Chapter 12 Quiz

Twenty questions to check your grasp of coverage structuring — deductibles, retentions, limits, sublimits, coinsurance, endorsements, and the documents that make a deal real. Answers are in the collapsed key at the bottom; resist opening it until you have committed to an answer.

Multiple Choice

1. A deductible does all of the following EXCEPT:

  • A. Shed small, frequent, high-friction losses the insurer would rather not administer
  • B. Lower the premium by the expected loss in the retained layer
  • C. Preserve the insured's incentive to prevent and minimize loss
  • D. Increase the insurer's maximum exposure on a catastrophic loss

2. A 5% named-windstorm deductible on a building insured for \$20,000,000 means that, on a named-storm loss, the insured retains the first:

  • A. \$100,000
  • B. \$1,000,000
  • C. \$5,000,000
  • D. 5% of the loss amount, whatever it is

3. The single most important difference between a self-insured retention (SIR) and a deductible is:

  • A. An SIR is always larger in dollar terms
  • B. Under an SIR the insured handles and pays claims within the retained layer, and the insurer is genuinely off the risk below it
  • C. An SIR applies only to property, never to liability
  • D. A deductible requires collateral and an SIR does not

4. A policy is written at \$1,000,000 per occurrence / \$2,000,000 aggregate. After two covered occurrences of \$1,000,000 each are paid, a third \$1,000,000 occurrence happens in the same year. The insurer pays on the third occurrence:

  • A. \$1,000,000
  • B. \$500,000
  • C. \$0 — the aggregate is exhausted
  • D. \$2,000,000

5. A sublimit is best described as:

  • A. A deductible that applies only to catastrophe perils
  • B. A cap on a particular coverage or peril set lower than the overall policy limit
  • C. The minimum premium an insurer will charge
  • D. The portion of a loss the insured retains before coverage attaches

6. Under an 80% coinsurance clause, an insured collects only a proportional share of a loss when it:

  • A. Suffers a total loss
  • B. Carries insurance equal to or above 80% of the property's full value
  • C. Carries less than 80% of the property's full value
  • D. Files more than one claim in a policy year

7. A binder is:

  • A. A non-binding estimate of what coverage might cost
  • B. A temporary contract that grants coverage immediately, pending issuance of the formal policy
  • C. A document that only the broker, not the insurer, can issue
  • D. The formal policy itself

8. The most expensive error an underwriter can make on a binder is to:

  • A. Issue it on the wrong company letterhead
  • B. Leave off a restriction or subjectivity the underwriter intended to apply
  • C. Date it one day early
  • D. Include the premium amount

9. A large-deductible workers'-compensation program creates a special exposure for the insurer because:

  • A. Workers' comp has no limits, so the deductible is meaningless
  • B. The insurer must pay statutory benefits from the first dollar and relies on the insured's credit to reimburse the deductible
  • C. Coinsurance applies to workers' comp
  • D. The insured handles the injured worker's claim directly

10. Which structure forces an insured to retain the bottom slice of a catastrophe loss, while keeping the full policy limit available above it?

  • A. A sublimit on the catastrophe peril
  • B. An aggregate limit
  • C. A percentage (catastrophe) deductible
  • D. A coverage letter

11. An ACV-roof endorsement on a building with an aging roof is an example of:

  • A. A broadening endorsement that fills a coverage gap
  • B. A restrictive endorsement that carves out a hazard the underwriter won't price into the base deal
  • C. A manuscript form
  • D. A coinsurance waiver

12. A drafting ambiguity in a manuscript policy form is generally construed:

  • A. In favor of whichever party a court prefers
  • B. Against the insurer who drafted it (contra proferentem)
  • C. Against the insured, since they accepted the terms
  • D. As if the standard bureau language applied

13. Genuinely novel, manuscript-heavy risks often end up in the surplus-lines (non-admitted) market primarily because:

  • A. Surplus-lines premiums are always cheaper
  • B. Surplus-lines carriers have freedom of form and rate, escaping the admitted market's form-filing requirements
  • C. Admitted carriers are legally forbidden from writing manufacturing risks
  • D. Surplus-lines policies do not need limits

14. Raising a commercial account's deductible from \$10,000 to \$100,000 reduces the premium by approximately:

  • A. \$90,000 — the full additional retention
  • B. The expected losses that fall in the \$10K–\$100K retained layer, plus a claims-handling-expense credit
  • C. Nothing, since the limit is unchanged
  • D. Exactly half the original premium

15. The path from an underwriting decision to active coverage runs, in order:

  • A. Binder → coverage letter → policy → submission
  • B. Submission → coverage letter (offer) → binder (coverage starts) → policy issued
  • C. Policy → binder → coverage letter → submission
  • D. Coverage letter → policy → submission → binder

Short Answer

16. Explain the difference between a per-occurrence deductible and an aggregate deductible, and give one reason a sophisticated insured might prefer the aggregate structure.

17. A building's full value at the time of loss is \$10,000,000. The policy has an 80% coinsurance clause and a \$50,000 deductible. The insured carried \$6,000,000 of insurance and suffered a \$2,000,000 loss. Compute the loss payment and identify the coinsurance penalty in dollars.

18. Why is a pricing model looking at a large-deductible account's loss history reading a "censored" distribution, and what judgment must the underwriter add that the model cannot?

19. Name the two flavors of endorsement (by their effect on coverage) and give one example of each, with the underwriting purpose it serves.

20. For the Harbor Steel property, you set a 5% named-windstorm deductible and a separate, smaller all-other-perils deductible. Explain why two different deductibles, rather than one, is the right structure for this account.

Answer Key (click to expand) **1. D.** A deductible reduces the insurer's exposure; it never increases it. On a catastrophic loss a deductible (especially a flat one) is a small fraction of the loss, but it still *reduces*, not increases, what the insurer pays. (§12.1) **2. B.** 5% of the \$20,000,000 insured value = \$1,000,000 retained by the insured before the policy responds to a named storm. The percentage applies to the *value*, not to the loss amount. (§12.1) **3. B.** Under an SIR the insured (often via a TPA) investigates, defends, and pays claims within the retention; the insurer is genuinely off the risk below the SIR. Under a deductible the insurer typically handles the whole claim and bills the deductible back. (§12.2) **4. C.** Two \$1M occurrences exhaust the \$2M aggregate. The third occurrence, though within the per-occurrence limit, has no aggregate left and the insurer pays \$0 — the insured discovers the gap at the worst moment. (§12.3) **5. B.** A sublimit is a cap inside the policy limit, set lower than the overall limit, for a particular coverage or peril. (§12.3) **6. C.** Carrying *less* than the required percentage (here 80%) of full value triggers the proportional penalty on every loss, including partial losses far below the limit. (§12.4) **7. B.** A binder is a temporary contract granting immediate coverage pending the formal policy; it is real insurance. (§12.7) **8. B.** A binder binds exactly what it says; an omitted restriction or subjectivity grants the broader coverage, and the insurer cannot retroactively narrow it after a loss. (§12.7) **9. B.** Statutory WC benefits must be paid to the injured worker from the first dollar regardless of any deductible; the insurer fronts them and relies on the insured's credit (hence collateral) to reimburse. (§12.2) **10. C.** The percentage catastrophe deductible forces the insured to retain the bottom slice of a storm loss while leaving the full limit available above it. A sublimit, by contrast, caps the *top*. (§12.1, §12.3) **11. B.** Settling an aging roof at ACV restricts coverage to carve out a hazard (a worn-out roof) the underwriter is unwilling to price at replacement cost into the base deal. (§12.5) **12. B.** *Contra proferentem*: ambiguity is construed against the drafter — the insurer — which is why manuscripting demands conservative, explicit drafting. (§12.6; Ch. 4) **13. B.** Surplus-lines carriers have freedom of form and rate, so they can write the non-standard manuscript forms the admitted market's form-filing rules would slow or block. (§12.6; Ch. 4) **14. B.** The credit is the expected loss in the \$10K–\$100K retained layer plus a claims-handling-expense credit — a much smaller number than the \$90,000 of additional retention. (§12.1) **15. B.** Submission → coverage letter (the offer) → binder (coverage starts immediately) → formal policy issued. (§12.7) **16.** A per-occurrence deductible applies to *each* loss event separately (three losses, three deductibles), doing behavioral work on every claim. An aggregate deductible caps the insured's *total* retained losses for the year, after which the insurer pays from the first dollar. A sophisticated insured with a predictable frequency of small losses may prefer the aggregate because it converts an open-ended stream of retained losses into a known maximum. (Trade-off: it weakens the per-loss incentive near the cap.) (§12.1) **17.** Insurance required = 80% × \$10,000,000 = \$8,000,000. Penalty ratio = carried / required = \$6,000,000 / \$8,000,000 = 0.75. Loss payment = \$2,000,000 × 0.75 − \$50,000 = \$1,500,000 − \$50,000 = **\$1,450,000**. The coinsurance penalty is \$2,000,000 − \$1,500,000 = **\$500,000** (before the deductible). The insured under-insured to 60% of value where the policy required 80%. (§12.4) **18.** Only claims that *pierced* the large deductible ever appear in the loss runs, so the model sees a truncated/censored distribution and may report a falsely low loss ratio. The underwriter must ask what the model cannot see: how many sub-deductible claims the insured is generating (available from the TPA), whether frequency is trending up, and whether the insured's balance sheet can fund a bad year and reimburse the deductible. (§12.2) **19.** *Restrictive* endorsements carve out a hazard (e.g., an ACV settlement on an aging roof, turning a near-decline into a qualified yes). *Broadening* endorsements add coverage or fill a gap (e.g., additional-insured status for a customer required by contract, or ordinance-or-law coverage). On many accounts you do both in one policy. (§12.5) **20.** The named-windstorm deductible (a *percentage* deductible) handles the correlated catastrophe peril that a flat deductible cannot — forcing the insured to retain a large first slice of any storm loss off the insurer's coastal book. The smaller AOP (all-other-perils) deductible handles the account's real frequency driver — fire — shedding small claims and keeping the insured's housekeeping incentive sharp without making routine coverage meaningless. One deductible cannot do both jobs well; catastrophe and working losses are different problems. (§12.1, The Underwriting File)