Chapter 1 Self-Check Quiz
Twenty questions. Answer before opening the key at the bottom. The multiple-choice questions test recall and recognition; the short-answer questions test whether you can use the ideas.
Multiple choice
-
The single most important reason insurance "works" mathematically is: a. Insurers invest premiums in the stock market b. The law of large numbers makes aggregate losses predictable across a pool c. Most policyholders never file a claim d. Governments guarantee insurer solvency
-
A policyholder who pays \$1,200 a year and will probably never collect is still rational to buy insurance because: a. They expect to come out ahead financially on average b. They are risk-averse and value removing the chance of ruin over the expected cost c. Insurance is legally required for everyone d. The premium will be refunded if no claim is filed
-
"Risk pooling" means: a. Charging every insured the same premium b. Combining many exposures so the losses of the few are paid by the premiums of the many c. Investing reserves in a pooled fund d. Reinsuring every policy individually
-
As the number of independent, similar exposures in a pool grows, the relative volatility of total losses: a. Grows in proportion to the pool b. Stays the same c. Shrinks (roughly as one over the square root of the expected number of losses) d. Becomes impossible to estimate
-
Which of the following is least like an insurable risk? a. Fire damage to a warehouse b. A driver's liability for an at-fault accident c. The risk that a new product line won't sell (a business gamble) d. A homeowner's loss from a kitchen fire
-
The insurability criterion that catastrophe risk (e.g., hurricane) violates most directly is: a. Definite and measurable loss b. Loss that is not catastrophic to the insurer (independence across the pool) c. Economically feasible premium d. Fortuitous loss
-
Adverse selection refers to: a. Insurers selecting only the worst risks b. The tendency for those who most expect a loss to be the most eager to buy coverage c. A regulator selecting which insurers may operate d. Choosing the wrong reinsurer
-
An online insurer offers one flat price and markets to people who just received a serious diagnosis. The most likely result is: a. A perfectly balanced risk pool b. A pool skewed toward high risks, rising prices, and a possible death spiral c. Lower losses than expected d. No effect, because price is fixed
-
The best one-line description of underwriting's relationship to adverse selection is: a. Underwriting causes adverse selection b. Underwriting is irrelevant to adverse selection c. Underwriting is the cure for adverse selection d. Adverse selection only matters in reinsurance
-
A business cancels a planned sprinkler upgrade because its property is now fully insured. This is an example of: a. Adverse selection b. Moral or morale hazard (reduced incentive to prevent loss) c. The law of large numbers d. A catastrophe exposure
-
The clearest example of moral hazard (as opposed to morale hazard) is: a. Forgetting to lock the warehouse b. A failing owner who deliberately sets fire to over-insured inventory c. Driving a little faster because the car is insured d. Not bothering to install smoke detectors
-
Deductibles and coinsurance exist primarily to: a. Make policies more confusing b. Reduce the insurer's payout and preserve the insured's incentive to prevent loss c. Satisfy reinsurers d. Comply with the law of large numbers
-
In the insurance value chain, the underwriter sits: a. After claims, to review what was paid b. At the selection gate — after distribution, before pricing finalizes and issuance binds c. Entirely outside the chain d. Only in the reinsurance function
-
A combined ratio above 100% means: a. The insurer is very profitable b. The insurer paid more in losses and expenses than it collected in premium (an underwriting loss) c. The insurer wrote too few policies d. The reserves are fully funded
-
"Reinsurance" is best described as: a. Selling a policy twice b. Insurance for the insurer — transferring part of its risk, especially catastrophe, to reinsurers c. A type of customer policy d. The same thing as a deductible
Short answer
-
Explain, in two or three sentences, why an insurer cares more about the variance of losses than their average. (§1.1)
-
An insurer writes 20,000 identical, independent policies, each with a 1-in-1,000 chance of a \$500,000 loss. Compute the expected number of losses, the total expected loss, and the pure premium per policy. (§1.2)
-
Define adverse selection and name two underwriting tools that counter it. (§1.4)
-
Distinguish moral hazard from morale hazard with one original example of each. (§1.5)
-
The Harbor Steel account's prior carrier is non-renewing it. Give one reason this might be a red flag and one reason it might be harmless. (§1.7, The Underwriting File)