Chapter 2 Exercises

Work these the way the chapter taught you to read history — not as trivia, but with the underwriter's question at every stop: what risk was someone trying to transfer, and what did they invent to make it possible? Items marked with a dagger (†) have worked solutions in Appendix: Answers to Selected Exercises; the rest are for discussion or self-test. Section references like (§2.3) point you back to the relevant part of the chapter.

A. Recall and definitions

  1. † Define bottomry in one sentence, and explain in one more why the charge above ordinary interest functioned as a premium rather than as interest. (§2.1)
  2. State the principle of general average in plain language, and give the classic example the chapter uses. (§2.1)
  3. Explain what Lloyd's of London is — and, just as important, what it is not. Name the role of a syndicate, a member, and a lead underwriter. (§2.3)
  4. † Define the tontine, and explain the single feature that made it both attractive and dangerous. (§2.6)
  5. In one or two sentences each, distinguish the actuary from the underwriter as the chapter frames them. Which "prices the class" and which "prices the case"? (§2.4)
  6. What is a fire mark, and what entirely modern underwriting practice does the fire mark stand for? (§2.2)
  7. The chapter calls the mortality table "the first credible predictive model in the history of insurance." What did it let a life insurer estimate, and from what raw material? (§2.4)

B. The ancient and early modern roots

  1. The chapter says bottomry "bundled a loan and an insurance into one instrument." Describe the decisive later step — completed in the medieval Italian city-states — that separated the two, and explain why that separation mattered for the growth of insurance. (§2.1)
  2. † Explain in what sense general average is the concept of risk pooling (Chapter 1) appearing "as a moral and legal mechanism rather than a statistical one." How does it differ from the kind of pooling the law of large numbers describes? (§2.1; Ch.1)
  3. Fire insurance "did not work in 1600 and did work by 1700," the chapter argues, "not because the peril changed but because the conditions for insurability changed." State precisely which conditions changed and connect this to Chapter 1's insurable-risk criteria. (§2.2; Ch.1)
  4. Why did the early London fire offices charge different premiums for timber versus brick construction — and what would have happened to an office that charged them the same price? Name the Chapter 1 concept that office would have fallen victim to. (§2.2; Ch.1)

C. Apply the history (underwrite this submission)

  1. † Underwrite the slip. You are a name in the coffeehouse, ~1690s. A broker brings a slip: insure the ship Prosperous and her cargo, London to the West Indies and back, valued together at £6,000, in wartime. Decide how you would respond, and explain in two or three sentences why you would subscribe a share rather than the whole — and what modern mechanisms (name two) descend from that decision. (§2.3; preview Ch.12, Ch.27)
  2. A merchant in the same market asks you to insure his house against fire. It is the year 1650 — before the Great Fire. Explain why you, as an underwriter of that era, would have no good way to write this risk as a standalone product, and what would have to exist first. (§2.2)
  3. Place each of Harbor Steel's exposures on the historical timeline by naming, for each, the era or event that first made it insurable: (a) steel and components in transit; (b) fire on the plant building; (c) named-windstorm catastrophe; (d) workers' compensation; (e) products liability. (§2.1–§2.6, the Underwriting File)

D. Find the red flag

  1. † Find the red flag (historical). A late-19th-century life insurer is selling deferred-dividend (tontine-style) policies in enormous volume and reporting spectacular profits year after year. Senior management points to the profits as proof the strategy is sound. Identify the red flag a disciplined observer should raise, state the historian's question the chapter says you should ask, and name the real-world reckoning that eventually came. (§2.6)
  2. A modern carrier prices its risks straight off a bureau manual whose territorial definitions and rating factors were built decades ago from historical loss data, and never asks where that data came from. Using the chapter's argument, explain the hidden danger, and name the modern technology (and chapter) where the same danger reappears. (§2.7; preview Ch.32, Ch.35)
  3. Identify the moral-hazard red flag in both of these historical arrangements, and explain why each created a financial incentive for harm: (a) a bottomry loan that is fully forgiven if the ship sinks; (b) an 18th-century life policy taken out by a stranger on another person's life. (§2.1, §2.4)

E. The actuarial revolution and the limits of the table

  1. † Explain, using the chapter's framing, why "you cannot predict when one person will die, but you can predict how many of a large group will" — and tie this directly to the law of large numbers from Chapter 1. (§2.4; Ch.1)
  2. The chapter says the entire craft of life underwriting "exists in the gap between the table's class rate and the individual's true risk." Explain what this means, and predict (you will meet him in Chapter 6) how an applicant like David Okafor — mildly elevated cholesterol and family history, but excellent blood pressure and an active life — illustrates that gap. (§2.4; preview Ch.6, Ch.17)
  3. Equitable Life is credited with putting life insurance "on a sound scientific footing." Name the two things it did that earlier life "insurers" did not, and explain why each was necessary for the business to be durable rather than a lottery. (§2.4)

F. Reform by catastrophe, and the social function

  1. State the chapter's organizing claim that "insurance reforms by catastrophe" in your own words, and give three distinct examples from the chapter of a disaster or scandal that produced a permanent rule you still work under. (§2.2, §2.4, §2.6)
  2. † For each of the three modern catastrophes named in §2.6 — Hurricane Andrew (1992), the September 11 attacks (2001), and Hurricane Katrina (2005) — name one concrete, lasting change to underwriting practice or policy forms that the chapter attributes to it. (Keep your answer qualitative; invent no figures.) (§2.6)
  3. The chapter argues that much insurance regulation is "the scar tissue of abuses" — conduct-driven reform, not catastrophe-driven. Give two examples of such conduct-driven reform from the chapter, and explain how each connects to theme six (insurance serves a social function). (§2.6)

G. Memo and ethics

  1. † Write the short memo. Your underwriting manager, new to the industry, asks: "Why do we still have a percentage wind deductible and a catastrophe load on coastal property? It feels like we're punishing the insured for where they live." In a short memo (150–250 words), use the history in §2.6 to explain where these features came from and why they exist — and acknowledge honestly the social tension the Compliance Corner in §2.2 raises. (§2.2, §2.6)
  2. Ethics dilemma. The early fire offices priced timber housing far above brick and declined the worst structures — sound risk-based pricing that nonetheless charged the poorest, in the most flammable housing, the most (or excluded them). The chapter calls this "a permanent feature of pricing by risk, not a flaw we have since fixed." Take a position: does the underwriter have any obligation beyond pricing accurately to the risk? Argue both sides, and connect your answer to the actuarial-fairness-versus-social-fairness tension you will meet in Chapter 35. (§2.2; preview Ch.35)
  3. The chapter notes that betting on a stranger's death is "not insurance; it is a wager dressed as one." Explain the principle that separates insurance from a wager, name the doctrine (owned by Chapter 4) that enforces it, and give one modern situation where an underwriter must still confirm this principle is satisfied. (§2.4; preview Ch.4)

H. The long arc and the Underwriting File

  1. † The Underwriting File extension. Write a short "historical perspective" note for the top of the Harbor Steel file (120–200 words): identify which single exposure on the account is the oldest insurable risk it presents and which is among the youngest, and explain in one or two sentences why the account's hardest exposure (the named windstorm) is hard for a reason as old as insurance itself. Do not attempt to price or set terms — this chapter's File beat is context only. (§2.1–§2.6, the Underwriting File)
  2. The chapter claims that "the algorithm on your screen is the heir of the bottomry lender's route-and-season pricing, the fire office's construction classes, and the actuary's mortality table." Defend this claim by stating the one job all of these tools share and the one limitation they all share. (§2.7)
  3. Trace the arc "from ledger to algorithm" in five named stages, in order, from the handwritten ledger to machine-learning models, and say in a phrase what each stage added. (§2.7)
  4. † The chapter argues that the move from ledger to algorithm "is not a break with history but its latest chapter," because the relationship between the tool and the judgment "has not changed at all." State that unchanging relationship in a single sentence, and explain how the Harbor Steel model-override you will see in Chapter 32 (a model scores it 7/10; the underwriter writes it at a 6) is "the same move, in principle," as the first life underwriter rating an applicant against the mortality table. (§2.7; preview Ch.32)