risks and ignoring speculative
risks. B) using too much of one risk treatment measure and
ignoring other risk treatment methods. C) focusing narrowly
on one area and not viewing risk holistically. D) everyone
assuming someone else is responsible for managing a risk and no one
taking leadership.

Answer: C

The first step in the enterprise risk management process is
A) risk analysis. B) implementing and monitoring the
program. C) risk identification. D) selection of
risk treatment measures.

Answer: C

A bank stores depositor data electronically. The data include
financial account values, social security numbers, and other
information. An outside party was able to gain access to the bank�s
customer data through unauthorized access to the bank�s computer
system. The outside party was able to steal money from the accounts
and to sell customer data, including social security numbers, to
others. This scenario illustrates
A) terrorism risk. B) climate change risk.
C) speculative financial risk. D) cyber-liability
risk.

Answer: D

A risk manager analyzed fleet accident data to help determine which
loss control measures would provide the greatest safety incentives for
drivers. Examining data to generate information that will help make
more informed decisions is called
A) predictive analytics. B) catastrophe
modeling. C) sensitivity analysis. D) data
mining.

Answer: A

West Coast Insurance writes property and liability insurance in
California, Oregon, and Washington. These states are all susceptible
to earthquakes. To help determine how much reinsurance to purchase,
West Coast Insurance hired an organization to use a computer algorithm
to estimate what its insured losses would be if a severe earthquake
occurred. West Coast Insurance based its purchase of reinsurance on
the loss estimates. This scenario illustrates using
A) value-at-risk analysis. B) catastrophe
modeling. C) risk mapping. D) a risk management
information system.

Answer: B

Palmer Polymers is changing from a traditional risk management
program to an enterprise risk management program. As a first step, the
risk manager determined all the risks that the organization faces.
Next, she created a grid with loss frequency on the x-axis and loss
severity on the y-axis. Then she plotted all of the loss exposures
based on frequency and severity. The grid and the plotted loss
exposures are called a
A) probability distribution. B) catastrophe
model. C) risk map. D) risk management information
system.

Answer: C