Chapter 4 Exercises

Work these the way an underwriter reads a file: ask of every statement can I rely on it, and what may I do if it is wrong, and of every rate am I allowed to charge this, and is it fair. 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 (§4.3) point you back to the relevant part of the chapter.

A. Recall and definitions

1. † Name the four special features of an insurance contract from §4.1 (adhesion, aleatory, conditional, unilateral) and, in one phrase each, say what each one means. (§4.1)
2. Define utmost good faith and explain, in one sentence, which §1.4 problem it exists to fight. (§4.1)
3. † Distinguish insurable interest from indemnity in one sentence each. Which one is "the gate" and which is "the measure"? (§4.2)
4. State the timing rule for insurable interest in (a) property insurance and (b) life insurance, and give the moral-hazard reason for the difference. (§4.2)
5. Distinguish a representation from a warranty. Which is tested for materiality and substantial truth, and which (at strict common law) must be exactly true? (§4.3)
6. Define concealment and state the two things that generally must be true for a concealment to let the insurer rescind. (§4.3)
7. † Explain subrogation in two sentences: what right it gives the insurer, and the two purposes it serves. (§4.4)
8. What did United States v. South-Eastern Underwriters (1944) decide, and how did the McCarran-Ferguson Act (1945) respond? (§4.5)
9. Name the three-part legal standard that a rate must satisfy (the "not , not , not ___" test). (§4.6)
10. Define surplus lines and name two protections an insured gives up when a risk is placed there instead of in the admitted market. (§4.7)

B. The contract and its doctrines

11. † A property policy contains a clause that can reasonably be read two ways — one favoring coverage, one denying it. Which way will a court most likely resolve the ambiguity, and which contract feature (§4.1) drives that result? Explain in three sentences. (§4.1)
12. An applicant takes out a \$1,000,000 fire policy on a building owned entirely by an unrelated third party with whom the applicant has no financial relationship. What doctrine voids this arrangement, and what specific danger is the doctrine guarding against? (§4.2)
13. Harbor Steel wants to insure its \$20M building for a \$30M limit "to be safe." Explain, using the indemnity principle, why you should not simply grant the higher limit, and what danger over-insurance creates. (§4.2)
14. † A company holds a key-person life policy on its founder. The founder retires and, three years later, dies. The insurer argues there was no insurable interest at the time of death and refuses to pay. Is the insurer right? Explain using the life-insurance timing rule. (§4.2)
15. Explain why subrogation, contribution, salvage, and the prohibition on collecting twice for one loss are all described in the chapter as "the indemnity principle doing its job." Pick two and say how each enforces indemnity. (§4.2, §4.4)

C. Disclosure, representations, and warranties

16. For each statement below, decide whether a false version would most likely be treated as an immaterial misrepresentation, a material misrepresentation, or a (warranty-like) condition, and explain why: (a) "The plant is 50,000 square feet" when it is actually 49,800; (b) "We have had no fire losses in five years" when there were two; (c) a protective-safeguards clause requiring the sprinkler system to be kept in working order. (§4.3)
17. † An applicant does not lie on the application but stays silent about a pending lawsuit they know is material and deliberately hide. The insurer later discovers it. What is this called, and what remedy may the insurer have? What two elements must the insurer generally show? (§4.3)
18. Explain why the chapter calls the application "the legal instrument through which the duty of utmost good faith is operationalized." What does this imply about how you should document what an applicant tells you? (§4.3)
19. † (Find the red flag.) The Harbor Steel submission lists the 2023 fire but describes its cause vaguely as "equipment-related," when the loss-control narrative you later obtain points to a hot-work (welding) ignition that a permit program would have prevented. Identify the disclosure issue, explain whether — on these facts alone — this looks more like an innocent representation, a material misrepresentation, or a concealment, and state what you would do before concluding it is any of them. (§4.3; previews Ch.33)
20. Explain the modern problem that automated/accelerated underwriting creates for the doctrines of disclosure (§4.3): if a model pre-fills a submission and binds with no question put to the applicant, what legal protection may the insurer have quietly given up, and what should the product designer do about it? (§4.3)

D. Subrogation in practice

21. † A third-party driver negligently rear-ends a Harbor Steel truck; you pay the \$40,000 physical-damage claim under Harbor Steel's policy (illustrative figure). Trace the path of the dollar under subrogation: who pays whom, in what order, and what is the net effect on (a) Harbor Steel, (b) the at-fault driver, and (c) your company's true cost of the loss? (§4.4)
22. Harbor Steel's largest customer demands, in its purchase contract, that Harbor Steel's insurer waive subrogation against the customer. Explain what your company gives up by agreeing, and list two disciplines the Compliance Corner recommends before allowing the waiver. (§4.4)
23. In a state following the "make-whole" rule, a subrogation recovery is too small to cover both the insured's deductible and the insurer's payment. Who is generally repaid first, and why does that fact matter when you set a deductible (Chapter 12)? (§4.4)

E. Regulation and rates

24. † Place the four rate-regulation systems — prior-approval, file-and-use, use-and-file, open competition — in order from most to least restrictive, and explain in one sentence each how the timing of the regulator's review differs. (§4.6)
25. Explain the apparent paradox that "the same law that stops gouging also forbids under-pricing." Which two parts of the three-part rate standard correspond to each, and why is the regulator, in principle, on the side of rate adequacy? (§4.6)
26. The NAIC has "no direct legal authority of its own," yet it shapes insurance regulation across all fifty states. Explain how — and name two things the NAIC actually produces or maintains. (§4.5)
27. † (Underwrite this submission — the placement question.) You hold the Harbor Steel program at a mid-size admitted regional carrier. The catastrophe-exposed property is the piece your filed program may not be able to accommodate. Walk through the decision: what determines whether the property stays on admitted paper or moves to surplus lines, what is lost if it goes to surplus lines, and which later chapters' work you need before you can actually decide. (§4.7, §4.5; The Underwriting File)
28. A producer offers a prospective insured a "discount" by quietly kicking back part of the commission to win the account. Name the prohibition this violates and give the two rationales the chapter offers for it. (§4.7)

F. Fairness, classification, and ethics

29. State the paradox at the center of §4.7 in your own words: why must insurance "discriminate" to function, and where does that legitimate discrimination become unfair? (§4.7)
30. † Which classifications are off the table entirely, in every jurisdiction, regardless of any claimed statistical correlation? Explain the two reasons the chapter gives for why a mere correlation does not make such a factor usable. (§4.7)
31. (Ethics dilemma.) A data scientist on your team has built a rating model that materially improves loss prediction (a better Gini) but achieves much of its lift from a ZIP-code-based feature that, on testing, produces prices strongly correlated with race because of historical segregation — though race is nowhere in the model. The model is legal-looking and arguably "just predicting risk." Lay out the competing considerations (actuarial accuracy, the proxy-discrimination problem, your duty under §4.7, the social function of insurance) and state what you would recommend and why. Do not resolve it glibly in either direction. (§4.7; previews Ch.35)
32. Explain proxy discrimination to a new colleague using one concrete (constructed) example, and explain why "the factor is statistically predictive" is not a sufficient defense of its use. (§4.7)

G. Memos and the Underwriting File

33. † (Write the memo.) Draft a short (150–250 word) "legal frame" memo for the Harbor Steel file that a senior underwriter could read in one minute. Cover the three legal facts this chapter puts on the file: the disclosure duty (and the loss-cause record to confirm in writing), the insurable interests (owner, mortgagee, key-person), and the admitted-vs-surplus-lines question for the cat property. State the running disposition. (The Underwriting File)
34. The chapter says a waiver of subrogation Harbor Steel grants to a customer is "a real transfer of risk to your company." Write three sentences you would say to the broker to explain why you must see and price the waiver rather than treat it as boilerplate. (§4.4)
35. (Underwriting-File extension.) List three documents you would want in writing on the Harbor Steel file specifically because of the doctrines in this chapter — and, for each, name the doctrine that makes the written record matter. (§4.3, §4.2; The Underwriting File)
36. (Synthesis across chapters.) In one paragraph, connect three ideas: adverse selection (Chapter 1), the duty of utmost good faith (§4.1, §4.3), and rate adequacy (Chapter 3). Show how the law of disclosure and the discipline of pricing are both responses to the same underlying problem. (§1.4, §4.1, §4.3; Ch.3)