RIMS Financial Analysis & Planning 3 — Questions and Answers
Question 1: A risk manager is evaluating whether to purchase an umbrella policy or increase primary limits. Which financial concept is central to this decision?
- Marginal cost of additional coverage versus marginal benefit of risk transfer (Correct answer)
- Solvency II capital requirements
- Mark-to-market accounting
- Debt-to-equity ratio
Correct 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.
Question 2: In insurance budgeting, which method allocates costs to business units based on each unit's proportional share of total insured exposure?
- Activity-based costing
- Pro-rata allocation by exposure (Correct answer)
- Retrospective rating
- Aggregate stop-loss method
Correct 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.
Question 3: Which metric measures the variability of actual losses around expected losses and is critical in sizing retained risk?
- Coefficient of variation (Correct answer)
- Sharpe ratio
- Price-to-earnings ratio
- Return on invested assets
Correct 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.
Question 4: When a risk financing program uses an aggregate stop-loss arrangement, what does the stop-loss protect against?
- A single catastrophic loss exceeding a per-occurrence limit
- Total losses in a policy period exceeding a defined aggregate threshold (Correct answer)
- Losses caused by excluded perils
- Investment losses in the captive's portfolio
Correct 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.
Question 5: Which of the following is an advantage of a finite risk insurance program from a financial planning perspective?
- It eliminates all risk transfer costs
- It provides multi-year smoothing of loss volatility and improves cash flow predictability (Correct answer)
- It avoids any regulatory capital requirements
- It guarantees a profit-sharing arrangement with no downside
Correct 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.
Question 6: A risk manager calculates a net present value (NPV) of risk financing alternatives. Why is NPV preferred over simple payback period?
- NPV is easier to compute manually
- NPV accounts for the time value of money across all cash flows (Correct answer)
- NPV ignores uncertainty in future cash flows
- NPV is required by GAAP for risk disclosures
Correct 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.
Question 7: Under a retrospective rating plan, which factor limits the insured's maximum premium regardless of actual losses incurred?
- Minimum retained loss ratio
- Basic premium factor
- Maximum premium factor (Correct answer)
- Excess loss premium factor
Correct 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.
RIMS Financial Analysis & Planning 3
A risk manager is evaluating whether to purchase an umbrella policy or increase primary limits.
Which financial concept is central to this decision?