Insurance

Question 1

Risk

Answer 1

A condition with the possibility of loss
A situation with an exposure to loss

Question 2

Peril

Answer 2

The CAUSE of a loss
Examples:
Fire, windstorm, liability, collision, theft, sickness or injury

Question 3

Hazard

Answer 3

A condition that may create or increase the chance of loss arising from a given peril. May increase frequency or severity of loss.

Question 4

Concept of

Insurance

Answer 4

Pooling of risks and transferring them to an insurance company to replace uncertainty (a possible large loss) with certainty (coverage in exchange for a premium).

Question 5

Law of Large Numbers

Answer 5

As the # of independent events increases, the likelihood grows that the actual results will be close to the expected results.

Ins company needs large # of similar exposure units

Question 6

Adverse Selection

Answer 6

Adverse selection is the occurrence of people who need insurance the most being the most likely to purchase it. Insurance companies want to minimize their risk by also insuring healthy policyholders, yet unhealthy or high-risk individuals are more likely to apply for coverage

Adverse selection in the insurance industry involves an applicant gaining insurance at a cost that is below their true level of risk.

Someone with a nicotine dependency getting insurance at the same rate of someone without nicotine dependency is an example of insurance adverse selection.

Insurance companies have three options for protecting against adverse selection, including accurately identifying risk factors, having a system for verifying information, and placing caps on coverage. https://www.investopedia.com/articles/insurance/082516/examples-adverse-selection-insurance-industry.asp

Question 7

Morbidity

Question 8

Insurable Risks

Answer 8

For an insurance company to assume a risk, the risk must have ALL of the following characteristics:
1. Large # of homogeneous exposure untis to make losses reasonably predictable
2. Loss produced by the risk must be definite and measurable
3. Loss must be fortuitous or accidental
4. Loss must NOT be catastrophic to insurance company

Question 9

Basic Rules of Risk Management

Answer 9

1. Coverage for potential catastrophes should be purchased first (life, disability, health, homewoners, auto)
2. Severity is more important than probability
3. High probability will mean higher premiums or a decline of coverage by the carrier.

Question 10

Risk Control

Answer 10

Risk ….

1. Avoidance
2. Diversification
3. Reduction

Goes with risk financing (retention, transfer)

Question 11

Examples of

Risk Avoidance

Answer 11

1. Rent instead of buy
2. Don’t buy a house with a swimming pool

Question 12

Examples of

Diversification of Risk

Answer 12

Store assets at different locations

Question 13

Examples of

Risk Reduction

Answer 13

1. Install sprinker system, smoke detectors and burglar alarm for home
2. Create safety programs for businesses

Question 14

Retention of Risk

Answer 14

Deductibles in insurance policies
Coinsurance in insurance policies
Self-Insurance

Question 15

Transfer of Risk

Answer 15

1. Insurance
2. Hold harmless agreements/hedging contracts
3. Incorporation of your business

Question 16

Type of Risk Management

HIGH Severity, LOW Frequency

Answer 16

Risk Transfer (aka Insurance)

Question 17

Type of Risk Management

HIGH Severity, HIGH Frequency

Answer 17

Avoidance

Insurance premiums would be cost prohibitive

Question 18

Type of Risk Management

LOW Severity, HIGH Frequency

Answer 18

Retention
Reduction

Frequency implies risk transfer (insurance) will be costly

Question 19

Type of Risk Management

LOW Severity, LOW Frequency

Answer 19

Retention

Question 20

Principle of Indemnity

Answer 20

A principle underlying insurance contracts (other than life) under which the insurer seeks to reimburse the insured for approximately the amount lost, no more and no less.

Question 21

4 Principles Supporting Indemnity

Answer 21

1. Insurable Interest
2. The concept of actual cash value
3. Other insurance (limit the ability to profit from a loss)
4. Subrogation

Question 22

1 of 4 Principles Supporting Indemnity

Insurable Interest

Answer 22

A right or relationship with regard to that which is insured so that the insured will suffer financial loss from a loss.

Must operate at issuance of policy AND at time of loss in property and casualty insurance. With LI, insurable interest must operate at time of issue, but need not be present at time of death

Question 23

Contract Requirements

These must applly for a contract to be legally enforceable

Answer 23

1. There must be an agreement preceded by an offer and an acceptance by the one to whom the offer is made (the application)
2. There must be consideration (usually money)
3. the principal must have legal capacity to execute contracts
   * Incompetent/intoxicated adults have limited or no capacity to execute contracts
   * Minors may have capacity to contract for necessities only
4. The contract must be for a lawful purpose

Question 24

Contract Characteristics

Answer 24

. Unilateral
* 2. only one of the parties to an insurance contract (the insurer) makes a binding promise that if broken breaches the contract

Adhesion
* 3. Contract is accepted “as is” or not at all

. Waiver Provision
* Neither an agent nor the insured can alter a contract … only the president, VP, secretary, etc

Question 25

# Insurance contracts are aleatory contracts Aleatory Contract

Answer 25

The amt of $$ spent by contract parties is typically unequal.

Question 26

# Something an insurance company can do to a contract Recession

Answer 26

The contract is deemed null from its beginning due to fraud, misrepresentation, concealment, or mutual mistakes as to a material fact.

Question 27

Reformation

Answer 27

The contract can be amended when the original intent between the parties was not expressed

Question 28

Subrogation

Answer 28

When an insurer pays a claim, it takes over the legal rights its insured had against a negligent third party

Question 29

Collateral Source Rule

Answer 29

In tort liability, the plaintiff's measure of damage should not be mitigated by payments received from sources other than the negligent party

Question 30

Risk Financing

Answer 30

1. Retention 2. Transfer | Goes with risk control (avoidance, diversification, reduction)

Question 31

Personal Risk

Answer 31

1. Death 2. Disability 3. Poor health 4. Unemployment 5. Superannuation

Question 32

Property Risk

Answer 32

1. Real 2. Personal 3. Auto

Question 33

Actions that create Liability Risk

Answer 33

1. Negligence 2. Intentional Torts 3. Strict Liability

Question 34

Legal Liability

Answer 34

**2 Types of Torts:** 1. Intentioanal 2. Unintentional

Question 35

Tort

Answer 35

A wrongful act other than a breach of contract | civil action

Question 36

Intentional Tort

Answer 36

assault, battery, libel, slander, false arrest

Question 37

Unintentional Tort

Answer 37

Negligence or Carelessness

Question 38

Attractive Nuisance

Answer 38

A pool that isn't fenced Vacant land where kids play Land with access to a river or lake

Question 39

Negligence per se

Answer 39

Standard of care is set by a statute | School zones and crosswalks

Question 40

Strict Liability

Answer 40

Limited to **manufacturers and distributors of products found to be defective.** | Romaine w/ e.coli, cars w/defects, legal drugs that cause illness, death

Question 41

Absolute Liability

Answer 41

An **extra hazardous condition** which results in losses to others | (keeping wild animals, blasting). ## Footnote Workers comp falls under this.

Question 42

Vicarious Liability | Respondeat Superior

Answer 42

When one person is held liable for the **negligent behavior of another person.** | manager at insurance agency who is responsible for the agents

Question 43

Assumption of Risk

Answer 43

When one party recognizes and understands danger in an activity yet voluntarily chooses to encounter it, another party cannot be held responsible for the injury.

Question 44

Contributory Negligence

Answer 44

Any negligence on the part of the injured party, although slight, defeats the claim. | jaywalking, drunk driving

Question 45

Comparative Negligence

Answer 45

Any degree of negligence on the part of the injured party does not defeat the claim but is used in some manner to mitigate damages payable to the other party. | Pedestrian is 20% negligent, driver 80% ... damages adjusted accordingly

Question 46

Last Clear Chance

Answer 46

Any contributory negligence of the injured party will not bar recovery of damages if the other party, immediately prior to the accident, had a last clear chance to prevent the accident but failed to do so. | Road rage

Question 47

Methods of Calculating LI Needs

Answer 47

1. Income Replacement * Capital Utilization (Human Life Value) * Capital Retention/Preservatioin 2. % of Income 3. Personalized Needs Approach

Question 48

Calculating Capital Utilization | Human Life Value ## Footnote Principal depleted at end of bene life

Answer 48

BEG N = # years needed PMT = Annual $$ amt Inf Adj IR **Solve for PV** | PV invested at Inf Adj IR will generate PMT tomorrow ## Footnote and will increase each year until spouse dies (at N)

Question 49

Calculating Capital Preservation | Capital Retention ## Footnote Principal not dipped into

Answer 49

Money Needed each year/IR + 1st Year amt of money | *Danko says not to use Inf Adj IR ... instead rate of return - inflation ## Footnote When question does not give N assume it is Capital Preservation/Retention

Question 50

# 5 Sources of info Process of Underwriting | insurance

Answer 50

1. An application for insurance 2. Info from agent or broker 3. Investigations 4. Info bureaus 5. Physical exams

Question 51

Loss Adjustment Process

Answer 51

1. Notice of loss 2. Investigation 3. Proof of loss 4. Payment or denial

Question 52

HO Insurance Policy | What does it cover?

Answer 52

1. Dwelling 2. Contents 3. Personal Liability

Question 53

Declarations Page

Answer 53

Contains things like name, address, etc of applicant

Question 54

# HO Insurance Section I Coverage

Answer 54

A. Dwelling B. Other Structures C. Personal Property D. Loss of Use

Question 55

# HO Insurance Section II Coverage

Answer 55

E. Personal Liability F. Medical Payments

Question 56

# HO Section I Coverage A Dwelling

Answer 56

Dwelling + any attached structure (garage, decks, fences) | Land is specifically excluded from coverage ## Footnote Not covered in renter's policies

Question 57

# HO Section I Coverage B Other Structures

Answer 57

Ex: pool, detached things like garages, fences, patios or living spaces ## Footnote Not covered in renter's policies

Question 58

# HO Section I Coverage C Personal Property

Answer 58

* Covered anywhere in the world (not just when inside insured home). * Sublimits for watercraft, jewelry and furs, silverware, money * Property specifically excluded: animals, motor vehicles/aircraft, property of roomers or boarders, property in an apartment rented to others | HO policies generally don't cover exposures related to being a landlord. ## Footnote Endorsements can be added to cover property in a rented room (Landlord's Furnishings)

Question 59

# HO Section I Coverage D Loss of Use

Answer 59

Coverge for additional living expenses arising from damage to the insured property. | Necessary increase in living exp to maintain normal standard of living. ## Footnote Normal monthly exp of $4K, increased by $1K d2 house fire - ins will pay increase of $1k

Question 60

# HO Section II Coverage E Personal Liability

Answer 60

Provides protection for damages for which an insured is legally liable arising out of bodily injury or property damage. Specific exclusions include: 1. liabilities from business activities or professional services 2. Usage of motorized land vehicles (except recreational vehicles or motorized golf crds used on property) 3. usage of watercraft unless < 50 hp or sailboat < 26ft 4. aircraft usage 5. bodily injury to a person who is eligible for worker's comp ## Footnote Included in all policy types, including renters

Question 61

# HO Section II Coverage F Medical Payments

Answer 61

Provides limited amount per person of coverage for necessary medical expenses of persons other than the insured who are injured while on the insured location. | NOT liability coverage ## Footnote included in all policy types, including reters

Question 62

Perils | 3 Broad Types

Answer 62

1. Basic Form 2. Broad Form 3. Open Perils

Question 63

# Peril Basic Form

Answer 63

**Basic Form of Perils Examples (HARVEST WFL):** Windstorm Hail Aircraft Riot Vandalism Vehicles Explosion Smoke Fire Lightning Theft

Question 64

# Peril Broad Form

Answer 64

Basic (HARVEST WFL) + RAF * Rupture of a System * Artificially generated electricity * Falling Objects * Freezing of plumbing

Question 65

# Peril Open Peril

Answer 65

The *insurer* agrees to pay for damage by any peril except those specifically excluded. **Open perils coverage is generally the right choice for the CFP exam because it covers unusual risks that are not named under the Basic and Broad Forms.**

Question 66

# 8 Exclusions | to all HO Forms

Answer 66

**OPEN WIF** 1. Ordinance of law 2. Power Failure 3. Earthquake 4. Neglect 5. Nuclear Hazard 6. War 7. Intentional Loss 8. Flood

Question 67

Req HO amt

Answer 67

Is always 80% of replacement value

Question 68

Req Ins for commercial bldgs

Answer 68

90% of replacement value ## Footnote * CFP board likes to test this

Question 69

# Life Insurance Options Nonforfeiture Options | 3 ## Footnote **Nonforfeiture options**, dividend options, settlement options

Answer 69

1. Cash 2. Reduced paid-up insurance 3. Extended Term ## Footnote **Nonforfeiture options**, dividend options, settlement options

Question 70

# Life Insurance Options Dividend Options ## Footnote Nonforfeiture options, **dividend options**, settlement options

Answer 70

1. Cash 2. Reduced premium due 3. Accumulate w/interest 4. Paid-up additions 5. One-year term **(5th dividend)** ## Footnote Nonforfeiture options, **dividend options**, settlement options

Question 71

# Life Insurance Options Settlement Options ## Footnote Nonforfeiture options, Dividend options, **Settlement Options**

Answer 71

1. Cash 2. Interest Only 3. Fixed Period 4. Fixed Installment 5. 4 life-income options *(pure or single life; period certain; joint and survivor; refund)* ## Footnote Nonforfeiture options, Dividend options, **Settlement Options**

Question 72

# Non-Forfeiture Option Extended Term Insurance | Paid-Up Term ## Footnote 1 of 3 NF Options

Answer 72

Maintains original death benefit for a limited number of years | So that insured doesn't have to forfeit policy d2 premium non-payment ## Footnote 1 of 3 NF Option

Question 73

# Non-Forfeiture Option Cash Option ## Footnote 2 of 3 NF Options

Answer 73

Policy can be surrendered anytime for cash value less any policy indebtedness plus accumulated dividends. A 6-mo delay clause applies to distribution of cash value (tested, but not often practiced) ## Footnote 2 of 3 NF Options

Question 74

# Non-Forfeiture Option Reduced Paid-Up ## Footnote 3 of 3 NF Options

Answer 74

* Face amount of policy will be reduced. * The paid up insurance death benefit will be the amount the cash value would purchase as a net single premium. * No additional premium due ## Footnote 3 of 3 NF Options

Question 75

# Part of NF options Automatic Premimum Loan (APL) Provision | applies during grace period

Answer 75

* Policy will remain in force with a policy loan outstanding * He can pay off loan w/int at any time * Not required to re-instate policy * 2 Variants 1. Reduced Paid-Up: to re-instate, must prove insurability 2. Extended Term: To reinstate must prove insurability

Question 76

# Per NAIC Life Insurace Policy Illustration Model Law | Illustrations must include what? ## Footnote applicable only to non-variable policies

Answer 76

1. Name of insurer 2. Name and address of producer 3. Name, age, sex of proposed insured 4. Underwriting and rating classification 5. Initial death benefit

Question 77

Primary diff b/w MEC and non-MEC | MEC is single premium policy after 1988 ## Footnote Once a MEC, always a MEC

Answer 77

**Loans and withdrawals** Non-MEC: generally NOT taxable MEC: generally taxable (this is a disadvantage of MECs) ## Footnote Once a MEC, always a MEC

Question 78

# For LI policies Transfer for Value | why is it important? ## Footnote not applicable to tx to: insured, partnership, corp, divorce

Answer 78

The most important exception to general rule that LI death proceeds are federally income tax free to bene | If policy tx'd for valuable consideration, income tax exclusion is lost ## Footnote Think viatical settlement

Question 79

# Tax-Free Exhange of LI Rules Section 1035 Exchange | For LI and Annuity Contrtacts

Answer 79

1. Exchange of one life insurance policy for another 2. Annuity for annuity 3. LI for Annuity 4. LI or Annuity for LTC policy Must have same owner/insured (or annuiant wrt annuity) | If these rules are met, the exchange is **TAX FREE**