Financial Services Insurance Test Bank Docx Chapter.6

Chapter 06 Financial Services: Insurance

KEY

1. In recent years, the total assets of insurance companies in the U.S. have been decreasing. 

2. Due to a recent increase in demand for new insurance products, the number of life insurance companies as been increasing in the United States. 

3. Credit default swaps are a product offered by insurance companies. 

4. The process of life insurance uses risk pooling to transfer income-related uncertainties from a group of individuals to an insured individual. 

5. As of 2015, there were less than 900 life insurance companies and aggregate industry assets were approximately $6.5 trillion. 

6. Commercial banks sold over 25% of fixed-return annuities, an insurance product, in 2015. 

7. Adverse selection is a situation where customers who most need insurance are more likely to apply for insurance. 

8. Adverse selection cannot be reduced by insurance companies so it is considered to be a cost of doing business. 

9. Ordinary life insurance includes term life, whole life and endowment life in addition to the two newer forms like variable life and universal life. 

10. Term life insurance includes a savings element as well as the pure insurance element. 

11. A term life policy allows the policyholder to vary the maturity of the policy. 

12. The policy that will pay a specific dollar benefit to beneficiaries and remains in effect as long as premiums are paid is called whole life. 

13. The policyholder can vary the premium payments on an endowment life policy. 

14. With variable life insurance, the term “variable” refers to the variable nature of the benefit because premium payments are invested in mutual funds whose return can vary over time. 

15. In group life insurance, lower rates on policies can be offered because of cost economies as a result of mass administration of plans and reduced selling and commission costs. 

16. Employers that sponsor non-contributory group life insurance require the employee to pay the insurance premiums. 

17. Economies of scope represent the principal advantage of group life over ordinary life policies for insurance companies. 

18. The benefit payment of a credit life policy usually varies based on the outstanding principal and interest of the loan it is intended to insure. 

19. Annuities are the reverse of life insurance in that they are different means of liquidating a fund. 

20. The payments from an annuity offered by a life insurance company can either begin immediately or may be deferred to start at some future date. 

21. Annuities must be purchased using a single lump sum of money. 

22. Annuities are popular retirement savings products because investment returns on contributions are tax-deferred. 

23. By regulation, the payments on an annuity contract must stop when the annuity holder dies. 

24. The rate of growth in the annuities market is increasing primarily because of the recent changes in the capital gains tax rates. 

25. As of 2014, sales of annuities and sales of traditional life insurance policies were approximately equal. 

26. Life insurance companies also manage private pension plans that may include guaranteed investment contracts (GICs). 

27. Pension fund management is a relatively small portion of the life insurance industry. 

28. By 2015, life insurance companies were managing approximately 40% of all private pension plans. 

29. Although life insurance companies also provide health and accident insurance, they underwrite less than 35% of all health insurance policies. 

30. The cash surrender value of a life insurance policy represents the payment to the insured's beneficiaries at the time of death. 

31. Life insurance companies tend to concentrate their investments at the longer term of the investment spectrum. 

32. The policy reserves on the liability side of the balance sheet of a life insurance company are estimated based on actuarial assumptions of expected future liability commitments on currently existing contracts. 

33. Because of the large amounts of policy reserves that life insurance companies carry as liabilities, they are rarely surprised by unexpected fluctuations in expected future payouts. 

34. Returns on an insurer’s asset portfolio and new premium income flows act as a backup to unexpected policy losses. 

35. As of 2015, chartering of life insurance companies can be done only at the state level. 

36. Separate accounts business represents those policies and annuities whose return or payout is dependent on the return earned on the premiums invested in the separate account. 

37. Separate accounts business only appears as a liability on a life insurer’s balance sheet. 

38. Insurance companies can increase the spread between premium income and policy payouts only by increasing the premium payments. 

39. The Wall Street Reform and Consumer Protection Act (2010) led to the Federal Reserve becoming a major supervisor of insurance firms.

40. As of 2015, the Federal Reserve oversees approximately one-third of U.S. insurance company assets. 

41. Insurance guaranty funds involve a permanent fund similar to the FDIC for the purpose of compensating the policyholders of failed insurers. 

42. State-sponsored insurance guarantee funds are run and administered by private insurance companies operating in the state. 

43. Insurance guarantee funds are administered by federal insurance regulators. 

44. A permanent guarantee fund for the insurance industry does not exist. 

45. As currently structured, contributions to a state-sponsored guarantee fund are collected only after the actual failure of an insurance company. 

46. As currently structured, state guarantee funds will continue to collect premium payments and honor life policies and annuity obligations of a failed insurance company. 

47. In the case of an insurance company failure, policyholders immediately receive a payout of the cash surrender value of their policies. 

48. During the most recent financial crisis, life insurance companies with large proportions of separate accounts business were well-protected from the decline in the debt and equity markets. 

49. The total assets of property-casualty insurers were approximately 35 percent of life insurer’s total assets as of 2015. 

50. The property casualty insurance industry is concentrated where a few large firms dominate the market. 

51. Property insurance involves coverage against the loss of personal property as well as protection against legal liability claims.

52. PC (property-casualty) insurers tend to offer products that combine features of property insurance and liability insurance into single policy packages. 

53. Property-casualty underwriting risk only exists when the premiums generated on a given insurance line are less than the claims (losses) on the line. 

54. The largest property-casualty (PC) insurance companies have become less influential over the past decade. 

55. Industry leaders appear to be increasing their share of the PC business over time. 

56. PC insurers are forbidden from marketing similar products to both individuals and commercial firms. 

57. As with the life insurance industry, property-casualty firms tend to invest the majority of their assets and long-term investments.

58. Unlike the life insurance industry, property-casualty insurers have more uncertainty about the timing of policy payouts. 

59. In general, maximum levels of losses in the property-casualty industry are more predictable for liability lines than for property lines. 

60. The expected loss potential is more difficult to determine with low-severity, high-frequency events. 

61. Automobile liability insurance provides protection against theft or damage to the vehicle. 

62. Unexpected increases in inflation cause loss rates to increase more for long-tail risk than for short-tail risks. 

63. Loss adjustment expenses refer to the costs surrounding the loss settlement process. 

64. An operating ratio greater than 100 indicates that the insurance product line was profitable for a giving year. 

65. Property-casualty insurers tend to have a higher level of liquidity risk than life insurers. 

66. One reason for the recent decline in the expense ratio for PC insurers is an increase dependence on independent brokers to sell and distribute insurance policies. 

67. Hurricane Sandy, which struck the east coast of the United States in 2012, continues to be the worst catastrophe for the PC industry. 

68. Insurance companies have resisted the investment in technology that banks and other financial service firms have pursued. 

69. The Insurance Regulatory Information System (IRIS) is a standardized examination system used to measure the profitability of insurance companies. 

70. Unlike the banking industry, globalization of financial services is having little or no effect on the insurance industry. 

71. The four basis classes or lines of life insurance are ordinary life, group life, industrial life, and credit life. 

72. Life insurance protects against morbidity or ill health and health insurance protects against mortality risk and accidents. 

73. The surrender value of a policy is the cash value of a policy received from the insurer if a policy holder surrenders the policy after the maturity date. 

74. The McCarran-Ferguson Act of 1945 represents legislation confirming the primacy of state over federal regulation of insurance companies. 

75. The primary function of insurance companies is to 

A. generate fees for the banks that sell insurance products.

B. sell a variety of consumer investment products.

C. protect policyholders from adverse events.

D. assist in the transfer of wealth into the future.

E. provide contracts that encourage policyholders to save current income.

76. The largest line of life insurance in terms of total contract value in the U.S. is 

A. ordinary life.

B. group life.

C. industrial life.

D. credit life.

E. noncontributory life.

77. The problem of adverse selection 

A. implies that many people who do not need insurance coverage have it through group plans.

B. means that those people who apply for insurance are the least likely to need insurance coverage.

C. causes insurance underwriters to alter the health statistics of the general population when determining appropriate premiums.

D. creates a savings element along with the insurance component of the premium and policy.

E. does not exist in the insurance industry.

78. A reasonable way to overcome some of the risk of adverse selection in the life insurance business can be accomplished by

A. refusing to underwrite policies.

B. industrial life.

C. endowment life.

D. variable universal life.

E. variable life.

79. Insurance policy benefits are classified on an insurance company's balance sheet as 

A. liabilities, because the insurance company may have to pay out the benefits.

B. assets, because policy benefits are valuable to the company.

C. liabilities, because customers may fall behind on their premium payments.

D. assets, because policy benefits are fully covered by premium payments.

E. liabilities, because insurance companies must maintain a capital base to cover the payments of benefits.

80. Which of the following is pure life insurance with a savings element built in 

A. term life.

B. universal life.

C. endowment life.

D. variable universal life.

E. variable life.

81. An insurance policy that protects an individual over an entire lifetime as long as the premiums are paid is called 

A. term life.

B. universal life.

C. whole life.

D. endowment life.

E. variable life.

82. An insurance policy in which fixed premium payments are invested in mutual funds of stocks, bonds, and money market instruments is called 

A. term life.

B. universal life.

C. whole life.

D. endowment life.

E. variable life.

83. Which of the following involves fixed premium payments and a benefit payout at the time of death that will depend on investment returns over the life of the policy? 

A. Term life.

B. Variable life.

C. Whole life.

D. Endowment life.

E. Universal life.

84. An insurance policy that often is the least expensive to the insured because of the policy does not include a savings plan is called 

A. term life.

B. universal life.

C. whole life.

D. endowment life.

E. variable life.

85. An insurance policy that allows both the premium amount and the maturity of the life contract to be changed by the insured is called 

A. term life.

B. universal life.

C. whole life.

D. endowment life.

E. variable life.

86. Which of the following insurance products protects a lender against a borrower's death prior to repayment of the debt? 

A. Credit life.

B. Universal life.

C. Whole life.

D. Endowment life.

E. Variable life.

87. Annuities offered by life insurance companies are a financial contract that 

A. is used to build up a fund.

B. pays only fixed returns to groups of employees.

C. is used to liquidate a fund.

D. pays only variable returns to individuals.

E. None of the options.

88. Variable universal life insurance policies 

A. have fixed premiums and a fixed benefit payout.

B. have fixed premiums, but allow the benefit payout to vary with investment returns.

C. have a fixed benefit payout, but allow the premium to vary with investment returns.

D. allow both the premium and benefit payout to vary with investment returns.

E. allow both the premium and benefit payout to vary with investment returns, but have a fixed maturity date.

89. The largest asset category on the balance sheet of U.S. life insurance companies as of 2015 was 

A. government securities.

B. corporate bonds.

C. corporate stock.

D. cash.

E. mortgages.

90. The largest liability category on the balance sheet of U.S. life insurance companies as of 2015 was 

A. net policy reserves.

B. policy claims.

C. premium and deposit funds.

D. commission, taxes and expenses.

E. capital surplus.

90. Which of the following are not a type of property-casualty insurance?

A. personal liability insurance

B. fire insurance

C. homeowner’s multiple-peril insurance

D. commercial multiple peril insurance

E. automobile liability and physical damage insurance

91. Guaranteed investment contracts (GICs) offered by a life insurance company 

A. are endowment life policies marketed to group insurance policyholders.

B. are short- and medium-term debt instruments sold to fund their pension plan business.

C. can only be purchased by a group life insurance plan.

D. earn a return based on the consumer price index (CPI).

E. Short- and medium-term investments in venture capital firms.

92. The surrender value of an insurance policy is 

A. the expected payment commitment on existing policy contracts.

B. a fund established and held separately from the company's other assets.

C. the cash value paid to the policyholder if the policy is terminated before it matures.

D. the same as the endowment payout.

E. the price at which the company may repurchase the policy.

93. Separate accounts business of a life insurance company represents 

A. policies written that cover individuals as a group.

B. liabilities owed to other life insurance companies as a result of reinsurance.

C. the cumulative cash value paid to policyholders if the policies are terminated before maturity.

D. a fund established separately from the other funds of the insurance company and invested without regard to the usual diversification restrictions.

E. the cumulative price that the company may repurchase policies from existing customers.

94. Annuities are an important product sold by life insurance companies. Which of the following statements is correct as of 2015? 

A. Life insurance contracts continue to dominate premiums written while annuities are of less importance.

B. The value of annuity sales are more than double those of traditional life insurance lines.

C. Retirement accounts and private pension plans are not allowed access to the annuities of life insurance companies.

D. The funds in an annuity can only be invested in guaranteed investment contracts (GICs).

E. All annuities are listed as separate accounts business on the life insurer's balance sheet.

95. Which of the following did NOT occur in the life insurance industry during the most recent financial crisis? 

A. Low equity values reduced asset-based fees on separate account assets.

B. Losses were incurred on holdings of commercial mortgage-backed securities and commercial loans.

C. Asset-based fees declined on products such as variable annuities and pension fund assets that were tied to equity returns.

D. Low interest rates and harsh economic conditions caused many policyholders to terminate or surrender their policies.

E. Historically low interest rates caused increased demand for whole life policies.

96. The McCarran-Ferguson Act of 1945 

A. separated commercial banking from insurance activities.

B. mandated federal insurance company charters.

C. stipulated that insurance companies are to be regulated at the state level.

D. initiated a national insurance guaranty fund.

E. limited insurance company assets to low risk government securities.

97. As of 2015, the primary regulator of both the life and property-casualty insurance industry is/are the 

A. state insurance commissions.

B. NAIC.

C. Federal Reserve.

D. IRIS.

E. new federal oversight commission yet to be named.

98. The insurance company that was the largest beneficiary of federal bailout funds during the most recent financial crisis was 

A. Globe Life.

B. UBS.

C. State Farm.

D. AIG.

E. New York Life.

99. Underwriting risk faced by property-casualty insurance companies may result from unexpected 

A. increases in loss rates.

B. decreases in loss adjustment expenses.

C. increases in investment yields.

D. cancellations of policies by customers.

E. increases in policy premiums.

100. Life insurance guaranty funds 

A. are sponsored by state insurance regulators.

B. involve a permanent reserve fund similar to the FDIC's bank deposit reserve.

C. require uniform contributions from each state when there is a failure of an insurance company.

D. make policyholder payments immediately in the event of an insurance company failure.

E. are regulated by the Federal Reserve Bank.

101. Property-casualty insurance involves 

A. insurance coverage related to the loss of real and personal property.

B. insurance protection against legal liability exposure.

C. insurance protection against injuries in employment related work.

D. insurance coverage related to the loss of real and personal property and insurance protection against legal liability exposure.

E. insurance coverage related to the loss of real and personal property and insurance protection against injuries in employment related work.

102. The predictability of losses depends on a number of characteristics of perils insured including:

A. property versus liability

B. severity versus frequency

C. long tail versus short tail

D. product inflation versus social inflation

E. all of the above are included

103. The two policy categories offered by property-casualty insurers that are most likely to be subject to rate regulation are 

A. auto insurance and worker's compensation.

B. homeowner multiple peril and commercial multiple peril.

C. earthquake and flood.

D. surety bonds and financial guaranty.

E. product liability and farm owner multiple peril.

104. If losses on a particular line of medical malpractice insurance were $650 million and premiums earned were $575 million, the loss ratio would be 

A. 1.13 implying that this line of insurance is profitable.

B. 1.13 implying that this line of insurance is unprofitable.

C. 0.88 implying that this line of insurance is profitable.

D. 0.88 implying that this line of insurance is unprofitable.

E. -$75 million implying that this line of insurance is unprofitable.

Feedback:

The line is unprofitable because the loss ratio is greater than one.

105. If losses on a particular line of fire insurance were $430 million, premiums earned were $595 million, and loss adjustment expenses were $95 million, the combined ratio would be 

A. 0.88 implying that this line of insurance is profitable.

B. 0.88 implying that this line of insurance is unprofitable.

C. 1.13 implying that this line of insurance is profitable.

D. 1.13 implying that this line of insurance is unprofitable.

E. 0.22 implying that this line of insurance is profitable.

Feedback:

The line is profitable because the loss ratio is less than one.

106. For property-casualty insurers, loss rates are more predictable for 

A. low-severity high-frequency events.

B. low-severity low-frequency events.

C. high-severity high-frequency events.

D. high severity low-frequency events.

E. low severity medium-frequency events.

107. Higher uncertainty of losses forces property-casualty firms to 

A. invest in more short-term assets than life insurance firms.

B. invest in more long-term assets than life insurance firms.

C. hold a lower percentage of capital and reserves than life insurance firms.

D. invest in riskier equity securities than life insurance firms.

E. conduct more separate accounts business than life insurance firms.

108. For property-casualty insurers, losses are higher for lines that are exposed to 

A. long tails and low inflation.

B. long tails and high inflation.

C. short tails and low inflation.

D. short tails and high inflation.

E. short tails and no inflation.

109. Factors that affect the predictability of claims loss exposure include 

A. unexpected increases in inflation.

B. the frequency and severity of loss.

C. the concept of long-tail risk.

D. property versus liability coverage.

E. All of the options.

110. If the loss ratio on a line of insurance is 70 percent and loss adjustment expenses are 33 percent, then the line is profitable before dividends if the ratio of 

A. commissions and other expenses are 15 percent and investment yields are 10 percent.

B. commissions and other expenses are 5 percent and investment yields are 6 percent.

C. commissions and other expenses are 16 percent and investment yields are 20 percent

D. commissions and other expenses are 15 percent and investment yields are 12 percent.

E. commissions and other expenses are 6 percent and investment yields are 4 percent.

Feedback: Losses + Adjustment Expense = 70 + 33 = 103
Need a net investment yield of at least 3 percent to reach profitability. That is, investment yields have to be at least 3 percent higher than commissions and other expenses. The only selection that meets this criteria is [commissions and other expenses are 16 percent and investment yields are 20 percent]

112. An insurance company collected $31.0 million in premiums and disbursed $28 million in losses. Loss adjustment expenses amounted to $5.0 million. The firm is profitable 

A. if dividends paid to policyholders is $4 million and income generated on investments is $4 million.

B. if dividends paid to policyholders is $10 million and income generated on investments is $14 million.

C. if dividends paid to policyholders is $6 million and income generated on investments is $2 million.

D. if dividends paid to policyholders is $10 million and income generated on investments is $4 million.

E. if dividends paid to policyholders is $4 million and income generated on investments is $2 million.

Feedback: Premiums collected − (Losses + Adjustment Expense) + Investment income − Dividends paid to policyholders > 0 to generate a profit
Premiums collected − (Losses + Adjustment Expense) > − (Investment income − Dividends paid)
31.0 - (28.0 + 5.0) = -2
Investment income must be at least $2 million higher than dividends paid. The only selection where this is the case is [if dividends paid to policyholders is $10 million and income generated on investments is $14 million]

113. You start an annuity with $1million and expect to receive 12 equal payments beginning at the end of the first year. The guaranteed annual interest rate is 6 percent. The annual payments that you expect to collect are 

A. $88,333.33.

B. $119,277.03.

C. $59,638.51.

D. $56,262.75.

E. $112,525.50.

Feedback: Ordinary annuity cash flow

114. Calculate the annual cash flows of a $2 million, 10-year fixed-payment annuity earning a guaranteed 8 percent annually if the payments are to start at the end of this year. 

A. $137,990.27.

B. $275,980.53.

C. $298,058.98.

D. $149,029.49.

E. $220,000.00.

Feedback: Ordinary annuity cash flow

115. What explains the recent increase in many large insurance companies conversion to stockholder controlled companies? 

A. Pressure from policyholders.

B. Additional premiums.

C. Access to equity markets.

D. Tax concerns.

E. Regulatory requirement.

116. Which of the following is an advantage of converting from a mutual insurance company to a stockholder-controlled company? 

A. Publicly held companies have access to equity markets for additional capital for future business expansion.

B. Mutual organizations are subject to higher regulatory standards than public companies.

C. Ability to offer more insurance products than those allowed under mutual ownership.

D. Publicly held insurance companies can convert to federal charters but mutual organizations cannot.

E. Mutual organizations can only underwrite policies in the state in which they are chartered while publicly held organizations can expand nationwide.

117. Which of the following is NOT a possible result when a property-liability company purchases reinsurance? 

A. improved capital position.

B. limits on losses on reinsured policies.

C. stabilized cash flows.

D. dilution of earnings per share.

E. All of the options are possible results of purchasing reinsurance.

118. Which account refers to the reserve set-aside that contains the portion of a premium that has been paid before insurance coverage has been provided? 

A. Unearned premiums.

B. Prepaid premiums.

C. Premium reserves.

D. Policy reserves.

E. Outstanding premiums.

119. The largest asset on property-casualty insurers' balance sheet as of 2015 was 

A. cash.

B. bonds.

C. common stock.

D. short-term securities.

E. mortgages and mortgage-backed investments.

120. The largest liability on property-casualty insurers' balance sheet as of 2015 was 

A. loss reserve and loss adjustment expenses.

B. unearned premiums.

C. cash.

D. policyholder surplus.

E. conditional reserve funds.

121. Which of the following arises in policies in which the insured event occurs during a coverage period but a claim is not filed or reported until many years later? 

A. Short-tail losses.

B. Adverse selection.

C. Moral hazard.

D. Long-tail losses.

E. Social inflation.

122. What does the loss ratio measure in any particular year? 

A. Payouts on policies to premiums earned.

B. Amount of premiums earned relative to the payout on policies.

C. Overall underwriting profitability of a line.

D. Loss adjustment expenses to premiums earned.

E. Commission and other acquisition costs to premiums written.

123. Which of the following is used as collateral when an insurance company issues policy loans? 

A. Expected premium payments.

B. Existing policies.

C. Unearned premiums.

D. Guarantee funds.

E. U.S. Treasury Bills.

124. What is essentially understood to be insurance for property-casualty insurance companies? 

A. Policy reserves.

B. Conditional reserve funds.

C. Reinsurance.

D. Unearned premiums.

E. Surplus notes.

125. Which of the following observations concerning reinsurance is FALSE? 

A. It is an alternative to managing risk on a PC insurer's balance sheet.

B. Non-U.S. reinsurers are majority players in U.S. reinsurance business.

C. It does not enable the insurer to improve its capital position.

D. It can be used to limit losses and stabilize cash flows.

E. It represented 2.3 percent of total PC industry assets in 2015.

126. Which of the following statements regarding catastrophe bonds is not true? 

A. The yields are higher than traditional bonds like treasuries.

B. The yields are higher than asset-backed securities and commercial mortgage-backed securities.

C. There currently do not exist any potential challenges to the catastrophe bonds market.

D. Institutional investors are particularly interested in catastrophe bonds because of their portfolio diversification benefits.

E. Catastrophic property damage risks do not correlate with the risks of other asset classes.

127. The operating ratio for a PC insurer equals 

A. loss ratio plus the ratios of loss adjustment expenses to premiums earned.

B. loss ratio plus expense ratio plus dividend ratio.

C. combined ratio minus dividends paid to policyholders.

D. acquisition costs plus dividends paid as a proportion of premiums earned.

E. combined ratio after dividends minus the investment yield.

128. Calculate the annual cash flows of a $2 million, 10-year fixed-payment deferred annuity earning a guaranteed 8 percent per year if annual payments are to begin at the end of the sixth (6^th) year. 

A. $218,973.21.

B. $202,752.97.

C. $343,321.86.

D. $405,505.95.

E. $437,946.42.

Feedback: Deferred annuity cash flow

129. Calculate the annual cash flows of a $500,000, 12-year fixed-payment annuity earning a guaranteed 6 percent per year if annual payments are to begin at the end of the current year. 

A. $59,638.51.

B. $56,262.75.

C. $29,819.26.

D. $83,841.52.

E. $28,131.37.

Feedback: Ordinary annuity cash flow

110. Calculate the annual cash flows of a $500,000, 12-year fixed-payment deferred annuity earning a guaranteed 5 percent per year if annual payments are to begin at the end of year 4. 

A. $32,652.38.

B. $79,018.76.

C. $62,195.01.

D. $65,304.76.

E. $31,097.50.

Feedback: Deferred annuity cash flow