PSI Insurance and Risk Management 4 — Questions and Answers
Question 1: Which of the following is NOT one of the four elements required for a valid insurance contract?
- Offer and acceptance
- Consideration
- Competent parties
- Subrogation rights (Correct answer)
Correct answer: Subrogation rights
Valid contracts require offer and acceptance, consideration, competent parties, and legal purpose — subrogation is a policy provision, not a contract element.
Question 2: What is the primary purpose of reinsurance?
- To allow insureds to purchase coverage from multiple insurers simultaneously
- To allow insurers to transfer portions of risk to other insurers (Correct answer)
- To provide coverage after the primary policy limit is exhausted
- To regulate premium rates charged to policyholders
Correct answer: To allow insurers to transfer portions of risk to other insurers
Reinsurance allows a primary insurer (ceding company) to transfer a portion of its risk to another insurer (reinsurer) to manage large exposures.
Question 3: Under the doctrine of 'reasonable expectations,' courts will interpret policy language in favor of:
- The insurer's stated intent
- The insured's reasonable understanding of coverage (Correct answer)
- The state insurance department's guidelines
- Industry standard policy interpretations
Correct answer: The insured's reasonable understanding of coverage
The reasonable expectations doctrine holds that coverage should align with what an average insured would reasonably expect the policy to provide.
Question 4: A 'warranty' in an insurance policy is best described as:
- A statement made by the insured that is believed to be true
- A statement by the insured that is guaranteed to be true, breach of which may void the policy (Correct answer)
- An insurer's promise to pay all covered losses
- A rider that extends coverage to additional perils
Correct answer: A statement by the insured that is guaranteed to be true, breach of which may void the policy
A warranty is an absolute guarantee by the insured; breach of a warranty — even if unrelated to a loss — may give the insurer grounds to void the policy.
Question 5: Which of the following describes a 'named perils' property policy?
- Covers all causes of loss except those specifically excluded
- Covers only the causes of loss that are specifically listed in the policy (Correct answer)
- Provides no coverage unless loss exceeds the deductible
- Applies only to commercial property
Correct answer: Covers only the causes of loss that are specifically listed in the policy
A named perils policy covers only those specific causes of loss (perils) that are explicitly listed in the policy.
Question 6: What is the function of the 'other insurance' clause in a property or liability policy?
- It prevents an insured from buying coverage from multiple insurers
- It determines how the insurer will share payment when multiple policies cover the same loss (Correct answer)
- It eliminates coverage for losses caused by government-owned property
- It requires the insured to notify all other insurers of a claim
Correct answer: It determines how the insurer will share payment when multiple policies cover the same loss
The other insurance clause (pro rata, contribution by equal shares, or excess) governs how payment is apportioned when two or more policies cover the same loss.
Question 7: In risk management, 'risk avoidance' means:
- Purchasing insurance to fund potential losses
- Eliminating an activity or exposure that creates risk (Correct answer)
- Reducing the frequency of losses through safety measures
- Retaining financial responsibility for small losses
Correct answer: Eliminating an activity or exposure that creates risk
Risk avoidance involves completely eliminating the source of risk — for example, choosing not to engage in a particular activity.
PSI Insurance and Risk Management 4
Which of the following is NOT one of the four elements required for a valid insurance contract?