APP Risk Assessment & Underwriting 3 — Questions and Answers
Question 1: A buyer discovers that a sole-source supplier is experiencing financial distress. Which risk response is most appropriate?
- Immediately terminate the contract
- Qualify alternative suppliers as a contingency (Correct answer)
- Increase order volume to support the supplier
- Transfer all risk to a broker
Correct answer: Qualify alternative suppliers as a contingency
Qualifying alternative suppliers reduces concentration risk and ensures supply continuity if the financially distressed supplier fails.
Question 2: What does the term 'moral hazard' mean in an insurance and risk management context?
- Ethical violations by insurance agents
- Increased risk-taking behavior after obtaining insurance coverage (Correct answer)
- Fraud committed against insurers
- The legal obligation to act in good faith
Correct answer: Increased risk-taking behavior after obtaining insurance coverage
Moral hazard occurs when having insurance reduces the incentive to avoid risky behavior, since losses are partially covered.
Question 3: Which quantitative risk analysis technique uses repeated random sampling to model the probability distribution of outcomes?
- Delphi method
- Monte Carlo simulation (Correct answer)
- SWOT analysis
- Decision tree analysis
Correct answer: Monte Carlo simulation
Monte Carlo simulation runs thousands of iterations with random variable inputs to produce a probability distribution of possible outcomes.
Question 4: A supplier's Dun & Bradstreet PAYDEX score of 40 indicates:
- Excellent payment performance ahead of terms
- Payments averaging 30 days beyond terms (Correct answer)
- The supplier is in bankruptcy proceedings
- A new company with no payment history
Correct answer: Payments averaging 30 days beyond terms
A PAYDEX score of 40 indicates the supplier typically pays invoices approximately 30 days beyond agreed terms, signaling financial stress.
Question 5: In procurement risk assessment, 'force majeure' clauses are primarily used to:
- Penalize suppliers for late delivery
- Excuse contract performance due to unforeseeable extraordinary events (Correct answer)
- Transfer pricing risk to the buyer
- Establish dispute resolution procedures
Correct answer: Excuse contract performance due to unforeseeable extraordinary events
Force majeure clauses relieve parties of contractual obligations when extraordinary events beyond their control prevent performance.
Question 6: Which method assigns a numerical score to risks based on weighted criteria such as likelihood, severity, and detectability?
- Bow-tie analysis
- Failure Mode and Effects Analysis (FMEA) (Correct answer)
- Root cause analysis
- Gap analysis
Correct answer: Failure Mode and Effects Analysis (FMEA)
FMEA calculates a Risk Priority Number (RPN) by multiplying scores for occurrence, severity, and detectability to prioritize failure modes.
Question 7: When a company self-insures against procurement risks, the key financial requirement is:
- Purchasing a large commercial policy
- Maintaining adequate reserves to cover potential losses (Correct answer)
- Transferring all risk to the supply chain
- Eliminating all high-risk suppliers
Correct answer: Maintaining adequate reserves to cover potential losses
Self-insurance requires setting aside sufficient financial reserves to pay claims that would otherwise be covered by an external insurer.
APP Risk Assessment & Underwriting 3
A buyer discovers that a sole-source supplier is experiencing financial distress.
Which risk response is most appropriate?