Insurance General Insurance 5 — Questions and Answers
Question 1: What is 'reinsurance' and why do insurers purchase it?
- A second policy purchased by the insured for extra protection
- Insurance purchased by an insurer to protect itself against catastrophic losses (Correct answer)
- A government-backed guarantee for insolvent insurers
- A policy that covers only commercial properties
Correct answer: Insurance purchased by an insurer to protect itself against catastrophic losses
Reinsurance is insurance that insurers buy from other companies to limit their exposure to large or catastrophic losses, stabilizing their financial position.
Question 2: Under the principle of indemnity, what is the maximum amount an insurer should pay on a covered loss?
- The full policy limit, regardless of actual loss
- An amount that restores the insured to their pre-loss financial position, not more (Correct answer)
- Twice the value of the loss to account for inconvenience
- The depreciated value minus the deductible plus interest
Correct answer: An amount that restores the insured to their pre-loss financial position, not more
The principle of indemnity holds that insurance should restore the insured to their financial position before the loss — no profit, no shortfall.
Question 3: Which type of insurance policy is typically required by lenders when a borrower finances a vehicle?
- Medical payments coverage
- Collision and comprehensive coverage (Correct answer)
- Uninsured motorist coverage
- Guaranteed asset protection (GAP) only
Correct answer: Collision and comprehensive coverage
Lenders require collision and comprehensive coverage to protect their financial interest in the vehicle while the loan is outstanding.
Question 4: What does 'pro rata cancellation' mean in insurance?
- The insurer charges a penalty for early cancellation
- The insurer refunds the unearned premium proportional to the remaining policy period with no penalty (Correct answer)
- The insured must pay a flat fee to cancel at any time
- Coverage continues for 30 days after cancellation notice
Correct answer: The insurer refunds the unearned premium proportional to the remaining policy period with no penalty
Pro rata cancellation returns the exact unearned portion of the premium for the remaining policy period without any penalty or short-rate charge.
Question 5: Which of the following is an example of 'adverse selection' in insurance?
- An insurer choosing only the safest applicants to cover
- High-risk individuals disproportionately seeking insurance, driving up costs for the pool (Correct answer)
- An agent submitting fraudulent applications on behalf of clients
- An insurer raising premiums uniformly across all policyholders
Correct answer: High-risk individuals disproportionately seeking insurance, driving up costs for the pool
Adverse selection occurs when people with higher-than-average risk are more likely to purchase insurance, creating an imbalanced, costly risk pool.
Question 6: What is the role of an 'insurance adjuster'?
- To sell insurance policies to new clients
- To investigate claims and determine the amount an insurer should pay (Correct answer)
- To set premium rates for different risk categories
- To audit insurer financial statements for solvency
Correct answer: To investigate claims and determine the amount an insurer should pay
An insurance adjuster (or claims adjuster) evaluates insurance claims to determine coverage applicability and the fair settlement amount.
Question 7: What distinguishes a 'stock insurance company' from a 'mutual insurance company'?
- Stock companies only sell life insurance; mutual companies sell property insurance
- Stock companies are owned by shareholders; mutual companies are owned by policyholders (Correct answer)
- Mutual companies are regulated federally; stock companies are regulated by states
- Stock companies offer lower premiums because they have no profit motive
Correct answer: Stock companies are owned by shareholders; mutual companies are owned by policyholders
A stock insurer is owned by shareholders who receive profits as dividends, while a mutual insurer is owned by its policyholders who may receive dividends from surplus.
Insurance General Insurance 5
What is 'reinsurance' and why do insurers purchase it?