NAB Risk Management and Insurance 3 — Questions and Answers
Question 1: What is the key difference between 'pure risk' and 'speculative risk' in risk management?
- Pure risk involves only the possibility of loss or no loss, while speculative risk involves the possibility of gain or loss (Correct answer)
- Pure risk is insurable while speculative risk is not ever insurable
- Pure risk affects individuals while speculative risk affects institutions only
- Pure risk is measured quantitatively while speculative risk is qualitative only
Correct answer: Pure risk involves only the possibility of loss or no loss, while speculative risk involves the possibility of gain or loss
Pure risks have outcomes of loss or no loss (e.g., fire), while speculative risks involve opportunities for both gain and loss (e.g., investments).
Question 2: Which of the following best describes 'moral hazard' in insurance?
- The risk that an insurer will go bankrupt before paying claims
- The tendency for insured parties to take on more risk because they are protected against loss (Correct answer)
- Fraudulent misrepresentation on an insurance application
- The probability that a covered loss event will occur
Correct answer: The tendency for insured parties to take on more risk because they are protected against loss
Moral hazard occurs when insurance coverage changes the behavior of the insured, leading them to take greater risks than they otherwise would.
Question 3: In risk management, Value at Risk (VaR) is defined as:
- The average loss expected over a given time horizon
- The maximum expected loss over a specific time period at a given confidence level (Correct answer)
- The total insured value of a financial portfolio
- The minimum capital required to cover catastrophic losses
Correct answer: The maximum expected loss over a specific time period at a given confidence level
VaR estimates the maximum potential loss a portfolio could face over a defined period given a specified confidence level (e.g., 95% or 99%).
Question 4: A professional indemnity insurance policy primarily covers:
- Physical damage to business premises
- Claims arising from professional negligence, errors, or omissions in the provision of services (Correct answer)
- Employee workplace injuries
- Damage to goods in transit
Correct answer: Claims arising from professional negligence, errors, or omissions in the provision of services
Professional indemnity insurance protects professionals against claims from clients alleging negligence or mistakes in the services provided.
Question 5: The 'four Ts' framework for treating identified risks includes transfer, terminate, tolerate, and:
- Test
- Track
- Treat (further) (Correct answer)
- Transform
Correct answer: Treat (further)
The four Ts of risk response are: Transfer (shift risk to another party), Terminate (avoid the activity), Tolerate (accept the risk), and Treat (implement controls to reduce it).
Question 6: What is 'adverse selection' in the context of insurance underwriting?
- Choosing the lowest premium option without reading policy exclusions
- The tendency for higher-risk individuals to be more likely to seek insurance coverage (Correct answer)
- Selecting only profitable risks to insure
- The insurer's decision to deny claims due to policy exclusions
Correct answer: The tendency for higher-risk individuals to be more likely to seek insurance coverage
Adverse selection occurs when those most likely to make claims are also those most likely to purchase insurance, skewing the risk pool.
Question 7: Which risk category includes risks arising from inadequate or failed internal processes, people, and systems or from external events?
- Market risk
- Credit risk
- Operational risk (Correct answer)
- Reputational risk
Correct answer: Operational risk
Operational risk, as defined by Basel II/III, encompasses losses from failed internal processes, human error, system failures, and external events like fraud.
NAB Risk Management and Insurance 3
What is the key difference between 'pure risk' and 'speculative risk' in risk management?