Chapter 2 - Insurance Companies and Pension Plans (FRM Part 1- Book 3)
Chapter 2 - Insurance Companies and Pension Plans
Chapter 2 - Insurance Companies and Pension Plans
1. What is the primary function of life insurance companies?
A. To provide coverage for property loss
B. To provide financial protection for policyholder’s beneficiaries in case of death
C. To cover medical expenses
D. To cover the accidental damage to property
Life insurance companies primarily protect policyholders by providing a specified payment to their beneficiaries in case of death.
2. Which type of life insurance provides coverage for a specified amount of time, with no payment made if the policyholder survives the term?
A. Endowment life insurance
B. With-profits endowment policy
C. Term life insurance
D. Unit-linked endowment policy
Term life insurance provides coverage for a fixed period, with payment made only if the policyholder dies within that period.
3. What is a key feature of with-profits endowment life insurance policies?
A. Higher payout if the insurance company’s investments perform well
B. Fixed payout regardless of investment performance
C. No payout if the policyholder survives the term
D. Payout linked to the stock market
A with-profits endowment policy involves a higher payout if the insurance company’s investments perform well.
4. What is the primary characteristic of a unit-linked endowment policy?
A. The policyholder receives a fixed payout
B. The payout is fixed and does not depend on investment performance
C. The policyholder chooses an investment, and the payout is linked to the investment’s performance
D. It does not provide a payout if the policyholder survives the term
A unit-linked endowment policy involves the policyholder choosing an investment, and the payout is linked to the performance of that investment.
5. What is a characteristic of group life insurance?
A. Medical examinations are required for all members
B. It only covers accidental death
C. It pools risks for a large number of individuals
D. Only employers can buy this insurance for their employees
Group life insurance involves pooling risks for a large number of individuals, and medical exams are often not required.
6. Which of the following is a key risk faced by insurance companies?
A. Increased premiums
B. Moral hazard
C. Too many claimants
D. Low investment returns
Insurance companies face risks such as moral hazard, where policyholders might take on more risk because they are insured.
7. What is the main characteristic of whole life insurance?
A. It provides coverage for the policyholder’s life with payment occurring upon death
B. It provides coverage for a fixed period
C. It only provides coverage in the case of accidental death
D. It requires higher premiums as the policyholder ages
Whole life insurance provides coverage for the policyholder’s entire life, and the payment occurs upon death, with premiums typically fixed throughout the policy's term.
8. How is the surplus premium in whole life insurance used?
A. It is refunded to the policyholder
B. It is invested by the insurance company for the policyholder
C. It is used to increase the premium in future years
D. It is transferred to other policyholders
The surplus premium, which is the excess amount of premium paid over the risk cost, is invested by the insurance company on behalf of the policyholder.
9. What happens to the cost of one-year life insurance policies as the policyholder ages?
A. It remains constant throughout the policyholder’s life
B. It decreases each year
C. It increases as the policyholder gets older
D. It increases significantly only in the last few years
The cost of one-year life insurance increases as the policyholder ages, especially when the policyholder reaches older age.
10. What is a characteristic of variable life insurance?
A. The final payout may be increased if the underlying investments perform well
B. The premium amount is fixed regardless of investment performance
C. It guarantees a fixed payout regardless of investment performance
D. The policyholder can adjust the amount of coverage anytime
In variable life insurance, the final payout may be increased based on how well the underlying investments perform.
11. What is the main difference between annuity contracts and life insurance contracts?
A. Annuity contracts provide a lump sum payment to the policyholder
B. Life insurance contracts are only available for senior citizens
C. Annuity contracts provide a stream of future payments in return for an initial lump sum
D. Life insurance contracts are not available for individuals over 50
Annuity contracts involve an initial lump sum payment in return for a stream of future payments, which is the opposite of life insurance contracts that provide a payout upon death.
12. What is a deferred annuity?
A. An annuity that begins immediately
B. An annuity that begins after a specified number of years
C. An annuity that offers fixed payouts for a certain period
D. An annuity that can be withdrawn at any time without penalties
A deferred annuity begins after a specified number of years, as agreed upon in the contract.
13. What is the primary purpose of Property and Casualty (P&C) insurance?
A. To cover losses arising from property damage and third-party liability
B. To cover the cost of the policyholder’s medical expenses
C. To provide coverage for a fixed term period
D. To insure the policyholder against death or disability
Property and Casualty insurance primarily covers property damage (e.g., fire, theft) and liability for injuries to third parties (e.g., accidents, injuries on premises).
14. What kind of risks do Property insurance companies face?
A. Only low-impact, predictable risks
B. Catastrophe risks from events like natural disasters
C. Only minor, individual claims
D. Only medical liability risks
Property insurance companies face catastrophe risks that arise from large-scale events, such as natural disasters, where many claims are filed at once.
15. How do Property insurers manage catastrophe risks?
A. By ignoring geographical information
B. By randomly selecting areas for coverage
C. By using geographical, seismographic, and meteorological information
D. By offering uniform coverage in all locations
Property insurers manage catastrophe risks using data from geographical, seismographic, and meteorological sources to assess the probability and severity of such events.
16. What type of coverage does Casualty (Liability) insurance provide?
A. Coverage for third-party liability from injuries on the policyholder's premises or caused by their vehicle
B. Coverage for the policyholder’s own property damage
C. Coverage for employee health insurance
D. Coverage for life insurance claims
Casualty insurance covers third-party liability for injuries sustained by others on the policyholder’s premises or due to their vehicle use.
17. Why are Property and Casualty insurance payouts difficult to predict?
A. Claims are generally predictable and fixed
B. Payouts are based on annual premium rates
C. Claims are highly dependent on specific individuals
D. Payouts are subject to fluctuating and unpredictable events like natural disasters
Property and Casualty insurance payouts are difficult to predict because they depend on fluctuating events such as natural disasters or liability claims, which are hard to estimate.
18. What does health insurance cover for policyholders?
A. Coverage for medical services not covered by publicly funded healthcare systems
B. Coverage for life insurance premiums
C. Coverage for property damage or theft
D. Coverage for automobile accidents
Health insurance provides coverage for medical services that are not covered by publicly funded healthcare systems, such as hospital treatment and prescription medications.
19. How do premiums for health insurance typically behave?
A. Premiums always increase due to the policyholder's worsening health
B. Premiums may increase due to general increases in healthcare costs, but not due to worsening health
C. Premiums decrease as the policyholder’s health worsens
D. Premiums are fixed regardless of healthcare cost changes
Health insurance premiums typically increase due to general rises in healthcare costs, but they do not usually increase because of the policyholder’s health conditions.
20. Can health insurance coverage be denied for individuals with preexisting medical conditions?
A. Yes, coverage is always denied for preexisting medical conditions
B. Coverage is denied only for certain medical conditions
C. Coverage is never denied for preexisting medical conditions
D. In some cases, insurance coverage may not be denied for preexisting but unknown medical conditions
Health insurance may not deny coverage for preexisting medical conditions if they were not known at the time of application, as per some policy terms.
21. What is a common feature of health insurance premiums?
A. Premiums are fixed and do not change over time
B. Premiums are highly volatile and change frequently
C. Premiums are influenced by the policyholder’s age
D. Premiums are typically impacted by general healthcare inflation
Health insurance premiums typically rise due to overall increases in healthcare costs, rather than due to the individual policyholder's health.
22. What is a major risk faced by insurance companies in terms of paying policyholder claims?
A. High premium payments from policyholders
B. Insufficient funds to satisfy policyholders' claims during a sudden surge of payouts
C. Overreliance on a single investment strategy
D. Excessive diversification of investments
Insurance companies may face insufficient funds to satisfy policyholders' claims due to sudden surges in payouts (e.g., mortality or catastrophe risks) or payouts continuing for longer than expected (e.g., longevity risk).
23. How can market risk affect insurance companies?
A. By decreasing the premiums charged to policyholders
B. By increasing the claims from policyholders
C. By reducing the returns on investments, especially if defaults increase
D. By causing the insurance company to increase its premiums
Market risk arises when insurance companies invest in fixed-income securities. If defaults suddenly increase, the returns on these investments may decrease, causing losses for the company.
24. What is credit risk for insurance companies?
A. Risk of insufficient capital to cover claims
B. Risk of operational failure in claims processing
C. Risk of higher-than-expected insurance payouts
D. Risk of loss if banks or reinsurance companies default on obligations
Credit risk arises when insurance companies transact with banks and reinsurance companies. If these counterparties default on their obligations, the insurance company may suffer losses.
25. What is operational risk for insurance companies?
A. Losses due to system failures or external events like computer failure or human error
B. Losses due to higher-than-expected claims
C. Losses due to market risk and poor investment returns
D. Losses due to excessive diversification in investments
Operational risk for insurance companies includes losses due to system failures, external events, computer failures, or human errors that disrupt operations.
26. What is the primary purpose of a mortality table in insurance?
A. To estimate interest rates for premium calculation
B. To identify high-risk professions
C. To estimate the probability of death at various ages
D. To monitor inflation impact on insurance
Mortality tables are used to estimate the probability of death for individuals at each age, helping insurers calculate premiums.
27. According to the 2013 mortality table, what is the probability of a 40-year-old male dying within the next year?
A. 0.2092%
B. 2.092%
C. 20.92%
D. 95.908%
The probability is 0.002092 which is 0.2092% as per the table for a 40-year-old male.
28. What is the average life expectancy of a 40-year-old male according to the table?
A. 40.00 years
B. 38.00 years
C. 80.00 years
D. 38.53 years
The table shows a remaining life expectancy of 38.53 years for a 40-year-old male.
29. How is the probability of death between ages 70 and 71 calculated?
A. Subtracting the survival rate at 71 from the death rate at 70
B. Subtracting the survival rate at age 71 from that at age 70
C. Adding the survival rate at both ages
D. Dividing the death rate at 70 by that at 71
It is calculated as 0.73461 − 0.71732 = 0.01729 or 1.73%.
30. Given a 70-year-old male survives to age 70, what is his probability of death within the following year?
A. 1.73%
B. 2.29%
C. 2.35%
D. 3.00%
It is calculated as 0.01729 / 0.73461 = 0.023536 or approximately 2.35%.
31. What is the probability that a 70-year-old male dies in the second year (between ages 71 and 72)?
A. 2.51%
B. 2.35%
C. 1.73%
D. 5.00%
It is calculated as (1 − 0.023528) × 0.025693 = 0.025088 or approximately 2.51%.
32. How is the breakeven insurance premium calculated using mortality tables?
A. By dividing expected payouts by life expectancy
B. By multiplying survival rate with interest rate
C. By subtracting probability of death from 1
D. By equating the present value of expected payout and premium payments
The breakeven premium is calculated by equating the present value of expected payouts to the present value of expected premiums.
33. What does a loss ratio of 65% indicate for an insurance company?
A. $65 of every $100 in premiums is paid out in claims
B. The company has made 65% profit
C. Only 35% of the premiums are used for claims
D. Premiums have dropped by 65%
A 65% loss ratio means that $65 of every $100 in premiums is used to pay claims.
34. What does the expense ratio represent for a property-casualty insurer?
A. Premiums received from customers
B. Operating expenses as a percentage of premiums
C. Investment returns as a percentage of claims
D. Total assets as a percentage of liabilities
The expense ratio measures the proportion of premiums used to cover expenses like claims investigation and broker commissions.
35. How is the combined ratio calculated?
A. Loss ratio minus expense ratio
B. Loss ratio plus investment income
C. Loss ratio plus expense ratio
D. Premiums minus claims
The combined ratio is the sum of the loss ratio and the expense ratio, showing the total cost of claims and expenses as a percentage of earned premiums.
36. What does it mean if the combined ratio is more than 100%?
A. The company is losing money on its underwriting activities
B. The company is making profit through underwriting
C. The company has high investment income
D. Premiums are more than claims and expenses
A combined ratio above 100% means the company is paying out more in claims and expenses than it earns in premiums.
37. What does the operating ratio measure in an insurance company?
A. Total claims paid as percentage of revenue
B. Dividend payments divided by premiums
C. Loss ratio plus investment income
D. Combined ratio after dividends minus investment income
The operating ratio includes underwriting performance and investment income to assess overall profitability.
38. Which of the following is added to the combined ratio to get the combined ratio after dividends?
A. Expense ratio
B. Dividends paid to policyholders
C. Claims reserve
D. Investment income
The combined ratio after dividends includes dividends paid to policyholders, expressed as a percentage of premiums.
39. If the loss ratio is 60% and the expense ratio is 30%, what is the combined ratio?
A. 90%
B. 70%
C. 30%
D. 100%
Combined ratio = Loss ratio (60%) + Expense ratio (30%) = 90%.
40. Why is investment income deducted in the calculation of operating ratio?
A. To reduce the loss ratio
B. To adjust premium pricing
C. Because it contributes to profitability
D. To calculate dividends
Investment income reduces the operating ratio because it offsets underwriting losses and contributes to overall profit.
41. What does the term "moral hazard" refer to in insurance?
A. The possibility that insurance may not cover all losses
B. The risk that insurance coverage may lead to riskier behavior
C. The risk that insurers may deny legitimate claims
D. The possibility of natural disasters impacting insurance
Moral hazard arises when having insurance coverage causes the policyholder to act less cautiously or more recklessly than they otherwise would.
42. Which of the following is an example of moral hazard?
A. A person drives recklessly because they have collision coverage
B. An insurer increases premiums after a claim
C. A person forgets to renew their policy
D. An insurance policy lapses due to non-payment
Moral hazard refers to behavior changes after getting insurance, such as a driver being more reckless knowing they are covered.
43. What is one common method insurers use to reduce moral hazard?
A. Increasing the premium
B. Offering more comprehensive coverage
C. Introducing deductibles
D. Giving loyalty discounts
Deductibles make the policyholder responsible for part of the loss, discouraging careless behavior and reducing moral hazard.
44. How does coinsurance help in reducing moral hazard?
A. By covering all losses fully
B. By limiting the total payout
C. By waiving deductibles
D. By making the policyholder bear a percentage of the cost
Coinsurance provisions require the insured to pay a part of the claim, ensuring they have a financial stake and discouraging overuse.
45. Which of the following best describes a policy limit?
A. The maximum amount an insurer will pay for a covered loss
B. The minimum coverage provided by an insurer
C. The amount of deductible a policyholder pays
D. The number of claims allowed in a year
A policy limit sets a cap on how much the insurer will pay for a claim, helping control the insurer’s risk exposure.
46. What is meant by adverse selection in insurance?
A. Choosing the best policy from available options
B. Insurers preferring high-risk individuals
C. Insurers being unable to distinguish between good and bad risks
D. The insured avoiding premium payments
Adverse selection occurs when an insurer cannot differentiate between low-risk and high-risk policyholders and ends up insuring more high-risk individuals.
47. Which of the following is an example of adverse selection?
A. An insurer charging higher premiums to smokers
B. More sick individuals opting for a health insurance plan
C. Policyholders comparing insurance plans online
D. A driver switching insurance providers annually
Adverse selection occurs when individuals with higher risk are more likely to purchase insurance, potentially increasing the insurer's liabilities.
48. What is a common method used to reduce adverse selection?
A. Conducting initial due diligence like medical tests or reviewing driving records
B. Offering flat premiums for all customers
C. Providing lifetime insurance without conditions
D. Avoiding insurance for high-risk individuals
Initial due diligence like health checks or checking driving history helps insurers assess risk better and prevent adverse selection.
49. Why is adverse selection a problem for insurers?
A. It leads to higher sales commissions
B. It increases administrative burden
C. It reduces the variety of policies offered
D. It increases the likelihood of insuring high-risk individuals
When adverse selection occurs, insurers may unknowingly cover more high-risk individuals, increasing their claims and financial risks.
50. Ongoing due diligence to mitigate adverse selection may include:
A. Waiving future premium hikes
B. Ignoring changes in customer behavior
C. Updating driving records and adjusting premiums accordingly
D. Allowing customers to skip renewals
Monitoring changes in risk and updating premiums based on new information helps reduce adverse selection over time.
51. What does mortality risk refer to in life insurance?
A. The risk of living longer than expected
B. The risk of dying earlier than expected
C. The risk of a medical claim getting rejected
D. The risk of inflation reducing payout value
Mortality risk arises when policyholders die earlier than expected, resulting in earlier-than-planned payouts by the insurer.
52. Longevity risk is particularly relevant for which of the following products?
A. Term insurance
B. Health insurance
C. Annuities and defined benefit pensions
D. Travel insurance
Longevity risk refers to policyholders living longer than expected, leading to longer annuity payments and increased liabilities for pension schemes.
53. How can life insurance and annuity businesses hedge each other's risks?
A. Mortality risk affects life insurance negatively but benefits annuity business, and vice versa for longevity risk
B. By selling more insurance policies
C. Through higher commissions to agents
D. By terminating policies early
Life insurance companies may hedge risks since mortality risk increases payouts in life insurance but decreases the annuity payout duration, and vice versa.
54. What is a longevity bond?
A. A bond that pays more as mortality rate increases
B. A life insurance-linked savings bond
C. A bond issued by elderly policyholders
D. A bond whose coupon depends on the number of surviving members in a group
Longevity bonds pay coupons based on the number of surviving individuals in a defined population, helping insurers hedge longevity risk.
55. Which of the following could be a formula used in longevity derivatives?
A. (Actual mortality rate × age factor) ÷ premium
B. (Expected age – actual age) × policy term
C. (Fixed mortality rate – actual mortality rate) × principal amount
D. (Sum insured ÷ number of survivors)
Longevity derivatives often use formulas like (fixed mortality rate – actual mortality rate) × principal amount to determine payouts.
56. What does Solvency II regulate in the European Union?
A. Capital requirements for life insurance companies only
B. Capital requirements for both life insurance and property-casualty insurance companies
C. Premium rates for insurance companies
D. Interest rate regulations for insurers
Solvency II sets capital requirements for both life insurance and property-casualty insurance companies in the EU, focusing on ensuring their solvency and stability.
57. What happens when the capital of an insurance company falls below the Solvency Capital Requirement (SCR)?
A. The company must increase its capital above the SCR
B. The company is automatically liquidated
C. The company is not allowed to accept new policies
D. The company faces no immediate consequences
If an insurance company's capital falls below the SCR, it is required to increase its capital to meet the SCR threshold to maintain solvency.
58. How does the Minimum Capital Requirement (MCR) impact insurance companies under Solvency II?
A. It has no effect on business operations
B. It only applies to life insurance companies
C. If capital is below MCR, business operations may become significantly restricted
D. It leads to immediate regulatory shutdown
If an insurance company's capital falls below the MCR, it may face significant restrictions on its business operations until the capital is restored.
59. Which of the following is NOT one of the components used to calculate the Solvency Capital Requirement (SCR)?
A. Investment risk (assets)
B. Underwriting risk (liabilities)
C. Operational risk
D. Marketing expenses
The SCR is calculated based on investment risk, underwriting risk, and operational risk. Marketing expenses are not considered in the SCR calculation.
60. Why does a property-casualty (P&C) insurance company require more equity capital than a life insurance company?
A. P&C companies have fewer claims than life insurance companies
B. Life insurance products are riskier than P&C insurance products
C. P&C insurance contracts have potentially catastrophic claims
D. Life insurance companies are required to hold more capital by law
Property-casualty insurance companies face more catastrophic risk and large claims, thus requiring more equity capital to maintain solvency.
61. How are insurance companies regulated in the United States?
A. Insurance companies are regulated at the state level
B. Insurance companies are regulated at the federal level
C. Insurance companies are regulated by the SEC
D. Insurance companies are not regulated in the United States
In the United States, insurance companies are regulated at the state level, with each state having its own set of rules and regulations.
62. How does the guaranty system for insurance companies work in the United States?
A. Insurance companies create their own separate funds for claims
B. The federal government provides direct funding to insurance companies
C. Each insurer must be a member of the guaranty association in the state it operates
D. The state guarantees all claims of insurance companies
In the U.S., insurance companies must be members of a state guaranty association. When an insurer becomes insolvent, other insurers contribute to a state guaranty fund to cover claims.
63. What happens when an insurance company becomes insolvent in a state with a guaranty association?
A. The state pays all claims directly
B. The insolvent company is liquidated and no claims are paid
C. The federal government steps in to cover claims
D. Other insurance companies contribute to a fund to pay policyholder claims
When an insurance company becomes insolvent, other insurance companies in the state contribute to the state guaranty fund, which helps settle claims for policyholders of the insolvent company.
64. How does the guaranty system for banks differ from that of insurance companies?
A. Banks have no guaranty system in place
B. Banks contribute to a permanent fund managed by the FDIC to protect depositors
C. Banks must create a new fund every time a default occurs
D. Banks rely on state guaranty funds to settle depositor claims
The guaranty system for banks involves a permanent fund managed by the FDIC, to which banks contribute regularly, in contrast to insurance companies, which contribute only when a default occurs.
65. What is the main distinction between the guaranty system for insurance companies and that for banks?
A. Banks have a permanent fund while insurance companies contribute only when a default occurs
B. Insurance companies have no guaranty system in place
C. Insurance companies contribute to a permanent fund like banks
D. Banks do not have any capital requirements unlike insurance companies
The key distinction is that banks contribute to a permanent fund managed by the FDIC, while insurance companies only contribute when a default occurs, and there is no permanent fund.
66. Which of the following is true for a defined benefit pension plan?
A. The employer contribution is fixed, and the employee's pension benefit is uncertain
B. The pension benefit is explicitly stated and usually based on salary, years of service, and a fixed percentage
C. The pension benefit depends on the employee’s choice of investment options
D. The employee bears the risk of underperformance of pension investments
In a defined benefit plan, the pension benefit is explicitly calculated based on salary, years of service, and a fixed percentage, with the employer bearing the investment risk.
67. What is the primary risk borne by the employer in a defined benefit pension plan?
A. The risk of the employee living longer than expected
B. The risk of the pension fund's investments underperforming
C. The risk of employees failing to contribute enough
D. The risk that the present value of pension obligations exceeds the market value of assets
In a defined benefit plan, the employer bears the risk that the present value of pension obligations exceeds the value of the plan’s assets.
68. Which of the following is a characteristic of a defined contribution pension plan?
A. The pension benefit is predetermined based on salary and years of service
B. The employee receives a guaranteed pension amount regardless of investment performance
C. The pension benefit depends on the investment performance of the contributions made by both the employee and employer
D. The employer bears all investment risks associated with the pension fund
In a defined contribution plan, the pension benefit depends on the performance of the investments in the individual account, and the employee bears the investment risk.
69. How does the pension benefit in a defined benefit plan differ from that in a defined contribution plan?
A. In a defined benefit plan, the pension is determined by the performance of investments, while in a defined contribution plan, it is based on salary and service years
B. In a defined benefit plan, the pension is predetermined, whereas in a defined contribution plan, the pension depends on the investment outcomes
C. In both plans, the employer guarantees a fixed pension benefit
D. There is no difference between the two types of plans
In a defined benefit plan, the pension is predetermined, while in a defined contribution plan, the pension depends on the contributions made and the performance of the invested funds.
70. In which pension plan does the employer bear the risk of underperformance in investment returns?
A. Defined benefit plan
B. Defined contribution plan
C. Both defined benefit and defined contribution plans
D. Neither defined benefit nor defined contribution plan
In a defined benefit plan, the employer bears the risk of underperformance of investment returns because they are responsible for ensuring the employee receives the promised pension.
71. Which type of life insurance provides coverage for a fixed period and pays a specified amount if the policyholder dies during that period?
A. Whole life insurance
B. Term life insurance
C. Annuity insurance
D. Universal life insurance
Term life insurance provides coverage for a fixed period and pays out if the policyholder dies within that period.
72. Which risk increases for an insurance company when policyholders live longer than expected, leading to longer annuity payout periods?
A. Mortality risk
B. Credit risk
C. Longevity risk
D. Operational risk
Longevity risk refers to the risk of policyholders living longer than expected, which increases the risk of longer annuity payouts for the insurer.
73. What is the main risk faced by insurance companies due to poor returns on their investments?
A. Operational risk
B. Credit risk
C. Market risk
D. Liquidity risk
Poor returns on investments expose insurance companies to market risk, which may affect their ability to meet policyholder claims.
74. Which of the following types of insurance companies are regulated at the state level in the United States?
A. Life insurance companies
B. Nonlife (P&C) insurance companies
C. Health insurance companies
D. All of the above
In the United States, insurance companies, including life, nonlife (P&C), and health insurance, are regulated at the state level.
75. What is a key difference between a defined benefit pension plan and a defined contribution pension plan?
A. In a defined benefit plan, the employee bears the investment risk
B. In a defined contribution plan, the pension is predetermined
C. In a defined benefit plan, the employer contribution is fixed
D. In a defined benefit plan, the pension benefit is predetermined, while in a defined contribution plan, it depends on investment performance
In a defined benefit plan, the pension benefit is predetermined based on factors like salary and service years, while in a defined contribution plan, the benefit depends on investment performance.
76. What is the formula for calculating the combined ratio for a Property and Casualty (P&C) insurance company?
A. Loss ratio + dividends
B. Loss ratio − expense ratio
C. Loss ratio + expense ratio
D. Expense ratio + investment income
The combined ratio for a P&C insurance company is calculated by adding the loss ratio and the expense ratio.
77. What does the "operating ratio" of an insurance company represent?
A. Combined ratio + dividends
B. Combined ratio after dividends + investment income
C. Investment income − expense ratio
D. Combined ratio after dividends − investment income
The operating ratio is calculated by subtracting investment income from the combined ratio after dividends.
78. Which of the following is a method used to mitigate moral hazard in insurance?
A. Deductibles
B. Deductibles, coinsurance, and policy limits
C. Greater due diligence
D. Initial screening only
Methods to mitigate moral hazard include the use of deductibles, coinsurance, and policy limits, which encourage responsible behavior by the policyholder.
79. What is the difference between "moral hazard" and "adverse selection" in the context of insurance?
A. Moral hazard is about insurer's claim payments being higher than expected; adverse selection is about unpredicted market behavior.
B. Moral hazard is when policyholders act recklessly due to insurance; adverse selection is when the insurer cannot differentiate between good and bad risks.
C. Moral hazard refers to insurer behavior, while adverse selection refers to customer behavior only.
D. Moral hazard is the risk of lower claims, while adverse selection is the risk of higher claims.
Moral hazard involves the risk that insurance may lead policyholders to act recklessly, while adverse selection occurs when the insurer cannot differentiate between good and bad risks.
80. Under Solvency II regulations, what happens if an insurance company’s capital is below the Minimum Capital Requirement (MCR)?
A. The company is required to liquidate immediately
B. The company can continue operating without restrictions
C. The company must increase capital above the Solvency Capital Requirement (SCR)
D. Business operations may become significantly restricted
If an insurance company's capital falls below the Minimum Capital Requirement (MCR), its business operations may become significantly restricted.
