Chapter 2 Quiz

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Chapter 2 Quiz

Twenty questions to check your grasp of the history and why it still shapes your desk. Fifteen multiple choice, five short answer. Answers are in the collapsed key at the bottom — try the whole set before you open it.

Multiple Choice

1. A bottomry loan differs from an ordinary loan principally because:

A) it charges no interest at all
B) the debt is canceled if the ship is lost, and the charge above ordinary interest functions as a premium
C) it can only be made to governments
D) it must be repaid in cargo rather than cash

2. The principle of general average holds that:

A) all insurers must charge the same average rate
B) a loss deliberately incurred to save a venture from a common peril is shared proportionally among all parties whose property was saved
C) the shipowner alone bears any loss to cargo
D) average losses are pooled across all voyages a merchant ever makes

3. The Great Fire of London (1666) is credited with catalyzing fire insurance largely because:

A) it proved fire could never be insured
B) it created, through the rebuilding, a larger and more standardized stock of buildings to pool, and made fire vivid as a catastrophe worth transferring
C) it was the first fire in recorded history
D) it caused Parliament to nationalize all insurance

4. The word underwriter originates from the practice, in Edward Lloyd's coffeehouse, of:

A) writing insurance policies in invisible ink
B) individuals writing their names underneath a description of a marine risk to accept a share of it
C) underpricing risks to win business
D) writing claims rather than premiums in the ledger

5. Which statement about Lloyd's of London is correct?

A) It is the world's largest single insurance company
B) It is a marketplace and society in which syndicates, backed by members' capital, underwrite risks on a subscription basis
C) It only insures British ships
D) It is a government agency that regulates insurance

6. The early London fire offices charged different premiums for timber versus brick construction. An office that charged them the same price would most directly fall victim to:

A) general average
B) the law of large numbers
C) adverse selection — it would attract a disproportionate share of timber owners
D) reinsurance

7. A mortality table (life table) allows a life insurer to estimate:

A) exactly when a specific applicant will die
B) the probability that a person of a given age will die within the year, derived from how many of a large group survive to each age
C) the price of reinsurance
D) the construction class of a building

8. Equitable Life (1762) is significant chiefly because it was among the first life insurers to:

A) refuse to insure anyone over 40
B) set premiums that varied by the insured's age using mortality data and hold reserves adequate to its long-term promises
C) sell only to the aristocracy
D) operate without any mathematical methods

9. The chapter distinguishes the actuary from the underwriter by saying, in effect:

A) the actuary prices the individual case; the underwriter builds the tables
B) the actuary prices the class (builds tables/models, sets class rates and reserves); the underwriter prices the case (accepts or declines the individual risk)
C) they do exactly the same job
D) the underwriter has no use for the actuary's work

10. A tontine scheme is defined by the feature that:

A) all subscribers receive equal payouts regardless of when they die
B) as members die, their shares are redistributed among the survivors, so the last survivors gain most
C) it can only be sold to one person
D) it pays nothing to anyone

11. The late-19th-century American tontine / deferred-dividend scandals led most directly to:

A) the abolition of all life insurance
B) major reforms (restrictions on deferred-dividend policies, transparency requirements, stronger state regulation) following a famous investigation of the life-insurance industry
C) the founding of Lloyd's
D) the invention of the mortality table

12. The Philadelphia Contributionship (1752) is best described as:

A) America's first stock insurer, owned by shareholders
B) America's oldest property insurer, a policyholder-owned mutual that practiced inspection-based, prevention-minded selection
C) a reinsurance company
D) a federal regulatory agency

13. The McCarran-Ferguson Act (1945) is significant because it:

A) created a single national insurance regulator
B) returned the primary regulation of insurance to the states after a Supreme Court ruling had held insurance to be interstate commerce
C) banned all insurance across state lines
D) abolished the NAIC

14. Bodies like ISO (Verisk) and NCCI originated from the insight that insurers could underwrite and price more consistently if they:

A) stopped collecting any data
B) pooled their loss experience across companies and published standardized rates and classifications
C) each used a completely different rating method
D) relied solely on individual underwriters' memories

15. The chapter's central argument about the move "from ledger to algorithm" is that:

A) the algorithm replaces the underwriter entirely
B) it is a sharp break with everything that came before
C) it is the latest movement in a long arc, and the relationship between the tool (which advises) and the underwriter (who decides) has not changed
D) the bureau manual was the last useful tool ever invented

Short Answer

16. Explain how a bottomry loan contained, in embryo, the moral hazard problem — and what ancient pricing practice was already doing frequency × severity by feel. (§2.1)

17. Fire insurance "did not work in 1600 and did work by 1700," the chapter says, "not because the peril changed but because the conditions for insurability changed." Name the conditions that changed. (§2.2)

18. Why is betting on a stranger's life "not insurance, but a wager dressed as one," and what doctrine (owned by Chapter 4) was created to curb the abuse? (§2.4)

19. State the chapter's claim that "insurance reforms by catastrophe," and give two examples from the chapter of a disaster or scandal that produced a permanent rule. (§2.2, §2.4, §2.6)

20. The chapter says the modern predictive model and the eighteenth-century mortality table share the same job and the same limitation. State both the shared job and the shared limitation. (§2.4, §2.7)

Answer Key (try the questions first)

**Multiple choice:** 1. **B** — the canceled debt on loss, and the charge above ordinary interest as a premium, are what make bottomry a risk-transfer instrument. (§2.1) 2. **B** — general average shares a deliberate sacrifice among all who benefited from it. (§2.1) 3. **B** — the rebuilding created a larger, more standardized, poolable building stock, and made fire vivid as a transferable catastrophe. (§2.2) 4. **B** — to *write under* the risk was to accept a share of it; hence "underwriter." (§2.3) 5. **B** — Lloyd's is a marketplace/society of subscribing syndicates backed by members' capital, *not* a single insurance company. (§2.3) 6. **C** — a single price for unequal risks invites adverse selection; the timber owners would flood in. (§2.2; Ch.1) 7. **B** — the table gives the age-specific probability of death, the *frequency* a life underwriter needs. (§2.4) 8. **B** — pricing by age from mortality data, plus adequate reserves, put life insurance on a scientific footing. (§2.4) 9. **B** — the actuary prices the class; the underwriter prices the case. (§2.4) 10. **B** — redistribution of dying members' shares to survivors is the defining tontine feature. (§2.6) 11. **B** — the deferred-dividend abuses led, after a famous investigation, to reform and stronger state regulation. (§2.6) 12. **B** — the Contributionship was America's oldest property insurer, a mutual practicing inspection-based selection. (§2.5; and Ch.1 case study) 13. **B** — McCarran-Ferguson returned primary insurance regulation to the states. (§2.5; owned by Ch.4) 14. **B** — pooling industry loss experience into standardized rates is the origin of the rating/advisory bureaus. (§2.7) 15. **C** — the arc bends toward data, but the tool-advises/underwriter-decides relationship is unchanged. (§2.7) **Short answer:** 16. If the debt is forgiven when the ship is lost, a dishonest or desperate shipowner has an incentive to *let* the ship be lost (scuttle it or overstate the loss) — the moral-hazard problem of Chapter 1. Ancient lenders priced the charge by route and season — the dangerous winter passage cost more than the calm summer one — which is *frequency × severity* (Ch.6) being priced by experience, long before the formula existed. (§2.1) 17. The *peril* (fire) was unchanged; what changed were the conditions for insurability: the post-fire rebuilding produced a larger stock of *broadly similar*, more standardized, better-documented buildings — a *pool* large enough for the law of large numbers to begin to work (Ch.1's first insurable-risk criterion). Insurability is a property of the risk *plus the machinery*. (§2.2; Ch.1) 18. Betting on a stranger's death manufactures a stake in someone else's misfortune rather than protecting against a real loss to oneself; it creates a financial incentive to wish or hasten the death — a grotesque moral hazard — and is therefore a wager, not insurance (and it covers a speculative-style stake, not a pure risk of loss to the policyholder). The **insurable interest** doctrine (Chapter 4) was created to require a genuine financial or familial stake in the insured life. (§2.4) 19. Insurance rarely changes by abstract improvement; it changes because a catastrophe or scandal forces a reckoning that becomes a permanent rule. Examples (any two): the Great Fire of London → fire insurance and inspection (§2.2); reckless life-insurance gambling → the insurable-interest requirement (§2.4); the tontine/deferred-dividend scandals → restrictions and stronger state regulation (§2.6); Hurricane Andrew → catastrophe models and percentage wind deductibles (§2.6). (§2.2, §2.4, §2.6) 20. **Shared job:** both estimate the risk and suggest a price (the table gives the class mortality; the model gives a score/price), each more finely than the tool before it. **Shared limitation:** both are built on the past and price the class or the pattern; neither can see the particular, novel, or changing thing about the individual risk that the historical data never captured — so in every era the tool advises and the underwriter decides. (§2.4, §2.7)