Financial Analysis & Planning Flashcards

A risk manager is evaluating whether to purchase an umbrella policy or increase primary limits. Which financial concept is central to this decision?

Answer: Marginal cost of additional coverage versus marginal benefit of risk transfer

The decision hinges on comparing the incremental premium cost of higher limits against the incremental protection value for low-probability, high-severity losses.

In insurance budgeting, which method allocates costs to business units based on each unit's proportional share of total insured exposure?

Answer: Pro-rata allocation by exposure

Pro-rata allocation distributes insurance costs in proportion to each unit's share of a measurable exposure base such as payroll, revenue, or property values.

Which metric measures the variability of actual losses around expected losses and is critical in sizing retained risk?

Answer: Coefficient of variation

The coefficient of variation (standard deviation divided by mean) measures relative volatility and helps risk managers understand how unpredictable retained losses may be.

When a risk financing program uses an aggregate stop-loss arrangement, what does the stop-loss protect against?

Answer: Total losses in a policy period exceeding a defined aggregate threshold

An aggregate stop-loss caps cumulative losses over a policy period, protecting the insured when many smaller losses collectively exceed the aggregate retention.

Which of the following is an advantage of a finite risk insurance program from a financial planning perspective?

Answer: It provides multi-year smoothing of loss volatility and improves cash flow predictability

Finite risk programs spread losses over multiple years, reducing the income statement volatility caused by large single-year losses and improving financial planning accuracy.

A risk manager calculates a net present value (NPV) of risk financing alternatives. Why is NPV preferred over simple payback period?

Answer: NPV accounts for the time value of money across all cash flows

NPV discounts all future cash flows to present value, making it a superior tool for comparing alternatives with different cost and benefit timing profiles.

Under a retrospective rating plan, which factor limits the insured's maximum premium regardless of actual losses incurred?

Answer: Maximum premium factor

The maximum premium factor sets a ceiling on the retrospective premium, protecting the insured from unlimited cost escalation in catastrophic loss years.