ARM Risk Financing and Insurance 2 — Questions and Answers
Question 1: A manufacturer forms a wholly owned insurance subsidiary that insures only the parent's own loss exposures. What type of captive is this?
- Group captive
- Pure (single-parent) captive (Correct answer)
- Rent-a-captive
- Risk retention group
Correct answer: Pure (single-parent) captive
A pure captive is owned by one parent and insures only that parent's (and affiliates') exposures.
Question 2: Under the federal Liability Risk Retention Act of 1986, risk retention groups may insure which type of exposure?
- Property exposures only
- Workers compensation only
- Commercial liability exposures (Correct answer)
- Personal auto and homeowners exposures
Correct answer: Commercial liability exposures
The Act permits risk retention groups to write liability coverage (other than workers compensation) for their commercial members.
Question 3: Which risk financing plan lets an organization pay its own losses up to a set amount, with the insurer having no obligation to pay until that amount is exhausted?
- Large deductible plan
- Self-insured retention (Correct answer)
- Guaranteed cost plan
- Paid-loss retrospective plan
Correct answer: Self-insured retention
With a self-insured retention, the insured adjusts and pays losses within the retention, and the insurer pays only above it.
Question 4: In a large deductible plan, what does the insurer typically require of the insured to protect against nonpayment of deductible reimbursements?
- Collateral such as a letter of credit (Correct answer)
- A finite risk endorsement
- Cession of all premiums to a reinsurer
- A pure captive affiliation
Correct answer: Collateral such as a letter of credit
The insurer pays losses within the deductible and seeks reimbursement, so it requires collateral to cover credit risk.
Question 5: Which of these is a component of an organization's cost of risk?
- Gross sales revenue
- Retained losses (Correct answer)
- Capital expenditures on new plants
- Dividends paid to shareholders
Correct answer: Retained losses
Cost of risk includes retained losses, insurance premiums, risk control costs, and administrative costs.
Question 6: An insurer reinsures 40 percent of every policy in a line of business, and the reinsurer receives 40 percent of premiums and pays 40 percent of losses. What type of reinsurance is this?
- Surplus share
- Per risk excess of loss
- Quota share (Correct answer)
- Catastrophe excess of loss
Correct answer: Quota share
Quota share reinsurance cedes a fixed percentage of every policy's premiums and losses.
Question 7: Which statement best describes a hold-harmless agreement used as a risk financing technique?
- It moves the financial consequences of a loss to another party by contract (Correct answer)
- It permanently removes the loss exposure from the organization
- It is a type of insurance policy issued by a licensed insurer
- It is a retention technique funded through a captive
Correct answer: It moves the financial consequences of a loss to another party by contract
A hold-harmless agreement is a noninsurance transfer of the financial consequences of loss, not of the exposure itself.
